CFP Module 4 tax planning

worthless securities deductions

Securities must be completely worthless to be deductible. Losses are considered to be capital losses occurring on the last day of the year in which the securities become worthless. These losses are treated as capital losses (discussed later).

married filing jointly MFJ

Spouses in a marriage legally recognized under federal law or in the state of domicile may file a joint return, even though one spouse has no income or deductions, if they are not legally separated or divorced on the last day of the tax year. - It is usually advantageous for married persons to file a joint return because the combined amount of tax is usually lower. When a spouse dies during the tax year, the surviving spouse may file MFJ in that year. This election should be coordinated with the administrator or executor of the deceased spouse's estate.

compensation-related loans

The employer makes a below-market loan to an employee. As a result, the lender-employer has interest income and compensation expense for the amount of the imputed interest. The borrower-employee has compensation income and interest expense for the same amount. Like gift loans, there is also an exception for compensation-related loans that are less than or equal to $10,000. However, the exception for loans between $10,001 and $100,000 does not apply because all of the parties to compensation-related loans are not individuals.

ordinary income property

The following are ordinary income property: Cash Short-term capital gain property (property held less than one year) Works of art, books, or letters, when given by the person who produced them Inventory

kiddie tax

The kiddie tax rules provide for a limited standard deduction of $1,100 (2020) against unearned income on the child's income tax return. The next $1,100 is taxed to the child at the child's marginal tax rate. Any net unearned income over $2,200 is taxed to the child at the parent's or parents' marginal income tax rate (if higher than the child's marginal rate). The standard deduction rulesS applicable to earned income, or a combination of earned and unearned income, are the same as those previously discussed. (*See note at the beginning of this section.) The kiddie tax applies to a child under 19 years of age (at the close of the tax year), or under 24 years of age if a full-time student.

seven-pay test

assumes a step process over the first seven years of the cash value life insurance contract. Putting too much premium in the life insurance contract, either each year or cumulatively, will trigger MEC status. Essentially, the IRS is asserting that cash value life insurance is simply too good of a tax shelter and it is necessary to curb or regulate its use.

acquisition debt

debt that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer. Acquisition debt also includes debts from the refinancing of other acquisition indebtedness, but only to the extent of the amount (and term) of the refinanced indebtedness.

tax loss harvesting

deliberately sell select securities at a loss to reduce the client's overall tax liability

wash sale

disallows a loss on the sale or disposition of stock or other securities (including options or contracts to sell or acquire) if the taxpayer purchases substantially identical stock or securities within either 30 days before or 30 days after the date of the sale or disposition. The definition of substantially identical is not precise. A stock or security is substantially identical if it is not different in any material, or essential, way. Factors to be considered include interest rates, dividend rights, maturity dates, and conditions of retirement. Stocks or securities are not substantially identical if they have a different issuer or obligor.

investment interest expense

interest paid on indebtedness used to acquire investment assets. The most common example of such expense is margin account interest. This form of interest is deductible up to the amount of the taxpayer's investment income. If, however, the interest is not taxable (such as municipal bond interest), then the investment interest is not deductible because there is no interest income to offset.

tuition and fees deduction

taxpayer may claim an above-the-line deduction of up to $4,000 for qualified tuition and related expenses for higher education paid by that taxpayer during the tax year, subject to applicable adjusted gross income (AGI).

progressive income tax system

the more taxable income a taxpayer has, the higher the tax bracket in which the last dollar is taxed. Put another way, low income workers lose a smaller percentage of their earnings to taxes.

short sales

when an investor borrows a security from a broker and then sells it, with the understanding that the security must later be bought back (hopefully at a lower price) and returned to the broker. This transaction is still governed by the capital gain and loss rules, so long as the short sale property constitutes a capital asset in the hands of the taxpayer. Generally, the gain or loss is not recognized until the short sale is closed. A capital gain from a short sale generally will be considered short term (unless the investor closes the short sale with securities held for the long-term holding period). A loss generally will be treated as a short-term capital loss. The loss may be treated as a long-term capital loss if the investor closes the sale, with substantially identical securities held for the long-term holding period prior, to the sale date

policy distributions

withdrawals, loans taken as cash or used to pay premiums, and dividends received as cash or used to pay a loan. Policy distributions do not include dividends retained by the insurer to pay premiums or to purchase paid-up insurance or other benefits. Assignments, or pledges, of any part of the modified endowment contract, if they are used to cover burial expenses or prearranged funeral expenses if the maximum death benefit does not exceed $25,000, are also not treated as distributions.

bad debts deductions

A deduction is allowed for business debts that become partially or wholly worthless if the income from the debt was previously included in the taxpayer's income. Business bad debts are deductible as an ordinary loss. Some nonbusiness bad debts can be written off but only if they are completely worthless. Nonbusiness bad debts are always considered short-term capital losses

Qualifying Widow(er) with Dependent Child (also called surviving spouse SS)

A taxpayer with a dependent child and whose spouse has died within the past three years may use this filing status. For example, an individual whose spouse died in 2020 and has a dependent child may file as a qualifying widow(er) for taxable years 2021 and 2022. During 2020, the widow(er) may file as MFJ because the deceased spouse was alive at some time during that year. The taxpayer must put the dependent's Social Security or taxpayer identification number on the return to use this status. - The filing of a joint return in the year of death by a surviving spouse should be coordinated with the administrator or executor of the deceased spouse's estate. Qualifying widow(er) status entitles the taxpayer to use joint income tax return rates.

alimony taxation

Alimony payments arising as a result of divorce or separation decrees executed prior to 2019 are typically taxable to the recipient, as they are deductible by the payor. If the divorce decree or separation instrument is executed after December 31, 2018, the alimony payments are not includible as income, nor are they deductible by the payor. Therefore, practitioners should take note of the date the divorce was finalized

single

Generally, this is an unmarried, legally separated, or divorced individual who does not qualify for any other filing status. Note that married individuals who live apart from their spouses, as of the last day of the tax year, and maintain a household for a dependent child may be able to use the more advantageous head of household filing status.

taxation of disability insurance

Disability payments may or may not be taxable. The taxability of benefit payments from disability income is dependent on how the premiums were paid. Benefit payments from individually owned and paid for policies generally are not taxable because the premiums were paid with after-tax dollars. Benefit payments from group policies, where premiums have been paid by the employer, generally are taxable to the employee. When policy premiums are paid partly by the employer and partly by the employee, a portion of the benefit payments will be taxable to the employee (the percentage of premium paid by the employer), and a portion will not be taxable to the employee (the percentage of premium paid by the employee).

public charities (50% organizations)

For gifts of ordinary income property, taxpayers generally may not deduct more than 50% of their AGI for donations to public charities. These public charities are often referred to as 50% organizations. These 50% organizations include churches, schools, hospitals and medical research organizations, and governmental units. Other organizations that allow charitable deductions of up to 60% of AGI include operating, conduit, pass-through, distributing, community, and pooled-fund foundations. Again, these are nonetheless commonly referred to as 50% organizations.

dependents with unearned or earned income tax

A limited standard deduction amount of $1,100 (for 2020) may be used by the taxpayer against unearned income (interest, dividends, etc.). For this purpose, unearned income is defined as income other than earned income, (i.e., income from wages, salaries, summer jobs, etc.) For any taxpayer eligible to be treated as a dependent, with earned income or a combination of earned and unearned income, the rules are slightly more complex. The allowable standard deduction for the dependent is the greater of (1) $1,100 or (2) the amount of earned income plus $350, not to exceed the full standard deduction amount ($12,400 in 2020). These rules apply to all taxpayers eligible to be treated as a dependent on another taxpayer's return.

qualifying child

A qualifying child must be the taxpayer's child, stepchild, foster child, brother, stepbrother, sister, stepsister, or a descendant of any of the previously listed and must have lived with the taxpayer more than half of the tax year. The individual must pass an age test, meeting one of the following standards: Under age 19 at the close of the tax year A full-time student and under age 24 at the close of the tax year Totally and permanently disabled at any time during the tax year To satisfy the support test, the individual must not have provided more than 50% of his own support (scholarships do not count), and the individual cannot claim any other individual as a dependent. The individual may not file a joint return for the tax year (unless the only reason a return was filed was to obtain a refund of tax withheld). The individual generally must also be a U.S. citizen, U.S. national, or resident of the United States, Canada, or Mexico

tax-free scholarships

A scholarship or fellowship grant is tax free (excludable from gross income) only if you are a candidate for a degree at an eligible educational institution. The IRS states that a scholarship or fellowship grant is tax free only to the extent that it doesn't exceed your qualified education expenses, isn't designated or earmarked for other purposes (e.g., room and board), doesn't prohibit its use for qualified education expenses; and doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship.

Lifetime Learning Credit

A tax credit for all years of college or graduate school. It also applies to working adults taking classes to improve their work skills. $2000 or 20% of u to $10,000 of expenses

modified adjusted gross income (MAGI)

AGI before deducting IRA contributions For purposes of this course, the following deductions and exclusions are not permitted when calculating MAGI: IRA deduction Student loan interest deduction Foreign earned income exclusion and foreign housing exclusion Exclusion of qualified savings bond interest from Series EE bonds Exclusion of Qualified Adoption Expenses The key point to remember is that MAGI is used to calculate many phaseout limits. In other words, MAGI determines taxpayer eligibility for other credits and deductions such as the aforementioned student loan interest deduction and the child tax credit

AMT preference items

Accelerated cost recovery deductions on real property in excess of the straight-line method (no longer common, because all real estate placed in service after 1986 is depreciated using straight-line) Accelerated cost recovery deductions on leased property in excess of the straight-line method Accelerated cost recovery deductions for personalty placed in service after 1986, to the extent the deductions exceed the 150% declining-balance method amount calculated over the ADR midpoint life of the asset Percentage depletion in excess of adjusted basis (but not for independent oil and gas producers and royalty owners) Excess intangible drilling costs (IDC) are the excess of the amount allowable over the amount deductible had the cost been capitalized and amortized over a 10-year period. The rules related to the treatment as a preference item vary depending upon whether or not the taxpayer is considered an integrated oil company. Bargain element on the exercise of an incentive stock option (bargain element is the excess of the FMV at the exercise date over the option price). If the stock is sold in the same tax year that the option is exercised, there is no AMT adjustment required. Research and experimental costs, circulation expenses, and mining exploration and development costs deducted, to the extent the deduction exceeds the amount that would have been deductible had the costs been capitalized and amortized over a 10-year period (a 3-year period for circulation expenses) Rapid amortization of a certified pollution control facility in excess of amortization under the alternative depreciation method The completed-contract method for long-term contracts entered into after February 28, 1986, is not allowed for AMT purposes; the percentage-of-completion method must be used in computing alternative minimum taxable income (AMTI). Tax-exempt interest on qualified private-activity municipal bonds, but not for bonds issued in 2009 and 2010 Passive farm losses are treated as a preference item. Seven percent of the excluded gain from qualified small business stock (if the QSBS was acquired after September 27, 2010, there is no AMT preference)

exclusion ratio for annuities

Annuity payments or periodic payments from a commercial annuity are partially a return of capital and partially interest income. Upon annuitized payments, the return of capital is nontaxable, and the interest is treated as ordinary income. The exclusion ratio for annuities consists of the investment in the annuity contract divided by the total expected return. This ratio is multiplied by the annual return each year to determine the annual amount that is excluded. To get the total expected return, multiply the annual payments by a life expectancy factor supplied by the appropriate treasury table.

use-related property

If it is use-related property, and the donor-taxpayer chooses to deduct the tangible personal property's FMV, then the taxpayer is limited to 30% or 20% of AGI annually, depending on the identity of the recipient charity. If the taxpayer chooses to deduct the basis in the property, the limits are 50% and 20%, respectively.

exclusions

Certain items of income receive special treatment and are not included as income, and thus, are not subject to taxation. do not have to be included as gross income. Life insurance proceeds received by reason of death of the insured (excluding policies transferred-for-value or owned by a qualified retirement plan), a gift or most inheritances received, interest received from municipal bonds, child support payments received, workers' compensation insurance proceeds, and many employee fringe benefits are common examples of items that are excluded from income. Some of these excluded fringe benefits include employer-provided health insurance coverage, group term life insurance coverage up to $50,000, qualified employee discounts, and employee educational assistance.

charitable contributions by c-corportations c-corps

Charitable contributions by corporations are also subject to special rules. A corporation may only deduct, in a given tax year, up to 10% of its taxable income.

mutual fund taxation

If an investor sells shares of a mutual fund, there is a tax owed on any gain. This gain is measured by the difference between the sales proceeds and the investor's basis (i.e., adjusted cost) in the shares.

charitable contribution of loss property or depreciated property

If the property to be donated is property with a current value that is less than its original basis, such as depreciated property or property whose current FMV is less than its original basis, only the current lower value may be deducted as a charitable contribution. Any capital loss inherent to the loss of value on the property is not deductible if the loss property is donated. If possible, the donor should sell the property in an arm's-length transaction to a third person that would allow the donor to recognize the capital loss (as long as the loss is otherwise deductible under the capital loss rules) and then donate the cash received to the charity separately.

use-unrelated property

If the recipient charity does not have a related use for the gifted tangible personal property (use-unrelated property), the maximum deduction allowed is generally limited to the lesser of the fair market value (FMV) of the property or the donor's tax basis in the property, limited to 50% or 20% of AGI annually, depending on the type of charity.

charitable contributions by flow-through entities

If the taxpayer has made contributions in excess of the limits prescribed in the current year, the taxpayer is entitled to carry forward the excess deduction for up to five years. At the end of five years or upon the death of the taxpayer, the carry forward expires.

excess contributions carry forward

If the taxpayer has made contributions in excess of the limits prescribed in the current year, the taxpayer is entitled to carry forward the excess deduction for up to five years. At the end of five years or upon the death of the taxpayer, the carry forward expires.

charitable contribution deductions

If the taxpayer itemizes, these are often fully deductible in the current year. This topic is discussed at greater length in subsequent modules.

income taxation of trusts and estates

In General 1. A trust is a legal arrangement whereby an individual transfers legal ownership of property to a trustee. 2. Trust income can be taxed to the following: a. Trust—if income is accumulated in the trust b. Beneficiary—if income is distributed from the trust c. Grantor—if the trust is a grantor trust (discussed in the following) 3. An estate is a legal entity that comes into existence upon the death of an individual and remains in existence until the decedent's assets pass to the heirs. a. The estate consists of the probate estate. b. The estate holds and protects the assets, collects income from those assets, and satisfies obligations of the estate until all the assets are distributed. 4. Persons or entities that are responsible for trusts and estates are called fiduciaries.

property acquired by gift

In a situation where the donee, the recipient of a gift, assumes the donor's adjusted basis, the donor's holding period is tacked. In other words, the donee's holding period begins on the date that the donor acquired the property. Thus, if the fair market value (FMV) on the date of the gift is greater than the donor's adjusted basis, the recipient of the gift is treated as holding the property, beginning with the date that the donor acquired the property. Alternatively, if the FMV on the date of the gift is used as the donee's basis, the holding period starts on the date of the gift.

Constructive Receipt Doctrine

Income that is constructively received is taxed to a taxpayer as though it had actually been received. As a result, if there is no substantial limitation or restriction on a taxpayer's right to bring the funds under personal control, the constructive receipt doctrine will apply. For example, a payroll check issued on December 31 by an employer that is available to be picked up by the employee on that date is income for that year. Delaying the check retrieval from the employer until January of the next year does not change the fact that the taxpayer had the right to it (constructive receipt) in the prior year.

constructive receipt

Income that is constructively received is taxed to a taxpayer as though it had actually been received. As a result, if there is no substantial limitation or restriction on a taxpayer's right to bring the funds under personal control, the constructive receipt income tax rule or doctrine will apply. For example, a payroll check issued December 31 by an employer that is available to be picked up by the employee on that date is income for that year. Delaying the check retrieval from the employer until January of the next year does not change the fact that the taxpayer had the right to it (constructive receipt) in the prior year.

legal and accounting fees deductions

Legal and accounting fees incurred for personal purposes are not deductible. When legal and accounting fees are incurred in connection with a trade or business or for the production of rents and royalties, they are deductible in calculating AGI, as discussed in earlier in this module.

meals and lodging for the employer's provided convenience

Meals furnished by the employer on its business premises and for its convenience to employees are not taxable. This also includes the benefit of an executive dining room. If lodging is provided for free as an employee benefit, the employee must accept it as a condition of employment for the benefit to be excludable from income

long term capital gain taxation

Most net long-term capital gains and qualified dividends are taxed at rates of 0%, 15%, or 20%. The rate applicable to the long-term capital gains is determined by the taxpayer's taxable income, which includes the long-term capital gain income.

Related party sales of loss property, IRC section 267

No loss deduction is allowed from a sale or exchange between certain related taxpayers. Related taxpayers include the following: Members of the seller's family including brothers, sisters, parents, grandparents, children, etc. (in-laws are not included) Controlled corporations (if more than 50% ownership is by taxpayer) Certain business organizations, if one person owns more than 50% of each An estate and beneficiary Certain trustees, grantors, and beneficiaries The disallowed loss generally increases the basis of the acquired property, such that a later resale (to an unrelated party) of the property results in a smaller gain.

adjusted gross income (AGI)

Once total income has been determined, the next step in the federal income tax formula is to calculate the taxpayer's adjusted gross income (AGI). Accordingly, certain deductions are subtracted from the taxpayer's gross income to arrive at AGI. The important fact to note regarding these deductions is that a taxpayer who does not itemize deductions is still entitled to any of these adjustments to total income—commonly referred to as deductions for AGI (assuming the requirements to take advantage of the particular deduction are met). Importance of AGI: There are several functions served by the taxpayer's AGI: AGI is used to set the limit (the floor) on allowable medical expense deductions. The deductible floor for medical expenses is 7.5% (per the SECURE Act of 2019) of the taxpayer's AGI. AGI is used to set limits on allowable casualty loss deductions. After subtracting a $100 floor per loss, casualty losses are deductible only to the extent they exceed 10% of the taxpayer's AGI. Personal casualty losses are only deductible if they occur in a federally declared disaster area. AGI is used to set maximum annual deduction limits (ceilings) on charitable contribution deductions. AGI is one of the factors used to determine whether contributions to a traditional individual retirement account (IRA) will be deducti

accident and health plans

Premiums paid by the employer for accident, health, and disability income insurance plans (group plans) are deductible by the employer and generally excludable from the employee's income. Benefits paid under employer-sponsored accident and health (medical) plans are also not included in the taxpayer's income. However, if the employer pays all or part of the premiums on a group disability plan, the benefits are taxable to the employee when received. If the employee pays a portion of or the entire premium for a disability plan, the benefits received are not taxable to the employee, to the extent of the proportion of employee-paid premiums. For example, an employer pays 60% of the premium for disability insurance, and the employee pays 40%. Only 60% of the disability insurance benefits received by the employee under the plan is taxable to the employee. The other 40% is not includable in the employee's income and is tax free

personal casualty loss

Pursuant to the TCJA, personal casualty losses are deductible only if incurred in a federally declared disaster. The event must result in property damage, and it must be sudden, unusual, and unexpected (such as a hurricane, tornado, or wildfire). For a loss to insured property, if an insurance claim is not filed in a timely manner or at all, the loss is not a casualty loss.

taxation of t-bills

T-bills are short-term versions of zero coupon bonds—that is, they make no interest payments per se but are sold at a discounted face value. An investor might buy a T-bill for $9,530 and receive $10,000 six months later at maturity. The difference between the holder's tax basis and the face value is the total return, which is treated as ordinary income. That income recognition falls into the year in which the face value is paid over to the investor, not when the T-bill is purchased. State and local governments do not impose their own taxes on U.S. Treasury securities.

equivalent tax bracket

TC = d × m where: TC = amount of tax credit (or tax savings) d = before-tax benefit (amount of exclusions or deductions) m = marginal income tax bracket

tax treatment of distributions to beneficiaries

Tax Treatment of Distributions to Beneficiaries 1. The beneficiary is taxed on an amount equal to the distribution deduction. 2. The fiduciary receives a deduction for the distribution. 3. Income distributed to the beneficiary maintains its character (e.g., capital gain, ordinary income, etc.). 4. A beneficiary who receives a distribution from a fiduciary will receive a Schedule K-1 each year. a. K-1 summarizes the amounts and character of the various items of income that constitute the taxable portion of the distribution. b. A beneficiary who receives a distribution from a fiduciary with both taxable and nontaxable DNI will only be taxed on a portion of the distribution received.

taxation of treasury notes and bonds

Tax treatment of treasury notes and bonds is the same as it is for corporate bonds. In the cases of treasury notes and bonds, that interest is exempt from state and local income taxation

taxation of social security benefits

Taxation is based on provisional income. Provisional income is the beneficiary's modified adjusted gross income (MAGI) + municipal bond interest + 1⁄2 of the Social Security (or tier 1 railroad) retirement benefits.

caculating AMT

The AMT may be calculated as follows: Step 1. Adjusted gross income (AGI) is increased by any tax preference items and increased or decreased by the appropriate adjustments. Step 2. That figure is reduced by the allowable itemized deductions. The resulting figure is the alternative minimum taxable income (AMTI). Step 3. The AMTI is then reduced by the appropriate AMT exemption amount to arrive at the AMT base. Step 4. A tax rate of 26% applies to AMT base amounts up to and including $197,900 (2020). A 28% rate applies to amounts in excess of $197,900. The 15% or 20% rate applicable to long-term capital gains and qualified dividends also applies for AMT purposes. Step 5. The AMT amount is compared to the regular tax. If the regular tax after credits equals or exceeds the AMT amount, then no AMT payment is required. If the regular tax is less than the AMT amount, then the difference is the AMT payment required. Step 6. The AMT payment required is then reduced by any refundable credits, and the allowable AMT foreign tax credit, and the low-income housing credit for low-income housing property placed in service after 2007. For 2013 and beyond, the personal nonrefundable credits are allowed against the AMT, as well as being used against the regular income tax liability. Among those allowed are the adoption credit, the child and dependent care credit, the child tax credit, and the Lifetime Learning and American Opportunity Tax Credits.

the 50% election

The amount of charitable deduction that may be taken in a given year historically has been restricted by the limitation that deductions for long-term capital gain property (and appreciated, use-related, tangible personalty held more than one year) may not exceed 30% of a taxpayer's AGI if the contribution is made to a 50% organization. However, a taxpayer may make a so-called 50% election (reduced deduction election). In this event, the taxpayer elects a deduction of up to 50% of AGI in a given year, but they are limited to the adjusted basis of the property as the total allowable amount of deduction. This election only applies to contributions of long-term capital gain property made to 50% organizations.

interaction of kiddie tax with earned income

The computation of the child's tax when there is a combination of earned and unearned income is more complex. We must reduce the AGI by the standard deduction, which is the amount of earned income plus $350, not to exceed the full standard deduction of $12,400 (2020). This gives us the taxable income. The unearned income is reduced by $2,200, resulting in net unearned income (the amount subject to the parental rate). The remaining taxable income is attributable to the earned income and will be subject to the child's tax rate schedule.

IRS requirements for donation of property costing $500 of more

The name and address of the organization and the date of the gift A description of the property The date acquired by the taxpayer The fair market value of the property and how that value was obtained The taxpayer's adjusted basis in any appreciated property gift Any reduction in the value of appreciated property claimed by the taxpayer The terms of any agreement with the charitable organization The amount claimed as a deduction In addition, qualified appraisals are required for donated property when the claimed value is over $5,000, or in the case of closely held stock, when the claimed value is over $10,000. The information regarding the appraisal (but not the appraisal itself) must be attached to the return. It is common for a charitable deduction to be denied if the required information is not furnished

reimbursed employee expenses

The tax treatment of reimbursed employee business expenses depends on whether the reimbursements are made under an accountable plan or a nonaccountable plan. In an accountable plan, employees must substantiate their expenditures, and employees who receive advances must return any amounts that exceed their substantiated expenses. All other plans are nonaccountable plans (also known as allowance plans) that require all expense allowances to be included on an employee's W-2 as taxable income and do not require documentation from the employee. When employee business expenses are reimbursed under an accountable plan, the reimbursements are excluded from the employee's gross income, and the expenses are not deductible by the employee.

SALT taxes (state and local taxes)

The types of taxes that are deductible on Schedule A of Form 1040 (as an itemized deduction) may be summarized as state, local, and foreign real estate taxes; state and local sales taxes; state and local personal property taxes (e.g., personal automobiles); and state, local, and foreign income taxes.

athletic facility provided to employees

The value of an athletic facility or gym provided by the employer on its premises, if solely for the use of the employee and the employee's dependents, is nontaxable to the employee. If an employer pays the dues of an outside health club for the employee, the dues are taxable.

itemized deductions for AMT

There are certain itemized deductions allowed against the alternative minimum taxable income. Note that the standard deduction is not allowed for AMT purposes. Those allowable itemized deductions include medical expenses in excess of 7.5% of adjusted gross income; casualty losses in excess of 10% of adjusted gross income and the $100 floor, if from a federally declared disaster zone; gambling losses to the extent of gambling winnings; qualified housing interest; investment interest expense to the extent of qualified net investment income; estate taxes paid on a decedent's income; and charitable contribution deductions.

net investment income tax (NIIT)

There is a 3.8% tax, also known as the Medicare Contribution Tax, imposed on taxpayers with unearned income, such as interest, dividends, and net capital gains. Although extremely similar in purpose to the aforementioned Additional Medicare Tax, the NIIT is actually a separate tax on investment income. The key difference is that Additional Medicare Tax is an additional .9% imposed on wages and self-employment income. (Not coincidentally, when imposed, the total employer/employee Medicare contribution adds up to 3.8% of wages.) The NIIT is a 3.8% tax imposed on portfolio income. Portfolio income is not normally subject to any Medicare tax at all. It is possible for a taxpayer to be subject to both taxes if their wages and investment income exceed certain thresholds.

collectibles and section 1250 property

There is a maximum 28% rate that is applicable to certain long-term capital gains. This rate applies to net gains on collectibles, if held for more than one year. Collectibles may include coins, works of art, among many others. Gold and silver exchange-traded funds (ETFs) are generally not taxed as securities, but as collectibles. This means long-term capital gains on the funds are taxed at a maximum rate of 28% rather than the lower 15% or 20% rates that would apply to long-term capital gains on the sale of most securities.

taxation of treasury inflation-indexed securities

These Treasury securities combine a fixed interest rate with the principal amount of the securities, adjusted for inflation. The interest payments are taxed when received. The inflation adjustments to the principal are taxable in the year in which such adjustments occur, even though the inflation adjustments are not paid until maturity. The interest is exempt from state and local income taxation.

tax-avoidance loans

These are below-market loans that significantly affect the borrower's or lender's federal income tax liability and are made primarily for the purpose of tax avoidance. If the principal purpose of the loan is for tax avoidance, none of the previous exceptions apply

private charities (30% organizations)

These organizations include certain private nonoperating foundations, veterans' groups, fraternal associations, and other not-for-profit associations. These are called 30% organizations. For gifts of cash and other ordinary income property to these 30% organizations, the law limits the amount that a taxpayer may deduct in a given year to 30% of the taxpayer's AGI. Again, this 30% limitation applies to gifts of ordinary income property. For gifts of long-term capital gain property to 30% organizations, the deduction is limited to 20% of the taxpayer's AGI.

employment of family members

This allows a portion of the business profits to be paid to the employed family member as salary or wages, which are, in turn, deductible as a business expense by the owner. This has the effect of shifting income from the owner's high bracket to the employed family member's lower bracket, and it may allow the latter to establish an individual retirement account (IRA) to shelter this income further. Employing family members, however, is not without its problems and abuses. An attempt to employ a family member who is a minor or away at school may result in serious problems. While there is no set age limit in terms of an employment relationship with family members, employment of a very young child may result in disallowance of the deductions and possible imposition of tax penalties. The child may use his own standard deduction amount ($12,400 in 2020) to offset earned income. However, in the event of an audit by tax authorities, a valid business purpose behind the child's employment must be proved to avoid construing that the income was a gift by the parent. Another consideration involves the payment of the Federal Insurance Contributions Act (FICA) and federal unemployment taxes. Wages paid to an employer's child under age 18 are not subject to the FICA or the federal unemployment taxes. For this rule to apply, the parent's business must be unincorporated

items or benefits provided by an employer

This is the broad category of employer-provided fringe benefits

transfer for value

This rule can render a portion of the death benefit of a life insurance policy as includible in income. This rule applies when a life insurance contract is transferred for valuable consideration (i.e., a sale transfer as opposed to a gift transfer or swap transfer). A calculation is necessary to determine the amount of proceeds excludible from income. The amount of the death benefit that is excludible is the actual value of consideration paid by the transferee to acquire the contract (or the interest in the contract), plus any premiums, or other amounts paid by the transferee subsequent to the transfer. There are five safe-harbor exceptions to the transfer for value rule. None of the proceeds will be includible as income if the following occur: Sale of the policy is to the insured, insured's spouse, or insured's ex-spouse if incident to a divorce under Sec. 1041 Sale to a business partner of the insured Sale to a partnership in which the insured is a partner Sale to a corporation in which the insured is a shareholder or officer Sale to anyone whose basis is determined by reference to the original transferor's basis (i.e. a gift or swap)

gifting to minors using UGMA/UTMA accounts

This technique allows a donor to create an investment account for the minor without having to set up a trust. The general rule for taxation of UGMA/UTMA accounts is that income from the custodial property will be taxed to the minor, whether distributed or not, except to the extent it is used to discharge a legal obligation of the parent. However, should this income exceed $2,200, it may be subject to the kiddie tax. UGMA and UTMA accounts are a relatively simple and effective way to gift property to a minor. For a child not subject to the kiddie tax, proper planning with long-term capital gains or qualified dividends may yield tremendous tax savings.

types of trusts

Types of Trusts 1. Simple trust a. Trust is required to distribute all income to beneficiaries each year. b. Charitable donations are prohibited. c. Principal distributions are prohibited. 2. Complex trust a. A trust that can accumulate income. b. Principal can be distributed. c. The trust pays tax on accumulated income. 3. Grantor trust a. If a trust is a grantor trust, the grantor pays tax on all trust income. b. Trust is ignored for income tax purposes. c. A trust will be a grantor trust if the grantor retains the power to control enjoyment. These powers include the power to i. add or remove beneficiaries; ii. determine the timing of distributions; iii. alter the beneficiaries' share of principal or income; iv. retain a reversionary interest in either corpus or income; v. control the beneficial enjoyment (either the grantor, a nonadverse party, or both); vi. retain certain administrative powers; vii. revoke the trust; and viii. retain the ability to take income distributions, hold or accumulate income for future distributions to the owner or a nonadverse party, or apply income to the payment of life insurance policies on the life of the grantor or the grantor's spouse (e.g., a funded irrevocable life insurance trust [ILIT]).

head of household HH

Unmarried individuals who maintain a household for a qualifying child or relative under the tax law (usually a dependent child or a dependent parent) often use this status and pay tax according to a schedule with rates somewhere between that of MFJ and single filing status. The taxpayer must put the dependent's Social Security or taxpayer identification number on the return to use this status.

bargain sale to charity

When a donor-seller transfers property to a charity (or other tax-exempt organization) in exchange for a sum that is less than the FMV of the property, a bargain sale to the charity occurs. This transaction is considered part sale and part charitable contribution, for which the donor's basis in the property and any appreciation are allocated on a pro rata basis to both the sale and gift portions. The donor must recognize the taxable gain on the sale portion to the extent it exceeds the allocated basis of the donor-seller.

married filing separately MFS

When filing separate returns, each spouse reports only the spouse's own income and applicable deductions and credits. In addition, each spouse must use the tax rates for married persons filing separately. Married couples may file in this manner if they are going through a divorce proceeding or simply do not want to assume the joint and several liability of MFJ status. - It should be noted that some deductions and credits are limited or unavailable to taxpayers using this filing status. However, if married taxpayers file separate returns and live in a community property state, the taxpayer and the taxpayer's spouse must each report half of the combined community income and deductions, in addition to any separate income and deductions. This could drastically change any advantage that may exist in filing separate returns

donor advised funds

With a DAF, a taxpayer may lump several years' worth of charitable contributions into a single DAF contribution, take the charitable contribution deduction in that year (possibly allowing the taxpayer to itemize deductions that year), and then direct that grants to their selected charities be paid from the DAF over the next few years.

Modified Endowment Contract (MEC)

a life insurance contract that meets both the state law definition and the IRC definition of a life insurance contract, and fails the seven-pay test

foreign tax credit

a means of avoiding double taxation by granting a tax credit for taxes paid or accrued to a foreign country or U.S. possession. However, a taxpayer may not take advantage of both the foreign tax credit and foreign earned income exclusion permitted under U.S. tax law. If the tax in the foreign jurisdiction is more than the U.S. tax (which is typically the case), it is generally more advantageous to take the foreign tax credit, which cannot create a refund (nonrefundable). The average U.S. investor usually pays at least some foreign tax unwittingly via mutual funds. Global mutual funds typically own international stocks and pay nominal taxes to those foreign governments.

tax credits

a means of implementing social or economic objectives by providing more equitable benefits for taxpayers in various marginal income tax brackets than can be achieved through allowed exclusions or deductions.

Child and Dependent Care Tax Credit

a nonrefundable tax credit and is permitted for a portion of dependent care expenses paid for the purpose of allowing the taxpayer to be gainfully employed. To be eligible to take the credit, the taxpayer must have earned income; be paying the dependent care expenses in order to work (or be looking for work); and keep a home for a qualifying individual.

American Opportunity Tax Credit

a partially refundable tax credit of up to $2500 a year to help defray college expenses for the first four years of postsecondary education

qualifying relative

an individual who is not a qualifying child and bears a specified relationship to the taxpayer such as a parent, in-law, niece, nephew, aunt, uncle, or is unrelated to the taxpayer but resided in the taxpayer's principal home during the tax year. The taxpayer must have provided more than half of the person's support for the tax year.

joint and several liability

each spouse is responsible for the entire tax liability and not just half of the tax liability due. This is the case even if one spouse cannot locate the other spouse.

alternative minimu tax (AMT)

essentially a second income tax system that parallels the regular federal income tax. The purpose of the AMT is to ensure that taxpayers who reduce their tax liability below a certain point by utilizing tax preference items (items that were afforded preferential treatment for regular income tax purposes) will be required to pay at least a minimum amount of income tax.

windfall

example: winning the lottery constructive doctrine receipt applies. for example, if someone elects the annuity option on lottery winnings, they still must claim the full value in taxes income that yr

education assistance

excluded from an employee's income in any one year period, up to a maximum of $5,250

items characterized by love, affection, or assistance

excluded from income. An example of this is a gift, bequest, or inheritance. Life insurance proceeds paid by reason of death also fall into this category.

items that are socially desirable or a matter of legislative grace

excluded from income. An example of this is workers' compensation payments and the partial exclusion of the taxation of Social Security benefits. Interest on state and local government obligations (such as municipal bonds) encourages such investments and fall into this category. Some items related to educational incentives are excluded from gross income, as well. For example, distributions from a Coverdell Education Savings Account or a qualified tuition (Section 529) plan are excluded from gross income of the student if the distributions are used to pay qualified education expenses of an eligible student. Education funding is covered in Module 2 of this course.

items that, per the tax code, make the taxpayer whole again

excluded from income. Examples include compensatory damages, injury or sickness payments, and amounts received under property and casualty insurance contracts for certain living expenses.

items that are a return of capital

excluded from income. For example, a taxpayer's adjusted tax basis in an investment constitutes a tax-free return of capital.

IRS form 1040

if you see the entry Schedule C income reported on the cash flow statement of any taxpayer on form 1040, you know that the individual is self-employed

net investment income

includes investment income, such as the taxable income from interest, dividends, annuities, net royalties, and net rental income. Also included in the definition is net gain (when taken into account in computing taxable income) attributable to the disposition of property.

imputed interest rules

loans. 1. When a lender has issued a below-market-rate loan, the lender may be required to impute (recognize) interest income or the borrower may receive an interest expense deduction when, in fact, no interest has been received or paid. a. Imputed interest is calculated using the federal government's borrowing rate, compounded semiannually and adjusted monthly. b. If the interest charged on the loan is less than the federal rate, the imputed interest is the difference in interest determined using the federal rate and the interest determined using the actual rate. 2. The imputed interest rules apply to the following types of below-market-rate loans: a. Gift loans—The lender has interest income, and the borrower has interest expense to the extent of imputed interest. In addition, a gift has been made to the borrower in the amount of imputed interest. Gift loans may only occur between individuals. b. Compensation-related loans—The employer makes loans to employees. The corporation has interest income and compensation expense for the amount of the imputed interest. The borrower will have compensation income and interest expense, which may or may not be deductible, in the same amount. c. Corporation-shareholder loans—These are loans to a nonemployee shareholder by the corporation. The corporation will have interest income and a dividend distribution for the amount of the imputed interest. The shareholder-borrower will have dividend income and interest expense (may or may not be deductible) for the same amount. d. Tax avoidance loans—These loans significantly affect the borrower or the lender's federal tax liability. 3. Exceptions and limitations to the imputed interest rules include the following: a. No interest is imputed on total outstanding gift loans in the aggregate of $10,000 or less between individuals, unless the proceeds are used to purchase income-producing property. i. Also an exception for compensation-related or corporation-shareholder loans that are less than or equal to $10,000 b. On loans between individuals greater than $10,000 and less than or equal to $100,000, the imputed interest cannot exceed the borrower's investment income (from all sources) for the year. i. A further exception carved out by law states that if the borrower's investment income for the year does not exceed $1,000, no interest is imputed on loans of $100,000 or less. c. If the principal purpose of the loan is tax avoidance, none of the exceptions apply.

student loan interest deduction

maximum allowable deduction is $2,500

new debt

mortgage debt incurred after December 15, 2017. The deductibility of the interest on this debt is limited to $750,000 of acquisition indebtedness.

old debt

mortgage debt, or qualified residence interest, incurred on or before December 15, 2017.

adoption credit

nonrefundable tax credit for qualified adoption expenses that is generally taken in the year the adoption becomes final. Qualified adoption expenses include adoption costs, court costs, and attorney fees, but do not include costs of a surrogate parenting arrangement or any costs incurred for adopting a spouse's child (i.e., a second family). The credit may be allowed for the adoption of a child with special needs, even if the taxpayer does not have any qualified expenses.

fringe benefits

nontaxable in full or at least in part. Fringe benefits are a part of the compensation package given to an employee who is not salary but consists of valuable consideration such as employer-paid health insurance, life insurance, retirement plan contributions, and educational assistance. As a general rule, if these benefits discriminate in favor of highly compensated employees (HCEs) or key employees (e.g., in the case of nonqualified deferred compensation plans established on behalf of a corporate executive), you should be aware that taxation may result and a separate set of tax provisions apply.

qualified dividends

receive favorable income tax treatment. Qualified dividends are taxed at the rates applicable to long-term capital gains. A 0% rate applies to qualified dividends if the taxpayer's taxable income is less than $80,000 (for married couples filing jointly); a 15% rate applies for qualified dividends if they fall between the taxable income breakpoints of $80,000-$496,600 (for married couples filing jointly). A 20% rate applies to qualified dividends above the $496,600 breakpoint (for married taxpayers filing jointly). There are different breakpoint figures for different filing statuses. These rates apply for both the regular tax and the alternative minimum tax (AMT).These figures are for 2020 and are indexed for inflation. Preferential rates are available only to eligible dividends from stock; interest earned from CDs, bonds, and savings accounts is not eligible. Only certain dividends are eligible for this preferential rate. For example, dividends received from most foreign corporations, credit unions, mutual insurance companies, real estate investment trusts, farmers' cooperatives, and tax-exempt entities; deductible dividends from employer securities owned by an employee stock ownership plan (ESOP); and dividends from stock owned for less than 61 days in the 121-day period beginning 60 days before the ex-dividend date do not qualify.

grantor trust rules

require that the trust's income be taxed to the grantor.

basis calculations: average cost method

requires the seller of the shares to identify shares of the fund that are sold. Detailed records must be kept to enable proper identification of shares. To accomplish this method, the investor indicates to the mutual fund company which shares, based on purchase date, are being sold. The gain, if any, on these shares is then computed using the excess of the total sales price over the basis of the shares sold.

basis calculations: specific identification

requires the seller of the shares to identify shares of the fund that are sold. Detailed records must be kept to enable proper identification of shares. To accomplish this method, the investor indicates to the mutual fund company which shares, based on purchase date, are being sold. The gain, if any, on these shares is then computed using the excess of the total sales price over the basis of the shares sold.