Tax Research Chapter 11: Tax Planning for Individuals
starting in 1993, long-term capital gains are excluded from the definition of
"net investment income" because they are taxed at low capital gains rates
Tentative Minimum Tax (tax calculation) *
- Non-corporate taxpayers with AMTI of $175,000 (mfj) or less are taxed at rate of 26 percent, AMTI beyond that AMTI is taxed at a rate is 28 percent - Long term capital gains are taxed at regular capital gains tax rates of 15 percent, 20 percent, 25 percent or 28 percent
Alternative Minimum Tax Credit calculation
- The Code permits a credit against the regular tax liability for that portion of the AMT tax paid in previous years that is attributable to timing differences only. - However, the credit cannot reduce the regular tax liability below the minimum tax liability for the carryover year. - The credit may be carried forward indefinitely
Outright Gifts to Minors to Save for College Education tax consequence
- property is subject to the gift tax as a completed gift, which means the donor loses control of the property. - child has complete dominion and control of the property upon attaining the age of majority - earnings are tax in the year earned at the child's rates unless the "kiddie" tax applies
What are the tax advantages to investing in rental real properties? *
-the cost of acquisition can be leveraged to resulting in tax deductible interest payments on the mortgage. -The taxpayer receives the benefit of non-cash flow depreciation deductions which may help to create tax losses while the activity maintains actual positive cash inflows. 2 cash-flow sources: investment and tax loss value -the active real estate participant exception permits the taxpayer a limited offset of passive losses against other types of income, subject to phase-out for higher AGI levels. -It is also likely that when the asset is sold gain will be taxed as capital gain, because depreciable income-producing properties are Code Sec. 1231 assets; thus, any gain above depreciation recapture would be taxed at 15 percent.
Code provisions that allow for some tax planning include the following: (6)
1. Tax-exempt income and fringe-benefits 2. Capital gains and losses 3. Rental investments as tax shelters. 4. Selected personal deductions including alimony and contributions of appreciated property. 5. Vacation Rental Homes 6. College Education Expenses for Children
certain Code provisions exist to limit the taxpayer's ability to abuse tax incentives and preferences, including the following; (3)
1. The Alternative Minimum Tax 2. Passive Activity Loss Limitation Rules 3. Investment Interest Expense Deduction Limitations
In what three categories of income does Code Sec. 469 place all income?
1. active trade or business 2. passive income 3. portfolio income
in what order must expenses for vacations homes with significant personal use be deducted?
1. expenses otherwise deductible 2. expenses not otherwise deductible for personal use property, but deductible for rental properties, that do not affect basis 3. deductions that affect basis
3 main tests for material participation (there are a total of 7)
1. taxpayer participated more than 500 hours in the activity 2. the taxpayer participates more than 100 hours and no other owner participates more than the taxpayer 3. the taxpayer participates more than 100 hours in each of several activities and her total participation in > 100 hour activities is greater than 500 hours
key factors to consider when determining activity (5)
1. type of business 2. common control 3. common ownership 4. geographic location 5. business interdependences
Today, _____ percent of the regular tax FTC is allowed to offset AMT, thus making a deduction election unattractive.
100
capital gains can be taxed at
15 percent, 20 percent, 25 percent or 28 percent depending on the category of gain in which it falls and that short-term capital gains and losses are taxed at ordinary rates
A taxpayer may carryback an NOL for _____ and forward for _____
2, 20
The qualifying taxpayer may use up to _______ of PAL per year to offset against other types of income.
25,000, the offset is subject to a phase-out for higher levels of income
phase out range formula
25,000-((agi-100,000)/2)
2 AMT tax rates
26% and 28%
Generating additional income when in the phase-out range has the potential effect of increasing the marginal tax rate to
50%
A recent legislative enactment permits the taxpayer a refundable credit for a long-term unused what?
AMT credit ( greater than 3 years old )
The difference between the exercise price and the fair market value of an ISO is an
AMT tax adjustment
7 percent of gain on Sec. 1202 stock is an
AMT tax preference item
What role do adjustments and preference add-backs play in fulfilling the minimum tax objectives?
Adjustments and preference add-backs are made to remove some of the tax incentives and preferences provided by the tax law, which may not have a basis in the determination of economic income.
If the payee spouse wishes to receive a certain monthly alimony payment in after tax-dollars, the amount which must be paid in pre-tax dollars to achieve this result can be determined as follows
After tax payment desired * (100% - payee's marginal tax rate) = Required alimony payment before taxes.
Education Individual Retirement Account
An individual may contribute $2,000 per year per individual until that beneficiary reaches 18 years of age.
After tax cost of benefit for fringe benefits=
Cost of benefit provided by employer/(100% - the taxpayer's marginal tax rate.)
The general rule regarding itemized deductions:
If a taxpayer finds that his itemized deductions will be near the standard deduction, it may be best to defer expense recognition to the next tax year to receive the full benefit of itemizing.
De Minimis Rule
If the property is rented at fair rental value (FRV) for less than 15 days, the taxpayer recognizes no income and takes no deductions for the rental use.
Insignificant Personal Use
If the property is used for personal purposes less than the greater of (1) 14 days or (2) 10 percent of the time the property is rented at FRV, the property is treated as a rental property and items of income and deduction are reported on Schedule E.
Significant Personal Use
If the property is used for personal purposes more than the greater of (1) 14 days or (2) 10% of the time the property is rented at FRV, the property is treated as a personal use asset; that is, vacation rental property.
What year-end tax planning could an individual do around long-term capital gains because of the tax rate differential between capital gains and ordinary income?
It is best to use short-term losses to offset short-term gains; they should not be generated in years in which significant favorable long-term capital gains have been recognized.
What is the Alternative Minimum Tax and why was it created by Congress?
It was enacted as a mechanism to ensure that taxpayers who had significant economic income, but paid little or no regular tax by taking advantage of tax incentives and preferences (deductions, credits and income exclusions), would pay some minimum amount of tax.
are miscellaneous itemized deductions permissible for AMT purposes?
NO
are state and local taxes paid deductible for AMT purposes?
NO
are the standard deduction and personal and dependence exemptions allowed for AMT purposes?
NO
can income for interest earned on private activity bonds be excluded from income?
NO
Breakeven Rate of Return =
Rate of Return on Nontaxable investment/(100% - the taxpayer's marginal tax rate).
Personal itemized deductions such as mortgage interest and taxes are deductible on
Schedule A
What is the capital gain netting process and how are capital gains and losses taxed? (4 steps)
Step 1: Determine individual gain or loss on each sale or exchange transaction. Step 2: Classify the gain or loss as long-term or short-term. Step 3: Net all short-terms and net long-terms. Step 4: If short terms and long-terms are different, net the nets.
Alternative Minimum Tax (AMT) caclulation
The alternative minimum tax is the excess of the tentative minimum tax (TNT) over the regular tax liability (RT).
What is regular, continuous and substantial involvement?
The involvement threshold is not high and the taxpayer will qualify as long as he participates in making the major decisions related to the property, such as rental terms, approving lessees, and financing.
active rental real estate participation exception
The taxpayer must be an active participant in the activity which requires that the taxpayer (1) have at least a 10-percent ownership in the activity, (2) is not a limited partner and (3) the taxpayer demonstrates, regular, continuous and substantial involvement in the rental activity.
What factors should the taxpayer consider in determining whether to forego the 15-percent rate?
The taxpayer should consider the time value of money (that is paying additional tax up-front) and whether she believes the interest disallowed in the current year will ever be deductible.
Generally, taxpayers who are faced with a current year AMT liability and with little or no AMT credit available should consider
accelerating income recognition and/or decelerating expense deductions with the result that additional income will be taxed at an AMT rate of 26 or 28 percent as opposed to regular income tax rates which could be as high as 35 percent
as the interest income is included in AMTI, this amount is
added to the taxpayer's net investment income for purposes of computing his investment interest expense deduction.
the election which allows long-term capital gains and qualified dividends to be included in investment income results in
additional investment income, taxable for both regular and AMT purposes at ordinary rates, is offset by a higher investment interest expense deduction.
Adjustments to AMT result in either _______ or a ______ to regular taxable income and are contained in Code Secs ______
an addition, a subtraction, 56 and 58
In general, In computing the taxpayer's charitable contribution deduction, the taxpayer may deduct the _____ but is limited to ________
asset's fair market value (FMV), however the overall deduction is limited to 30 percent of the taxpayer's AGI.
the impact of long-term capital gains recognition on the state income tax deduction disallowance for AMT purposes should be considered
before substantial long-term capital gains are recognized
In general, the passive activity rules limit the
deductibility of losses from passive activities to income generated by those activities.
The taxpayer may not include long-term capital gains or qualified dividends taxed at a rate of 15 percent in net investment income for purposes of
determining her investment interest expense deduction
Some states ______ exclude gain on the sale one's personal residence and some do not exclude 50 percent of the gain on Sec. 1202 stock.
do not
Code Sec. 71
does permit the former spouses to designate amounts that would otherwise be taxable as alimony as "not alimony."
if the taxpayer receives no AMT benefit by carrying back its AMT NOL (it had no AMT liability), he should consider
electing to forego the carry back
For years the taxpayer may find himself in AMT, he should consider an available
election which allows long-term capital gains and qualified dividends to be included in investment income if the taxpayer foregoes preferential capital gains treatment.
When accelerating income recognition, at some point (the break-even point) the taxpayer's regular tax liability will
equal the AMT liability, after which point, the income will be taxed at higher rate for regular tax purposes.
Similar to a standard deduction, each taxpayer is entitled to an AMT
exemption amount that is phased out for higher levels of Alternative Minimum Taxable Income (AMTI).
individual tax planing involves
exploring ways to reduce the taxpayer's overall tax liability, lawfully, through application of the tax laws
if losses exceed gains, whether short-term or long-term, the taxpayer may deduct losses only to the extent of
gains plus $3,000 (with unlimited carry forwards.)
disallowed code secant 163(d) amounts are carried forward
indefinitely
Deductible mortgage interest does not include
interest paid on home equity loans
Portfolio income is
investment income, unearned income
active trade or business income
is earned by a taxpayer who materially participates in a trade or business activity.
passive income
is earned from a trade or business activity in which the taxpayer does not materially participate.
Code Sec. 163(d)
limits the interest expense deduction of a noncorporate taxpayer to his "net investment income."
pursuant to Code Sec. 163(d)(4)(B) the taxpayer may ELECT to include
long-term capital gain and qualified dividends [15% gain] in the calculation of net investment income by foregoing taxation at preferential capital gains rates.
why it is advantages to classify an activity with material participation if the activity is generating losses?
losses will be treated as ordinary and available to shelter other types of income
passive activity losses ___ deducted in the current year may be carried forward _____ and used when
not, indefinitely, there is passive income or when the activity generating the losses is disposed of in a taxable transaction.
The tax consequences of owning a vacation rental home are dependent on the extent
of personal use
Before Code Sec. 469 was enacted a taxpayer, usually a high income taxpayer, could use losses from activities in which he was not actively engaged to shelter against
other types of income including ordinary income and investment income
Pursuant to Code Sec. 469, rental activities are what by default?
passive
Private Activity Bond Interest is a
permanent positive AMT adjustment; thus, no AMT credit is available.
Adjustments to AMT can result from _________ or _______ differences
permanent, timing
In general, if the taxpayer finds himself subject to AMT in the current year, he may consider
postponing the payment of real estate and personal property taxes until the following year when he can receive the benefit of these items under the regular tax scheme as itemized deductions. (the taxpayer can consider electing out of this installment method, but there is not much advantage to this)
AMT tax preferences generally include
provisions enacted prior to current AMT tax scheme, including depletion in excess of basis, and excess intangible drilling costs
"activity" is determined pursuant to
reg. 1.469-4
Preferences result in additions only to
regular taxable income and are specified in Code Sec. 57.
expenses of vacation rental home that is has insignificant personal use must be allocated between
rental and personal use
Code Sec. 172
requires that the taxpayer be consistent in this election for both regular and AMT purposes
For regular tax purposes gain is recognized when the stock
sold
If the taxpayer foresees being in AMT for a number of years, she may want to consider
staggering the exercise of options
long-term capital gains may be subject to what type of taxes?
state income
who would benefit of electing out of installment method?
taxpayers that have a significant amount of depreciation recapture, which is taxed at ordinary rates in the year of sale. (The rate differential would be 26 or 28 percent for AMT, but as high as 39.6 percent for regular tax purposes.)
exception to rental activities default passive categorization?
the active rental real estate participation exception
Taxpayers who exercise ISOs must recognize income equal to
the difference between FMV and the option price
The only credit available for use against the AMT is
the foreign tax credit
the amount of the refundable credit for a long-term unused AMT credit is
the greater of (1) the lesser of the unused credit or $5,000 or (2) 20 percent of the long-term credit.
A taxpayer who incurs debt to carry an investment may deduct
the interest expense paid on that loan, subject to certain limitations
The AMT rate on long-term capital gains cannot exceed
the rate imposed for regular tax purposes; preferential capital gains rates apply.
In general recognizing long-term gains in the 15-percent capital gains group at year-end should be avoided in years in which
the taxpayer has recognized significant capital losses.
It is best not to recognize long-term losses in years in which
the taxpayer has significant long-term capital gains as they are more favorably used to offset short-term capital gains or ordinary income.
alternative to FMV deduction of charitable contributions and limit
the taxpayer may elect to deduct the asset's adjusted basis [fair market value less unrecognized gain] in which case the deduction is limited to 50 percent of the taxpayer's AGI.
Because private activity bond interest is not excluded from the AMT tax base, it is included in
the taxpayer's net investment income for purposes of computing the AMT investment interest expense deduction.
The starting point for the AMT calculation is
the taxpayer's regular taxable income to which both positive and negative adjustments are made and preference items are added back.
why is it advantage to classify an activity that is profitable as passive?
to group it with other activities that are passive and showing losses for offset
In general, if the taxpayer had to pay for services, such as an employer paying an employee's medical insurance premiums, the savings are considerable when compared
to the employee paying the premiums with after-tax dollars.
expenses of significant personal use vacation rental homes are deductible only
to the extent of income and excess deductions may be carried forward
When are medical expenses deductible?
to the extent they exceed 10% of AGI
A taxpayer should consider decreasing positive AMT adjustments by
using slower cost recovery methods (straight-line or ADS) to compute depreciation for regular tax purposes, if the taxpayer is going to be subject to AMT into the future.
can an adjustment which slows down deprecation from that computed under MARCS or ACRS be made for AMTs?
yes, its a timing difference
is alimony deductible?
yes, to the person that pays it, and it is includible in income for the recipient