Chapter 3 - Taxable Entities, Tax Formula, Intro to Property Transactions
There are three types of recognized gains or losses, depending on the asset types:
1. Capital Asset - Capital gain or loss 2. Ordinary Asset - Ordinary Gain or loss 3. Section 1231 Asset - Sec. 1231 Gain or loss
Trust
A legal entity created when the title of property is transferred by a person (the grantor) to the fiduciary (the trustee).
Partnerships (General, Limited, and Limited Liability Partnerships)
A partnership is a conduit for Federal income tax purposes. This means that the partnerships itself is not subject to Federal income tax and that all items of partnership income, expense, gain, loss, or credit pass through to the partners and are given their tax effect at the partner level.
Fiduciary
A person who is entrusted with property for the benefit of another, the beneficiary. The individual or entity that acts as fiduciary is responsible for managing and administering the entrusted property, at all times faithfully performing the required duties with the utmost care and prudence. Two types of fiduciary relationships are the trust and the estate.
Sole Proprietorship - Schedule C
A sole proprietorship is not considered a separate taxable entity. The business transactions are simply those of the owner and are reflected in his or her income and expenses for tax purposes. The income and expenses are treated similarly to other income and deductible expenses for tax purposes and are reported on Schedule C of the individual tax return. The sole proprietor must pay self employment tax on his or her net income. Individuals must also pay self employment tax on any other income from personal services (other than as an employee) even if it does not rise to the level of a business.
Adjusted Gross Income (AGI)
AGI serves as the basis for the determination of the amount of certain other deductions, such as medical expenses and charitable contributions. AGI is simply a point of reference used for classifying deductions: deductions are either classified for or from AGI. The calculation of many deductions, credits, and other tax items is made with reference to AGI. Medical expenses, for example, are only deductible to the extent they exceed 10% of AGI.
Limited Liability Companies (LLC)
All 50 states and the District of Columbia have passed legislation creating a relatively new form of business entity: the LLC. It is a cross between a partnership and a corporation. Created under state law by filing articles of organization. The owners of an LLC are called members and can be individuals, partnerships, regular corporations, S corporations, trusts, or other LLCs. (Two or more members usually for the entity). Like a corporation, an LLC can act on its own behalf and sue and be sued; like a corporation, members generally possess limited liability except that they may be liable for their own acts of malpractice in those states that allow professionals to form LLCs. An LLC with two or more owners is treated as a partnership for tax purposes unless it elects to be treated as a corporation. (The LLC is a partnership unless it checks the box on Form 8832 to be treated as a regular C corporation). An LLC with only one member is disregarded and treated as a sole proprietorship unless it elects to be treated as a corporation. A limited partner's share of partnership income has been viewed more similar to investment income (e.g., dividends and interest) than business income.
Realized Gain or Loss =
Amount Realized - Adjusted Basis
Prepayments
Any prepayments by the taxpayer are also subtracted from the gross tax in arriving at the tax due. Prepayments most commonly occur in the form of estimated tax payments required during the year and withholding of Federal income taxes from salaries and wages by employers.
Standard Deduction
Based on Filing Status; Indexed Annually for Inflation Additional Standard Deduction for: Elderly (65 +); Blind Limitations on Use of Standard Deduction: Married Filing Separately; Nonresident Aliens; Dependents
Tax Credits
Credits are amounts provided in the statute that directly reduce the tax. Certain credits are allowed for various economic and social reasons. Perhaps the most common personal credit is the child tax credit. Another is the credit for job-related expenses incurred for the care of a child under age 13, a disabled dependent, or a disabled spouse. Other credits are allowed for such things as education, the use of alcohol fuel and rehabilitation of certain older buildings.
Itemized Deduction
Deductions that are not deductible for AGI. The majority of itemized deductions are for selected personal, family, and living expenses that Congress believed should be allowed for various policy reasons.
Net Short-Term (Held One Year or Less) Capital Gains
Fully Taxable at Regular Tax Rates
Nonresident Aliens
International Taxation. International taxation involves tax treatment of income of citizens and residents earned abroad and of nonresident aliens earned in the U.S. Nonresident alien individuals are taxed on their U.S. source income. Similarly, foreign corporations pay a U.S. income tax on certain portions of their U.S. income. If foreign income taxes are paid on foreign source income by a U.S. citizen or resident, a credit is usually allowed against the U.S. tax on the foreign source income. If a U.S. citizen is a resident of a foreign country or outside the U.S. for eleven months within a twelve month period, he or she may elect to exclude any foreign income earned from personal services (up to $101,300 for 2016) from U.S. taxation. This may, or may not, be more attractive than the foreign tax credit.
Net Capital Losses
Maximum $3,000 Deduction for AGI, Carry Forward Excess
Net Long-Term (Held Over a Year) Capital Gains
Net Capital Gains Maximum 20% Tax Rate (for those in 39.6% tax bracket --- taxable income over $415,050; $466,950 MFJ, $441,000 HH);15% for those in 25-35% tax brackets; 0% for those in 0-15% tax brackets
Recognized Gain or Loss =
Realized G(L) - Deferred G(L) - Excluded G(L)
S Corporations
S corporations normally are not separate taxable entities, but are treated as conduits, passing their income and losses through to their shareholders. It is taxed virtually in the same fashion as a partnership. The only corporations that qualify for S status are those that have 100 or fewer shareholders and meet certain other tests. Like a partnership, the S corporation's items of income, expense, gain, or loss pass through to the shareholders to be given their tax effect at the shareholder level. Distributions form an S corporation, like those from partnerships, normally are nontaxable since they usually represent previously taxed income. The S corporation files and information return (Form 1120S) similar to that of a partnership, reporting the results of the corporation's transactions and how those results allocated among the shareholders.
U.S. Citizens and Resident Aliens of Any Age
Section 1 of the Internal Revenue Code provides that a tax is imposed on the taxable income of all individuals. As might be expected, the term individual generally applies to U.S. citizens. However, it also includes persons who are not U.S. citizens, but who are considered residents, so called resident-aliens. For resident-aliens, the tax would be levied on both their U.S. income and any foreign income.
Regular or C Corporations
Section 11 of the Internal Revenue Code imposes a tax on all corporations. The corporate income tax applies to both domestic corporations and foreign corporations that operate a trade or business in the United States. For tax purposes, a corporation is treated as a C corporations (a regular corporation) unless it is eligible and elects to be treated as an S corporation. C corporations, like individuals, are treated as separate taxable entities. Many believe that the earnings of a corporation are subject to double taxation because any part that is distributed as dividends is subject to tax at the shareholder level. This is because the dividends generally are taxable to the shareholders. A shareholder (even one with a controlling interests) can be an employee of the corporation in which he or she holds an interest. The employees of a business, including any employee/owners of a corporation, pay payroll duties—FICA, Medicare, unemployment tax, etc—on the amount of salaries and wages.
Tax Exempt Organizations - Unrelated Business Income Tax (UBIT)
Since inception, U.S. tax laws have exempted from federal income taxation charitable and religious organizations as well as a variety of nonprofit associations. Although tax-exempt entities usually do not pay tax, there are exceptions. If a nonprofit organization conducts a business unrelated to the purpose for which its exemption granted, any income resulting from that business would be subject to tax.
Gross Income
The amount of income remaining after the excludable items have been removed.
Taxable Income
The base tax to which the tax rates are applied to determine the taxpayer's gross tax liability (i.e., the tax liability before any credits or prepayments).
Deductions for Adjusted Gross Income (DFORs)
The deductions for AGI are certain deductions specified in the Code that are allowed regardless of whether the taxpayer itemizes his or her other deductions. Unless a deduction is included in the list in, it is an itemized deduction. The deductions for AGI do not have any particular common element, and generalization is therefore difficult.
Worldwide Income (For all Citizens/Residents, Including Expatriates)
The federal income tax on individuals applies not only to domestic (U.S) source income, but also to income from foreign sources. In other words, a U.S. citizen is subject to U.S. taxation on his worldwide income regardless of where he or she lives or the source of income.
Tax Formulas
The mathematical relationships used to compute the tax for various taxable entities.
Personal and Dependency Exemptions
The personal and dependency exemptions are deductions based on the size and makeup of a taxpayer's family. For the year 2016, the exemption amount is $4,050 and it is increased to reflect increases in the consumer price index each year. These deductions are allowable as a personal exemption for the taxpayer and as dependency exemptions for any qualifying persons who are supported by the taxpayer. On a return for married persons filing jointly, there are two taxpayers and, therefore, two personal exemptions. The exemption deductions are phased out for higher income taxpayers.
Property Transactions
The tax treatment of sales, exchanges, and other dispositions of property.
Taxable entities
Those entities that are subject to taxation and those that are merely conduits.
Deductions
Those items that are subtracted from gross income to arrive at taxable income.
