CPA Exam REG Series-M
Penalties on Early Withdrawals of Savings
Adjustmt to arrive at AGI.
Appeals Process
Administrative appeals process, not appeals ct. If an agreemt can't be reached at the rev agent level, the taxpayer receives a copy of the rev agent's report and a 30-day letter (prelim notice) notifying the taxpayer of the right to appeal. Taxpayer then has 30 days to request an admin appeal w/ an appeals officer (appeals conference). The goal of the appeals process handled by the IRS office of appeals is to resolve tax controversies w/o litigation. If an agreemt is reached w/ the appeals division, the taxpayer signs Form 870-AD. Int stops accruing when the form is rec'd and accepted by the IRS. This settlemt is normally considered binding on both parties. If agreemt isn't reached, a 90-day letter will be issued. If an appeals conference wasn't requested after the receipt of the 30-day letter, or if the taxpayer and IRS still don't agree on the proposed adjustmt after the appeals conference, a 90-day letter (notice of deficiency) is issued. The taxpayer has 90 days to pay the deficiency or file a petition w/ the US tax ct. If the taxpayer would like to litigate, but prefers the case to be heard in the US district ct or ct of fed claims, must first pay the tax deficiency and then sue the IRS for refund in the ct if the IRS denies the claim for refund (they will).
Indenture
Agreemt or deed btw parties specifying the terms of any debt. Don't confuse w/ debentures, which are certificates evidencing unsecured debt.
Section 18 of the 1934 Act
Subjects a defendant to liab for false/misleading info in the registration stmt or other req'd reports (10-K, 10-Q, 8-K). The defendant isn't liable if they can prove lack of scienter.
Trick to Computing Estimated Income Tax Payments
Can use the annualized method, but *CAN'T* use the PY method if there was no IT liab in the PY.
Tax Credits
Dollar for dollar reduction of tax. Reduce personal tax liab. 2 basic types of tax credits: 1. Personal tax credits: reduce tax, but no refund. May make personal tax liab 0, but may not result in a cash refund. Incl: -child and dependent care credit -elderly and perm disabled credit -education credits (lifetime learning credit) -retiremt savings contr credit -foreign tax credit (FTC) -gen bus credit -adoption credit 2. Refundable credits: reduce tax and can get a refund. These are subtracted from IT liab. May result in a cash refund when the credit exceeds tax liab owed even if no tax is withheld from wages. These are refundable credits (or pmts treated as refundable credits) shown in the pmts section of the Form 1040: -child tax credit (refund is limited) -earned income credit -withholding taxes (W-2) -excess social sec paid -american opportunity credit (40% refundable)
General Partnership/Joint Venture; Duties and Legal Obligations of Partners, Profit and Loss Allocation, and Distributions
Duties/legal obligations of partners: each partner owes a fiduciary duty to the pship and other partners. Partners are personally liable for *ALL* contracts entered into and torts committed by other partners w/in the scope of pship bus or which are otherwise auth'd (GP does not = LLP). The partners' liab is joint and several, so each partner is personally/individually liable for the *ENTIRE* amt of all pship obligations. In many states, a creditor can't satisfy a judgmt against an indiv partner unless the partner was named in the lawsuit and the assets of the pship are exhausted. P/L allocation (GP = LLP): absent an agreemt otherwise, all partners have equal rights to share in the profits of the pship, regardless of the $$/services contr'd. Book ex for sharing of profits: A, B, C, D, and E form a gen pship to mfg clothing. A contrs 40% of the cap, B contrs 30%, C contrs 20%, D contrs 10%, and E agrees to design all the clothes. All partners will share profits equally absent an agreemt to the contrary. Unless the partners agree otherwise, they share losses in the same manner as profits. Book ex for sharing of losses: same facts as above. If there's a 100k loss, absent an agreemt to the contrary, all partners will be responsible for 20k of the loss (100k/5, equal!). The examiners often ask how partners will share P/Ls. The key is to remember that, as w/ partners' mgmt powers, unless the partners provide otherwise, P/Ls will be split equally, regardless of the partners' contrs. If a partner can't contr his share of losses (bc of bankruptcy or other refusal), the remaining partners must make up the share on a pro rata basis. Distrs: salary. Unless agreed otherwise, partners are *NOT* entitled to comp for services rendered for the pship. Book ex for comp: same ex. If A, B, and C never did any work for the pship and D and E worked full time to mfg the clothes, D and E would have no right to be paid for their services (unless A, B, and C breached an agreemt to work).
When an Employer Voluntarily Pays an Employee's Share of FICA Taxes
Entitled to reimbursemt from employee. If they don't seek rembursemt, the pmt is considered a bus exp deductible by the employer and TI to the employee.
Unemployment Compensation (FUTA)
Excludes SE. Establishes a state-run system of ins to provide inc to workers who have lost their jobs. FUTA provides fed guidelines, but the states actually administer the program, set stds, and determine pmts. All employers who have quarterly payrolls of at least $1,500 or who employ at least 1 person for 20 weeks in a yr must participate in the system. Unlike FICA, SE persons don't participate. Bc most employers must participate under FUTA, the examiners often try to trick you into thinking every employer must participate. Not true. The 1,500 min or time rqmts must be met. Unemploymt taxes are payroll taxes gen assessed only against the employer. The fed unemploymt TR currently is 6% of the first 7k per yr of comp for each employee. Employers can get a credit against the fed tax due for pmts made on acct of state unemploymt taxes of up to 5.4% of the first 7k. The state rate can be reduced if the employer has a below-avg rate of unemploymt claims from prior employees. The employer's pmt is deductible as an ord bus exp. Bc the employee gen doesn't pay the tax, it's not deductible by the employee. When the examiners test on unemploymt issues, often test on this concept. Remember that the employer may deduct the tax (bc they pay it), but the employee may not take a deduction. Unemploymt (FUTA) benefits are gen available only when an employee's job termination wasn't his fault. Benefits are distr'd to employees by the state govts. The amt paid varies btw states, but is usually determined by how long the employee has worked and his former rate of pay. Pmts aren't limited to the amt that has been paid by the employer on the employee's behalf. Most important things to remember abt FUTA for the exam: -employer must pay if it employs an employee for at least 20 weeks in a yr or paid 1,500 in wages in a quarter. Employee doesn't pay. -bc the employer pays, the tax is deductible as a bus exp. Employee can't deduct the pmt. -if an employer's claim rate is low, may get a deduction for state unemploymt tax. -the employee's benefits aren't limited to contrs made on his behalf.
Agent's Power to Contractually Bind the Principal; Contractual Liability Continued
For agent's liab to 3rd party for contract duties: 1. Disclosed principal (agent not liable if auth'd): if the agent discloses the existence and ID of the principal, 3rd party can't hold an auth'd agent liable on the contract. Every person repping himself as an agent impliedly warrants that he has the auth he purports to have. If the agent doesn't have such auth, the 3rd party can hold the agent liable for any damages caused based on breach of this implied warranty. 2. Partially disclosed (existence only) and undisclosed principal (existence and ID unknown): agent liable. If the principal's ID is *NOT* disclosed to the 3rd party (a partially disclosed principal) or neither the existence nor ID of the principal is disclosed to the3rd party (an undisclosed principal), the agent is liable on the contract w/ the 3rd party. Once the 3rd party discovers the principal's exact ID: -3rd party's election: can hold either the principal or the agent (but not both) liable if the principal was undisclosed/partially disclosed. 3rd party must elect whom to hold liable. -*NO* apparent auth w/ undisclosed principal (and no ratifying): if principal is undisclosed, can't be apparent auth bc there's no holding out of the agent by the principal. -*NO* effect on actual auth: the fact that the principal is undisclosed has no effect on the agent's actual auth since actual auth arises from the comms btw the principal/agent. The examiners often ask abt undisclosed principal situations. Key points: -principal is bound if the agent had auth. Irrelevant whether the principal was disclosed, partially disclosed, or undisclosed. If agent didn't have auth, principal is bound only if he ratifies. -agent can be held personally liable if the principal is partially disclosed (ID not disclosed) or undisclosed (neither ID nor existence disclosed). Agent doesn't have to tell 3rd party they are working for a principal, but can't give false info either.
Solving for Section 1231 Gain for Real Property Sold by Corporations
For real prop sold by corps, section 1231 gain is the total of the gain from selling the real prop for more than the OG cost + 80% of the gain due to depr. So if didn't sell prop for > OG cost, can just divide depr recapture by 20% and then multiply that amt by 80%.
Corporation Tax Summary Continued Further
GAAP exp items that aren't tax deductions: 1. Life ins exp (corp): -GAAP F/S: exp -IRC TR: not deductible -Diffs: perm 2. Penalties: -GAAP F/S: exp -IRC TR: not deductible -Diffs: perm 3. Lobbying/political exp: -GAAP F/S: exp -IRC TR: not deductible -Diffs: perm 4. Fed inc taxes (FIT): -GAAP F/S: exp -IRC TR: not deductible -Diffs: perm Special items: 1. Net CG: -GAAP F/S: inc -IRC TR: inc -Diffs: none 2. Net CL: -GAAP F/S: report as loss -IRC TR: not deductible -Diffs: temp 2(A) CB/Carryover (3/5 rule): -GAAP F/S: N/A -IRC TR: unused loss allowed as a ST CL -Diffs: temp 2(B) Related SH: -GAAP F/S: report as loss -IRC TR: not deductible -Diffs: perm 3. NOL: -GAAP F/S: report as loss -IRC TR: CB 2, CF 20 (hindsight is 2 x 20) -Diffs: temp 4. R&D: -GAAP F/S: exp -IRC TR: exp/amort/capitalize -Diffs: temp/perm/none
Gains (Excluded or Deferred); Installment Sales and Treasury and Capital Stock Transactions (by Corporation)
HIDE *IT*. Under the *I*nstallmt method, part of the pmts on a trans are rec'd in a tax yr after the yr of sale. Rev is reported over the pd in which the cash pmts are rec'd rather than all being recog'd at the time of the sale. Installmt sales are taxed when cash pmts rec'd. *T*reasury and cap stock trans by corp incl those corp trans exempt from gain (and any losses are disallowed - essentially corps are precluded from tax benefits or inc taxes resulting from dealing in their own stock): -sales of stock by corp -repurch of stock by corp -reissue of stock *Corps never report G/L on the sale of their own stock*!
Defenses: Parol Evidence Rule
Inadmissible. The parol (oral) evidence rule prohibits a party in a lawsuit involving a fully integrated (final) written contract (one that appears to be intended to reflect the entire agreemt btw the parties) from introducing evidence at trial of: -oral/written stmts made prior to the written contract or oral stmts made contemporaneously w/ the written contract and -that seek to vary the terms of the written contract (contradict). Oral/written mods made after the contract has been entered into (subseq mods) are admissible under the parol evidence rule. *A*fter = *A*dmissible. Also fraud, duress, mistake, or minor defenses can still be used. Book ex for parol evidence rule: B, a 16 YO, is looking at cars on L's used car lot. L tells B if B buys a car today, L will wash the car weekly for free for a yr. B selects a car and the parties sign a fully integrated agreemt setting out the parties, price, warranty, etc. but not mentioning the washing agreemt. Assuming L's stmt wasn't fraudulent (that she actually intended to wash the car when she made the stmt but later changed her mind), B will not be able to intro evidence of the stmt in ct. However, the parol evidence rule wouldn't prohibit B from introducing evidence of his age, since that's not seeking to vary the contract's terms. Parol evidence Qs are common. Key areas to examine: 1. Examiners love to test the time element in these Qs. Remember that prior/contemporaneous stmts that contradict the writing are inadmissible. Subseq stmts that contradict/change a term are admissible. 2. Examiners sometimes combine the parol evidence issue w/ a statute of frauds issue, usually in an oral mod fact pattern. Key is to address each issue sep. 1st, determine if the mod is enforceable (is the contract *as modified* w/in the statute of frauds?). Then determine whether it's admissible as evidence (subseq mods are admissible) under the parol evidence rule.
Calculation of Gain or Loss on Disposition
Realized= real world. Recog'd = record on the records/tax return. Gen, G/L on the sale of an asset is calc'd by comparing the amt realized on the disposition to the adjusted basis of the asset being relinquished in the trans. For certain types of trans, the gain is realized but not recog'd. Amt realized: money rec'd (boot/loot), cancellation of debt (COD, boot), FMV prop, LESS: selling exps. Adjusted basis of asset sold: purchase = cost, gift = rollover cost, inherited = step-up (down) FMV. Gain: *HIDE IT* -*H*omeowner's exclusion -*I*nvoluntary conversion -*D*ivorce prop settlemt -*E*xchange of like-kind (bus) -*I*nstallmt sale -*T*reasury capital and stock Loss: *WRaP* -*W*ash sale losses -*R*elated party losses -*a*nd -*P*ersonal losses [Amt realized - adjusted basis of asset sold] = G/L. All realized G/Ls are recog'd (reported on TR) unless HIDE IT or WRaP applies. If you can HIDE IT, don't have to pay tax on it. WRaP up those losses and throw them away, bc they're useless! Taxable gain recog'd = realized gain to the extent of boot/loot. You don't HIDE cash that you keep well enough, so taxable. Basically even if HIDE IT applies, taxed on boot bc you keep the cash.
For Appreciated Property Distributed to a Shareholder in a Nonliquidating Distribution
Remember to incr the E&P for any gain recog'd by the corp on the distr (ie FMV - corps basis in prop distr'd). This incrs the amt of the distr taxable as a div bc there's more E&P.
Tax Free Reorganization
Reorg incl: -mergers or consolidations (Type A). -the acq by 1 corp of another corp's stock, stock for stock (Type B). -the acq by 1 corp of another corp's assets, stock for assets (Type C). -dividing of the corp into sep operating corps (Type D). -recapitalizations (Type E). -a mere change in identity, form, or place of org (Type F). No G/L is recog'd by either the parent or sub corp when the parent, who owns at least 80%, liquidates its sub. The parent assumes the basis of the sub's assets as well as any unused NOL, CL, or char contr carryovers. For corps, the reorg is a nontaxable trans and all tax attributes remain (nontaxable = NBV). For SHs, the reorg is a nontaxable trans and the SH continues to retain their OG basis (nontaxable = NBV). The SH recogs gain to the extent that they receive boot/cash in the reorg. The GR for taxable events and basis applies to reorgs: -corp: nontaxable = no inc = NBV basis. Tax attributes don't change. -SH: nontaxable = no inc = NBV basis. Tax attributes don't change.
S Corporation Separately Stated Items v Ordinary Business Income
Section 1245 gains are taxed as ord inc and incl in the calc of ord bus inc. Section 1231 gains are reported as a sep stated item.
Features of a Chapter 7 Liquidation; Exceptions to Discharge
*FAT WED*. Certain debts of an indiv are *NOT* discharged under chs 7 or 11. These are the exceptions to discharge. Important to remember a bankruptcy case doesn't discharge all debts. Often examiners ask broad Qs like "which of these things is true under the bankruptcy code?" and an answer is "all of the debts of the debtor are discharged." This isn't true. These debts survive bankruptcy: -debts incurred by *F*raud, embezzlemt, or larceny: liabs for obtaining money, prop, or services by false representation/fraud, or through embezzlemt or larceny, aren't dischargeable. -*F*ines and penalties: any obligation to pay a fine/penalty/forfeiture owed to a governmental unit, like a traffic fine, survives the debtor's discharge, as do claims for ct costs. -*A*limony, maintenance, support, and settlemts from martial separation: debts owed to the debtor's spouse, former spouse, or child (in/out of wedlock) for alimony, maintenance, or support are nondischargeable, as are prop settlemts arising out of a divorce decree or sep agreemt. -*T*axes due w/in 3 yrs of filing: most tax claims (fed/state/local) are nondischargeable if the return for the tax was due w/in 3 yrs before the bankruptcy petition was filed. -*W*illful and malicious injury: liabs arising from willful/malicious injury to another aren't discharged. However, liabs arising from negligent torts are dischargeable. -*E*ducational loans: an educational loan owed to a NFP institution of higher education or a student loan that's made/guaranteed/insured/funded by a govt agency or commercial entity is not dischargeable, unless it would impose undue hardship. -*D*ebts undisclosed in the bankruptcy petition: any debt not scheduled or listed by the debtor in time to permit the creditor to file a timely proof of claim is nondischargeable, unless the creditor had notice or actual knowledge of the bankruptcy. -luxury goods: consumer debts incurred for luxury goods (boat, jewelry, etc.) aren't dischargeable if the debts aggregate over $675 to a single creditor and are incurred w/in 90 days if the order for relief. -open-ended credit to consumers: cash advances obtained by a consumer under an open-ended credit plan are presumed nondischargeable if the debts are incurred w/in 70 days of the order for relief and exceed the aggregate amt of $950. So, if a consumer makes purchases on a credit card in an amt > 950 in the 70 days before bankruptcy, the debt will survive bankruptcy. -operating a vehicle while intoxicated: D*W*I = *W*illful. Judgmts rendered against the debtor for death/personal injury incurred as a result of operating a motor vehicle, aircraft, or vessel while legally intoicated survive the debtor's discharge. -denial of discharge in prior bankruptcy: if a discharge was denied in a prior bankruptcy or a previous discharge was waived, debts that predate the prior bankruptcy are not dischargeable in a subseq case. This exception doesn't apply if the basis for denial in the prior case was that the debtor rec'd a discharge w/in 8 yrs. The examiners often ask what debts won't be discharged in bankruptcy. The key to remembering the 6 nondischargeable debts that most commonly appear on the exam is *FAT WED*: *F*raud, *A*limony, *T*axes, *W*illful and malicious injury, *E*ducational loans, and *D*ebts undisclosed in the bankruptcy petition.
Features of a Chapter 7 Liquidation; Distribution of the Debtor's Estate: Payment and Priorities
*IMPORTANT*! Once the debtor's assets have been collected and liquidated, and all objections at that level have been disposed of, the trustee will distr the assets of the estate. There are 3 basic categories of claimants, paid in this order (memorize): 1. secured claimants 2. priority claimants (9 subcategories. Need to know. *SAG WEG CTI*) 3. general creditors who filed their claims on time Pmts are made in full to secured claimants to the extent of the value of the collateral securing their claims (claims in excess of the collateral are treated like claims of other gen creditors). Whatever is left over is used to pay first-priority claimants in full, then second-priority claimants in full, third, and so on. If money is left over after paying all of the priority claimants, it's split among the gen creditors who filed claims on time. If there's not sufficient money to pay all creditors at a particular level, the creditors share pro rata. The priority rules are prob the most heavily tested rules related to bankruptcy on the CPA exam. Need to memorize order of pmt and the dollar limitations in SAG WEG CTI. Most importantly, remember that pmts are made 1st to secured creditors to the extent of the value of the collateral securing their claims and that claims in excess of the collateral are treated like claims of other gen creditors. 9 subcategories of priority claimants: *SAG WEG CTI*. 1. 1st priority; *S*upport obligations to spouse/children: 1st priority goes to claims for domestic support obligations owed to a spouse, former spouse, or child of the debtor on the date the petition is filed. 2. 2nd priority; *A*dministrative exps: the exps of a bankruptcy administration receive 2nd priority. Incl costs of preserving the estate, trustee fees, filing fees, attorney/acctant fees, etc. 3. 3rd priority; involuntary case *G*ap claims: claims that accrue in the ord course of bus after an involuntary petition is filed, but before the entering of the order for relief or appointmt of a trustee, receive 3rd priority.
Other Considerations Related to Cost Recovery Adjustments
1. AT CFs: financial models used for cap decisions focus a financial manager on the CFs assoc'd w/ an investmt and the comparison of those CFs w/ the expected rates/amts of return. B/c amort, depreciation, and depletion rep declining economic value of an asset but not an actual CF, these noncash exp charges must be added back to NI for the calc of AT CFs. AT CF = [earnings AT + amort + depletion + depr]. AT CF can also be repped as [pretax CF x (1 - tax rate)], where pretax CF is calc'd as [pretax earnings + noncash exps like amort, depletion, and depr]. 2. Tax savings assoc'd w/ deductions: the tax savings assoc'd w/ taking amort, depletion, or depr can be calc'd as [the amt of the exp x the MTR for the taxpayer]. This is important when considering investmt in an asset.
Tax Matters in the Federal Court System; Little Things to Remember
Taxpayers can rep themselves in any of the cts. The taxpayer doesn't have to go to DC to have a case tried in any of the cts, since the ct of fed claims allows videoconferencing and the tax ct has courtrooms across the country. Jury trials can only be requested in US district ct. The IRS gen has the burden of proof in civil cases before all of the cts for tax litigation.
Corporation; Calendar Year v Fiscal Year and Foreign Corporation Must Qualify
Calendar yr v fiscal yr: cos typically have the option of choosing a calendar YE (on 12/31) or a fiscal YE (ending on any other day than 12/31). For tax purposes, a fiscal YE must 1st be approved by the IRS. Foreign corp must qualify: a foreign corp must obtain a certificate of auth from each state in which it does intrastate bus. A foreign corp is a corp created under the laws of another state. Maintaining an office in the foreign state W/B an ex of being bus in the foreign state. Merely maintaining a bank acct, collecting a debt, or hiring employees in a foreign state are not instances of doing bus in the foreign state sufficient to trigger the qualification rqmt.
Liquidation of an LLC
The liquidation of an LLC and the consequences to its members will be treated the same as either a corp or a pship, whichever form the LLC elected to take for fed IT purposes upon formation.
Upon Dissolution of a Partnership
Each partner continues to have liab for pship debts and each partner continues to have apparent auth. The apparent auth of a partner can only be negated upon proper notice to 3rd parties.
Corporation; Directors: Rights, Duties, Obligations, and Authority Continued
Under the right to rely, a director is entitled to rely on info, opinions, reports, or stmts (incl F/S) if prepared by: -corp officers, employees, or a committee of the board whom the director reasonably believes to be reliable and competent or -legal counsel, acctants, or other persons as to matters the director reasonably believes are w/in such a person's prof competence. This is basically due diligence. Directors owe their corp a duty of loyalty and must act in the bests ints of their corp. The duty of loyalty prohibits directors from competing w/ the corp, but doesn't necessarily prohibit them from transacting bus w/ the corp (buying from/selling to the corp). An action in which a director has a conflict of int will be upheld only if: -after full disclosure the trans is approved by a disinterested majority of the BOD or the SHs or -the trans was fair and reasonable to the corp. The BOD has the power to set director comp. Gen, corps are allowed to indemnify directors for exps for any lawsuit brought against them in their corp capacity. The corp may also pay any judgmt imposed in a lawsuit on the director, except in a SH derivative suit. No indemnification if bad faith.
Common Features of Chapter 7 and 11 Cases; Claims Against the Estate and Miscellany
Claims against the estate: incl all rights to pmt from the debtor's estate. To have a claim allowed (right of pmt against the debtor's estate), unsecured creditors must *file* a proof of claim, and SHs must *file* a proof of int w/ the bankruptcy ct. Unless someone objects, a filed claim/int will automatically be allowed by the ct. An unsecured creditor who fails to timely file a claim may not take part in the distr of the debtor's estate. The GR is that a perfected security int passes through and survives bankruptcy even if the creditor doesn't file a proof of claim. Miscellany: the trustee can also serve as a professional (tax preparer, acctant, or lawyer) for the estate if the ct approves. A trustee serving as a tax preparer for the estate may receive comp as a prof in addition to the trustee's comp, if a ct approves.
Creditors' Rights Outside of Suretyship
When a debtor owes a creditor money and doesn't have sufficient funds to pay, the debtor has few options to alleviate the debt. Besides filing a petition for bankruptcy, the debtor can enter into a creditors' composition OR make an assignmt of the benefit of creditors. A creditor's composition is an agreemt btw the debtor and at least 2 creditors that the debtor pays the creditors < their full claims in full satisfaction of their claims. Contract consideration arises from the agreemt by each creditor w/ each other to take < his full claim. This proc results in the debtor being discharged in full for the debts owed the participating creditors after the debtor has paid the agreed amt. In an assignmt for the benefit of creditors, the debtor transfers some/all of his prop to a trustee, who disposes of the prop and uses the proceeds to satisfy the debtor's debts. The debtor is *NOT* discharged from unpaid debts by this proc since creditors don't agree to any discharge.
Tort Liability Continued Further
Although the GR is that an employer isn't liable for torts committed by an agent that is a mere indep contractor, an employer can be liable for torts of an indep contractor if the employer auth'd the tortious act or if the work involved an ultra-hazardous activity (blasting, which is basically demolitions). Summary chart for liab of principal for agent's torts: -Step 1: is the agent an employee or indep contractor (look chiefly to the extent of principal's control over the manner/method of agent's performance)? -if employee, step 2. -if indep contractor: principal is gen not liable for the torts of an indep contractor. -Step 2 (if employee): was the act w/in the scope of employmt (was the employee where he was supposed to be, doing what he was supposed to be doing, w/ the purposes of the employer in mind?)? -if yes, principal is liable. -if no, principal isn't liable.
Excluded Gift or Bequest
An amt will not be treated as an excluded gift/bequest if the governing instrument provides that the specific sum is payable only from the inc of the estate/trust.
Personal Holding Company Deductions in Determining Undistributed Personal Holding Company Income Prior to the Dividend-Paid Deduction
A PHC deducts fed inc taxes and net LT CG (less related fed inc taxes) in computing undistr'd PHC inc.
Determination of Partner's Share of Income, Credits, and Deductions; Taxable Income
A partner must incl his distr share of pship inc (even if not rec'd) in his TR for his taxable yr in which the taxable yr of the pship ends. Common concept on CPA exam is the timing of TI to a partner. Easy way to remember the timing of TI and basis impact is to assoc the pshop int w/ a bank acct: -inc is taxable and incr basis. -withdrawals are nontaxable and decr basis (already taxed on money withdrawing).
Distributable Net Income (DNI) Calculation
Absent written provisions to the contrary, CG/Ls are classified as principal and must remain w/ the estate/trust (allocated to corpus) to be taxed at the estate/trust level. Not part of DNI. All other TI (gross inc net of deductible exps) generated by fiduciary assets is gen classified as DNI, which is adj total inc w/ mods for TE int (which is incl in DNI and allocated as TE) and CG/Ls (excluded from DNI and allocated to corpus). For DNI purposes, there's nospecial rule abt exps chargeable against principal (corpus), so doesn't matter if for accting purposes something (like a trustee fee) is split btw corpus and income, still deducted in full for calcing DNI. Don't forget the inc distr deduction is the LESSER OF: -[DNI - TE int] or -[actual distr - TE inc (not just TE int)].
Unrelated Business Income (UBI); Taxation of UBI
Although an org may have TE status, it may become subj to regular corp IT on inc from a bus enterprise not related to its TE purpose (UBI). The fact that an activity results in a loss doesn't exclude it from the definition of an unrelated bus (if exps exceed inc, a NOL exists, which is subj to the CB and CF provisions of NOLs). When subj to tax (reqing filing of a form 990-T), the TE org must comply w/ code provisions regarding installmt pmts of estimated IT by corps. Tax on UBI. A corp is allowed a 1k specific deduction from UBI. No tax on 1st 1k, so only UBI in excess of 1k is subj to tax. In addition to the 1k specific deduction, these types of inc are excluded from tax: -royalties, divs, int, and annuities (except those derived from controlled orgs). -rents from real prop and rents from personal prop leased w/ real prop (if <50% is attributable to the personal prop), other than inc from debt-financed prop. -G/Ls on the sale/exchange of prop not held primarily for sale to customers in the ord course of trade/bus. -inc from research of a college/hospital. -inc of labor unions (and agricultural/horticultural orgs) used to establish a retiremt home, hospital, or sim exclusive-use facilities. -activities limited to exempt orgs by state law (like bingo games). Games of chance. -the value of secs loaned to a broker and the inc rec'd by a lender of secs to a broker, provided the identical secs are returned to the lender. -inc from the exchange/rental of membership lists of TE charitable orgs.
Corporation; Directors: Rights, Duties, Obligations, and Authority
Among the specific duties of the directors are the election, removal, and supervision of officers (directors gen review the conduct of officers and may remove an officer w/ or w/o cause); adoption, amendmt, and repeal of bylaws; fixing mgmt comp; and initiating fundamental changes to the corp's structure (*DAMS*). Directors aren't indiv agents, but fiduciaries. No proxy to vote, need a quorum, and must have majority vote to get things done. The BOD has sole discretion to declare distrs to SHs, incl divs, in the form of cash/prop/the corp's own shs. The SHs have no power to compel a distr. Directors who auth a distr in violation of law (like when the corp is insolvent) are personally liable to the extent the distr exceeds what would have been lawful. However, they can defend under their right to rely. The director can also recover from a SH who rec'd a contr knowing it was unlawful. Directors are fiduciaries of the corp and must act in the best ints of the corp. Directors are *NOT* insurers of the corps success. A director will *NOT* be liable to the corp for acts performed/decisions made in good faith, in a manner the director believes to be in the best int of the corp, and w/ the care an ordinarily prudent person in a like position would exercise (this is the bus judgmt rule. Due diligence necessary). Directors will be liable to the corp only for negligent acts/omissions (like failure to obtain fire ins, hiring a convicted embezzler as treasurer w/o looking at his record, etc.).
Affiliated Groups and Transfer Pricing
An affiliated group of businesses having ops in several countries and conducting sales btw affiliates could have a pricing structure that intentionally/unintentionally understates inc in some/all of those countries, incl the US and results in some countries not receiving as much inc tax. Book ex for sales btw affiliates: H co, a US based co, owns 100% of the stock of 3 subs, each in a diff country. -M co, a manufacturer in country M w/ a 10% tax rate. -W co, a wholesaler in country W having a 20% tax rate. -R co, a retailer in the US having a 30% tax rate. Country M and W use the US dollar. M co manufactures/sells widgets to W and unrelated parties. W also sells those widgets to R. R sells the widgets to retail to unrelated parties for $9/widget. M co's COGS is $1/widget. Assume none of the subs have any SG&A exps, M & W don't impose any withholding on divs paid by cos in those countries to SHs in other countries, and there's no inc tax on divs rec'd. Ideal way for H co to structure sales btw subs to minimize inc taxes: -M co sells to W at 10% tax rate, pays $0.80 of tax ($9 - $1 COGS = $8 x .1 = .8). NI is 7.20, want all inc reported here to pay lowest tax. -W sells to outsider or to R at 20% tax rate. COGS = SP, both are 9, so no EBT and no taxes. -R sells to outsider at 30% tax rate. COGS = SP, both are 9, so no EBT and no taxes. -the group isn't paying any inc taxes to the US or country W, so both of their taxing authorities W/B displeased. -IRC sections 482 and 6662(e)(3) provide the IRS w/ the auth to (i) adj the inc/deductions (incl the COGS) of M, W, and R to prevent evasion of taxes or clearly reflect inc AND (ii) to impose penalties w/ respect to those adjustmts. The IRS would most likely reduce R's COGS, and R would then pay IT to the US treasury. The corp group knows that every widget the group (via R) sells to end users/customers will bring the group $9. So, ignoring IRC section 182, the group wants to set up interco pricing arrangemts that will minimize the group's IT due, per sale, to all countries. The best way to do so is to have M sell to W at $9, W sell to R at $9, and R sell to the end customer at $9. That way, the entire profit of the corp group is reported by M, the co subj to the lowest IT rate.
Circular 230; Compliance
An indiv/indivs who have principal auth for overseeing a firm's fed tax practice must take reasonable steps to ensure the firm has adequate procs to ensure compliance w/ circular 230. I/C. Disseminate, educate, test. Potential failures to comply: -the indiv fails to have adequate procs to comply w/ circular 230, there's a pattern/practice of noncompliance, and this occurs through willfulness/recklessness/gross incompetence. -the indiv fails to ensure the procs for compliance are followed, there's a pattern/practice of noncompliance, and this occurs through willfulness/recklessness/gross incompetence. -the indiv knows/should know of a pattern of noncompliance and fails to take prompt action to correct it.
Who May Be a Debtor
Only a person who resides, or has a place of bus, in the US is eligible to be a debtor under the bankruptcy code. Person gen incl IPC and the like. Limitation in ch 7 liquidations is no *RIBS*. *R*ailroads, *I*ns cos, *B*anks, *S*avings institutions, and *S*mall bus investmt cos may not file for bankruptcy under ch 7. Limitation in ch 11 record is no *BIBS*. IBS is the same, B changes. Anyone who may be a debtor under ch 7 may also be a debtor under ch 11 (except a stock*B*roker or commodity *B*roker). A *R*ailroad may be a debtor under ch 11. Switch R for B! Although ch 11 is intended primarily for bus debtors, an indiv is eligible for relief under it. GR for both ch 7 and 11 is IPC and voluntary or involuntary. Important to know who may/may not file under various chs. If the debtor is an indiv, credit counseling is req'd. Must occur no > 180 days before filing the bankruptcy petition. In addition, debtors filing under chs 7 or 13 must complete a financial mgmt course before their debts are discharged.
Debt in Transfers to Corporations
Only considered boot when it's in excess of basis.
Section 754 Election and Section 743(b) Basis Adjustment
Pships have the option to make a section 754 election when certain distrs of prop from the pship to a partner occur, or when there's a transfer of a pship int by sale/exchange, or upon death of a partner. In the case of a section 754 election being made by reason of sale/exchange, a section 743(b) adjustmt follows. The section 743(b) adjustmt is the diff btw the value of the outside basis to the transferee partner (purch price) and his share of the pship's inside basis of the assets. The adjustmt, which can be pos/neg, is prorated over the pship assets under the rules set forth in section 755. The goal of the adjustmt is to make the transferee have an inside basis in the pship assets equal to his outside basis. The adjustmt is specially allocated only to the transferee and has no effect on the pship's inc/loss. Once the election is made, it remains in effect for all future trans (being revoked only w/ IRS permission). Even in the absence of a section 754 election, the IRS madates 743(b) adjustmt when there's a substantial BIL at the time of purch (inside basis > outside basis by 250k +). Book ex for transfer of pship int: O purchases B's 25% int in H pship for 500k. At the time of sale, H makes a 754 election to adj the basis of the pship asset. Immediately before the sale, the inside basis in the pship asset (a bldg) is 1.2M, and the FMV is 2M. Calc the basis adjustmt req'd under section 743(b) and descr the consequences of a future sale of the asset. -743(b) basis adjustmt = [500k purch price of pship int - 300k (O's 25% int in the 1.2M inside basis of the pship assets] = 200k. This is allocated entirely to O. The basis adjustmt is a tax concept and doesn't impact the BV of the pship's assets. -if the bldg is subseq sold at FMV of 2M, a tax gain W/B recog'd in the amt of 600k [2M - 1.4M adj basis w/ step up]. The 600k gain W/B allocated to the other parties besides O. No gain is allocated to O.
Tax Credits; Education Tax Incentives Continued Further
Summary of 2017 education tax incentives: Income exclusion: 1. US savings bond - series EE: -GR: exclude int inc -limit: must pay educational exp -income phase-out: AGI 78,150 - 93,150 (S) and 117,250 - 147,250 (MFJ). 2. Employer-paid education exps: -GR: exclude from inc -limit: up to 5,250 per yr -income phase-out: no inc limit 3. Scholarships: -GR: exclude from inc -limit: only tuition, books, and fees -income phase-out: not room and board Adjustmts: 4. Educator exp: -GR: deduct above the line -limit: $500/250 -income phase-out: no inc limit 5. Coverdell education savings acct: -GR: nondeductible -limit: 2k -income phase-out: AGI 95k - 110k (S) and 190k - 220k (MFJ) 6. Student loan int deduction: -GR: deduct above the line -limit: 2,500 -income phase-out: AGI 65k - 80k (S) and 135k - 165k (MFJ) 7. Tuition and fees: -GR: deduct above the line -limit: 4k -income phase-out: AGI 65k - 80k (S) and 130k - 160k (MFJ) Itemized deductions: 8. Educational exps: -GR: maintain and improve -limit: subj to 2% AGI test -income phase-out: none Credits: 9. AOC: -GR: 1st 4 yrs -limit: 2,500/person -income phase-out: AGI 80k - 90k (S) and 160k - 180k (MFJ) 10. Lifetime learning credit: -GR: after 1st 4 yrs -limit: 2k max -income phase-out: AGI 56k - 66k (S) and 112k - 132k (MFJ) Misc: 11. 529 plan (QTP): -GR: no deduction, no inc -limit: gift tax rules -income phase-out: none
Other Taxes
1. SE tax: boss and employee. The SE tax reps the employer portion and employee portion of FICA taxes (social sec and Medicare) imposed on SE inc. 100% of SE tax is collected as an other tax and reported in the other taxes section. 50% of this amt is reported as an adjustmt to arrive at AGI. 1- Additional Medicare tax: the affordable care act imposes an additional Medicare tax of 0.9% on wages > 250k for MFJ, 125k for MFS, and 200k for all other taxpayers. -employers are responsible for withholding this additional tax on all wages paid to an employee > 200k in a calendar yr. -any amts withheld in excess can be claimed as a credit on the taxpayer's indiv inc TR. -additional Medicare tax is calc'd on Form 8959 and reported in "other taxes" on Form 1040. 2- Net investmt inc tax: the net investmt inc tax went into effect 1/1/13 and applies a rate of 3.8% to certain net investmt inc of indivs w/ inc above the statutory threshold amts. The statutory threshold amts are 250k for MFJ and 200k for single or HOH. Gen, investmt inc incl, but isn't limited to: int, divs, CGs, rental and royalty inc, nonqualified annuities, and inc from businesses involved in the trading of fin instruments or commodities and businesses that are passive activities to the taxpayer. Form 8960 is used to calc the net investmt inc tax in the "other taxes" section.
Adjusted Basis and Holding Period of Assets Sold; Gifted Property Basis for Gain/Loss Purposes
2 of 3. GR: donor's rollover cost basis/NBV (gifts Nontaxable). Prop acq'd as a gift gen retains the cost basis it had in the hands of the donor at the time of the gift. Basis is incr'd by any gift tax paid that's attributable to the net appreciation in value of the gift. G/Ls are calc'd using this rollover cost basis (subj to exception). Exception: Lower FMV at date of gift. If the FMV at the date of gift is < the rollover cost basis from the donor, the basis for the donee depends on their future selling price of the asset. 1. Sale of gifts at a price > the donor's rollover basis (gain basis): when a taxpayer sells a gift for > the rollover basis, the gain shall be the diff btw the SP and that rollover basis. -Book ex: donor gives non-depreciable prop worth 3k w/ an adjusted basis of 5k to taxpayer, who subseq sells the prop for 6.5k. Basis used is the 5k rollover, gain is 1.5k (6.5k - 5k). -helps to put things in order. Write cost basis and FMV and see where SP falls on the scale. The one it's closer to (like higher cost basis if it's above cost basis) will be the one used to calc G/L. 2. Sale of gifts at a price < the lower FMV (loss basis): when a taxpayer sells the gift for < the lower FMV at the date of gift, the basis of the gift for purposes of determining the loss is the FMV of the gift at the time it was given. -Book ex: donor gives prop worth 3k w/ adjusted basis of 5k to taxpayer and subseq sells it for 1k. Basis used is the lower 3k, loss is 2k (3k - 1k). The loss may/may not be deductible depending on the situation. -SP of 1k is < 3k on the scale, closer to 3k so that's the basis used to calc the G/L. 3. Sale < rollover cost basis but > lower FMV (in the middle): when a taxpayer sells a gift for < the donor's rollover cost basis but > the lower FMV at the date of gift, *neither a gain or loss* is recog'd. The basis to the donee is the middle selling price! -continuing prior ex, if sell for 4k, that's in the middle of 5k and 3k. Basis is 4k, G/L is 0 (4k - 4k).
Contributions to a Corporation in Exchange for Stock
G/Ls are gen not recog'd by SHs and corps upon contr of prop in exchange for stock at formation when immediately after the transfer, the contributing SHs, in aggregate, control the corp (80%) to which they transferred the prop. Unlike the initial formation of a corp, it's likely that subseq contrs will not result in 80% control of the corp (like if only 1 member of the OG group is now transferring assets for stock, or a new SH is admitted). In this case, the control test won't be met and the contr is treated as a sale to the corp for FMV, resulting in a G/L recog'd by the contributing SH. This is for subseq transfers of stock.
Gains (Excluded or Deferred); Divorce Property Settlement
HI*D*E IT. Basis = NBV = nontaxable. When a divorce settlemt provides for a lump-sum pmt or prop settlemt, it's a nontaxable event. The basis of the prop to the recipient spouse will be the carryover basis (basis in hands of transferor). This rule applies regardless of whether the transfer is of prop sep owned by the transferor or is a division (equal/unequal) of community prop. Nonrecognition rules apply even if the transferred prop is subj to liabs that exceed the adjusted basis of the prop (w/ the exception of prop in trust).
Included Within/Excluded From the Scope of the Secured Transactions Article (Article 9) of the UCC
Incl the sale of A/R. Excl a landlord's lien, the assignmt of a claim for wages, and the sale of chattel paper as part of the sale of bus out of which it arose.
Fair Debt Collection Practices Act (FDCPA)
The federal FDCPA curbs abuses by collection agencies in collecting consumer debts. The act does *NOT* apply to a creditor attempting to collect its own debts, just to services that collect consumer debts for others. The act severely restricts collection agencies' ability to call 3rd parties, like relatives of the debtor, to indirectly pressure the debtor. Can contact 3rd persons to discover a debtor's whereabouts, but can't disclose that it's a collection agency or the debtor owes debt. The FDCPA also prohibits: -contacting the debtor at inconvenient/unusual times. In most cases convenient times are btw 8 AM and 9 PM. -contacting the debtor directly if the debtor is repped by an attorney. -using harassing/abusive language in talking to the debtor (pay or we will hurt you). -making false/misleading claims (we can put you in jail for not paying). -contacting the debtor at his place of employmt if the employer objects. A debtor has the power to terminate the collection agency's contacts by notifying the agency in writing that the debtor will not pay the debt and to stop further comm. The agency must stop comms except to inform the debtor that it's bringing a lawsuit/seeking other remedies. The FDCPA gives debtors the right to sue for actual damages (money) caused by the collection agency's misconduct. Also provides a statutory 1k damage award. The federal trade commission (FTC) can bring administrative enforcemt actions under the act to force a collection agency to comply w/ the act's provisions.
Late Payment Penalty
An extension is for time to file, not time to pay. Still need to pay by OG due date of return. Penalty is 1/2 a percent for each mo/fraction of a mo late, up to a max 25%.
Rescission
Available under the 34 act, but not section 11 of the 33 act (monetary damages only for 33 act).
Dissolved v Discharged; Chapter 7 Bankruptcy
Dissolved: corp/pship. Discharged: indiv.
US District Court Cases
Heard before 1 judge, not a panel of judges.
Miscellaneous Information from Question
If a partner w/o actual/apparent auth enters into a contract, the pship is only bound by it if it ratifies. Amending the pship agreemt (to grant auth) wouldn't bind the pship bc auth must exist at the time the contract is made or the pship must ratify the contract.
Little Nuance In MCQ
If a prop's FMV is < the amt of the liab assumed, its FMV is assumed to be the amt of liab assumed by the SH. So use liab amt to calc G/L instead of FMV.
Transfer to Fully Secured Creditor
Pmts to fully secured creditors (oversecured) w/in the preference pd (90 days or 12 mos for insiders) will not be set aside as a preferential transfer.
US v Foreign Source Income
Remember that inc from the sale of purch'd inv is sourced where title passes. Inc from compensation for personal services is sourced where the services are performed.
Personal Losses
Remember that these are *NOT* deductible! Like sale of personal prop (ex: furniture).
Quirky S Corporation Rule
Rule that S status terminates if passive investmt inc is >25% of gross receipts for 3 consecutive yrs (3 strikes and you're out) only applies if the corp was a C corp at some point. If the corp has been an S corp from its inception, this is fine!
Calculating Sales Price for Equipment Sold
SP = [adjusted basis + gain].
Itemized Deductions
Shown on sch A of the 1040.
Solving For Depreciation Recapture for a Building Owned by an Individual
There is no depr recapture bc under current tax law the sale of real prop by indivs doesn't result in depr recapture, so all gain is section 1231 gain (none is recapture).
Adjustments to arrive at AMTI; Medical Expenses
These are an adjustmt to arrive at AMTI to the extent they *DON'T* exceed 10% of AGI (deductible if they're > 10% of AGI).
Tax Rate for an S Corporation that Pays Tax on Built-in Gains
35%, the highest corp tax rate.
Advanced Pricing Agreement Program
Binding contract btw the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustmt for a covered trans if the taxpayer files its return for a covered yr consistent w/ the agreed transfer pricing method.
Died Intestate
Died w/o leaving a valid will.
Qualified Dividends
Get a better tax rate. Available to lower tax brackets (15-20%), but not the highest ord inc tax brackets (up to 39.6%).
The Taxpayer Can Generally Avoid Penalties If...
He acted in good faith, there was a reasonable basis to support the tax position, and he didn't have willful neglect.
Depreciation; MACRS: Personal Property Other than Real Property
Machinery and equip. Types of prop: -3 yr 200% class: asset depr range (ADR) midpoints of 4 yrs or less. Excludes autos and light trucks, incl racehorses > 2 YO and other horses > 12 YO, and special tools. -5 yr 200% class: ADR midpoints of > 4 yrs and < 10 yrs. Incl autos, light trucks, comps, typewriters, duplicating equip, and copiers. -7 yr 200% class: ADR midpoints of 10 yrs +, and < 16 yrs. Incl office furniture/fixtures, equip, prop w/ no ADR midpoint not classified elsewhere, and incl railroad track. -10 yr 200% class: ADR midpoints of 16 yrs and more, and < 20 yrs. Incl boats and water transportation equip. -15 yr 150% class: ADR midpoints of 20 yrs and more, and < 25 yrs. Incl sewage treatmt plants, telephone distr plants, qualified improvemt, restaurant and retail prop, and comparable equip use for the 2-way exchange of voice and data communications. -20 yr 150% class: ADR midpoint of 25 yrs +, other than retail prop w/ an ADR of 27.5 yrs +, incl sewer pipes. Notice only bottom 2 are 150% (so after 20 yrs). For 3, 5, 7, and 10 yr prop (other than real prop) placed in service after 1/1/87, MACRS is computed w/ the 200% declining bal method. For 20 yr prop, MACRS is computed using the 150% declining bal method. SV is ignored under these methods. In general, a half-yr convention applies to personal prop, under which such prop placed in service or disposed of during a taxable yr is treated as having been placed in service/disposed of at the midpoint of the yr. This is in the yr you buy/sell it. If >40% of depreciable personal prop is placed in service in the last quarter of the yr, the mid-quarter convention must be used (identify the MACRS table w/ mid-quarter as the applicable convention to calc depr). This is if bottom-heavy w/ 40% in last quarter. Quarters can be split btw the % at the beginning of the quarter until YE and the % at the end of the quarter until YE (for Q4, 25% until YE at beginning of quarter, 0% at end. 1/2 is 12.5% until YE). Both mid-quarter and mid-yr conventions are for machinery and equip (personal prop). Book ex for MACRS depr: shows half-yr convention. Remember SV ignored. Gen, the calc of MACRS depr exp for an entity that has been in op for the entire yr is to take the purch price (+ improvemts) and multiply that amt by the applicable MACRS factor. Proration isn't applicable in the gen case and only applies to short tax yrs (when the entity begins ops some pd of time into the tax yr). Assume a co started bus in Y1 and purch'd office furniture on 2/14/Y3 for 10k. Assume this was the only asset purch during the yr (to avoid possibly applying the mid-quarter convention rules) and that no special depr rules apply. Office equip is MACRS 7 yr prop. -the depr exp for Y3 W/B [10k x .1429 (from MACRS table)] = $1,429. -the depr exp for Y4 W/B [10k x .2449] = $2,449. -the exp is lower in the 1st yr bc of the 1/2 yr convention. -the sum of the factors in the MACRS table for a type of asset will = 100. -gives depr table for machinery and equip, showing applicable depr method as 200 or 150% declining bal switching to SL. Shows applicable recovery pd (3, 5, 7, 10, 15, and 20 yrs). Shows applicable convention as half-yr. Calc of depr exp is simple once you can ID the applicable factor.
Avoiding a Contract Based on Duress
Must show that the seller's improper threats actually induced the purchaser to assent to the contract. Did the wrongdoers actions actually affect the other party?
The Gift Tax (Form 709); Recipients: Nontaxable
Nontaxable = no inc = NBV. The recipient of a gift pays no gift tax, and the gift doesn't rep TI to the recipient. The GR for the basis of gifts rec'd is that the basis to the recipient equals the [donor's basis + gift tax paid due to the appreciation in value inherent in the gift].
Points on a Mortgage on the Purchase of a Personal Residence
Points on a home mortgage loan to purch a principal residence are deductible in the yr paid to the extent that the pmt of points is an established practice in the area and the amt paid doesn't exceed the points gen charged in the area for a home loan. Other than that, the points are capitalized and amort over the life of the loan.
MCQ Nuance - Revoking S Election
S corp status can be revoked if SHs owning > 50% of the total no of issued/outstanding shs consent. The percentage of voting v nonvoting SHs isn't considered, just the total. So don't be preoccupied w/ classification as voting/nonvoting, just ensure the total no of SHs is at least 50% to revoke.
Bankruptcy Questions
Savings and loans may not participate in ch 11 or 7 bankruptcy proceedings. Ins cos can't go into bankruptcy voluntarily/involuntarily under the bankruptcy code.
Anti-Fraud Provisions of the 1933 Act
Still apply to mat misreps in NFP F/S. Where a prospectus is issued and contains mat misreps, liab can be imposed under the 33 act. Doesn't matter that NFP secs are exempt from registration.
Misc Notes From Introductory Video
Taxable = always use F*M*V. *N*ontaxable = *N*o inc, *N*BV used.
Gains and Losses; Calculation Rules
The basic formula in determining the G/L is: [Amt realized - adjusted basis of asset sold] = G/L. Amt realized incl: 1. cash rec'd (boot/loot) 2. assumption of debt by buyer (if excess COD, boot/loot) 3. prop rec'd at FMV and 4. services rec'd at FMV The amt realized is *reduced* by selling exps (like broker's commissions). Book ex for realized gain: taxpayer conveys commercial prop in which he has a basis of 70k and which is subj to a mortgage of 45k to X for 60k in cash, and X's assumption of the mortgage on the prop. Determine the amt realized on the sale and the G/L realized. -amt realized = [60k cash + 45k COD] = 105k. -realized gain = [105k amt realized - 70k basis] = 35k.
Summary of Formation Defenses
The examiners often ask if a particular defense will make a contract void or voidable. Chart summarizing the rules. Defenses making contract void: *AIM PE* -*A*djudicated incompetency -*I*llegality -*M*utual mistake -*P*hysical duress -fraud in the *E*xecution Defenses making contract voidable: -fraud in the inducemt -innocent misrep -economic duress -undue influence -unilateral mistake -minority -intoxication
Basis; Basis of Contributing Partner's Interest Continued
Use old/contr'd assets' holding pd (PP&E). If the prop was prev a cap asset or section 1231 asset in the hands of the partner, the partner's HP for the pship int incl the HP of the prop contr'd. If the prop is an ord inc asset (like inv), the HP begins on the date the prop is contr'd to the pship. Subseq contrs will incr a partner's basis. Subseq withdrawals will decr a parter's basis. After initial formation, the partner's basis will: -incr by his pro rate share of inc and incr by new pship liabs. -decr by his pro rata share of losses and decrs in pship liabs. When a partner contrs prop w/ a FMV higher/lower than the props adjusted basis (NBV), a BIG or built-in loss (BIL) exists at the date of contr. Upon the subseq sale of that prop, the BIG/L that existed at the date of contr must be specially allocated to the contributing partner. Any G/Ls that occur after the contr date are allocated among the partners in the pship. So w/ prior ex where T gave bldg: If FMV was 500k and NBV was 100k, 400k BIG. Allocate this to T on sale.
Worthless Stock: Section 1244 Stock (Small Business Stock)
When a corp's stock is sold/becomes worthless, an OG stockholder can be treated as having an ord loss (fully tax deductible) instead of a CL, up to 50k (100k if MFJ). Any loss in excess of this amt W/B a CL, which would offset CGs and then a max of 3k (1.5k if MFS) per yr W/B deductible. Max ord loss deduction: -100k if MFJ. -50k for all other filers. Qualifications: -cash/prop paid to the corp in exchange for its 1st 1M of cap stock. -the stock must have been issued to an indiv SH or pship for money/other prop, but not stock/secs or services rendered.
S Corporations
*C* Corp = *C*o pays tax. *S* Corp = *S*H pays tax. Small, closely held corps may elect to be treated in a manner sim pships. All the earnings/losses of the corp are passed through to the SHs. Corps whose owners elect to treat them as flow-through entities are classified as such under the subchapter S rules of the IRC. This election gen results in no corp-level tax, but indivs are taxed on their share of corp earnings regardless of whether the corp actually distrs the earnings to them. An S corp is formed by 1st forming a C corp and then making an election (agreed upon by all SHs) on Form 2553 to be treated as an S corp. Realized/recog'd G/L to the corp and SHs upon contr of assets in exchange for stock are computed in the same manner as a C corp. Although setting up an S corp affords a co many tax advantages sim those of pships, some S corp traits are the same as C corps. Taxability of SH contrs to an S corp are governed under Section 351, in the same manner as C corps. A contr will be tax-free if it's: 1. a contr of prop (NBV) (not services - taxable at FMV). 2. solely in exchange for stock and 3. after the transfer, the SH (or group of them transferring in an integrated trans) has control of the corp through 80% stock oship. Transfers falling outside these terms will be treated as a taxable sale (gain recog'd for FMV rec'd over SH's basis). The rqmts for section 351 are fairly easily met upon formation of an S corp, but are harder to meet upon subseq contrs of prop by indiv SHs or new SHs. Contrs to the S corp also incr the SH's basis. Book ex for contrs to S corps: R contrs prop w/ FMV of 20k and an adjusted basis of 10k in exchange for stock in F corp, an existing S corp. Immediately after the transfer, R owns 20% of F's stock (needed 80% to be tax-free). Determine the realized/recog'd G/L on the transfer to R and his basis in the S corp stock. -recog'd gain = [20k FMV - 10k adjusted basis] = 10k. This is bc R didn't have 80%+ oship in F after the exchange, so has to recog gain on transfer. -R will have a 20k basis in F (10k carryover basis + 10k gain recog'd). F's basis in the prop rec'd is also 20k.
Defenses of Surety
*CPRS*. Don't have to pay the creditor. 1-3 = *C*reditor bad faith. 1. Defrauded principal: the surety may use as a defense that the principal debtor was induced to enter into his contract by the creditor's fraud. However, fraud by the principal debtor is not a good defense for the surety against the creditor unless the creditor was aware of the fraud. 2. Duress upon principal: the surety isn't liable if the principal debtor's promise was obtained by duress and the surety didn't know of the duress. 3. Illegality of the principal's obligation: the surety isn't liable if the underlying obligation btw the creditor and principal debtor is illegal. 4. Discharge of principal's obligation: if the underlying obligation is *P*aid or the principal debtor tenders *P*erformance, and the creditor refuses to accept it, the surety is no longer liable. If the creditor *R*eleases the principal, the surety is discharged unless the creditor reserved her rights against the surety. 5. *S*urety's incapacity or bankruptcy: the surety's own contractual incapacity (minority, adjudicated insanity, etc.) or bankruptcy is a defense for the surety. 6. Lack of consideration: no contract. Like all contracts, the promise to serve as a surety must be supported by consideration to be enforceable. That doesn't mean the surety must be paid! An unpaid surety (gratuitous surety) will be bound if he makes the promise to act as surety *before* consideration flows from the creditor to the principal debtor. Book ex for gratuitous surety: a mother's gratuitous promise to serve as surety on her son's car loan is supported by consideration if the mom's promise is made before or contemporaneous w/ the time the seller becomes obligated to deliver the car. If the gratuitous promise is made after the son receives the car, there's no consideration to support the promise. 7. Variations of the surety's risk: gratuitous v paid. Any variation of the contract that changes a gratuitous surety's risk will discharge the gratuitous surety. A variation of a contract that changes a compensated surety's risk will discharge surety only if the change is mat and incrs the surety's ROL (see 9 and 10). Book ex for comp'd v gratuitous surety: the principal is OG obligated to build a parking lot 148 feet by 90 feet. If the principal and creditor agree to change the contract to a lot 138 x 90 ft, a gratuitous surety is discharged. The risk has been varied. But a compensated surety wouldn't be discharged, both bc the change doesn't appear mat and bc it makes performance easier (smaller lot).
Defenses: Fraud
*NO* defenses is the 3rd element of a legally enforceable contract. Defenses can make a contract unenforceable. This means the innocent party's duty is discharged. 2 defenses have been discussed - lack of agreemt and lack of consideration. Defenses are the most tested area in contracts. Pay close attention to the details. One key to making the right choice it to remember that very few defenses make a contract void (unenforceable by either party). Most make it voidable (may be voided at the option of the party adversely affected). So if you see a choice that says a contract is void bc of a certain defense, be careful - chances are it's incorrect. A contracting party can establish the defense of fraud if they can prove all 5 elements of *MAIDS*: 1. *M*isrep of *M*aterial fact by defrauding party: must be of a material fact. Opinions/stmts of value don't constitute facts unless made by experts. 2. *A*ctual or reasonable reliance: victim actually and reasonably relied on the misrep. Didn't indep check value from misrep in *M*. 3. Intent to *I*nduce reliance: make sale. The purpose of the defrauding party in making the misrep was to induce the victim to rely on the misrep. 4. *D*amages: compensatory and punitive. The defrauder is liable to anyone who suffered a loss. The defrauded party may rescind the contract or sue for $$ damages, but *NOT* both. 5. *S*cienter (intent to deceive): fraud is an intentional tort. The misrep must be made w/ scienter. This means the defrauder must make it knowingly/intentionally. This element also can be fulfilled by making the misrep w/ a *reckless* disregard for the truth (constructive fraud/gross negligence). Fraud can also be categorized by whether or not the defrauded party knew a contract was being made. Fraud in the execution occurs when a party is deceived into signing something that he doesn't know in a contract (ball player signs "autograph book" that's actually a contract). Fraud in the execution *makes a contract void*, not voidable, bc there's no meeting of the minds. Fraud in the inducemt is when the defrauded party is aware he is making a contract, but terms are mat misrepped. Most fraud is fraud in the inducemt. Makes a contract voidable.
The Securities Act of 1933; Exemption from Registration: Securities and Transaction Exemptions
*NOT* every sale of secs is covered by the 1933 act. The act has 2 types of exemptions; securities exemptions (secs issued by certain types of issuers) and trans exemptions (secs issued in certain types of trans). Section 3 of the 33 act specifically exempts these secs from the registration rqmts, they never have to be registered: *BRINGS* -secs issued by *B*anks and savings and loans (like CDs). -secs of regulated common carriers (like secs issued by *R*ailroads). -*I*ns policies (but stocks, bonds, and sim secs of ins cos are not exempt). -secs issued by *N*FP orgs. -secs issued by the *G*ovt (except for certain secs issued for proprietary rather than governmental purposes). -*S*T commercial paper (notes, bonds, etc.) w/ a maturity date of 9 mos or less. -secs issued under ch 11 of the bankruptcy code. -secs issued by a church plan or sim entity that's not an investmt co. The examiners often ask abt exemptions from the registration rqmts of the 33 act. Remember that all issues of secs must be registered unless the secs are exempt. Favorite secs exemptions on the exam incl secs of charitable orgs and bonds issued by municipalities for governmental purposes. Trans exemptions depend on the nature of the offering. Unlike secs exemptions, which exempt a sec forever, the trans exemptions exist only for the trans in Q. If the secs are resold, they must be registered unless they qualify for another exemption. Trans exemptions: -casual sales exempt: not an issuer, underwriter, or dealer. Registration rqmts apply only to issuers, underwriters, and dealers. Sales by others are considered casual sales and are exempt. Book ex for casual sale of securities: D, a CPA, owns 10k shares of GM stock and decides to sell them. She need not register, this is a casual sale. D is not the issuer, an underwriter, or a dealer. -exchanges w/ existing holders and corp reorgs: the 33 act provides an exemption when an issuer exchanges secs w/ its existing holders provided no commission is paid (stock divs and stock splits). There's also an exemption for govt-approved exchanges that occur as a result of corp reorg. -intrastate sales: section 3(a)(11) of the 33 act provides an exemption for secs offered and sold only to persons who are residents of the issuer's state (state in which it's doing bus). Under rule 147, which implements section 3(a)(11), the entire issue must be offered and sold only to residents of that state, the issuer must do at least 80% of its bus in that state, and purchasers can't resell the secs for 9 mos to nonresidents of that state.
Losses (Nondeductible)
*WRaP* up these losses and throw them away bc they're nondeductible (useless!). [Amt realized - basis of asset sold] = G/*L*. 1. *W*ash sale loss: a wash sale exists when a sec (stock/bond) is sold for a loss and repurch'd w/in 30 days before/after the sale date. Dealers in secs are excluded from wash sale rules if the loss occurs from a trans made in the ord course of bus. The loss on the wash sale is disallowed for tax purposes. The basis of the repurch'd sec = [purch price of the new sec + disallowed loss on wash sale]. Or, alternatively [basis of the old sec - proceeds from sale + purch price of the new sec]. The date of acq of the repurch'd sec is the date of acq of the OG sec. OG date. If a sec is sold resulting in a gain and it's repurch'd w/in 30 days, the taxpayer can't use substituted basis. Instead must pay CG tax and use the new purch price as the basis. Gain is recog'd/taxed. Book ex for inability to use substituted basis: B entered into 2 trans in April. -on 4/1: sold 100 shs of IBM. Cost 22k, SP was 21k, 1k loss. -on 4/25: bought 100 shs of IBM for 21.5k. The shs sold during the yr were purch'd 15 yrs ago. Determine if the sale qualifies as a wash sale, any loss allowed, and the basis of the purch'd stock. -qualifies as wash sale bc stock repurch'd w/in 30 days of sale. -loss disallowed! -basis of stock in 2nd purch = 22.5k [21.5k new cost + 1k disallowed loss]. The CPA exam has often tested the wash sale rules by having the taxpayer purch shares of the same stock 30 days *BEFORE* the sale of stock that resulted in a loss. This is *STILL A WASH SALE*, and any loss is disallowed! Ex: on 1/4 buy 1 sh for $100. On 3/5, buy another sh for $40. On 3/15, 1st sh is sold for $41. Realized loss is $59 (100 cost - 41 SP). Won't be recog'd bc of the wash sale rules. 2. *R*elated party trans: sales btw related parties aren't considered arms-length, and the loss is gen disallowed. Fam and 50% owned bus are related parties. For the basis, use gift tax rules. *a*nd 3. *P*ersonal loss: no deduction is allowed for the loss on a nonbus disposal/loss. An itemized deduction may be available in the casualty/theft category. The *WRaP* rules only apply to losses, not gains!
Defenses: Statute of Frauds Continued
-for *G*oods sold for $500 or more (MY LE*G*S): must be in writing. If a sales contract has been modified, it is the contract as it has been modified that determines whether a writing is req'd. Book ex for sale of goods for $500 or more: A offers to buy 200 books from B at $3 each to sell in her store. This contract must be in writing. Subseq, A discovers she has room only for 150 books and so calls B and asks if her order can be reduced. B agrees. The contract need not be in writing. Conversely, if the contract was for 150 books and then was mod to 200 books, a writing W/B req'd. The examiners often try to trick you w/ the $500 threshold. It applies only to good contracts. a $200 land contract must be evidenced by a writing, and so must a $400 3-yr service contract, etc. If you see $500 in an answer choice, be careful. If it doesn't involve the sale of goods, choice is prob wrong. The contract itself need not be in writing. All that's req'd is some writing that provides evidence of the mat terms of the contract that's signed by the person being sued. So a letter abt the contract could suffice, even one seeking to revoke it. Contracts for the sale of goods gen need only have a quantity term and a signature. The terms may be stated in > 1 doc. There's no rqmt that all terms be stated in a single writing. Remember the sig you're looking for is that of the person being sued. The other party's signature isn't needed and won't do. Failure to satisfy the statue of frauds doesn't prevent the formation of a contract, but makes the contract unenforceable by 1 or both of the parties. *UNLESS* already performed, admitted, or specially manufactured.
Alternative Minimum Tax; Exemption Amounts and Adjustments v Tax Preference Items
1-2 of 4. 1. Exemption amts: for 2017, the exemption amt is -[54,300 - {25% x (AMTI - 120,700)}] for single -[84,500 - {25% x (AMTI - 160,900)}] for MFJ -[42,250 - {25% x (AMTI - 80,450)}] for MFS In no case can the exemption be < 0! Calc: [AMTI - approp threshold] = excess. [Excess x 25%] = reduction. [Exemption - reduction] = AMT exemption allowed. Book ex for calc of AMT exemption: B and M file a joint return in 2017. AMTI is 258,900. Calc exemption: -[258,900 AMTI - 160,900 threshold] = 98k excess. -[98k excess x 25%] = 24,500 reduction. -[84,500 exemption - 24,500 reduction] = 60k AMT exemption allowed. 2. Adjustmts v tax preference items: Adjustmts are defined in the tax code as specific items that may incr/decr AMT, bc the treatmt of the item for AMT purposes is diff from that for regular tax purposes. Items 1-5 below are timing diffs that may incr/decr AMTI. Items 6-9 are items that may be incl in deductions for regular tax purposes, but not for AMT purposes. and will only incr AMTI. Exs of common adjustmts: *PANIC TIME* Incr/decr AMTI: 1- *P*assive activity losses 2- *A*ccelerated depr (post-1986 purch) 3- *N*OL of the indiv taxpayer 4- *I*nstallmt inc of a dealer 5- *C*ontracts - % completion v completed contract Only incr AMTI (disallowed itemized deductions): 6- *T*ax deductions 7- *I*nt deductions on some home EQ loans 8- *M*isc deductions not allowed. Also *M*edical exps, but those req no adjustmt for taxpayers under 65. 9- *E*xemptions (personal) and std deduction Tax preference items are always add-backs, by definition of the tax code. These items will result in more inc or fewer deductions being recog'd in AMT v regular tax. Incr AMTI. Exs of common tax preference items: (*P* for *P*reference!) 1- *P*rivate activity bond int inc (on certain bonds) 2- *P*ercentage depletion deduction (excess over adjusted basis of prop) 3- *P*re-1987 accelerated depr
Book Examples for AMT
1. AMT calc for a taxpayer not in an AMT position: X corp, a C corp, had a bunch of activity in the CY (given). Has a cumulative pos ACE adjustmt at the BOY of 45k. Step 1: determine regular TI and calc the regular inc tax liab. -[500k net sales + 50k divs from 50% owned co] = 550k gross inc. -[550k gross inc - 200k ord/necessary bus exps - 40k 80% DRD - 55k depr exp] = 255k TI. -regular tax liab is 82,700. -prob gives extra info for calcing AMTI. Step 2: Calc unadjusted AMTI, the ACE adjustmt, and determine whether the taxpayer is in an AMT position. -unadj AMTI = [255k TI + 10k preference for TEI from private activity bonds + 25k adjustmt for excess depr for regular tax purposes (55k regular tax depr - 30k AMT depr)] = 290k. -ACE = [290k unadj AMTI + 5k muni bond int +2k excess depr for AMT purposes (30k AMT depr - 28k ACE depr)] = 297k. -ACE adjustmt = [75% x (297k ACE - 290k unadj AMTI)] = 5,250. -[290k unadj AMTI + 5,250 ACE adjustmt] = 295,250 AMTI. -exemption = [40k - (25% x (295,250 - 150k))] = 3,687.50. -AMT base = [295,250 AMTI - 3,687.50 exemption] = 291,562.50. -TMT = [291,562.50 X 20% tax rate] = 58,312.50. The TMT is < the regular tax of 82,700, so just pay the regular tax liab. Not in an AMT position! No need to worry abt cumulative pos ACE adustmt since no CY negative ACE adjustmt.
Other Tax Return Preparer Penalties
1. Aiding and abetting understmt of tax liab (IRC section 6702, 6703(a)): this penalty applies to any person, not just preparers. IRS has the burden of proof to establish that any person is liable for this civil penalty. The penalty applies whether or not the understmt is w/ the knowledge/consent of the persons auth'd/req'd to file the return/affidavit/claim/doc. The IRC imposes a civil penalty (1k for taxpayers that aren't corps, 10k for corps, so even worse) on any person/entity who: -aids/assists in/procures/advises w/ respect to, the prep/presentation of any portion of a return/affidavit/claim/other doc. -knows/has reason to that such portion will be used in connection w/ any material matter arising under the IRC and -knows that such portion (if so used) would result in a understmt of the liab for tax of another person. Unless the law expressly states otherwise (does w/ this penalty), in any civil action/ct hearing, the taxpayer has the burden of proof to establish a preponderance of the evidence (>50%) that the law and the evidence don't support the position of the IRS concerning the matter in dispute. For any criminal action (ct proceedings regarding fines/imprisonmt), the govt has the burden of proof to establish by evidence beyond a reasonable doubt that the taxpayer is guilty of the charges. 2. Wrongful disclosure/use of TR info (IRC section 6713, 7216): GR is duty of confidentiality (incl refund/WPs). A TR preparer who discloses/uses info for any purpose other than to prep a TR shall pay a civil penalty of $250/disclosure or use (max annual penalty of $10k) and be guilty of a misdemeanor and fined not more than 1k or be imprisoned for not > 1 yr, together w/ the costs of prosecution. The client may also bring a civil suit against the preparer. Exceptions to the penalty/fine for wrongful disclosure/use of TR info: -disclosures allowed by any provision of the IRC and disclosures pursuant to a ct order (enforceable subpoena). -allowable uses (prep of SAL TRs and declaration of estimated tax). -disclosures/uses permitted by US treasury regs for quality and peer reviews and administrative orders. Confidential client info may be disclosed to any party if the client specifically consents to the release of info. Historically, the most commonly tested issued regarding the tax liab rules incl: -endorsing/cashing refund checks (endorsing/negotiating client's refund check, regardless of amt, is forbidden). $510 penalty. -prepping returns that understate tax liab (although a preparer can't willfully aid in understating tax liab, the preparer has no affirmative duty to check the veracity of the facts presented by the client, w/ possible exception for facts appearing implausible). -disclosure of TR info (memorize the situations where the preparer can disclose info w/o the client's consent. Disclosure in any other situation w/o client permission is disallowed). $250 penalty.
Calculation of AMT; Miscellaneous Items
1. Alternative NOL deduction (ATNOLD): Sim regular tax, AMT allows a deduction for a NOL, figured according to AMT rules (excess of deductions allowed for AMTI over inc allowed in computing AMTI). The ATNOLD is gen limited to 90% of AMTI, determined w/o regard to the ATNOLD and any domestic production activities deduction. 2. Exemption amt: as part of the AMT calc, the taxpayer is allowed an AMT exemption, which functions in a manner sim the std deduction for indivs and prevents some corps from being subj to the AMT. The exemption amt is subtracted from the taxpayer's AMTI. The exemption amt is [40k - (25% of AMTI over 150k)]. The exemption is totally phased-out at AMTI > 310k. Book ex for AMT exemption: assume AMTI is 210k. Calc the allowed AMT exemption. -[40k - (25% x (210k - 150k))] = 25k. 3. Tax rate: the tax rate on AMTI is a flat 20%. 4. AMT FTC: *only credit* allowed against TMT. 5. Minimum tax credit (MTC): The AMT system is an alternative tax system and, in a true sense, just an acceleration of a corp's inc taxes. A corp that pays AMT in 1 yr may use this as a credit in future yrs against the corp's regular inc tax liab. The unused MTC may be CF indefinitely (not back!). Against regular tax only.
Partnerships Continued; Exceptions to Nonrecognition of Gain (Taxable Events for Partners)
1. Cap int acq'd for services rendered (FMV): cap int in a pship reps the right to receive a share of cap in the pship if it liquidates. As such, it's valued at liquidation value. The value of a pship cap int acq'd for services rendered is ord inc to the partner. The pship either deducts or capitalizes the value of the cap int (according to the type of services the partner provides). Book ex for cap int acq'd for services rendered: a taxpayer has no prop to contr to a pship. Gets a 20% pship cap int in exchange for services. On the day he's admitted to the pship, the pship's assets have a basis of 20k and a liquidation value of 80k. Determine the amt of G/L recog'd to the taxpayer. -he will have to recog ord inc of 16k (20% of 80k). 2. Prop subj to an excess liab: when prop is contr'd that's subj to a liab, the excess of the liabs assumed by the other partners over the contr'd basis is treated as taxable boot and is a gain to the partner. In either case, incoming partner is taxed.
Corporate Distributions; Constructive and Stock Dividends
1. Constructive divs: Constructive divs are hidden/disguised divs (trying to get a tax deduction when giving money to SHs). Some trans, although not in the form of divs, are treated as such when the pmts aren't in proportion to stock oship. Exs: -excessive salaries paid to SH employees -excessive rents/royalties -"loans" to SHs where there's no intent to repay -sale of assets below FMV Corps may have an incentive to not classify the above as divs since the trans listed could create a deductible exp/loss, while *a div pmt isn't a deduction to the corp*. The IRS may classify these as divs to avoid giving the deduction to the corp and to count them as inc to the recipients. 2. Stock divs: A stock div is a distr by a corp of its own stock to its SHs. These are gen *NOT* taxable unless the SH has a choice of receiving cash or other prop (then taxable at FMV). The value of the taxable stock div would be the FMV on the distr date. The basis of a nontaxable stock div, where old/new shares are identical, is calc'd as [basis of old stock/total shares (old + new)]. Same overall basis, per sh amt decrs. Book ex for basis allocation after stock div: In Y1, L purch'd 100 shs of C stock for 18k (180/sh). In Y2, the corp declared a 50% stock div, and L got 50 new shs. After the stock div, the total basis is still 18k, but the basis/sh is 120k (18k/150 total shs).
Tax Credits; Foreign Tax Credit and General Business Credit
1. FTC: Personal tax credit (reduce tax liab but no refund). A taxpayer may claim a credit for foreign IT paid to a foreign country or US possession. There's a limitation on the amt of credit an indiv can obtain. In lieu of this credit, an indiv might find it better to deduct the taxes instead as an itemized deduction (which isn't limited). There's no limit on foreign taxes used as a deduction. However, FTCs are limited to the lesser of: -foreign taxes paid OR -[{TI from all foreign ops/(TI + exemptions)} x US tax = FTC limit. These amts are based on worldwide inc. Any excess/disallowed FTC may be carried over. CB 1 yr, CF 10 yrs. Disallowed amt W/B [foreign tax paid - FTC limit]. 2. General bus credit: Personal tax credit (reduce tax liab but no refund). This is a combo of: -investmt credit. -work opportunity credit (Extended through 2019 by PATH act). -alcohol fuels credit. -incr'd research credit (gen 20% of the incr in qualified research expenditures over the base amt for the yr). -low-inc housing credit. -qualified child care expenditures. -welfare-to-work credit. -employer-provided child care credit. -small employer pension plan start-up costs credit. -alternative motor vehicle credit. -other infrequent (not often on CPA exam) credits. The credit may not exceed "net inc tax" (regular IT + AMT - nonrefundable credits, other than the AMT credit) less the greater of: -25% of regular tax liab above 25k OR -TMT for the yr. So for tentative tax btw 0 and 25k, 100% allowed. For excess above 25k, 75% allowed, The sum of these gives the max credit permitted. Although some limits must be applied sep, unused credits gen may be CB 1 yr and CF 20 yrs.
Taxation of a C Corporation; Tax Credits
1. Gen bus credit: consists of a combo of any of these: -investmt credit -work opportunity credit extended through 12/31/19 -alcohol fuels credit -R&D tax credit (gen 20% of the incr in qualified research expenditures over the base amt for the yr) -low-inc housing credit -small employer pension plan start-up costs credit -alternative motor vehicle credit -other infrequent credits The credit may not exceed net inc tax (regular tax + AMT - nonrefundable tax credits, other than AMT credit) less the GREATER OF: -25% of regular tax liab over 25k OR -TMT for the yr. Ex: 225k of tax and credits. [225k tax - 25k] = 200k tax liab over 25k. [200k x .25] = 50k. [225k credits - 50k] = 175k gen bus credit. Subtracted greater of 50k calc'd or 40k TMT. Although some limits must be applied sep, unused credits may gen be CB 1 yr and fwd 20 yrs. 2. R&D tax credit (part of gen bus credit): designed to stimulate R&D activity of US cos by reducing their AT cost. The credit is gen calc'd as 20% of the incr in qualified research expenditures over a defined base amt. The research tax credit can also be calc'd using the alternative simplified credit. -the R&D credit is 1st computed sep and then subj to the limitations of the gen bus credit (since its a component of the gen bus credit). -the PATH act made the R&D credit perm going fwd. -eligible small businesses are able to use the R&D credit to offset AMT. An eligible small bus is one with <50M in avg gross receipts for the 3 preceding yrs. This isn't a typo, somehow 50M is "small." -qualified small businesses, those w/ < 5M in annual gross receipts and having gross reciepts for no > 5 yrs, are now able to use the R&D credit to offset the FICA employer portion of payroll tax. The amt of credit that can be used to offset payroll tax is capped at 250k for each eligible yr.
Determination of Partner's Share of Income, Credits, and Deductions; Miscellaneous
1. Guaranteed pmts: GPs are reasonable comp paid to a partner for services rendered or use of cap w/o regard to the partner's ratio of inc. They're allowable tax deductions to the pship and inc to the partner. -these are allowable tax deductions to the pship for services (guaranteed salary) or the use of cap (guaranteed int) w/o regard to pship inc or P/L sharing ratios (this incl the FMV of cap pship ints issued in exchange for services contr'd). This is like salary and int exp. -GPs are also incl on sch K-1, ln 4, as ord inc to the partner (may also be incl as part of net earnings from SE on ln 14a). -pmts that aren't guaranteed are merely another way to distr pship profits. *NOT* a tax deduction to the pship bc the pmts are considered partner draws/distrs. 2. Retiremt pmts: pmts rec'd by a retired partner that aren't in liquidation of a pship int (but are merely retiremt benefit pmts) are treated as follows: -ord inc to the recipient and -deductions to the pship. 3. Tax elections: pship decides (not the partners). Most elections that affect the calc of TI are made by the pship. Some of these are: -org expenditures and start-up costs. -accting methods (cash/accrual). -tax yr (fiscal, if not calendar). -depr methods (MACRS, SL, etc.). -elections out of installmt sale treatmt. -section 754 election for optional basis adjustmt of pship assets.
Requirements of Regulatory Agencies; IRS and SEC Disciplinary Actions
1. IRS: The IRC provides for criminal penalties for any person, incl a TR preparer, who counsels/preps a TR in a fraudulent/false manner w/ regard to any material matter. Beyond reasonable doubt, burden on govt. A person found guilty of making a false/fraudulent stmt in connection w/ a return is guilty of a felony and may be imprisoned for not > 3 yrs and/or fined not > 100k (500k for a corp). Civil penalties imposed by the IRS put the burden of proof on the taxpayer w/ a preponderance of evidence. Civil penalties: -IRS may prohibit an acctant from practicing before the IRS. -IRS may impose fines for various infractions. In addition to criminal/civil penalties, a person guilty of making false/fraudulent stmt on a return may be subj to a malpractice suit by the client. 2. SEC: The SEC may censure, suspend, or perm revoke an acctants right to practice before the SEC, incl the right to sign docs req'd by the securities act of 1933 and the securities exchange act of 1934. Civil penalties from SEC, it only investigates criminal. Suspension/revocation of the right to practice before the SEC can occur if: -acctant lacks the qualifications to rep others. -the acctant lacks character/integrity. -the acctant acted unethically/unprofessionally. -the acctant willfully violated fed security laws/regs. -the acctant was convicted of a felony or a misdemeanor involving moral turpitude or -the acctant's license to practice pub accting was suspended/revoked as a discplinary measure by a govt auth. The SEC may impose fines of not >100k (500k for a firm). Notice how monetary fines always have a limit. The SEC can issue cease/desist orders.
Alternative Minimum Tax; Alternative Minimum Taxable Income Calculation
1. Regular TI (base for calc). 2. Adjustmts (adds or subtracts): *PANIC* TIME. Temp timing diffs. -*P*assive activity losses are added back or recalc'd. -*A*ccelerated depr adjustmt: (a) on real prop, this is the diff btw regular tax depr and SL using a 40-yr life for prop placed in service after 1986. (b) on personal prop, this is the diff btw regular tax depr and 150% declining bal (w/ switch to SL). If a taxpayer elects 150% declining bal depr for tax purposes, there will be no AMT depr adjustmt of 200% declining bal eligible prop. (c) no adjustmt is req'd for prop expensed under section 179. -*N*OL must be recomputed. -*I*nstallmt method may not be used by dealer for prop sales. -*C*ontracts (LT): the diff btw the % of completion method and completed-contract method or any other method of accting is an adjustmt. Book ex for adjustmt related to contracts: M has a LT construction contract in Y1 and uses the completed-contract method for regular tax purposes. She reports inc for regular tax of 20k in Y4, the yr the contract is completed. AMT reqs the use of the % of completion method. Under this method, inc W/B reported as 2k in Y1, 5k in Y2, 5k in Y3, and 8k in Y4. -M has an AMT adjustmt in the amts of 2k in Y1 and 5k each in Ys 2-3. These adjustmts will incr AMTI bc more inc is being recog'd for AMT purposes than regular tax purposes. -in Y4, M has an adjustmt of 12k that will decr AMTI in Y4. This is bc regular tax recog'd the entire 20k in Y4, but AMT only recog'd 8k under % of completion. Bc AMT recog'd less inc in the final yr of the contract, the adjustmt is a decr to AMTI.
Rights on Default
1. Right to take possession of and sell collateral: most important and used of the rights on default. The secured party may take possession by self-help w/o judicial process if he can do so w/o a breach of the peace. The secured party may always take possession of the collateral by replevy action, a judicial action seeking the transfer of personal prop. After default and repo, the secured party may sell or lease the collateral, either in its condition when taken or after reasonable prep or processing. Disposition may be by either pub auction or private sale. -the sale/lease must be commercially reasonable in all respects: method, manner, time, place, or terms. -the debtor/other parties must gen be given notice of the sale. -the sale wipes out all subordinate ints, such as the int of secured parties w/ lower priority, lien creditors, and the debtor's int. A good faith purchaser of the collateral at the sale takes free of all subord ints, but *is subj to superior ints*. -the debtor has the right to redeem by paying off the indebtedness and costs before the sale, but this right is cut off by the sale. The examiners often ask abt the effect of a sale of the collateral. Remember that all subord claims are wiped out and there's no right of redemption by subord sec int holders or the debtor. Proceeds of a default sale are distr'd in this order: 1. 1st to pay the exps of of repo and sale. 2. 2nd to pay creditors w/ a sec int in the collateral in order of priority. The creditor w/ the highest priority must be paid in full before any proceeds can go to the secured creditor w/ the next highest priority. 3. Any surplus is paid to the debtor. If sale of the collateral doesn't bring in enough money to pay the exps of the sale and the debt, the secured party may bring a ct action to recover the deficiency from the debtor.
Corporate Distributions; Shareholder and Corporation Taxable Amounts
1. SH taxable amt: the taxable amt of a div from a corp's E&P depends on what type of entity the SH is. For indiv SH: -cash divs: amt rec'd. -prop divs: FMV prop rec'd. For corp SHs (subj to DRD): -cash divs: amt rec'd. -prop divs: FMV prop rec'd. 2. Corp paying div taxable amt: GR is the pmt of a div doesn't create a taxable event. A div is a reduction of E&P (RE). EXCEPTION: For prop divs, if a corp distrs appreciated prop, the tax results are: -corp recogs gain as if the prop has been sold (FMV - adjusted basis). So [FMV prop - NBV] = corp gain. Taxable event so FMV. -the recipient SH incl the FMV of the prop in inc as a div (to the extent of E&P). -when appreciated prop is distr'd, the corp can't recog a loss. -the gain recog'd by the corp incrs E&P. When the CPA exam has tested on tax issues relating to corps paying prop divs, it normally involves this sequence of events: 1- corp has no E&P (div wouldn't be TI). 2- corp distrs appreciated prop as a div. 3- corp has a recog'd gain (on prop div). 4- corp gain incrs/creates corp E&P. 5- div to SH is now TI to the extent of E&P.
Consolidated Tax Returns; Miscellaneous Items
1. Tax compliance rqmts: although supplementary attachmts and schs are req'd, consol'd TRs are filed w/ the same Form 1120 as single filing corps and by checking the box on P1 indicating the 1120 is being filed on a consol'd basis. 2. Tax accting methods and periods: members of the consol'd tax group are gen permitted to continue using the same accting methods in place before filing as a consol'd group. An exception is certain methods which use threshold limitations applied on a consol'd basis, like determination of whether a corp can use the cash method. Each member of the consol'd group *must use the parent's tax yr*. 3. Liab for taxes and estimated tax pmts: each member is jointly/severally liable for the entire consol'd tax liab, tax penalties, and int. Estimated tax pmts must be made on a consol'd basis starting w/ the 3rd consol'd TR yr. Prior to the 3rd consol'd TR yr, est tax pmts can be computed/paid on either a sep or consol'd basis.
Affiliated Groups and Transfer Pricing; Miscellaneous
1. Transfer pricing issues: the IRS often makes adjustmts when there are transfer pricing issues, which exist under these circumstances: 1- US based taxpayer transfers/sells/purchases/leases tangible prop or intangible prop to/from an affiliate that either: -isn't subj to US IT or -doesn't file a consol inc TR w/ the US based taxpayer. Related party. 2- US based taxpayer enters into loan agreemts/service contracts w/ an affiliate that either: -isn't subj to US IT or -doesn't file a consol'd inc TR w/ the US based taxpayer. Related party. 3- a US based taxpayer shares costs w/ an affiliate that either: -isn't subj to US IT or -doesn't file a consol'd inc TR w/ the US based taxpayer. Related party. 2. IRS options: these adjustmts incl the ability of the IRS to: -modify the basis of the assets and -req the taxpayer to recog inc w/ respect to an otherwise tax-free trans (like tax free, like-kind exchange or tax-free incorp of a bus). 3. Auth of the IRS to make adjustmts: the IRS' auth to make these adjustmts extends to any case in which, either by inadvertence/design, the TI of a controlled taxpayer is other than what the TI would have been if the taxpayer had been dealing at arms-length w/ an uncontrolled taxpayer. This auth isn't limited to cases of improper accting, fraud, sham trans, or devices/schemes designed to reduce/avoid tax by shifting or distorting inc/deductions/credits/allowances. However, the cts will reverse such adjustmts if the controlled taxpayer shows that the results of its trans are w/in an arms-length range established by 2+ uncontrolled comparable trans based upon a single pricing method.
Tax Return Preparer Compliance Penalties; Understatement Due to an Unreasonable Position [IRC Section 6694(a)] and Understatement Due to Willful or Reckless Conduct [IRC Section 6694(b)]
1. Understmt due to an unreasonable position: This penalty can be assessed bc of the understmt of a taxpayer's liab due to an unreasonable position taken by the taxpayer. A position is deemed unreasonable unless (important): -subst auth for the position, regardless, of disclosure, exists (33-50%). -reasonable basis for a disclosed position exists (>20%). -it's reasonable to believe that a tax shelter or reportable trans position would meet the more-likely-than-not std (>50%). IRS Form 8275 is used to disclose items/positions that aren't contrary to US treasury regs, but aren't otherwise adequately disclosed on a TR. Form 8275-R is used to disclose items/positions contrary to US treasury regs. The penalty for understmt due to an unreasonable position (ord negligence) is the *GREATER OF* 1k or 50% of the inc the preparer rec'd for the TR prep services. The penalty may be imposed on the preparer if: 1- a position is taken on the TR and understates the tax liab if there's no reasonable belief that the position W/B sustainable based on its merit. 2- the preparer had knowledge/should have known abt the unreasonable position. 3-disclosure of the position wasn't made and 4- the position lacks reasonable basis. 2. Understmt due to willful/reckless conduct: Willful, reckless, knowingly, intentionally. A compensated preparer is liable for a penalty if the preparer's understmt of taxpayer liab on a TR/claim for refund is due to the preparer's negligent/intentional disregard of rules/regs. Willful/reckless conduct (fraud, no good faith) is conduct that's ether: -a willful attempt to understate the tax liab or -a reckless/intentional disregard of tax rules/regs in spite of his signed declaration on the TR. A preparer isn't req'd to obtain supporting documentation (GR), unless the preparer has reason to suspect the accuracy of the info PBC. The preparer must make reasonable inquiries if the info provided by the taxpayer appears incorrect/incomplete. The penalty for willful/reckless conduct is the *GREATER OF* 5k or 50% of the inc the preparer derived w/ respect to the TR/refund claim. This is reduced by any penalty assessed bc of an understmt of a taxpayer's liab as the result of an unreasonable tax position by a preparer. Civil penalty incr and criminal as well.
Summary of Penalty Amounts
1. Understmt of liab due to an unreasonable position: greater of 1k or 50% of what was charged. 2. Understmt due to willful/reckless conduct by preparer: greater of 5k or 50% of what was charged. 3. Failure to furnish a copy of the return: $50. 4. Failure to sign the return as a preparer: $50. 5. Failure to furnish taxpayer ID no: $50. 6. Failure to retain a copy of the return : $50. 7. Failure to file correct info returns: $50. 8. Endorsing/cashing a refund check: $510. 9. Failure for due diligence on EIC: $510. 10. Wrongful disclosure: $250.
Tax Credits; Other Miscellaneous Credits
1. Withholding tax (paycheck credit): refundable credit (reduce tax liab and get refund). Refund or credit to next yr. All inc taxes withheld from a taxpayer's paycheck are treated as a credit against the taxpayer's tax liab. When this credit exceeds the tax liab, a refund is generated to the taxpayer. 2. Excess FICA (social sec tax withheld): refundable credit (reduce tax liab and get refund). Excess social sec tax withheld is treated as additional tax pmts withheld (Form 1040, ln 63). -2+ employers: an employee who has had social sec tax withheld in an amt > the max for a particular yr may claim the excess as a credit against IT (in the pmt section), if that excess resulted from correct withholding by 2+ employers. -1 employer: if the excess was withheld by 1 employer, the employer must refund the excess to the employee. No credit is allowed! 4. Small employer pension plan start-up costs credit: for eligible small businesses (w/ 100 or fewer employees who earned at least 5k in the preceding tax yr), a credit is allowed for 50% of the first 1k (up to $500/yr) of qualified start-up costs for establishing a new qualified pension plan for 3 yrs (starting w/ the yr the plan was established). -qualified costs incl exps to establish and administer the plan and provide info to employees regarding retiremt planning. -if the exps are used for the credit, they may not also be used as deductible ordinary and necessary bus exps. -employers aren't req'd to take the credit for any tax yr and may be able to take the credit in the yr that precedes the 1st yr of the plan. 5. Small bus health care tax credit: Under the current health care tax laws: -a credit of up to 50% of the employer's costs of the plan premiums (or the avg of the group's premium for small businesses w/in the taxpayer's state) is allowed as a credit for eligible employers, provided the employer contributes at least 50% of the costs of health coverage on behalf of employees enrolled in a qualified health plan offered through a Small Bus Health Options Program (SHOP). -small businesses receive the better tax benefits. -the credit is allowable as an offset to AMT. It isn't refundable, and the unused amt is CB 1 yr and CF 20 yrs. TE orgs, however, will receive a refund of the tax credit. -the costs for fam members, sole-props, partners, S corp owners w/ > 2% oship, and SHs owning >5% of corps are excluded. -if the exps were used to qualify for the credit, they're not allowable as tax deductions for employee benefits exp. 6. Residential energy credits: a max credit of 30% of qualifying solar electric or water heating prop installed in 2017 is allowed. 7. Premium tax credit (PTC): refundable credit that helps eligible indivs/fams w/ low/moderate inc afford health ins purch'd through a health ins mktplace. The credits are available immediately when the ins is purch'd to help eligible indivs pay for their monthly health ins premiums.
Tax Credits; Work Opportunity Credit and Child Tax Credit
1. Work opportunity credit: available to employers who hire employees from a targeted group. This is part of the gen bus credit (personal credit) and was extended through 2019 by the PATH act. The credit is for: -40% of the first 6k of the first yr's wages. -40% of the first 3k to certain summer youth. Qualified groups incl: -disabled -18-24 YOs from poor fams -vietnam vets from economically disadvantaged areas -certain food stamp recipients 2. Child tax credit: refundable credit (reduces tax liab and get refund). Taxpayers may claim a 1k tax credit for each qualifying child. The CARES rules on dependency exemptions apply here, except that a child must be under the age of 17 (not 19 and 24 age limits under CARES). The qualifying child must be a citizen, national, or resident of the US. Higher-inc taxpayers must reduce the allowable child credit by $50 for each $1k (or fraction thereof) by which the mod AGI exceeds: -110k for a joint return -75k for an unmarried indiv OR -55k for married indivs filing a sep return Low inc fams w/ children may use the credit to offset their inc taxes as well as social sec taxes paid for the yr. The child tax credit is refundable to the extent of the lesser of: -excess child tax credit (over tax liab) -earned inc less 3k (2017) multiplied by 15% For tax yrs beginning ater 12/31/15, return preparers will be subj to due diligence rqmts for returns that claim the child tax credit (much as they are currently subj to for returns that claim the earned inc tax credit).
Corporate Taxable Income; Trade or Business Deductions Continued Even Further
11. Bus gifts: $25/yr per person max deduction. 12. Bus M&E: 50% tax deductible to the corp. 13. Penalties and illegal activities: *NOT* deductible. Bribes, kickbacks, fines, penalties, and other pmts illegal under fed law or gen enforced state law aren't deductible. Sim, the top 2/3 of a treble damage pmts aren't deductible if the taxpayer has been convicted of an antitrust violation. 14. Taxes: state, city, and fed payroll taxes are tax deductible. All SAL taxes and fed payroll taxes are deductible when incurred on prop or inc relating to bus. Fed inc taxes (FIT) are *NOT* deductible, add back to book/GAAP inc. Foreign inc taxes may be used as a credit. 15. Lobbying/political expenditures: *NOT* tax deductible. Lobbying exps incurred in attempting to influence state/fed legislation are *NOT* deductible. Direct-type lobbying exps in connection w/ local governmental lobbying *are* deductible. Political contrs are *NOT* deductible. 16. Capital losses deduction: *NOT* allowed, only offset CGs. The 3k deduction for net CLs available to indivs isn't allowed to corps. A corp can only use CLs to offset CGs. Excess CLs may be CB 3 yrs, CF 5 yrs.
Corporate Taxable Income; Trade or Business Deductions Continued One Last Time...
17. Inventory valuation methods: must use the same method for GAAP/books and TR. In general, the tax method used for accting purposes can be used for IT purposes, provided the method clearly reflects inc and is consistent in application (opening/closing inventories must use the same valuation method). All taxpayers who have inv are req'd to use the accrual basis of accting for purchases/sales (even if cash method!). A change in inv method is considered a change in accting method and must be approved by the IRS. Basic valuation methods: 1. cost method: inventories are valued at cost (incl DL, DM, and attributable indirect costs {OH}), less discounts, plus freight-in. The cost methods of "prime cost" (no OH) and "direct cost" (incl VOH only) are *NOT* allowable for tax purposes. 2. LCM: invs are valued at the lower of cost (as in 1) or mkt, which for normal goods is gen the current bid price at the date of inv per each item in inv (the lower amt is determined based on each item, not the aggregate value of all inv). 3. rolling-avg method: gen won't be allowed when invs are held for a long time pd in some circumstances or when costs tend to fluctuate sig (unless the taxpayer regularly recalcs costs and makes certain adjustmts), as the method may not clearly reflect inc in certain cases. 4. retail method: in gen, this will approximate the cost or mkt of items in inv by subtracting the mark-up percentage to retail from the retail price, typically from inv that has a large volume of items. Common inventory identification methods (cost-flow assumptions) incl: -FIFO: most common method, unless the inv can be specifically ID'd. -LIFO: must be elected by the taxpayer in the 1st yr its used, and the taxpayer must use the same method for its F/S purposes. Sig adjustmts to inv valuations may be req'd to use LIFO. -specific ID method. IRC section 263A details the uniform capitalization rules that req certain costs normally expensed be capitalized as part of inv for tax purposes. This may cause the corp to make an M-1/M-3 adjustmt on their TR to conform to the rules. Certain methods of accting for inv (like strict cost method) don't provide for the capitalization of inventory costs that are req'd by the uniform capitalization rules. So, taxpayers subj to the uniform capitalization rules may not use some valuation methods. RM, DL, and OH expensed when sold. When inventories are deemed to be unsaleable/unusable, they must be valued at their expected selling price (bona fide SP) w/in 30 days minus the costs to dispose of them.
The Securities Exchange Act of 1934; Reporting Requirements
2 categories of cos are req'd to make reports (report 5% TIP). These cos are referred to as reporting cos. (1) all cos req'd to register under the 34 act must report (rqmts on prior card) and (2) any issuer that must register under the 33 act must also report. Cos registered under the 33 or 34 act are req'd to file these periodic bus reports: -Form 10-K (10-KSB for small businesses) is a req'd report that must be filed annually w/in 60 days (for large corps - 90 for small businesses) of the end of the fiscal yr. Must contain mat facts concerning mgmt or otherwise affecting the value of the co's secs and F/S certified by indep acctants. -Form 10-Q (10-QSB for small bus) is a quarterly report filed w/in 40 days for large corps (45 for small) of the end of the 1st 3 quarters of each fiscal yr. Must contain reviews of interim fin info by indep CPAs. -Form 8-K must be filed w/in 4 days after a major change in the co, like a change in control, disposition of major assets, change in officers/directors, resignation of directors, etc.
The Gift Tax (Form 709); Complete v Incomplete Gifts
2 of 2. Complete gifts qualify for the annual exclusion and, in most cases, aren't considered part of the gross estate at death. However, incomplete gifts are incl in the gross estate for purposes of calcing the estate tax. A gift is considered complete (and is subj to gift tax): -even though the donee isn't yet born, provided his identity can later be ascertained. -despite the possibility that the prop may revert to the donor at some future time. A gift isn't considered complete (and isn't subj to the gift tax) if it's conditional or revocable. A gift is conditional if it's subj to conditions precedent and will not be provided until the conditions have been met (like a recipient has to graduate to get gift). A gift is revocable if the donor reserves the right to revoke the gift or change the beneficiaries (life ins policy). The gift is complete when those rights terminate by reason other than the donor's death.
Liquidation of a Partnership; Sale of Partnership Interest (Liquidation)
2 of 3. As a GR, the partner has a CG/L when transferring a pship int bc a pship int is a cap asset. A partner who sells/exchanges his int in the pship has a recog'd G/L on transfer (GR: capital). The G/L is measured by the diff btw the amt realized for the sale and the adj basis of the pship int. If any pship liabs are allocated to the int and transferred to the buyer, they're considered part of the amt realized. Cap G/L calc: [Beg cap acct +/- % of inc/loss up to sale] = cap acct at sale date. [Cap acct at sale date + % of liabs] = adj basis. [Amt rec'd - adj basis] = CG/L. Amt rec'd incl cash, assumption of liabs by buyer, and FMV prop. Assumption of liabs here nets to 0 w/ % of liabs incl in the adj basis. Book ex for calcing amt realized on sale of pship int: K sells her int in J pship to the pship for 15k cash. The pship agrees to assume her 5k share in pship liabs. Determine the amt realized on he sale of K's pship int. -[15k cash rec'd + 5k liabs assumed by pship] = 20k amt realized. This will be compared w/ the basis of K's pship int to determine her G/L. Her basis = [cap acct + % liabs]. *Exception*: ord inc, not CG. Any gain that reps a partner's share of "hot assets" is treated as ord inc, as if cash were taken. Hot assets are: -unrealized (cash basis) receivables (as if exchanged for cash). -appreciated inv (as if exchanged for cash) and -recapture inc, regarding depreciable assets owned by the pship. All of these are hot assets bc would have been ord inc if realized.
Tax Return Preparer
2 of 3. License not req'd. TR preparer means any person who preps for compensation, or who employs 1+ persons to prep for comp, any TR req'd under the IRC, or any claim for refund of tax imposed by the IRC. The prep of a substantial portion of a return/claim for refund shall be treated as if it were the prep of the whole thing. Any tax prof w/ an IRS preparer tax ID no (PTIN) is auth'd to prep fed TRs. These indivs are often categorized as enrolled agents, CPAs, attorneys, annual filing season program participants, and PTIN holders. Book ex for not a TR preparer: a small firm hires 2 interns, who review the data PBC and enter the info into the TR software. The interns also call to request missing info but aren't permitted to offer tax advice. The returns are prepped/signed by managers. Here, the interns wouldn't be regarded as preparers. TR preparer does't incl a person who merely furnishes typing/reproducing/other mechanical assistance, preps a return/claim for refund of the employer (or of an officer/employee of the employer), or preps as a fiduciary (trustee, executor, etc.) a return/claim for refund of any other person. Enrolled agents, CPAs, and attorneys have unlimited rep rights (tax practitioner - license) before the IRS. Tax profs w/ these credentials may rep their clients on any matters, incl audits, pmt/collection issues, and appeals. PTIN holders classified as annual filing season program participants and preparers who are PTIN holders w/o a creditial and don't participate in the annual filing season program have limited rep rights. TR preparers who have an active PTIN but no prof credentials and don't participate in the annual filing season program are auth'd only to prep TRs. Effective 1/1/16, PTIN holders who don't hold a prof credential and don't participate in the annual filing season program have no auth to rep clients before the IRS (generally. Except regarding returns they prepped/filed 12/31/15 and prior).
Adjusted Basis and Holding Period of Assets Sold; Gifted Property Basis Continued
2 of 3. Regardless of the basis for G/L purposes (may not be known at the time depr is to begin), the basis for depr purposes (if applicable) is the LESSER of: -the donor's adjusted basis at the date of gift OR -the FMV at the date of gift. The amt of A/D will then reduce the taxpayer's basis calc'd for G/L purposes before the actual G/L on sale is determined. Book ex for determining basis: a donor gives prop worth 3k w/ an adjusted basis of 5k to a taxpayer. Determine the basis of the prop if: -the prop is in a gain situation on sale: basis is 5k. -the prop is in a loss situation on sale: basis is 3k. -the prop is in a zero G/L situation on sale for depr purposes: basis is the middle price sold for (like 4k). -for purposes of calcing depreciation on the asset before the sale, the depreciable basis is 3k, the lower FMV. Summary of these G/L rules: -if sell higher than donor's basis, use donor's basis to determine gain (closest to it on scale). -if sell btw donor's basis and lower FMV at date of gift, no G/L. Use SP as basis, so nets to 0. -if sell lower than lower FMV at the date of gift, use lower FMV to determine loss (closest to it on scale). Rollover both the cost and holding pd. The recipient of a gift normally assumes the donor's HP. However, under the exception, if the FMV at the time of the gift is used (loss basis) as the basis of the gift, the HP starts as of the date of the gift. Book ex for basis of gifted stock and G/L on resale: -GR (FMV higher): Donor's basis is 20k. FMV at gift date is 40k. Donee's SP is 30k, basis to donee for G/L is 20k (rollover). Taxable gain is 10k (30k - 20k). -Exception (FMV lower): -scenario 1: Donor's basis is 20k, FMV at gift date is 13k, donee's SP is 25k. Donee's basis is 20k, taxable gain is 5k (25k - 20k). -scenario 2: Same facts as above except donee's SP is 10k, so basis is 13k. Deductible loss is 3k (10k - 13k). -scenario 3: Same facts as above except donee's SP is 15k, so basis is 15k (same as SP), and G/L is 0 (15k - 15k).
Book Examples for AMT Continued
2. AMT calc for a taxpayer in an AMT position: same facts as prior ex. Step 1: determine regular TI and calc regular IT liab. Same as prob above. -prob gives info relevant for calcing AMTI. Step 2: calc unadj AMTI, the ACE adjustmt, and determine whether the taxpayer is in an AMT position. -unadj AMTI = [255k TI + 200k preference for TEI from private activity bonds + 25k excess depr taken for regular tax (55k regular tax depr - 30k AMT depr)] = 480k. -ACE = [480k unadj AMTI + 5k muni bond int + 2k excess depr for AMT (30k AMT depr - 28k ACE depr)] = 487k. -ACE adjustmt = [75% x (487k ACE - 480k unadj AMTI)] = 5,250. -AMTI = [480k unadj AMTI + 5,250 pos ACE adjustmt] = 485,250. -exemption is 0 since AMTI > 310k, so AMT base is same as AMTI. -TMT = [485,250 AMT base x 20% tax rate] = 97,050. -AMT liab = [97,050 TMT - 82,700 regular tax liab] = 14,350. Pay this in addition to regular tax, so ultimately pay the greater 97,050 TMT amt. In an AMT position here bc TMT > regular tax liab. TEI from muni bonds isn't a preference item for AMT. No need to worry abt the cumulative pos ACE adj of 45k since no CY negative ACE adjustmt.
Legal Liabilities Continued
2. Commission of a tort: wrongful act. Unintentional is ord negligence, intentional is fraud. CPA liab can also come from commission of a tort. 3 relevant torts: -negligence (ord) -constructive fraud (gross negligence). Reckless. -fraud. Intent/willful. Bottom 2 are fraud, so punitive damages too. For ord negligence, best defense is due diligence (WPs). As a GR, CPA owes a duty to their client not to perform work negligently. If the CPA performed negligently, can be held liable for damages. Negligence reqs a breach of the duty to exercise due care. The std of care owed by a CPA is to perform w/ the same skill/care expected of ordinarily prudent CPAs under the circumstances. Negligence often incl (1) failure to properly supervise and (2) failure to warn of a known I/C weakness. To make a case for negligence, plaintiff must show: -defendant owed a duty of care to plaintiff. -defendant breached that duty by failing to act w/ due care. -breach caused plaintiff's injury and -damages. A CPA's duty to act w/ reasonable care gen runs only to clients and any person or *limited forseeable class* of persons who the CPA knows will be relying on the CPA's work (creditors, investors). A minority of states follow the ultramares decision, which limits CPA liab more narrowly to persons in privity of the contract w/ the CPA (clients) and intended TPBs (named).
Alternative Minimum Tax; Alternative Minimum Taxable Income Calculation Continued
2. Continued: PANIC *TIME*. Itemized deductions that are always adds to regular TI. Perm diffs. -*T*axes reduced by taxable refunds (if refunds meet the tax benefit rule) are added back. -*I*nterest: (a) mortgage int not used to buy, build, or improve a qualified dwelling (house/apartment/condo/mobile home not used on a transient basis) is added back. (b) investmt int exp must be recalc'd. (c) home mortgage int is ok (*NOT* added back for AMT). -*M*edical exps must exceed 10% of AGI. No adjustmt is needed for taxpayers under age 65. OK/NA bc the 10% is also used in itemized deductions. -*M*isc deductions subj to the 2% floor aren't allowed (they're added back). -*E*xemptions: personal/std deductions *may not be claimed*. Add back. Note: charity is *NOT* an add-back for AMT. Book ex for AMT adjustmts: In Y2, J has various itemized deductions. They incl int on acq indebtedness on her home of 11,200, state IT deductions of 9,200, char contrs of 3k, and home EQ int on a loan not used to improve the home of 6,500. -total adjustmts for AMT purposes: [9,200 state inc taxes + 6,500 home EQ int] = 15,700. -these adjustmts incr AMT bc they're the disallowance of deductions that are allowed for regular tax purposes. -the char contrs and acq indebtedness are not adjustmts for purposes of AMT. Other AMT adjustmts incl: -ISOs -recalc G/L on sale of depreciable assets -pollution control facilities -mining exploration/developmt costs -circulation exps -research and experimental expenditures -passive tax shelter farm activities
Perfection of the Security Interest Continued
2. Perfection by taking possession (pledge): tangible. Oral agreemt for attaching is ok. A secured party may perfect a security int in most types of collateral by taking possession of it. This is sim when a pawn shop takes an item in exchange for a loan of money. The prop owner can redeem the pledged item by paying back the amt borrowed. A security int in accts, deposit accts, nonnegotiable docs, or gen intangibles (like a patent) can't be perfected by possession, even if the collateral is tangibly repped (like by a ledger book). 3. Perfection by control: sec ints in investmt prop may be perfected by control. Basically a secured party (or other purchaser) has control of an item of investmt prop when the secured party has taken whatever steps are necessary to be able to have the investmt prop sold w/o further action from the owner. If the collateral is a securities acct (few ppl actually physically have the stocks/bonds they own), the creditor will have control if the owner instructs the brokers or mutual fund co that the secured party now has whatever rights in the acct the owner has or that the broker or mutual fund co is to comply w/ the secured party's orders w/o further consent of the owner. Book ex for control: A borrows 100k from bank. As security, bank reqs A to give it a sec int in his brokerage acct, which has a current mkt value of 200k. Bank can perfect this int through control by having A instruct the brokerage co to follow bank's orders regarding the acct.
Elements of a Legally Enforceable Contract; Agreement: Termination of Offer Continued
2. Rejection by offeree: 2nd way to term offer. Offeree can term offer by rejecting it. Once offer is effectively rejected, can't be accepted. The offeree can reject expressly (say no). A counteroffer is also considered to be *BOTH* a rejection (terminates the OG offer) and an offer (for which the OG offeror is now the offeree who may accept/reject). Book ex for rejection by offeree: -A offers to sell B his car for $450. B says no. Offer is term'd. If B has a change of heart and tells A "I accept," B has at most made a new offer. No contract is created. -Same thing, but B says "no, but I'll give you $425." B has rejected and made a new offer through a counteroffer. -mere inquiry is not a counteroffer (would you take..?). A rejection is effective when rec'd. Book ex for rejection: On 1/3, S sent B a signed letter offering to sell his warehouse for 95k. On 1/5, B wrote S a letter saying he wouldn't pay 95k bc the price was too high. On 1/6, B was advised a sim prop had recently been sold for 99k, so emailed S to accept the offer from 1/3. B's letter arrived the next day. There's a contract bc rejection isn't effective until rec'd and the rejection here arrived after the offer was accepted by email. 3. Termination by op of law: 3rd way to term offer. If either of the parties dies or becomes incompetent prior to acceptance, the offer is term'd by op of law. It's not necessary that the death/incompetency be comm'd to the other party. -exception: an option contract is not term'd by the death of a party. Book ex for termination: D offered to sell S a parcel of land for 300k. If either D or S dies before the offer is accepted, the offer will term by op of law. However, if S paid consideration for the offer (creating an option contract), the offer will remain open for the pd of the option (S or S' estate could accept during the option pd and a contract W/B formed w/ D or D's estate). If the subj matter of the offer is destroyed before the offer is accepted, the offeree's power of acceptance is term'd by op of law. If the subj matter of the proposed contract becomes illegal, the offer will term. Book ex for termination due to illegality: L offers V a share in his casino bus. Prior to acceptance, a law is passed banning casinos. Offer is auto-term'd.
Rights on Default Continued
2. Retention of collateral in satisfaction of debt: GR is yes, except for 60% rule discussed below. -trans not involving consumers: after default, a secured party may keep the collateral in full/partial satisfaction of the debt (may keep the collateral, offset its value against the debt, and seek to recover the diff from the debtor if the collateral only partially satisfies the debt). -trans involving consumers: w/ consumers, the secured party may keep the collateral only in full satisfaction of the debt (no deficiency may be recovered). -notice must be given in full or partial satisfaction cases: either way, the secured party must give notice of its intent to keep the collateral to the debtor and other secured parties. -*EXCEPTION* to the GR; compulsory disposition of consumer goods (60% rule): in consumer goods cases in which the debtor has paid at least 60% of the loan, the secured party must sell the collateral w/in 90 days after repo, unless the debtor waives this right. 3. Debtor's right of redemption: pay all creditors in full. Until the sale or discharge of the debt through retention of the collateral, the debtor may redeem the collateral by paying all of the obligations secured by the collateral plus all reasonable exps incurred relating to the repo. 4. Judicial action: reduce claim to judgmt. Instead of using self-help, on default, the secured party may bring an ordinary judicial action for the amts due and levy on the collateral after judgmt. The secured party may have the collateral seized at the same time he begins the judicial action.
Other Taxes Continued
2. Tax penalty imposed by individual mandate section of the affordable care act: tax penalty is imposed on certain indivs not covered by health ins. For 2017, the amt of the tax is the lesser of $695/person or 2.5% of fam inc, w/ a max of $2,085. -children are assessed at 50% of the minimum penalty. -certain low-inc taxpayers are exempt. -the penalty is prorated by month. -no penalty applies to a gap in coverage of 3 mos or less. -the IRS is prohibited from using liens or levies to collect the tax. 3. Kiddie tax: int and div inc. The net unearned inc of a dependent child under 18 YO (or a child age 18 to under 24 who doesn't provide over 1/2 their own support and is a full-time student) is taxed at the parent's higher tax rate. Net unearned inc is calc'd by taking the child's total unearned inc (from divs, int, rents, royalties, etc.) and subtracting 2,100: the childs allocable 2017 std deduction of 1,050 (or investmt exp if greater) + an additional 1,050 (which is taxed at the child's rate). Although the inc > 2,100 is taxed at the parent's MTR, it's nonetheless reported on the child's tax return. Parents may elect to incl on their own return the unearned inc of the applicable child provided that the inc is btw 1,050 and 10,500 and consists solely of int, divs, and CG distrs. Rate schedule: -2017 child's unearned inc of 0-1,050: 0% tax rate. -unearned inc of 1,051 - 2,100: child's tax rate. -unearned inc of 2,101+: parent's tax rate.
Tax Credits; Education Tax Incentives Continued
2. The lifetime learning credit: personal tax credit (reduce tax, but no refund). 2k max/yr. Available for an unlimited no of yrs for qualified tuition and related exps (except books) at eligible educational institutions. The credit is equal to 20% of qualified exps up to 10k (so 2k max). Qualified exps incl pmts for undergrad and grad courses, certain professional degree courses, and courses to acq/improve job skills. The credit doesn't vary based on how many students are in the fam (1 per tax yr). As w/ the AOC, exps paid by a dependent child are treated as made by the parent. For 2017, the phase-out begins w/ mod AGI > 56k (112k MFJ), w/ full phase-out at 66k (132k MFJ). 3. Coverdell education savings acct distrs: a taxpayer may claim the AOC or lifetime learning credit and also exclude from gross inc the amts distr'd from a Coverdell education savings acct on behalf of the same student (use in conjunction). The distr can't be used for the same education exps for which either the AOC or lifetime learning credit was claimed (no double dipping). No longer part of 3 now, just more info. The taxpayer doesn't have to choose 1 type of credit on their return for the yr. A parent may claim a lifetime learning credit for the exp of 1 child and an AOC for the exps of another child in the same yr. Using both the AOC and lifetime credits in the same yr on diff kids is ok. A qualified tuition program (QTP; 529 plan) is exempt from all fed inc taxation. It's a program under which a person may purch tuition credits or make cash contrs to an acct on behalf of a beneficiary for pmt of qualified higher education exps. The program must be established/maintained by a state, state agency, or an eligible educational institution. Eligible educational institutions gen incl any accredited postsecondary educational institution, so long as contrs made to the program are held in a qualified trust (meets the rqmts under code section 408(a)(2) and (5). Qualified higher education exps (QHEEs) incl tuition, fees, books, supplies, and equip req'd by an education institution for enrollmt or attendance. These exps also incl the reasonable cost of room/board if the beneficiary is enrolled at least 1/2 time. Distrs from a QTP, incl cash, earnings, and in-kind distrs, may be excluded from a designated beneficiary's gross inc to the extent the distr is used to pay for QHEEs
Federal Judicial Process
3 cts. When a taxpayer and the IRS can't reach an agreemt on a tax matter administratively either w/ a rev agent or the appeals division, the dispute must be settled in the fed ct system. Either the IRS or taxpayer can initiate the process. In the fed ct system, the US tax ct (1), district ct (2), and ct of fed claims (3) are considered trial cts. The US ct of appeals, fed ct of appeals, and US sup ct are considered appellate cts. Appellate cts are limited to a review of the trial record of the lower ct to determine if that lower ct applied the proper law in arriving at its decision. Seldom will an appellate ct disturb the trial ct's determination of the facts. The taxpayer can choose the route through the ct system that they deem most favorable. Key concepts related to the fed judicial process incl: -burden of proof: in most litigation, party bringing the case has this. In most civil tax cases, taxpayer has this. In certain situations, the burden of proof shifts to the IRS. The IRS has the burden of proof in any ct proceeding on inc, gift, estate, or generation-skipping tax w/ respect to factual issues provided that the taxpayer has introduced credible evidence, maintained books/records as req'd, and has complied w/ reasonable IRS requests. -doctrine of stare decisis: like english law, american law is often made by judicial decisions. Under this doctrine, judges are req'd to respect the precedents established by prior judicial decisions on the same set of facts. -appeal outcomes: an appeal can have a no of possible outcomes. The appellate ct may affirm (accept) or reverse the lower cts finding or it may send the case back to the lower ct for further consideration (remand). The US tax ct (1 of 3) is a specialized trial ct that hears only fed tax cases (inc, estate, gift, or certain excise taxes), gen prior to the time that formal tax assessmts are made by the IRS. Taxpayers who file petitions w/ this ct have the option of having the case heard before the informal small cases division (small tax cases) if the amt of tax in dispute doesn't exceed 50k for any 1 tax yr. Neither party may appeal the decision and the decision isn't considered precedent in other cts. The advantage of the US tax ct is it's the only forum where taxpayers can litigate w/o first having paid the disputed tax in full. The disadvantage is that trials are conducted before 1 judge who will be a tax expert, and there are no jury trials. Taxpayers are permitted to rep themselves. For a case to be heard, taxpayer must petition the tax ct, normally w/in 90 days of the IRS' mailing of a notice of deficiency (90-day letter) and demand for pmt of the disputed amt. Cases can't be taken to the tax ct before the IRS sends out the notice of deficiency. The US tax ct issues 2 types of decisions: 1- regular: normally involves a new/unusual point of law. 2- memorandum: concerns only the application of existing law or an interpretation of facts. Small tax case decisions are published as summary opinions.
Adjusted Basis and Holding Period of Assets Sold; Inherited Property Basis
3 of 3. Step-up (down) to FMV. GR: date of death FMV becomes basis. Prop acq'd by bequest/inheritance gen takes as its basis the step-up (down) to the FMV at the date of the decedent's death. Alternative valuation date for FMV C/B date distr'd or max 6 mos after death. If validly elected by the executor, the FMV on the alternate valuation date (earlier of 6 mos later or date of distr/sale) may be used to value all of the estate prop. The alternative valuation date is only available if its use lowers the entire gross estate and estate tax (although indiv assets may go up/down during the pd). If the alternative valuation date is validly elected, the asset is valued using FMV at the earlier of: -distr date of the asset OR -6 mos after death. This is the max. *6 mos, 6 feet down*. Book ex for sale of inherited prop: a testator died owning prop worth 60k and in which he had a basis of 20k. His son inherited the land and subseq sold it for 55k. -the loss on the sale of the prop is 5k (60k step-up basis - 55k SP). The gain inherent in the prop at testator's death goes unrecog'd bc his ston takes a basis in the land equal to the FMV at the date of death. Prop acq'd from a decedent is automatically considered to be LT prop regardless of how long it has actually been held. It's a *long* journey out of the grave. Book ex for basis of inherited prop: assume that a taxpayer inherited prop from a decedent. The FMV at the date of death was 20k. The prop was worth 15k 6 mos later and 22k when it was distr'd to the taxpayer 8 mos later (6 mo max!). It had a cost basis to the deceased of 5k. -basis of the inherited prop to the taxpayer if no alternative valuation date elected: 20k step-up (FMV at date of death). -basis if alternative valuation date elected: 15k step-down (FMV at the earlier of 6 mos after death or date of distr). -if beneficiary sold prop for 25k, CG assuming the alternative valuation date wasn't elected: 5k gain (25k - 20k). -if beneficiary sold prop for 25k, CG assuming the alternative valuation date was elected: 10k gain (25k - 15k).
Priorities; Perfected Security Interests
3 of 5 in the priority ranking. Non-PMSI. Perfected sec ints and judicial liens that have attached have the next highest priority after properly perfected PMSIs. If there are conflicted perfected sec ints or liens in the same collateral, these rules apply: For conflicting perfected sec ints, the first to file or perfect wins. This is perfected non-PMSI v perfected non-PMSI. When there are conflicting perfected sec ints in the same collateral, priority goes to the creditor who was 1st to *either* file or perfect (remember you can file before attachmt occurs, but won't be perfected until attachmt, so filing C/B before perfection). -if both secured parties perfected by filing, the one who filed 1st has priority, even if perfection wasn't completed upon filing. -if one party perfected by filing and the other perfected by another method (like taking possession), the party who filed will have priority if he filed before the other party perfected. Book exs for competing perfected sec ints (non-PMSI v non-PMSI): -F and R both claim a sec int in the same collateral. F's sec int attached on 1/1 and was perfected by filing on 3/1. R's sec int attached on 2/1 and was perfected by possession on 2/15. R's sec int is superior to F's bc R perfected (by taking possession) before F filed or perfected. The dates of attachment are irrelevant. -on 5/1, FB took a loan application from debtor seeking a 10k loan and had debtor sign a sec agreemt and financing stmt covering debtor's equip. On 5/2, FB filed a financing stmt covering the trans. On 5/3, SB loaned debtor 5k and took possession of the debtor's bulldozer to serve as collateral. On 5/4, FB loaned debtor the requested 10k. If debtor defaults in paying FB, FB has priority over SB in the bulldozer bc FB filed before SB perfected (by taking possession). SB was the 1st to perfect, since its perfection was effective upon taking possession of the machine. FB's int wasn't perfected until it gave debtor the $$. The first to file OR perfect has priority. -FB filed on 5/2 and attached/perfected on 5.4, -SB attached and perfected on 5/3. After FB filing, so FB has priority. The examiners often ask which of 2 perfected sec ints has priority. Remember that filing or perfection dates are the dates to look at. Attachmt dates are gen irrelevant. For a conflict btw a perfected sec int and a judicial lien, a judicial lien will have priority if it attached (ex: the sheriff seized the prop) before the sec int was perfected. If the sec int was perfected before the judicial lien attached, it has priority. A trustee in bankruptcy is treated as a hypothetical lien creditor on all of the debtor's prop as of the date the bankruptcy petition is filed. The bankruptcy trustee is subordinate to all prior perfected sec ints but has priority over subseq perfected sec ints unless they have retroactive effect (like PMSIs in equip collateral).
Liquidation of a Partnership; Complete Withdrawal
3 ways in which a partner may liquidate the pship int: -complete withdrawal -sale of pship int -retiremt/death 1 of 3. Complete withdrawal: in a complete liquidation, the partner's basis for the distr'd prop is the same as the adj basis of the partner's pship int, reduced by any monies actually rec'd. The adj basis needs to be determined immediately before the partner's liquidation, after all other items of pship inc/loss and liabs assumed have been taken into acct for the yr. [Beg cap acct +/- % of inc/loss up to withdrawal] = partner's cap acct. [Partner's cap acct + % of liabs] = adj basis at date of withdrawal. [Adj basis at date of withdrawal - cash withdrawn] = remaining basis to be allocated to assets withdrawn. This is a nontaxable liquidation. Rule is 0 out to get out, no G/L. Reduce the remaining basis to 0 by allocating it to the assets withdrawn. *Exception*: $ > basis. The partner recogs gain only to the extent that money rec'd exceeds the partner's basis in the pship; *Exception*: $ < basis (no other items). The partner recogs loss if money, unrealized receivables, or inv are the only assets rec'd and if the basis of the assets rec'd is < the partner's adj basis in the pship.
Alternative Minimum Tax; AMT Credit Carryforward Period and Credits Available to Reduce AMT
3-4 of 4. 3. Credit for PY minimum tax (AMT credit): certain allowable AMT paid in a taxable yr may be carried over as a credit to subseq taxable yrs. It may only reduce regular tax, not future AMT. The CF is forever! AMT from perm diffs (*TIME*) can't be CF as part of the credit. So if AMT is paid bc of those items, it's never recovered. Book ex for AMT credit: B pays AMT. His AMT credit carryover is calc'd to be 5k. If B is subj to AMT in a future yr, this credit isn't allowed to be applied to the AMT. If B isn't subj to AMT in a future yr, may apply this 5k credit against regular tax. CF against regular tax forever! 4. Credits: taxpayers can reduce their AMT liab by the full amt of their nonrefundable personal tax credits. For ex, these tax credits are permitted as a credit to reduce the AMT: *FACCE* it! -*F*TC -*A*doption credit -*C*hild tax credit and child/dependent care credit -*C*ontributions to retiremt plans credit (IRA) -*E*arned income credit -also residential energy credit.
Taxation of a C Corporation; Tax Credits Continued
3. Foreign tax credit (FTC): US corps taxed on worldwide taxable inc (WWTI). Domestic corps who have paid/accrued qualified foreign inc taxes to a foreign country or US possession may gen credit those taxes against their US inc tax liab on foreign source inc. A corp may choose annually to take either a credit or deduction for eligible foreign taxes paid/accrued. Gen, if a corp elects the benefits of the FTC for any tax yr, no portion of foreign taxes will be allowed as a deduction in that yr or any subseq yrs. The goal of the FTC is to keep a US taxpayer's WW effective tax rate from exceeding the US statutory tax rate, which is accomplished through the FTC limitation. FTC calc: 1. determine the qualified foreign inc taxes paid/accrued for the tax yr. To be creditable, the foreign levy must be a tax, the predominant nature of which is an inc tax in the US sense (taxes on wages, int, divs, and royalties gen qualify). 2. calc the FTC limitation as [pre-credit US tax paid in a yr x the ratio of foreign source TI earned to inc earned from both foreign/domestic sources (WWTI)]. So [pre-credit US tax paid x (foreign inc source TI/WWTI)]. 3. determine the LESSER OF the qualified foreign taxes paid (1) or the FTC limitation (2). Any unused FTCs can be CB 1 yr and CF 10 yrs. Book ex for FTC: R, a domestic corp, has 20M WWTI, incl 5M of inc from foreign sources. R paid 2.5M of qualified foreign taxes during the yr. Assume the US tax rate is 35%. Determine the FTC for R. 1. Qualified foreign taxes = 2.5M 2. US tax liab = [20M x 35%] = 7M. FTC limitation = [7M x (5M foreign source inc/20M WWTI)] = 1.75M. 3. Lesser of 1 and 2 is 1.75M. -R can carry its excess unused credits of 750k (2.5M - 1.75M) back 1 yr and fwd 10 yrs.
Legal Liabilities Continued Further
3. Fraud and constructive fraud (gross negligence): CPA liab can also arise through fraud/constructive fraud. Bad faith, pay punitive damages too, more people can sue. Elements of fraud (intentional misrepresentation): *MAIDS* -*M*isrep of a material fact. -*A*ctual and justifiable reliance by plaintiff on the misrep. -intent to *I*nduce plaintiffs reliance on the misrep. -*D*amages. -*S*cienter: intent to deceive (knowing the stmt was false). Book ex for tax preparer fraud: M, CPA, owned P tax services, inc. and for 3 yrs intentionally misreported deductions on his clients' TRs and electronically filed hundreds of incorrect FIT TRs w/ the IRS to generate fraudulent refunds. Elements of constructive fraud (gross negligence) are the same as actual fraud, except instead of intentionally deceiving (scienter), the defendant acts *recklessly* (like making a stmt w/o knowing whether it's true/false). A CPA's liab for fraud/constructive fraud is much broder than liab for negligence. Can be held liable to anyone who proves the fraud elements (MAIDS). Privity is *NOT* a defense to fraud. Liab is *NOT* limited to persons in privity, TPBs, or a limited class of persons who forseeably rely. Anyone can sue you for fraud if prove MAIDS. Best defense is lack of scienter - good faith. Summary of levels of fault: 1. reasonable care (due care) is taken: no negligence, not liable. 2. lack of reasonable care: ord negligence. CPA is liable to anyone they know/reasonably should expect will rely on their work. 3. lack of even slight care: gross negligence/constructive fraud, reckless. 4. actual fraud: actual intent to deceive. 5. criminal fraud: actual intent to deceive. Levels 1-4 are civil in nature, only 5 is criminal. The conduct that forms the basis of a level 4 civil fraud action is the same that forms the basis for a criminal prosecution (level 5) by the govt.
Determination of Partner's Share of Income, Credits, and Deductions; Tax Losses Continued
3. Passive loss limitations: after applying the tax basis and at-risk limitations, partner must consider the passive loss limitations to determine whether the loss from a pship is deductible. The passive activity loss (PAL) rules limit the ability of partners involved in passive activities (like rental or real estate or nonactive participation in a pship) from using ord losses from the passive activity to reduce ord TI. Now not part of 3. Any loss disallowed due to basis, at-risk, or passive activity limitations can be CF and used in a future yr when basis becomes available. Any unused loss resulting from the at-risk limitation can be CF until the partner generates additional at-risk amts to utilize the loss or until they're used to reduce the gain from selling a pship int. Any unused loss resulting from the PAL can be CF until additional passive inc can be generated to absorb the loss or until the taxpayer sells the activity that generates the passive loss. Book ex for tax basis, calc of at-risk amt, and loss limitations w/ active participation in bus: R created a LLC, which she elected to have taxed as a pship, to sell her handmade necklaces. R had an initial cash contr to the bus of 20k. Additionally, R was allocated 5k of recourse debt that she had personally guaranteed and 8k of nonrecourse debt. In the 1st yr of op, R was allocated 35k of loss from the LLC. Calc her basis in the LLC, at-risk amt, and how much of the loss she can deduct on her indiv TR. -tax basis = [20k cash contr + 5k recourse debt + 8k nonrecourse debt] = 33k. -at-risk amt = [20k cash contr + 5k recourse debt] = 25k. -R's loss is limited to her tax basis of 33k. -Once it clears that hurdle, limited to her at-risk amt of 25k. -R may deduct 25k of the 35k loss. The 2k loss suspended by the tax basis limitation (35k - 33k) is CF and can only be used when additional basis is created. The 8k loss limited by the at-risk criteria is CF until the partner generates additional at-risk amts to utilize the loss or sells the pship int. Book ex for tax basis, calc of at-risk amt, and loss limitations w/ passive activity: R created a LLC, which she elected to have taxed as a pship, to sell real estate. R isn't an active participant. Doesn't have passive inc from other activities. R had an initial cash contr to bus of 100k. Also was allocated 20k of recourse debt that she had personally guaranteed and 30k of nonrecourse debt. Allocated 50k of loss in the 1st yr of op. Calc her tax basis in the LCC and her at-risk amt. Calc how much loss from the LLC she can deduct on her indiv TR when considering the limitations imposed by the tax basis, at-risk, and passive activity limitations. -R's tax basis = [100k cash contr + 20k recourse debt + 30k nonrecourse debt] = 150k. -R's at-risk amt = [100k cash contr + 20k recourse debt] = 120k. -she clears the tax basis and at-risk hurdles when considering whether to deduct the 50k loss. -bc R has no passive inc from other sources, isn't able to deduct any of the loss. The loss is CF until she generates passive inc or sells the LLC that has generated the loss.
Section 1231, 1245, and 1250 Assets Continued
3. Section 1250 continued: For indiv taxpayers selling section 1250 prop at a gain the gain is characterized as a section 1231 gain and netted w/ other section 1231 G/Ls to determine if the indiv taxpayer has an overall net section 1231 gain or loss for the tax yr. When an indiv has sold a section 1250 asset at a gain and incl the gain w/ other section 1231 gains, an amt equal to the LESSER of (1) the recog'd gain on the sale of the section 1250 asset or (2) the SL A/D on the section 1250 asset is taxed at a max rate of 25%. Any gain in excess of the amt taxed at 25% is taxed at the preferential rates of 0, 15, or 20%. Book ex for section 1250 gain: L is a sole prop of B and is reported on sch C of B's indiv TR. L owned a bldg w/ an OG cost basis of 100k and SL A/D of 15k, resulting in a tax basis of 85k. L sold the bldg for 95k. Calc the amt recog'd on the sale along w/ the rate at which it's taxed. -recog'd gain on the sale = [95k SP - 85k tax basis] = 10k. -amt taxed at 25% is the lesser of the recog'd gain of 10k and the SL depr of 15k (so 10k). -no portion of the gain will be taxed at a preferential rate of 0, 15, or 20%. Summary of section 1250 recapture for indivs: -for portion of SP covering NBV, no G/L. Basis/cost recovery. -for portion of SP covering A/D, ord inc. Depr recapture. -for portion of SP above that, cap gain section 1231. The CPA Exam infrequently tests on the depr recapture rules. When tested, the section 1245 personal prop (machinery and equip) rules are typically the area. Simple rule of thumb for personal prop recapture: -loss = treat as ord loss (no limitation). -ord inc = gain to extent of A/D. -section 1231 (cap) gain = gain for SP in excess of OG cost.
Alternative Minimum Tax; Alternative Minimum Taxable Income Calculation Continued Further
3. Tax preference items: always "adds" to regular TI. -*P*rivate activity bond TE int (exceptions apply). -*P*re-1987 accelerated depr on real prop and leased personal prop (excess over SL for prop placed in service before 1987). -*P*ercentage depletion deduction (excess over adjusted basis of prop). Book ex for TE int preference item: In Y2 J has TE int of 15k. Of that, 1,300 is deemed to be from private-activity bonds. Her total preference for AMT purposes is 1,300. -result is 15k TE int is exempt from regular tax, but 1,300 of that must be recog'd for AMT. So only 13,700 (15k - 1,300) is exempt for AMT purposes. Book ex for AMTI calc: continuing same ex, assume in Y2 J has regular TI of 60k. From the above exs, her adjustmts are 15,700 and her preferences are 1,300. These are both added back to TI to arrive at AMTI. -calc: [60k regular TI + 15,700 AMT adjustmts + 1,300 AMT preference items] = 77k AMTI. -these items will both incr AMTI bc they are eliminating deductions from regular TI and adding inc to the regular TI.
Features of a Chapter 7 Liquidation; Distribution of the Debtor's Estate: Payment and Priorities Continued
4. 4th priority; *W*age claims up to 12,850: employees who have claim for wages earned w/in 180 days prior to the filing of the petition receive a 4th priority. This is limited to 12,850/employee. So if an employee is owed 15k for wages, 13k of which was earned w/in 180 days prior to bankruptcy, the employee would have a 12,850 priority claim and a 2,150 nonpriority claim. 5. 5th priority; *E*mployee benefit plans (EBPs) up to 12,850: claims for contrs to employee benefit plans (health ins or pension plans) receive a 5th-level priority if they arose w/in 180 days prior to bankruptcy. This may not exceed 12,850/employee and is *reduced by the amt paid to each employee as a 4th-priority wage claim*. Remember that there are 3 restrictions on priority pmts for unpaid wages and EBPs: -only unpaid wages and EBPs that arose w/in 180 days prior to filing are entitled to a priority. Those that arose after filing are nonpriority claims. -only unpaid wages and EBPs up to 12,850 receive a priority. -the 12,850 priority for EBPs is reduced by any amt paid to the employee for a priority wage claim. 6. 6th priority; *G*rain farmers and fishermen up to 6,325: claims of grain producers or US fishermen against a debtor who ops a grain storage facility or fish product storage/processing facility have a 6th priority up to 6,325. 7. 7th priority; *C*onsumer deposits up to 2,850: consumer claims for a deposit made to a retail bus prior to the retailer's bankruptcy are entitled to a 7th-level priority to the extent of 2,850/customer. Ex: if a customer made a 3k deposit for furniture to be delivered, but the seller files a bankruptcy petition prior to delivery, the customer is entitled to a 2,850 7th-priority and a 150 nonpriority claim. 8. 8th priority; *T*ax claims: most tax claims are entitled to an 8th-level priority. 9. 9th priority; personal *I*njury claims arising from *I*ntoxicated driving: DWI. Claims for death/personal injury arising from the op of a motor vehicle or vessel by the debtor while the indiv was legally intoxicated have a 9th priority. The examiners often ask Qs reqing candidates to prioritize debts. Remember that properly perfected secured creditors are paid up to the value of their collateral. They are unsecured, nonpriority creditors for any deficiency. The order of pmt for the 9 priority creditors (next in line) can be remembered w/ *SAG WEG CTI*: -*S*upport obligations to spouse/children. -*A*dministrative exps of a bankruptcy proceeding. -*G*ap creditors. -*W*ages up to 12,850/employee if earned w/in 180 days prior to filing. -*E*BP contrs up to 12,850/employee, reduced by wage claims, if earned w/in 180 days prior to filing. -*G*rain farmers' and fishermen's claims up to 6,325. -*C*onsumer deposits for goods paid for but not delivered up to 2,850. -*T*axes. -*I*njury claims caused by intoxicated driving.
Perfection of the Security Interest Continued Further
4. Automatic perfection: upon attachmt (2 for 1). Article 9 provides that a security int can be perfected simply by the attachmt of the security int w/o any rqmts. This is auto perfection. Only 2 types of auto perfection have appeared on the exam: 1- PMSI in consumer goods: personal use, don't have to file to perfect (it's automatic). A PMSI arises where the creditor either sells the collateral to the debtor on credit and reserves a sec int or advances the funds that are used to purch the collateral and reserves a sec int. *The only type of PMSI that's auto perfected is that in consumer goods*. A PMSI in inv or equip collateral must be filed to be valid. 2- small-scale assignmt of accts: assignmt of a few AR. Auto perfected. 5. Temp perfection: a security int in proceeds (trade-in) from OG collateral is continuously perfected for 20 days from the debtor's receipt of the proceeds. Book ex for temp perfection: R trades in her old stereo, which is collateral for bank's loan, for a new one. Bank's sec int in the new stereo is continuously perfected for 20 days from R's receipt of the new stereo. If the debtor moves from 1 state to another, perfection in the 1st state gen is valid for 4 mos (grace pd) after the debtor moves to the 2nd state. To maintain its priority, the creditor must perfect in the new state w/in the 4 mo pd.
Affiliated Groups and Transfer Pricing; Miscellaneous Continued
4. Limited right of a controlled taxpayer to make adjustmts: a controlled taxpayer has a limited right to make these adjustmts: -if necessary to reflect arms-length pricing, in a timely filed inc TR, a controlled taxpayer may report the result of controlled trans/transfers based upon prices diff from those actually charged. -w/ respect to untimely filed inc TRs and amended inc TRs, the taxpayer can't make any such adjustmts which result in decring TI. 5. Avoidance of penalties: a taxpayer may owe additional fed IT due to IRS adjustmts w/ respect to controlled trans/transfers. The taxpayer can gen avoid the substantial valuation misstmt penalty and gross valuation misstmt penalty if any 1+ of these circumstances apply: 1- section 482 study based on allowable pricing methods: the taxpayer may prep and document a section 482 study based upon allowable pricing methods set forth in the US treasury regs. The taxpayer must determine that the prices for controlled trans/transfers are in accordance w/ the allowable pricing methods set forth in the US treasury regs and that the taxpayer's use of such method was reasonable. The documented study must be completed no later than the date the taxpayer files the fed inc TR. 2- section 482 study not based on allowable pricing methods: the taxpayer may prep/document a section 482 study not based upon allowable pricing methods set forth in the US treasury regs. The taxpayer must establish that none of such pricing methods was likely to result in a price that would clearly reflect inc, that the taxpayer used another pricing method to determine such price, and that such other pricing method was likely to result in a price that would clearly reflect inc. The documented study must be completed no later than the date the taxpayer files the fed inc TR. 3- trans solely btw foreign corps: penalties may be avoided if any portion of such net incr in fed IT is attributable to any trans solely btw foreign corps unless, in the case of any such corps, the treatmt of such trans affects the determination of inc from sources w/in the US or TI effectively connected w/ the conduct of a trade/bus w/in the US.
Remedies Continued
4. Liquidated damages: agreed to in the contract. A liquidated damage clause is one in a contract that specs what damages will be if there's a breach (like forfeiture of a down pmt for a breach). A liquidated damage clause is enforceable if the amt is (1) reasonable in relation to the actual harm done and (2) not a penalty. 5. Punitive damages: gen are *NOT* available for breach of contract (ord negligence). They're available for fraud (intentional), which is a tort cause of action. Punitive damages often show up as a choice in contracts Qs. It's an incorrect choice unless the Q asks which remedy is not available or the cause of action is for fraud (tort) rather than breach of contract. 6. Rescission or cancellation: cancels the contract and restores the parties to their former position. This is available for mutual or unilateral mistakes, fraud, and most material contract breaches. Under the common law, a party can't rescind/cancel if a contract has been substantially performed (doctrine of substantial performance). The non-breaching party's only remedy is monetary damages for the minor breach. Not part of no 6. In order to fairly compensate parties for harm done, the law imposes the limitations of foreseeability and mitigation on monetary damages. -foreseeability: consequential damages are awardable only for those damages that at the time the contract was formed a party could reasonably foresee would result from a breach. -mitigation (reasonable efforts to avoid damages): under contract law, a non-breaching party can't recover for damages that could have been reasonably avoided (lease). The party must mitigate damages (don't just sit around and wait to sue, look for a new tenant!).
Determination of Partner's Share of Income, Credits, and Deductions; Miscellaneous Continued
4. Organizational expenditures and start-up costs: 5k exp, amort rest over 180 mos (15 yrs). Watch for dates! The pship may elect to deduct up to 5k each of org expenditures and start-up costs. Each 5k amt is reduced by the amt by which org expenditures/start-up costs exceed 50k. Any excess org expenditures or start-up costs are amort over 180 mos (beginning w/ the mo in which the active trade/bus begins). Allowable org expenditures incl fees paid for legal services in drafting the pship agreemt, fees paid for accting services, and fees paid for pship filings. Start-up costs incl training costs, advertising costs, and testing costs incurred prior to the opening of the bus. Under GAAP, all expensed. 5. Syndication costs (nondeductible): raising $. Things like offering materials. 6. Calc of COD inc: when a pship transfers a cap/profits int in the pship to a creditor in satisfaction of pship debt, the pship recogs COD inc. The amt of such inc is the excess of the amt of the debt discharged (cancelled) over the FMV of the pship int that the pship transfers to the creditor.
Types of Tax Exempt Organizations Allowed under the IRC Continued
4. Section 509 private foundations: incl all section 501(c)(3) corps other than those specifically excluded. The exclusions sep 501(c)(3) orgs into 2 groups: private foundation and pub charities. A foreign corp may qualify as a private foundation. Excluded orgs (public orgs): These 4 distinct categories aren't private foundations: -max (50 percent-type) charitable deduction donees. -broadly publicly supported orgs receiving no more than 1/3 of their annual support from members of the public and <1/3 from investmt inc and unrelated bus inc (UBI). -supporting orgs. -pub safety testing orgs. An annual info return (Form 990-PF) that discloses substantial contributors and amts of contrs rec'd is req'd. Termination of private foundations incl: -involuntary termination: private foundations will terminate when they become pub charities (*can't be both*). Termination by the IRS will result if the foundation commits repeated violations or willful and flagrant violation of any of the private foundation provisions. -voluntary termination: private foundation status need not be perm. Voluntary termination may be achieved by notifying the IRS of the plan to term, subj to a termination tax payback of the value of its aggregate tax benefits or net assets, whichever is lower. Alternatively, w/o a tax payback, a foundation may elect to distr all of its assets to an org qualifying for the max 50% deduction or it may op as a pub charity itself for at least 5 yrs. Note: a private foundation may have a charter that limits its exempt purpose, and it's not req'd to distr all of its net assets to any pub charity.
Corporate Taxable Income; Trade or Business Deductions Continued
5. Bus int exp: On bus - incurred and paid = deduction. On investmt - up to TI. Prepaid - deduct later when incurred. Most int paid/accrued during the taxable yr on indebtedness incurred for bus purposes is deductible. Prepaid int exp must be allocated to the proper pd to which it's related. Int exp on a debt incurred to purch TE bonds isn't deductible. Certain other types of int aren't deductible (beyond scope). 6. Char contrs: 10% of AGI limitation. Corps making contrs to recog'd charitable orgs are allowed a max deduction of 10% of their TI. Any disallowed char contr may be CF 5 yrs. Any accrual must be paid w/in 3.5 mos or 4.5 mos of the taxable YE to be deductible (accrue and pay by 4/15). Total TI (for the 10% limitation) is calc'd before the deduction of: -any char contr deduction -the DRD -any NOL CB -any CL CB -US production activities deduction 7. Bus losses or casualty losses related to bus (100% deductible): gen, any loss sustained during the taxable yr and not compensated for by ins or otherwise is deductible. The loss may be treated as ord or cap, depending on the type of assets involved in the casualty. Bus casualty losses are treated slightly diff than for indivs bc: -no $100 reduction -no 10% of AGI reduction. For prop only partially destroyed, loss is limited to the LESSER OF: -the decline in value of the prop (change in FMV) OR -the adjusted basis of the prop immediately before the casualty (NBV). For fully destroyed prop (NBV): total loss. The amt of the loss is the adjusted basis (NBV) of the prop. For both this and partially destroyed, subtract any ins proceeds from the loss amt. Book exs for casualty loss: 1- B inc had major casualty loss in Y1 where warehouse bldg was seriously damaged (partially destroyed) by a storm. FMV of bldg before storm was 850k, 400k after. Adjusted basis of the prop was 600k. Ins reimbursemts were 300k. Determine the amt of casualty loss than can be deducted for tax purposes. -amt of casualty loss before ins reimbursemts is 450k (decline in FMV, less than the NBV of the prop). Subtracting the ins reimbursemt gives deductible loss. [450k - 300k] = 150k deductible loss. 2- same facts, but prop was totally destroyed. Determine the amt of casualty loss that can be deducted for tax purposes assuming the prop was totally destroyed. -deductible casualty loss W/B 300k (600k NBV - 300k ins proceeds). Use NBV, not FMV since totally destroyed.
Business Structures; Summary of Entities Continued
5. LLC: -formation: file articles of org w/ state. -liab of owners: members gen not personally liable beyond their investmt. -mgmt: members manage directly or can agree to appoint a manager. -transferability: absent agreemt otherwise, members can't transfer oship int w/o unanimous consent. -taxation: flow through, but members not managing have passive loss restrictions. 6. C corp: -formation: file articles of incorp or corp charter w/ state. -liab of owners: SHs gen not personally liable beyond their investmt. -mgmt: managed by BOD, which appoints officers to run day-to-day ops. -transferability: SHs are free to transfer oship int unless they agree otherwise. -taxation: inc taxed at corp level and taxed again to SHs when divs are distr'd (only non flow through entity here). 7. S corp: -formation: same as reg C corp, plus file S election. -liab of owners: SHs gen not personally liable beyond their investmt. -mgmt: managed by BOD, which appoints officers to run day-to-day ops. -transferability: SHs gen may transfer oship int unless they agree otherwise, but can't transfer to foreign or entity SHs. -taxation: flow through, but SHs not managing have passive loss restrictions.
Tax Return Preparer Compliance Penalties; Key Terms Continued
5. Negligence (ord): any failure to make a reasonable attempt to comply w/ the provisions of the internal rev laws or to exercise ord/reasonable care in the prep of a TR. Also incl any failure by the taxpayer to keep adequate books/records or to substantiate items properly. Not fraud (W/B willful/reckless). Diff penalties apply for negligence v fraud. 6. Person: indiv, trust, estate, pship, association, co, or C corp. 7. Reasonable basis: >20% chance tax position upheld. Relatively high std of tax reporting. Sig higher than not frivolous or not patently improper. Reasonable basis std isn't satisfied by a return position that's merely arguable or a colorable claim. If a return position is reasonably based on 1+ of the authorities, the return position will gen satisfy the reasonable basis std even though the position may not satisfy the substantial auth std. 8. Reportable transaction: also called listed and tax shelter (special rules apply). Any trans w/ respect to which info is req'd to be incl w/ a return/stmt bc such trans is of a type that the secretary of the US treasury dptmt has ID'd as having a potential for either tax avoidance (legal use/application of tax laws and cases to reduce the amt of tax due) or tax evasion (efforts, by illegal means/methods, to not pay taxes). 9. Substantial authority std: >33% but <50% chance of success. Objective std involving an analysis of the law and application of the law to relevant facts. Less stringent than the more-likely-than-not std (>50%). -there's subst auth for the tax treatmt of an item only if the weight of the authorities supporting the treatmt is substantial in relation to the weight of the authorities supporting the contrary treatmt. -there's subst auth for the tax treatmt of an item if the treatmt is supported by controlling precedent of the US ct of appeals to which the taxpayer has a right of appeal w/ respect to the item. -bc this std is an objective std, the taxpayer's belief that there's subst auth for the tax treatmt of the item isn't relevant.
Bankruptcy
6 types of bankruptcy cases under fed law: ch 7 liquidation, ch 9 muni debt adjustmt, ch 11 reorg, ch 12 fam farmers w/ reg inc, ch 13 adjustmt of debts of indivs w/ reg inc, and ch 15 ancillary and other cross-border cases. Must know 7, 13, and 11 below. In a ch 7 liquidation case, trustee is appointed. Indivs, pships, and corps (IPC) can declare ch 7. Trustee collects the debtor's assets, liquidates them, and uses the proceeds to pay off creditors to the extent possible. -If the debtor is an indiv/married couple, the debtor's debts are then discharged (relieved from person liab for most debts), w/ certain exceptions. -If the debtor is an artificial entity (corp), it's dissolved. No discharge is given but the effect is the same - debts are wiped out. In a ch 13 case (adjustmt of debts of indivs w/ reg inc), the debtor repays all/a portion of his debts over a 3 - max 5 yr pd. There's not a liquidation, but a trustee oversees the handling of a ch 13 proceeding. At the conclusion of a ch 13 proceeding, the remaining debts of the debtor are discharged. In a ch 11 reorg case (usually by a bus but available to IPC), no liquidation and a trustee is usually not appointed (GR). There's hope! -The debtor remains in possession of his assets and a plan of reorg (to pay off debts at a diff time/amt from what was OG due) is adopted. -creditors are paid to the extent possible and the bus continues. Examiners often ask if a trustee is req'd for a type of bankruptcy. Remember: -trustee is req'd for chs 7 and 13. -*NOT* req'd for ch 11, although the ct may appoint one if necessary. Ch 15 (ancillary and cross-border cases) is the US adoption of the model law on cross-border insolvency promulgated by the UN. Adopted to promote a uniform and coordinated legal regime for cross-border insolvency cases.
Affiliated Groups and Transfer Pricing; Miscellaneous Continued Further
6. Competent auth: advanced ruling = get IRS to approve before trans is done. In certain circumstances, the taxpayer can request that the IRS and taxing officials in the other country/countries together ascertain the approp transfer price so the taxpayer group isn't taxed twice on the same inc. Such a request is a "request for competent auth," and the taxpayer may make this request any time after an IRS action results in taxation inconsistent w/ the provisions of any applicable treaty. 7. Advance pricing agreemt (APA) program: binding agreemt w/ IRS. The IRS website states that in early 2012, the APA program merged w that portion of the office of the US competent authority (USCA) that resolves transfer pricing cases under the mutual agreemt procs of the US bilateral IT conventions to form the advance pricing and mutual agreemt (APMA) program. APMA's mission is to resolve actual/potential transfer pricing disputes in a timely, principled, and cooperative manner. An APA normally reqs agreemt on these issues: -choosing a transfer pricing method (TPM). -selecting comparable uncontrolled cos/trans (comparables). -deciding on the yrs over which comparables' results are analyzed. -adjusting the comparables' results bc of diffs w/ the tested party. -constructing a range of arm's-length results. -testing the results during the APA pd. -agreeing on critical assumptions. Often 2+ approaches to certain issues are possible, and there may be no clear basis for preferring one approach over another. In such situations, the IRS may give the taxpayer their preferred treatmt of some issues if the taxpayer agrees to the IRS using its preferred treatmt of other issues.
Taxpayer Penalties Continued
6. Penalty for substantial understmt of tax (accuracy-related penalty): 20% of the understmt of tax. An understmt is substantial if it exceeds the greater of 10% of the correct tax or 5k. -for C corps, other than PHCs, an understmt is substantial if the amt of the understmt exceeds the lesser of (a) 10M or (b) the greater of 10k or 10% of the correct tax. -if the IRS imposes this penalty, can't impose either (i) the negligence penalty w/ respect to an understmt of tax which is not substantial and penalty for disregard of rules/regs or (ii) the penalty for a substantial valuation misstmt. 7. Penalty for a substantial valuation misstmt: 20% of the understmt of tax w/ respect to a valuation for tax purposes to the extent the understmt exceeds 5k (10k for corps). -there are 2 distinct substantial valuation misstmt stds: one for IRC section 482 trans (related parties) and one for non-section 482 trans (non-related parties). -defenses for char contrs must incl good faith, qualified appraisals, and good faith investigation of value. -this penalty can't be imposed in addition to the negligence penalty or penalty for substantial understmt. 8. Fraud penalties: penalty incr to 75% and criminal. Both civil penalties (at least 75% of the understmt of tax due to fraud) and criminal penalties (as high as 100k, 500k for corps) can apply. The IRS must prove the taxpayer willfully and deliberately attempted to evade tax. -Criminal penalty and potential imprisonmt subj to an inflation adjustmt, top 100k (500k for corps), plus the IRS must prove beyond a reasonable doubt that the taxpayer criminally, willfully, and deliberately attempted to evade tax.
Defenses of Surety Continued
8. Extension of time v delay in collection: if the principal debtor and creditor agree to extend time, the above rules apply (gratuitous surety discharged, comp'd surety discharged if the change is mat and incrs risk). However, if the creditor doesn't agree to extend time, but merely delays in collection, the surety is not discharged. 9. Loss of security: collateral. The release of security held by the creditor discharges the surety in the amt of the security released. If the security is lost due to the creditor's inaction (failure to take the steps necessary to perfect it), the surety is discharged in the amt of the value of the security unless substantial and burdensome acts were req'd for protection of the security. If no notice is given of creditor repo of debtor's collateral, surety is released. If notice is given, surety can be accused of deficiency, 10. Release of cosurety: a release of a cosurety w/o the other cosurety's consent results in the remaining cosurety losing the right of contr against the released cosurety. The remaining surety is discharged to the extent that the surety could have recovered from the released surety. Book ex for release of cosurety: I loans F 50k. Q and W agree to act as comp'd cosureties in the amt of 50k each. I releases W w/o Q's consent and F defaults on the entire obligation. I demands pmt from Q. Q is discharged for 50% of the loan (25k) bc this is the amt Q could have collected from W by reason of the right of contr. 9 and 10 are partial releases for a compensated surety. 11. No defense situations: these are the very reasons why a creditor wants a surety. Surety must pay. The principal's fraud against the surety (like principal debtor lies to get surety to agree) is not a defense against the creditor unless the creditor knows of the lie. The fact that the principal debtor is/has become bankrupt/incapacitated is not a defense for the surety.
Corporate Taxable Income; Trade or Business Deductions Continued Further
8. Organizational expenditures and start-up costs: subtract 5k, excess over 15 yrs (180 mos). Watch date bus starts! The corp may elect to deduct up to 5k of organizational expenditures and 5k of start-up costs. Each 5k amt is reduced by the amt by which the org expenditures or start-up costs exceeds 50k, respectively. Any excess org expenditures/start-up costs are amort over 180 mos, beginning w/ the mo in which active trade/bus begins. -included costs: allowable org expenditures and start-up costs incl fees paid for legal services in drafting the corp charter, bylaws, minutes of org meetings, fees paid for accting services, and fees paid to the state of incorp. -excluded costs: don't incl costs of issuing/selling the stock, commissions, underwriter's fees, and costs incurred in the transfer of assets to a corp. Costs of raising cap. It's important for CPA candidates to remember the diff in GAAP (fin stmts) and tax (inc TR) rule for org and start-up exps. -tax rule: 5k exp maximum, 180 mos amort of remainder. -GAAP rule: exp immediately. Book ex for org expenditures: K, a newly org'd corp, was formed on 6/30/Y1 and began doing bus on 7/1/Y1 (1/2 yr). The corp will have a 12/31 YE. K incurred these exps in organizing the bus: -legal fees for drafting the corp charter: 15k -fees paid for accting services: 5k -fees paid to state of incorp: 3k -costs of selling shares of stock: 10k. Determine the deduction for org costs in Y1. -total exps = [15k + 5k + 3k] = 23k. -amort = [23k - 5k exp] = 18k. [18k/180 mos] = 100/mo. [100 x 6 mos] = 600. -[5k exp + 600 amort] = 5,600 deduction for org costs in Y1. -the cost of selling shs may not be amort, it's a reduction in the cap stock acct. 9. Amort, depr, and depletion: GW, covenants not to compete, franchises, TMs, and trade names must be amort on a SL basis over a 15-yr (180 mo) pd beginning w/ the mo such intangible was acq'd. For depr and depletion corps use the rules covered in R3. CPA exam likes to test diffs btw GAAP and tax rules. For purch'd GW (yrs 2002 and on): -tax rule: amort on SL basis over 15 yrs. -GAAP rule: not amort, test for impairmt annually. 10. Life insurance premiums/exp: -corp named as beneficiary and owns the policy (key person): premiums paid by the corp for life ins policies on key employees aren't deductible when the corp is directly/indirectly the beneficiary. *NOT* tax deductible. -insured employee named as beneficiary and owns the policy (fringe benefit): if the premiums are paid on ins policies where the beneficiary is named by the insured employee, such premiums are deductible as an employee benefit. Tax deductible fringe benefit.
Limited Liability Companies (LCCs)
A LLC is a sep legal entity from its owners. As w/ corp SHs, LLC members are *NOT* personally liable for the obligations of the bus. All members of an LLC have limited liab, which is diff from a limited pship, where at least 1 gen partner is personally liable for all pship debts. The bus owner files articles of org w/ the state where the LLC is org'd, sim the formation of a corp. This list summarizes some of the key points a bus owner should consider when trying to decide whether or not to org a bus as an LLC: -an LLC provides sim protection from liabs as a corp, but doesn't have the double taxation of a corp if the LLC is taxed as a pship. -LLC members gen have the right to amend the LLC op agreemt, provide input, and manage LLCs, yet corp SHs gen don't have these same rights. -an LLC can't become a pub co, it must convert to a corp before issuing an IPO. -S corps have restrictions on the type/no of SHs they may have. LLCs don't have these same restrictions. Unlimited members. US people, foreign people, and corps/pships all allowed. -a sole prop may become a single member LLC if it files articles of org w/ a state. This is a disregarded entity, so still use sch C of 1040. For fed IT purposes, an LLC is treated as 1 of these: a pship, corp, or sole prop. The IRC doesn't specifically address taxation of LLCs. A LLC w/ at least 2 owners is taxed as a pship unless an election is made to have the LLC taxed as a corp. Such an election is made on Form 8832, entity classification election. A single member LLC, not electing to be taxed as a corp, is considered a disregarded entity for fed IT purposes and will be treated as a sole prop (sch C). Form 8832 (entity classification election) incl: -info abt co making election. -election info. Lots of checkboxes.
Features of Reorganization Cases Under Chapter 11 Continued
A ch 11 plan must, among other things: -classify all claims (secured, 1st priority, 2nd priority, etc. under *SAG WEG CTI*, impaired, unimpaired, etc.). -descr the treatmt to be accorded each impaired class. -treat each claimant w/in a particular class identically and -establish ways to implement the plan. Any creditor/EQ sec holder (stockholder) who has filed a claim against the debtor's estate must be given an opp to accept/reject the plan. -a class of impaired claims is deemed accepted if it's accepted by creditors holding at least 2/3 in amt and > 1/2 in no of the allowed claims. -a class of impaired ints (EQ sec holders, stockholders) is deemed to have accepted the plan if it's accepted by the EQ sec holders having at least 2/3 in amt of the allowed claims. -*NOT* unanimous! The ct will confirm the plan if it meets certain conditions like (GR) being accepted by all impaired classes, providing for pmt in full for priority admin exps and gap claims, and the plan is feasible (has a reasonable chance of succeeding). A plan can be confirmed by the ct even if it's not accepted by all impaired classes if at least 1 impaired class has accepted, and the ct finds that the plan is not unfairly discriminatory and is fair and equitable w/ respect to any dissenting impaired classes. This is called a cram down A ct confirmed ch 11 plan is binding on all creditors, EQ sec holders, and the debtor, regardless of whether they accept the plan. Gen, once confirmed the debtor pays debts according to the plan. Unless the order provides otherwise, confirmation discharges the debtor from all preconfirmation debts except the debts not discharged under ch 7, which are also not discharged under ch 11 (*FAT WED*). So discharges most debts. Confirmation also terminates the automatic stay.
Features of a Chapter 7 Liquidation; Objections to Discharge
A ch 7 liquidation is for IPC, voluntary/involuntary, and indivs must pass inc tests. The goal of fed bankruptcy law is to give an honest debtor a fresh start financially by discharging most of their debts. In a liquidation, a bankruptcy trustee is appointed (7 and 13). The trustee collects all of the debtor's nonexempt prop, liquidates it, and pays off all of the debtor's creditors. Most debts of an indiv are discharged (the debtor is relieved from personal liab for them), but certain debts survive bankruptcy (*FAT WED*). Entities are dissolved, indivs are discharged. Creditors often want to prevent debtors from getting a ch 7 discharge. The code provides 2 kinds of ammunition for such claims: objections to discharge and nondischargeable debts. Objections to discharge destroy the entire ch 7 case, none of the debtor's debts will be discharged. Nondischargeable debts prevent the discharge of specific debts. These things will prevent the debtor from receiving any discharge (gen, debtor dishonest): -debtor not an indiv: technically, only indivs (real people, not artificial entities like corps) can receive a discharge under ch 7. Artificial entities seeking relief under ch 7 are dissolved at the conclusion of the case, so their debts are wiped out. -fraudulent transfers/concealmt of prop: debtor isn't entitled to discharge if he transferred, destroyed, or concealed prop in the yr before/after the petition was filed w/ the intent to hinder/delay/defraud creditors. -unjustifiably failed to keep books/records: the debtor isn't entitled to discharge if he unjustifiably concealed, falsified, or failed to keep/preserve adequate books/records from which the debtor's financial condition or bus trans might be ascertained. -prior discharge w/in 8 yrs: a debtor is entitled to only 1 discharge w/in an 8 yr pd. 8 yrs must elapse before another discharge can be granted. -commission of a bankruptcy crime: in addition to constituting fed crimes, these acts give rise to objections to discharge when committed knowingly/fraudulently in connection w/ the bankruptcy case: (a) making a false oath or acct (b) presenting or using a false claim (c) giving or receiving a bribe (d) withholding records or docs -failure to explain loss of assets: a debtor who is unable to explain satisfactorily the disappearance/loss of assets is not entitled to discharge. -refusal to obey orders or answer Qs: if a debtor refuses to obey a lawful order of the ct, a discharge is denied. The examiners sometimes ask what will prevent a party from getting a discharge in bankruptcy. The most often tested reasons are the 1st five; not an indiv, fraudulent transfers/concealmt of prop, unjustifiably failed to keep books/records, prior discharge w/in 8 yrs, and commission of a bankruptcy crime. Most frequent is failure to keep records.
Contracts; Methods of Formation and Sources of Contract Law
A contract is a promise the law will enforce (legally enforceable agreemt). Methods of contract formation are listed below. Examiners don't often ask for descrs of a contract using these terms, but it's important to know them bc they're sometimes used in Qs. -express contract: formed by language, oral/written. Book ex for express contract: A promises to give B $10 if B will wash A's car. Express contract. -implied-in-fact contract: formed by conduct. Book ex for implied-in-fact contract: A goes to the doctor and says he is sick. Doctor examines A and gives him an antibiotic. A and doctor have entered into a contract for the doctor's services, even though no oral/written promises were exchanged. Their conduct implies their intent to enter into a contract. -implied-in-law contract (quasi-contract): not a contract at all! Remedy that allows a plaintiff to recover a benefit unjustly conferred upon the defendant. Remedy to prevent unjust enrichment. Book ex for quasi-contract: J gives K 10k as a down pmt to purchase K's house. Contract is oral, so unenforceable. K decides to back out. J can recover the down pmt in quasi-contract. -unilateral contract: 1 promise, given in exchange for performance (ex: A promises to give B $10 if B will wash A's car). A contract isn't formed until performance is completed. -bilateral contract: 2 promises, a promise exchanged for a promise (ex: A promises to give B $10 if B promises to wash A's car). Contract is formed as soon as the promises are exchanged. Sources of contract law incl: 1. Common Law: gen derived from cts. Contracts involving *R*eal estate, *I*nsurance, *S*ervices, and *E*mploymt (*RISE*) are governed by the common law. This is the main focus on the CPA exam. 2. Uniform Commercial Code (UCC) Sales Article: the UCC is statutory law that has been widely adopted throughout the US. Its sales article (article 2) governs contracts for the sale of goods (moveable things). There are a no of special rules that apply to contracts for the sale of goods, but don't need to know them for the exam.
Corporation; Nature of a Corporation
A corp is a legal entity (exists as an entity distinct from its SHs. As a distinct legal entity, usually only the corp is liable for corp obligations. Gen, SHs, directors, and officers aren't personally liable for contracts made by their corp. Neither are they liable for corp torts, except to the extent to the extent the SH, officer, or director participated in the tort. Taxation: -C corp: double taxation. Gen, a corp is taxed as an entity distinct from its owners. Must pay taxes on any profits it makes. SHs gen don't have to pay tax on the profits of the corp until they're distr'd (as divs under tax laws). -S corp: flow through. The tax laws permit certain corps to elect to be treated like pships (profits aren't taxed at corp level but are treated as inc of the SHs). There are a no of restrictions on S corps, like: (a) stock can be held by no > 100 persons. (b) SHs must be indivs, estates, or certain trusts. (c) the corp must gen be a domestic corp. (d) there can be only 1 class of stock. (e) foreign SHs are gen prohibited. Corps are owned by their SHs, but unless the articles of incorp provide otherwise, the SHs don't run the corp. The power to run the corp is vested in the BOD, which is elected by the SHs. Except small closely held. A corp gen has a perpetual life (unique to corp). One of the key distinguishing chars of a corp is that its owners/SHs are free to tranfer all of their oship rights to others, unless otherwise agreed (unique to corp).
Audit Process Continued
A correspondence audit (no issues) arises as a result of IRS review for: -info errors (incorrect social sec nos or missing sigs) -matching issues (inc on TR doesn't match W-2 or 1099) -math errors For errors, the taxpayer is typically sent a revised calc and a brief explanation of any change made along w/ a bill for the additional amt due or check for a refund, as approp. There will be no need for a formal meeting w/ an IRS rep. If the pmt is made timely, there's no int on the underpmt. If the req'd pmt is not made timely, there's int fom the date of notice. If a formal examination is necessary, there may be an office or field audit. -office audit: conducted by an IRS rev agent, either in an IRS office or by correspondence, and is used for indiv returns w/ few/no items of bus inc. Usually, the taxpayer is merely req'd to substantiate an item of inc, a deduction, or a credit. -field audit: conducted by an IRS rep, either at the taxpayer's office/home or at the place of bus of the taxpayer's rep. The IRS makes the final determination of when/where/how the exam will take place. The taxpayer can make an audio recording of the exam interview. After an audit, the rev agent may either accept the return (no change report) or recommend certain changes. If agreemt is reached w/ the taxpayer, the taxpayer signs Form 870 (waiver of restrictions on assessmt and collection of deficiency in tax) and int stops accumulating on the deficiency 30 days after the form is filed. The taxpayer will get a bill for any additional taxes/int (gen calc'd from the due date of the return until pmt) or a refund check, incl int on it. By signing Form 870, the taxpayer waives the right to receive certain statutory notices and to petition the US tax ct and waives the right to the appeals process. Signing usually closes the case, but the IRS may assess additional deficiencies if necessary. If agreemt can't be reached at the rev agent level (indiv), the taxpayer receives a copy of the rev agent's report and a 30-day letter (prelim notice) notifying the taxpayer of the right to appeal. The taxpayer has 30 days to request an administrative appeal w/ an appeals officer (appeals conference, not ct of appeals). Small bus owners and SE indivs can resolve their tax disputes through a process called fast-track remediation. The goal for resolution w/ this is 60 days. A trained mediator from the IRS office of appeals is assigned to help the taxpayer and the IRS reach an agreemt on the disputed issues. Fast track remediation isn't available for issues for which there's no legal precedent in the cts, for which the cts in diff jurisdictions have rendered differing decisions, and in other specialized situations. If, at the end of the process, the issue remains unresolved, the normal appeals process is still available.
Taxation of Foreign Entities; Entity Classification
A foreign entity is gen classified as either a foreign branch or sub. A foreign branch is an unincorp'd foreign entity that's viewed as an extension of the domestic corp. It's not a sep legal entity. However, the earnings from the branch are gen taxed by the foreign host country as well. Fed tax consequences related to a foreign branch are: -P/Ls earned by the branch are treated as being earned directly by the domestic corp and are accordingly taxed in full when earned. This allows any losses incurred by the foreign branch to offset domestic inc earned by the US co. -a credit against taxes is allowed for the lesser of foreign tax imposed by the branch's host country or the FTC limitation. -remittance of branch profits back to the domestic corp is gen not a taxable event for fed tax purposes, as the profits are taxed when earned (one exception W/B any related foreign currency exchange G/Ls that occur upon repatriation). However, the foreign host country may impose a branch profits tax, which is basically a withholding tax on branch inc remitted back to the domestic corp. Foreign tax now, fed tax now. A foreign sub is a sep legal entity, incorp'd under the laws of the foreign host country. Accordingly, the sub profits are taxed by the host country. Fed tax consequences related to the foreign sub are: -inc earned by the sub isn't taxed until the earnings are brought back to the US in the form of a div. In this way, the US co has control over when foreign profits are recog'd. -certain types of inc earned aren't allowed to be deferred and are subj to immediate taxation (passive investmt inc). -bc the foreign sub is a sep legal entity and taxation on profits may be deferred, it's important that trans btw the US parent and foreign sub follow the rules of transfer pricing, or penalties will be imposed. Foreign tax now, fed tax later.
Gains (Excluded or Deferred); Homeowner's Exclusion
A gain isn't taxed if the taxpayer can *HIDE IT*. Gain to the extent of boot/loot rec'd is taxable. Boot incl: -cash: kept and not reinvested. -COD: excess debt assumed by buyer. [Amt realized - adjusted basis of asset sold] = G/L. There's a special group of trans on which any realized gain is excluded/not currently recog'd. These special statutory provisions are based on the idea that the taxpayer's investmt hasn't substantially changed, so recog of G/L on the trans S/B deferred. This is done through the device of *substituting* the taxpayer's basis in the prop given up for the basis of the prop acq'd. Homeowner's exclusion = *H*IDE IT. The sale of the taxpayer's personal principal residence is subj to an exclusion from gross inc for gain. The amt of the exclusion is: -500k for MFJ and certain surviving spouses. -250k for single, MFS, and HOH. -excess gain above these amts is taxable. To qualify for the full exclusion (up to the applicable dollar limit): -a taxpayer must have owned/used the prop as a principal residence for 2 yrs + during the 5-yr pd ending on the date of sale/exchange by a taxpayer. If only 1 spouse lived there long enough, use the 250k. -the pds of oship/use don't have to be continuous nor do they have to cover the same 2-yr pd. However, the gain eligible for exclusion may be reduced bc of nonqualified use. Book ex for homeowner's exclusion: a taxpayer w/ a single filing status purch'd a home and lived in it as her personal residence for 1 yr. After 1 yr, was transferred to work in a new city for 2 yrs. Continued to own the house and rent it. Moved home and lived in the house 1 yr before selling it. Determine if she qualifies for the homeowner's exclusion. -2 lived in, 2 out. So lived in house 2 out of 5 yrs (sold after 4). -she meets both oship and use tests bc she owned/used the house for 2+ yrs during the 5 yrs before the sale, even though the use of the prop wasn't in consecutive yrs. -she is eligible for the exclusion, but the gain eligible for exclusion may be limited bc of nonqualified use by the taxpayer. Either spouse for a joint return must met the oship rqmt, but both must meet the use rqmt w/ respect to the prop. If both don't qualify for the use rqmt, one may still be eligible to take the 250k exclusion. Book ex for use rqmt for married taxpayers: after owning/using his home as a principal residence for 3 yrs, a taxpayer marries and his new wife moves in. After 1 yr of marriage, they decide they need more space and decide to sell the home. Determine the allowed homeowner's exclusion. -the taxpayer meets both the oship and use test bc he has owned/used the home for at least 2 yrs before the sale (out of 5). -the spouse doesn't meet the oship and use test for at least 2 of the 5 yrs prior to the sale (used 1). -on the jointly filed TR, the max exclusion that may be claimed is 250k. If a widow/widower sells a home that the surviving spouse owned/occupied w/ the decedent spouse, the surviving spouse is entitled to the full 500k exclusion provided that the surviving spouse sells the home w/in 2 yrs after the date of the decedent spouse's death.
Agent's Power to Contractually Bind the Principal; Apparent Authority Continued
A gen agent will perform a series of trans involving a continuity of service (bus manager). A special agent will perform 1+ trans not involving continuity of service (realtor). Gen agent has broader apparent auth than special. Book ex for apparent auth of gen v. special agent: P hires A to manager her pet store. Also hires J to distr advertising brochures at the park at a festival. A is a gen agent, J is a special agent. A has broader apparent auth than J. When a principal terms an agent's actual auth, the agent will continue to have apparent auth until the principal *notifies* 3rd parties who might have known of the agency. -actual notice must be given to term apparent auth to old customers. -constructive notice (like a newspaper ad) must be given to term apparent auth to potential customers who may have known of the agency but hadn't done bus w/ the agent. So basically if agent quits/gets fired, must give notice to term apparent auth. If an agent's auth is term'd by op of law, apparent auth is also term'd by op of law and *no notice is needed*. Book ex for term of apparent auth: A has been P's office manager for 10 yrs and has regularly purch'd office supplies from T. P fires A, but doesn't notify T. If A purchases more office supplies from T purportedly on P's behalf, T can make P pay for them bc of A's apparent auth.
General Partnership/Joint Venture; Formation
A gen pship is formed whenever 2+ persons intend to carry on as co-owners of a bus for profit. Papers need not be drawn up to form a pship. Nothing need be filed w/ the state. An express agreemt is not req'd, an agreemt can be implied from conduct. Book ex for formation of a pship: S and B decide to op a hot dog cart together. S agrees to pay for the cart and B agrees to make/sell the hot dogs. The 2 also agree to split the profits. A pship has been formed even though S and B never expressly agreed to form one. A very common bus entities Q on past exams asks simply: what type of bus entity can be formed w/o organizational docs w/ the state? A pship or sole prop are the only possibilities. Formation of all other bus entities reqs filing some sort of organizational doc w/ the state. Cts sometimes try to distinguish joint ventures (JVs) from gen pships, but the legal rqmts and consequences, as well as advs/disadvs, are identical to those of a gen pship. For exam purposes, the key diff btw a JV and a gen pship is that a JV is formed for a single trans/project or related series of trans/projects. If it's unclear whether the parties intended to enter into a pship, an agreemt to share profits gives rise to a presumption that the parties intended to form a pship. As a GR, a gen pship agreemt need not be in writing. However, if the partners want to enforce an agreemt to remain partners for > 1 yr, a writing is req'd under the statute of frauds (M*Y* LEGS). The examiners often ask what's necessary to form a gen pship. The key is to remember three simple elements: (i) 2+ persons, (ii) who agree (expressly/impliedly) (iii) to carry on as co-owners of a bus for profit. There's no rqmt of a writing, even if the pship is to own land, unless the pship is to last for > 1 yr. Gen pships are treated as entities for most purposes (may hold prop and sue/be sued in own name, etc.), but they are not taxable entities for IT purposes.
Limited Partnership Continued
A limited partner may assign his int in the pship (EQ). The assignmt of a limited partner's int is like an assignmt in a gen pship, the assignee has the limited partner's rights to profits. Unless otherwise agreed, the assignor ceases to be a limited partner upon assignmt of all of his limited pship int. A new partner can be added only upon the consent of *ALL* partners. A limited partner doesn't owe a fiduciary duty to the pship (bc not an agent). If the partners have agreed on how profits are shared, the agreemt governs. Unless otherwise agreed, gen and limited partners share P/Ls in proportion to the value of the partners' contrs (unlike GP and LLP where share equally, more like a corp). Remember that a limited partner isn't liable for any loss beyond his cap contr. A limited pship may be dissolved by: -the occurrence of the time/event stated in the pship agreemt. -written consent of all partners (unanimous written consent needed to dissolve). -withdrawal/death of a gen partner or -judicial decree. The death of a limited partner will *NOT* dissolve the pship. After dissolution, if the LP is terminated, assets are distr'd in this manner: 1. to creditors, incl partners who are creditors. 2. to former partners in satisfaction of liabs that weren't paid on their withdrawal and 3. to partners, 1st to return their contrs, the to distr profits (based on capital). If there's a loss, only the gen partners will be personally liable. Limited partners have no personal liab beyond their capital commitmts.
Circular 230; Duties and Restrictions Continued
A practitioner may *NEVER* charge an unconscionable (grossly unfair) fee. A contingent fee (GR: not allowed) is only allowable in these 3 situations before the IRS (exceptions): -IRS examination or audit. -claim solely for a refund of int and/or penalties or -a judicial proceeding arising under the IRC. A practitioner may also face potential conflicts of int w/ respect to various clients. Even if one exists, practitioner may rep all clients if: -the practitioner reasonably believes they can competently rep the clients. -no state/fed law prohibits such rep and -each affected client *waives the conflict of int in writing* w/in 30 days after so waiving. A practitioner may not, w/ respect to any IRS matter, in any way use/participate in the use of any form of pub communication or private solicitation (any advertising) containing a false, fraudulent, or coercive stmt/claim, or a misleading/deceptive stmt/claim. Book ex for false advertising: a small accting firm w/ only CPAs advertises on TV talking abt attorneys on staff and guaranteeing tax refunds. This is prob a violation of circular 230 bc the firm has falsely advertised it has licensed attorneys when it doesn't and the ad incl a guarantee which C/B misleading to clients. Practitioners publishing a written fee sch must honor those fees for 30 days after the last date the fees were published (no bait/switch). If additional fees may be charged for certain matters, the stmt must indicate whether clients will be responsible for the costs. For communicating fee info: -for radio and TV broadcasting, the broadcast must be recorded and the practitioner must retain a recording of the actual transmission. -for direct mil and e-commerce comms, the practitioner must retain a copy of the actual comm, along w/ a list/other descr of persons to whom the comm was mailed/distr'd. -copies must be retained by the practitioner for at least 36 mos from the date of the last transmission/use.
Circular 230; Sanctions by the IRS for Violations of the Regulations and Petition for Reinstatement
A practitioner may be sanctioned by the IRS if he does any of this: -willfully violates any part of Circular 230 (except section on best practices for tax advisors). -recklessly or through gross incompetence violates sections 10.34 (stds w/ respect to TRs and docs, affidavits, and other papers), 10.35 (competence), 10.36 (procs to ensure compliance), or 10.37 (rqmts for other written advice). Possible sanctions incl censure (expressing severe disapproval, prob written stmt) and suspension or disbarment from practice before the IRS. May also impose monetary ($) penalties too, not exceeding the gross inc derived (or to be derived) from the conduct giving rise to the penalty. A practitioner disbarred/suspended may petition for reinstmt before the IRS after the expiration of 5 yrs following such disbarmt/suspension (or immediately following the suspension pd, if shorter than 5 yrs). Reinstmt won't be granted unless the IRS is satisfied that the practitioner isn't likely to engage thereafter in conduct contrary to the regs in Circular 230 and that granting such reinstmt wouldn't be contrary to the pub int.
Circular 230; Standards With Respect to Tax Returns and Documents, Affidavits, and Other Papers
A practitioner may not willfully/recklessly sign a TR or advise a client to take a tax position the practitioner knows/should know lacks a reasonable basis, is an unreasonable position, is a willful attempt to understate tax liab, or recklessly/intentionally disregards tax rules/regs. A practitioner can't advise a client to take a TR position on a doc/other paper that will be submitted to the IRS unless the position is not frivolous (has to have a reasonable basis). Can't advise client to submit any doc: -that will delay/impede the administration of fed tax law. -that's frivolous or -that contains/omits info demonstrating an intentional disregard of a rule/reg unless the practitioner also advises the client to submit a doc evidencing a good faith challenge to the rule/reg. The practitioner must inform the client of: -any penalties reasonably likely to apply w/ respect to a position taken on a TR if the practitioner advised the client on the position or prepped/signed the TR. -any penalties reasonably likely to apply w/ respect to any doc submitted to the IRS. -the opp to avoid penalties if the client discloses the position taken and the rqmts for adequate disclosure.
Elements of a Legally Enforceable Contract; Consideration Continued
A promise to perform, or performance of, an existing duty is not sufficient consideration. Things like police and contractors. This means in common law contracts the price term can't be modified unless consideration is given for the modification. Book ex for preexisting legal duty: -C is under a contract to sing at a concert for M. C decides she doesn't want to sing. To get her to sing, M offers to pay 5k more if she will. She agrees and sings. M doesn't have to pay her the extra 5k. There was no consideration for the promise bc of the preexisting legal duty rule - C was already obligated to sing. -S offers a 10k reward for recovery of his kidnapped daughter. J, a cop assigned to the case, recovers the daughter. J's performance of his official duty isn't sufficient considetation. *EXCEPTION*: if each party offers to give something diff than what was OG promised - no matter how trivial - the cts will usually enforce the promise despite the preexisting legal duty rule. Book ex for mod by both parties: Same facts where C didn't want to sing, except C offers to sing 5 min longer than OG obligated to. Mod is now binding. If the scope of the legal duty owed is the subj of honest dispute, then a modifying agreemt relating to it will ord be given effect. This is bc the parties are giving up their right to sue to have the dispute settled, and forbearance to sue is valid consideration. 2. Bargained-for exchange: Something isn't consideration unless it was given in exchange for other consideration. Must be bargained-for exchange of consideration. Promises to make a gift are unenforceable bc of lack of consideration. No bargained-for exchange w/ a gift. This is the GR. Exception is charity, detrimental reliance. If something has already been given/performed before the promise was made (past/moral consideration), it will not satisfy the bargain rqmt. Saving Tim. Book ex for moral consideration: a loose piece of molding fell of a building and was abt to hit P. Q, seeing this, pushed P out of the molding's path and was struck by it and seriously injured. P promised Q he would pay Q $100/mo for life. There's no consideration.
Partnership Tax Returns
A pship isn't subj to inc taxes, but it must still file a pship TR (Form 1065). A Form 1065 is an info return (incl schs K and K-1) that provides detailed info abt pship inc/exps and indicates the amt/type of each partner's distributive sh of inc/loss. Each partner is liable only for taxes due on his distributive sh of pship inc, as reported on sch K-1, regardless of whether the distr is actually made to the partner. A calendar yr is gen req'd for the pship tax yr. Pship return is due 3/15. A 3 mo deferral (fiscal yr ending in october, nov, and dec) is the max permitted. This means the no of mos btw the beginning of the tax yr chosen and the end of the req'd tax yr is 3 mos or less. A pship terminates when (pship dies on that date): -ops cease. -50% + of the total pship int in both cap and profits is sold/exchanged w/in any 12-mo pd (technical termination). -there are fewer than 2 partners (pship becomes a sole prop). The effects of a pship technical termination (change in partners > 50%) are: -a deemed distr to remaining partners and purchaser. -a hypothetical recontr of assets to a new pship. This is nontaxable (= NBV). Close old acct and open new one. Book ex for technical term: In Y1, M, S, and J form MSJ pship, w/ M and S as 25% partners and J as a 50% partner. In june of Y5, J sells his int in MSJ to Sp. Determine the consequences of J's sale of his pship int to the remaining partners and the pship. -bc J was a 50% partner, his sale of his MDJ int results in a technical term of the pship. All existing assets are treated as being distr'd to M, S, and Sp (new partner in Y5), then being immediately recontr'd to the new pship, MSS, on the day after the technical term of MSJ.
Tax Free Reorganization Continued
A reorg is treated as a nontaxable trans bc it results in the continuation of a bus in a mod form. In order to meet the continuity rqmt, the acquiring corp must continue the bus of the old entity or use a sig portion of the old corp's assets. In addition to the continuity rqmt, there's a control test. Control is defined as at least 80% of the total voting power of all classes of stock and at least 80% of all other classes of stock. Same rqmt as that of tax-free incorp. Reorgs are nontaxable (except to the extent of boot rec'd by SHs) bc the SHs haven't liquidated their investmt but have continued ops in a mod form. To distinguish the liquidation and reorganization rules: -liquidation: bus activity completely ceases, corp consequence is taxable, SH consequence is taxable. Corp dies and nothing survives. -reorg: bus activity continues, corp consequence is nontaxable, SH consequence is nontaxable. Bus is fixed and co survives.
Suretyship
A surety is one who agrees to be liable for the debt/obligation of another. A suretyship trans involves 3 parties: the creditor (lender, obligee), the principal (debtor, obligor), and the surety. A surety is directly liable on his contract. Diff from a guarantor, who is liable to the creditor only if the debtor doesn't perform his duty to the creditor. Book exs for surety v. guarantor: -A loans B 10k w/ a 6/1 due date. C is surety on the note evidencing the indebtedness. On 6/1, A, the creditor-obligee, may demand performance directly from C. C is liable even though A hasn't made demand upon B or placed B in default. -Same facts, but C is a guarantor. On 6/1, A may demand performance from C if and only if B defaults on the obligation (usually means fails to pay). A guarantor of collectibility is liable only if the creditor is unable to collect from the debtor after exhausting all legal remedies, incl demand, suit, judgmt, and exhaustion of all supplementary proceedings. The statute of frauds reqs written evidence of the promise to answer for the debt of another signed by the surety (MY LEG*S*). A suretyship undertaking not evidenced by a written memo is unenforceable (for surety or guarantor).
Estimated Tax and Inadequate Withholding
A taxpayer typically makes prepmts of tax during the yr. These pmts reduce the amt shown as total tax on the return and result in the calc of tax owed to the IRS or a refund owed to the taxpayer at the bottom of Form 1040. Pmts incl: -taxes withheld from paychecks (W-2 or 1099). -estimated taxes paid (quarterly, w/ extension, or applied from a PY). -excess social sec tax withheld (for 2+ employers). Estimated taxes (req'd minimum) are due to other inc (*NOT* salary). A taxpayer is req'd to make estimated quarterly tax pmts if *BOTH* of these conditions are met: 1. 1k+ tax liab: one condition is met if the amt of taxes owed (excess of tax liab over withholding) is expected to be 1k or more. 2. Inadequate tax estimates: the other condition is met if the taxpayer's withholding is < the lesser of (safe harbor): -90% of the CYs tax (annualized method) OR -100% of the last yrs tax (PY method) Must pay in advance. This applies even if an indiv files a tax return w/ a 0 tax liab in the PY. Exception: if the taxpayer had AGI > 150k (75k for MFS) in the PY, 110% of the PY's tax liab is used to compute the safe harbor for estimate pmts. If the taxpayer doesn't make the proper quarterly estimated pmt, a penalty may be assessed. There's no penalty due under the circumstances if the balance of tax owed at filing is under 1k. The IRS may waive the penalty is the failure to pay was the result of casualty, disaster, illness, or death of the taxpayer. If, toward the end of the taxable yr, a taxpayer determines that estimated pmts have been insufficient to avoid a penalty, a taxpayer can incr withholding from wages, and the withholdings will be considered to have been paid evenly during the yr. Such action will usually reduce or eliminate any penalty. A new W-4 will have to be completed and submitted to the taxpayer's employer.
Tort Liability
A tort is a wrongful act. Can be unintentional (negligence) or intentional (fraud). GR is respondeat superior: 1. GR is principal is *NOT* liable for the torts committed by his agent, only agent is liable. 2. Exception for employers. Under respondeat superior, employer can be liable for an employee's torts committed w/in the scope of employmt. 3. This does *NOT* relieve the agent of liab. Injured person may sue both the employer under respondeat superior and the agent. For respondeat superior, need to determine (1) if person is an employee or indep contractor and (2) if the tort occurred w/in the scope of employmt. Step 1: employer-employee relationship. An employer/master is liable only for torts of an employee/servant and is usually *NOT* liable for torts of indep contractors. 1. Right to control manner of performance is key: the most important factor for determining whether a person is an employee/indep contractor is the right of the principal to control the manner in which the person performs. An employer has the right to control employees, but has little control over the methods used by indep contractors. 2. Additional factors: where the right to control isn't clear, cts look to other factors, like whether the worker has a bus of his own, provides his own tools/facilities, length of the employmt (short v long/indefinite), basis of comp, and degree of supervision. -an employee is someone who works full time for the employer, uses the employer's facilities/tools, is compensated on a time basis, and is subj to the supervision of the principal. -an indep contractor is one who has a calling of his own and uses his own facilities/tools, is hired for a particular job, is paid a given amt for that job, and who follows his own discretion in carrying out the job. Ex: a CPA who performs an audit for a corp is an indep contractor.
Alternative Minimum Tax
AMT is a tax designed to ensure that taxpayers who take a large no of tax preference deductions pay a min amt of tax on their inc. The AMT is the excess of tentative AMT over the regular tax. The AMT is calc'd by first subtracting the AMT exemption amt from alternative minimum taxable inc (AMTI) to compute the taxable excess AMTI or AMT base. For all taxpayers except MFS, tax is then applied at: -26% on the 1st 187,800 of taxable excess AMTI and -28% on all taxable excess AMTI above 187,800 (2017 amts) The AMT is mandatory if it exceeds the regular tax. Calc: -[Regular TI +/- adjustmts + preferences] = AMTI. -[AMTI - exemption] = AMT base. -[AMT base x AMT rate] = tentative AMT tax. -[Tentative AMT tax - AMT foreign tax credit] = tentative minimum tax (TMT). -[TMT - regular inc tax] = AMT. Any amt of AMT is paid in addition to regular tax. So basically pay the greater of regular tax or TMT. Remember the FTC is taken here (AMT calcs are foreign to me!). Form 6251 AMT - indivs incl: -AMTI calc -AMT calc -tax calc using multiple CG rates -TBS here would prob be more Qs and fill in the blanks than completing this form. The CPA exam has focused the majority of questions concerning indiv AMT on these 4 areas: 1. exemption formula 2. distinguishing adjustmts from preferences 3. the AMT credit CF pd (against regular tax) 4. credits available to reduce AMT (not regular tax) These are detailed on the cards that follow.
Calculation of AMT; Regular Taxable Income: Adjustments
AMTI begins w/ regular TI/loss before a NOL, which is then modified by adjustmts, preferences, and the ACE adjustmt. When calcing AMT, adjustmts are items the taxpayer will either add back or subtract from regular TI depending on the treatmt of the item for AMT purposes. Adjustmts result from timing diffs btw the regular calc of corp TI and the AMT calc. For ex, if a corp's depr deduction is 100k and AMT only allows 70k, the 30k timing diff W/B an adjustmt added back to inc. Exs of adjustmts: *A LIE*. 1. *A*djustmts for G/L: when an asset is depr'd diff for calcing regular tax and AMT, its adjusted basis will also differ for regular tax and AMT. When the asset is sold, the corp will likely then recog a diff G/L for regular tax compared to AMT. If the regular gain is > AMT gain bc of excess depr for regular tax, corp will make a negative adjustmt to regular TI. 2. *L*T contracts: an adjustmt is calc'd for the diff btw rev under the completed-contract method and the % of completion method. The % of completion method must be used for AMT purposes (except home construction contracts). 3. *I*nstallmt sales-dealer: an adjustmt is calc'd for the diff btw full accrual rev and installmt sales rev. The installmt sale method isn't allowed for AMT purposes. 4. *E*xcess depr: 1- Depr adjustmt for prop placed in service after 1986 and before 1999: For AMT, real prop must be depr'd using the alternative depr system (ADS), which reqs the SL method over 40 yrs. The diff btw regular tax depr (which would use a recovery pd of 27.5 yrs, 31.5 yrs, or 39 yrs) and AMT depr is an adjustmt item. -For AMT, the 150% declining bal method (w/ a switch to SL) for personal prop using the applicable class life must be used. Any diff btw AMT depr and the reg tax depr (calc'd w/ 200% declining bal method) W/B an adjustmt item. 2- Depr adjustmt for prop placed in service after 12/31/98: after 1998, the same convention and recovery methods are gen used for reg tax depr and AMT. Exception is that prop depr'd for regular tax purposes using the 200% declining bal method (3, 5, 7, or 10 yr prop under MACRS) must be depr'd w/ the 150% declining bal method for AMT. The diff btw depr for regular tax purposes and AMT purposes is an adjustmt item. Book ex for depr adjustmt: C corp has calc'd TI of 500k for regular inc tax reporting purposes. The depr deduction calc'd using MACRS and taken for regular tax purposes was 18k. Depr calc'd for AMT purposes was 17k. Determine the depr adjustmt for AMT purposes. -The depr adjustmt to TI for determining AMT will be 1k. This will be added back to TI to calc unadjusted AMTI.
General Partnership/Joint Venture; Operation of a General Partnership
Absent an agreemt to the contrary, all partners have equal rights to manage the pship bus. Mgmt rights and voting power are *NOT* based on the amt contr'd. Book ex for mgmt rights in gen pship: A, B, C, D, and E form a gen pship to manufacture clothing. A contrs 40% of the cap, B contrs 30% of the cap, C contrs 20% of the cap, D contrs 10% of the cap, and E agrees to design all the clothes. Each partner has an equal right to participate in the mgmt of the pship. Decisions regarding matters w/in the ord course of the pship's bus may be controlled by majority vote, unless the pship agreemt provides otherwise. Matters outside the ord course of the pship's bus req consent of *ALL* of the partners. Exs of areas reqing unanimous consent (*memorize*!): -admitting new partners. -confessing a judgmt (admitting liab in a lawsuit) or submitting a claim to arbitration and -making a fundamental change in the pship bus (like the sale of a pship). Unanimous, so no apparent auth to act individually. Book ex for fundamental change in pship bus: in the pship descr'd in the previous ex, the decision whether to buy cloth from supplier may be approved by any 3 partners (3/5 = majority), but a decision to shift production from the mfg of clothing to the mfg of small appliances would have to be approved by all of the partners (fundamental change). Every partner is an agent of the pship for the purpose of its bus and the pship is their principal. An act of a partner apparently carrying on in the ord course of bus the bus of the pship will bind the pship through apparent auth. If a partner acts w/o actual/apparent auth, the pship can still become bound if it knows of the mat facts of a trans and assents (ratifies), either expressly or by accepting the benefits of the trans.
Defenses: Accord and Satisfaction and Novation
Accord and satisfaction and substituted contract: same parties, new agreemt. An accord is an agreemt to substitute one contract for another, and satisfaction is the execution of the accord. Accord and satisfaction discharge the OG duty. Until the accord is satisfied a party may sue under the OG contract or the accord. A substituted contract is sim an accord/satisfaction, but the duties under the OG contract are discharged immediately. Whether an agreemt is an accord or substituted contract depends on the intent of the parties. Book ex for accord and satisfaction: A agrees to sell his car to S for $450. The parties agree to substitute a contract for the sale of A's bike to S for $100. The new agreemt is the accord, when it's performed is the satisfaction. Novation: new party and old party is released. Novation is available as a defense to a party who has been released from a contract. Occurs when a new contract substitutes a new party for an old party in an existing contract. All parties must agree to the release. Book ex for novation: A agrees to build a garage for B, but then gets a more lucrative construction job. A asks B if it's ok to substitute D to build the garage. The parties agree to substitute D and release A. There has been a novation. A release or agreemt to discharge one of the parties w/o replacing that party is not a novation but a simple release. Such an agreemt usually reqs new consideration or detrimental reliance to be enforceable.
Advantages and Disadvantages of Filing a Consolidated Return
Advantages: -CLs of one corp offset CGs of another. -op losses of 1 corp offset op profits of another. -divs rec'd are 100% elim'd in consol bc they're interco divs. -certain tax deductions and credits may be better utilized when subj to the limitations of the overall consol'd group rather than indiv memebers. -a corp's NOL carryover may be applied against the inc of the consol'd group. -inc from certain interco sales may be deferred. Disadvs: -mandatory compliance w/ complex regs. -in the initial consol'd TR yr, a double counting of inv can occur if the group members had interco trans. -losses from certain interco trans may be deferred. -each member of the group must change its tax yr to the same as the parent corp. A corp joining the consol'd group may have to file a short yr return in addition to its inclusion in the consol'd filing in the same tax yr when adopting the parent corp's tax yr. -tax credits may be limited by op losses of other members. -the election to file consol'd returns is binding for future yrs and may only be terminated by disbanding the group or getting IRS permission. -many states don't allow the filing of consol'd TRs, so companies discover they file consol'd for fed purposes, but sep for state, resulting in extra tax prep time/expense. Book exs for eligibility to file consol'd: 1. O, an indiv, owns 100% of corps A and B. No common oship btw the 2 corps. The corps wouldn't qualify to file consol'd returns bc neither is 80%+ owned by another corp. Bro-sis. 2. Corp A owns 100% of corps B and C. Corps B and C own 60% and 40% of corp D, respectively. A, B, C, and D could file consol'd returns. Corp A would be the common parent. Parent-sub.
Creation of the Agency Relationship
Agency is a legal relationship where one person/entity (the principal) appoints another person/entity (the agent) to act on their behalf. As a GR, all that's req'd to create an agency relationship is a principal w/ contractual capacity (not a minor, not incompetent) and consent of the parties (the parties agree to act as principal/agent). Other requisites for creation: 1. Writing: gen *NOT* req'd to create an agency relationship, even if the contract the agent is to enter on the principal's behalf must be evidenced by a writing under the statute of frauds. -many states req a written agency agreemt if the agent is to buy/sell an int in land for the principal (MY *L*EGS). -note that a contract to find a buyer/seller (normal real estate broker's agreemt) and contract to build a house are contracts for services, so an oral agency involving such trans is valid. -agency agreemts that *CANNOT* be performed in 1 yr must be evidenced by a writing (M*Y* LEGS). 2. Capacity: only the principal must be competent. Agent need not have capacity. So a minor or mentally incompetent person can be appointed as an agent. 3. Consideration: *NOT* req'd to form an agency relationship. Examiners often ask what's necessary to create an agency. Gen, all you need is consent and a principal w/ capacity. A writing is necessary only if the agent will enter into land sales contracts or agreemt will take > 1 yr. Any answer that says a writing is req'd or the agent's auth must be signed by the principal is usually wrong. A power of attorney (POA) is a written auth of agency. The agent under a POA is referred to as an attorney in fact, but the agent need not be a lawyer. Just means the agent has the power to act on behalf of the principal. Gen, only the principal is req'd to sign to POA, no rqmt that agent signs it. The agent's auth is normally limited to specific trans ("special agents").
Agent's Power to Contractually Bind the Principal; Actual Authority
Agent's power to bind principal (to 3rd parties) can arise through: -a grant of actual auth (power and right) -apparent auth/estoppel (power but no right) -ratification (power but no right) Actual (real) auth is the auth the agent reasonably believes he possesses bc of the principal's comms to him. An agent w/ actual auth has the power/right to bind his principal to contracts w/ 3rd parties. Actual auth can be either express or implied. Express actual auth is oral/written instructions. Actual auth incl all powers the principal expressly grants w/in the 4 corners of the agency agreemt. Implied actual auth is auth the agent could reasonably believe is implied along w/ the express grant. Incl auth to do things reasonably necessary to carry out the agency (ex: a person hired to manage a bus will usually have the implied auth to hire employees, buy merch, etc.). The examiners have tested on the implied auth of a bus manager. Remember the manager is there to run the bus, not destroy it. Has auth to hire/fire employees, purch inv, and pay bus debts. NO implied auth to sell/mortgage bus fixtures/other prop of the principal (other than inv). Gen, an agent doesn't have implied auth to borrow money on the principal's behalf, such auth must be expressed. Term of actual auth can occur by: 1. Act of the parties: agent quits/gets fired. Term of an agency can occur through the acts of either the principal (revocation) or agent (renunciation). If the term violates the parties' contract, damages C/B available. If the agency is coupled w/ an int, only the agent has the power to term the agency relationship. 2. Accomplishmt of objective or expiration of stated pd: -if the agency is for a limited purpose (like to purch land), actual auth is term'd when the obj is accomplished (land purch'd). -if the agency is for a stated pd (like 6 mos), actual auth is term'd upon expiration of the pd. If no time is stated, actual auth terms after a reasonable time (how specific). 3. Termination of actual auth by op of law: actual auth is term'd automatically, by op of law, upon any of these events: -death of principal/agent. -incapacity of principal. -discharge in bankruptcy of principal. -failure to acq a necessary license. -destruction of the subj matter of the agency (ex: P hires A to buy car, which is destroyed before purch). -subseq illegality (ex: corp hires A to sell RM to a co in Asia. Subsequently, the Asian co is nationalized by the govt where it's located, and the govt makes it illegal for the co to purch materials from cos outside Asia). No actual/apparent auth anymore, no notice req'd. Term of agency by op of law is heavily tested, so know the list!
Depletion
Allowed on exhaustible natural resources, like timber, minerals, oil, and gas. The 2 methods of depletion are (1) cost depletion and (2) percentage depletion. Gen, must use the method that gives you the larger deduction. You must reduce the basis of your prop by the depletion allowed or allowable, whichever is greater. 1. Cost depletion (GAAP): under cost depletion, the remaining basis of the prop is divided by the remaining no of recoverable units (tons of ore, barrels of oil) to arrive at the unit depletion rate. The deduction for depletion is the depletion unit rate multiplied by the no of units sold for the yr. -Book ex for depr calc: oil prop having an estimated 1M barrels costs $1M. In Y1, 50k barrels were sold. Calc depletion deduction for Y1. -[$1M/1M barrels] = $1/barrel. -[$1/barrel x 50k barrels] = 50k deduction for Y1. If amt of recoverable units changes, can calc new cost depl rate as [(cost - PY depletion)/(remaining tons at BOY, incl tons sold during the yr)]. 2. Percentage depletion (non-GAAP): *P*reference for AMT. Tax only. To calc this, multiply a certain %, spec'd for each mineral, by gross inc from the prop during the tax yr. The deduction is limited to 50% of TI (excluding depletion) from the well or mine. The allowable percentages range from 5% to 22% depending on the mineral/substance being extracted. % depletion may be taken even after costs have been completely recovered and there's no basis. For oil and gas props only, the overall limitation of 50% of TI from the prop is incr'd to 100% (however, unless you're an independent producer or royalty owner, you gen can't use % depletion for oil and gas wells). The max amt of deductible depl in a yr is the greater of cost or % depletion allowable.
Taxation of a C Corporation; Personal Holding Company Tax
Also tax 2 of 3 on corps (this or the AET, AET doesn't apply to PHCs). PHCs are really corps set up by high tax bracket taxpayers to channel their investmt inc into a corp and shelter that inc through the low normal tax rate (15-25%) of the corp, instead of paying their higher indiv tax rates on the inc. The tax law criteria define PHCs as corps >50% owned by 5 or fewer indivs (either directly/indirectly at any time during the last 1/2 of the tax yr) and having 60% of adjusted ord gross inc consisting of: *NIRD* -*N*et rent (if <50% of ord gross inc) -*I*nt that's taxable (nontaxable is excluded - muni) -*R*oyalties (but not mineral, oil, gas, or copyright royalties) OR -*D*ivs from an unrelated domestic corp You're a *NIRD* if you try to set up a PHC, since the govt will foil your attempts! For the 5 or fewer indivs rule, husband/wife are considered 1 person. Corps deemed to be PHCs are taxed an additional 20% on their PHC NI not distr'd. TI must be reduced by fed inc taxes and net LT CG (net of tax) to determine the undistr'd personal holding co inc prior to the div paid deduction. The additional tax assessed is paid in addition to regular tax and AMT. There's no penalty if NI is distr'd (in actual or consent divs). PHCs aren't subj to the AET. The tax is self-assessed by filing a sep sch 1120 PH along w/ Form 1120. A personal service corp (PSC) is primarily involved in the performance of a field like accting, law, consulting, engineering, architecture, health, and actuarial science. PSCs are denied the right to use the graduated corp rates, and are taxed at a flat 35%.
Types of Tax Exempt Organizations Allowed under the IRC
Although not gen subj to inc tax, most exempt orgs are still req'd to file info returns w/ the US deptmt of treasury and have other detailed reporting and record keeping rqmts. Instances will exist in which the exempt org will owe tax for certain types of unrelated inc the org derives. Types: 1. Section 501(c)(1) org: org'd under an act of congress as a US instrumentality and doesn't req an application. Must be declared exempt under the IRC or the organizing legislation. Ex W/B a fed credit union. These orgs don't have an annual filing rqmt either, unlike other TE orgs. Almost all other exempt orgs must make written application for exempt status, be approved by the IRS, become incorp'd, and issue cap stock. The articles of org must limit the purpose of the entity to the charitable/exempt purpose. 2. Section 501(c)(2) org: org'd for the exclusive purpose of holding title to prop, collecting inc from that prop, and turning over the NI to an exempt org (ex: holding corps for exempt orgs). A 501(c)(2) corp issues cap stock and otherwise acts as a corp (no limit on salaries, other than "reasonableness"). Orgs seeking TE status under 501(c)(2) must file Form 1024 to apply, and incl the org's articles of incorp and bylaws in its application 3. Section 501(c)(3) org: Pub charities and private foundations. This is the most common type of exempt org and incl a community chest, community fund, foundation org'd/op'd exclusively for religious, charitable, scientific, pub safety testing, literary, or educational purposes, or a foundation org'd to foster national/international amateur sports competitions (only if none of the activities involve the providing of athletic facilities or equip), or to prevent cruelty to children or animals. The org must apply for TE status using Form 1023 and be approved by the IRS to be listed as an exempt org. Other disclosures, like the org's articles of incorp, bylaws, or fin records vouching for the org's TE activities, are typically req'd to be included in the application w/ Form 1023. Rqmts: -no part of net earnings may inure to the benefit of any private SH/indiv. -no substantial part of activities may be nonexempt activities (like carrying on propaganda or otherwise attempting to influence legislation). -the orgs may *NOT* directly participate in/intervene in any political campaign. Penalty for not meeting the rqmts is the loss of TE status.
Depreciation
An annual allowance given to a trade/bus for exhaustion, wear and tear, and normal obsolescence of assets. An asset's basis must be reduced by the depr allowed/allowable for a particular yr, even if depr wasn't claimed by the taxpayer for that particular yr. The mod accelerated cost recovery system (MACRS) is used for the majority of depr exp for federal taxation. -real prop (land and bldg) is land and all items perm affixed to it (like bldgs, paving, etc.). -personal prop (machinery, equip, and autos) is all prop not classified as real prop.
Income Taxation Rules for Estates and Trusts; Annual Estate Income Tax (Form 1041)
An estate is a legal entity that comes into existence upon the death of an indiv and continues to exist until all assets of the estate are distr'd. Complex estates can exist for a no of yrs. During the time the decedent's affairs are being managed, inc is generated and exps are paid, so the estate is a taxable entity. TR schedule: -if TI is 0-2,550: 15% tax rate of the amt over 0. -if TI is 2,550-6k: 382.50 + 25% of the amt over 2,550. -if TI if 6k-9,150: 1,245 + 28% of the amt over 6k. -if TI is 9,150 - 12.5k: 2,127 + 33% of the amt over 9,150. -if TI is 12.5k +: 3,232.50 + 39.6% of the amt over 12.5k. This is the highest indiv tax rate. These rates don't reflect the 20% max tax rate on net CGs (net LT CGs reduced by net ST CLs). Rates move up way quicker here. Once the estate is liquidated and all assets distr'd, the estate is no longer req'd to file a Form 1041 return. The exemption for an estate is 600. Form 1041 req'd when annual inc exceeds 600. No std deduction is allowed. Tax yr for the estate: -calendar yr TR is due 4/15. -fiscal yr tax return is due on the 15th day of the 4th mo after YE. -estate elects YE, you can die anytime. An estate is exempted from making estimated tax pmts for its 1st 2 tax yrs.
Agent's Power to Contractually Bind the Principal; Contractual Liability Continued Further
As a GR, only the principal (not agent) can hold the 3rd party liable to perform contract duties on a contract the agent entered into on the principal's behalf, even if the principal's existence/ID weren't disclosed. Book ex for 3rd party's liab: A entered into a contract w/ T to purch TVs for P. P instructed A to enter into the contract w/o disclosing she was acting on behalf of P. If T repudiates the contract, P may hold T liable even though it didn't know it was dealing w/ P. Principal can't hold the 3rd party liable where (exceptions): -principal's ID was fraudulently concealed (like if 3rd party indicates he won't do bus w/ principal, principal can't get around this by dealing through agent). -the performance to the principal would incr the burden on the 3rd party (Big co can't employ small co as an agent to enter into a supply rqmts contract w/o disclosing the contract is for big co, bc way more supplies needed for big).
Adjusted Basis and Holding Period of Assets Sold; Purchased Property
Assets can be: 1. Purchased 2. Gifted 3. Sold This is 1 of 3, purchased. Basis of purchased assets = [cost + cap improvemts]. Gen, the initial basis of prop is the cost of such prop to the taxpayer. The cost of prop incl all amts to purch the prop, prep it for use, and place it into service. Exs incl shipping costs, installation costs, sales taxes, and testing costs. -real prop is defined as land and all items perm affixed to it (bldgs, paving, etc.). Land and bldg. -personal prop is all prop that isn't real prop. Equip. Book ex for calcing basis: taxpayer purchases a piece of equip (personal) to be used in his bus. The cost of it is 5k. Shipping is 500 and installation is 200. Calc the basis of the equip. -[5k + 500 + 200] = 5,700 basis. The holding pd (HP) of purchased prop begins on the date of acq of the prop (purch date). The basis is adjusted down for the amt of any depr (reduce for A/D), allowed or allowable, taken by the taxpayer w/ respect to the asset. The basis that has been adj down by A/D is the adjusted basis or tax basis. Book ex for calcing adjusted basis: taxpayer has a machine purch'd for 10k. In Y1 and 2, deducts 1k from gross inc for depr. Determine the adjusted basis of the machine at the end of Y2. -A/D at the end of Y2 is 2k (1k depr exp/yr). Adj basis at end of Y2 = [10k - 2k] = 8k. Although most adjustmts req an incr or decr in basis, some spread it. Book ex for basis spreading: under the IRC, the receipt of a nontaxable stock div will req the SH to spread the basis of his OG share over both the OG shares and the new shares rec'd, resulting in the same total basis but a lower basis/sh of stock held. -[OG basis/total no of shs after stock div] = new basis/sh.
Tax Credits; Education Tax Incentives
Assuming the rqmts are met, a taxpayer has the opp to reduce and/or avoid taxes by taking advantage of the american opportunity credit, the lifetime learning credit, and/or a nontaxable distr from a Coverdell education savings acct used to pay higher education costs. 1. The american opportunity credit (AOC): refundable credit (reduce tax and get a refund). The AOC is available against fed IT for qualified tuition, fees, and course materials (incl books) paid for a student's first 4 yrs of postsecondary (college) education at an eligible educational institution. The enhanced credit, made perm by the PATH act, is equal to (max credit of 2,500 in 2017): -100% of the first 2k in 2017 of qualified exps plus -25% of the next 2k in 2017 of exps paid during the yr ($500). These sum to 2,500. The qualified exps are on a per student basis (multiple kids are ok) and must be incurred on behalf of the taxpayer, their spouse, or their dependent. If a child is claimed as a dependent by a parent, exps paid by both the parent and child are deemed to have been made by the parent for this purpose. The student must be at least half-time for at least 1 academic pd during the yr. The credit isn't available for exps of a student convicted of a fed/state felony drug offense in the calendar yr for which exps are incurred. For 2017, the phase-out begins w/ mod AGI > 80k (160k for MFJ), w/ full phase-out at 90k (180k MFJ). Subject to certain restrictions, 40% of the AOC is refundable (and the nonrefundable portion may offset both regular tax and AMT). So up to 1k (2,500 max credit x 40%) may be refunded. Continued on next card.
Effect of S Corporation Election on Shareholders; Taxability of Distributions to Shareholders
Bc S corps are only subj to a single level of tax, distrs from an S corp are gen not subj to taxation for SHs, as the SH has already been taxed on the inc yearly when it passes through on the SH's K-1. However, if a corp has corp E&P carried over from the former C corp when the S election was made, distrs may be taxable. Rules for determining the taxability of distrs: 1. S corp w/ no C corp E&P: -1st; distr to extent of basis of stock: not subj to tax, reduces basis in stock. ROC treatmt. -2nd; distr in excess of basis of stock: taxed as LTCG (if stock held for > 1 yr). CG distr treatmt. Book ex for taxability of distrs w/ no C corp E&P: F corp, a calendar yr S corp since its formation in Y1, has 2 equal SHs, C and R. During Y5, C rec'd distrs from F corp of 22k. At 12/31/Y5, after all adjustmts to basis had been made, except for distrs, C's basis in his F stock was 18k. -for Y5, C will treat 18k as a nontaxable ROC (reduction of basis of stock) and 4k as a LTCG. Accum'd S corp earnings are previously taxed to the SHs. 2. S corp w/ C corp E&P: -1st; distr to extent of AAA: not subj to tax, reduces basis in stock. S corp profits treatmt. -2nd; distr to extent of C corp E&P: taxed as a div, doesn't reduce basis in stock. Old C corp taxable div treatmt. C corp E&P is the amt the C corp never paid out as a div (double tax). -3rd; distr to extent of basis of stock: not subj to tax, reduces basis in stock. ROC treatmt. -4th; distr in excess of basis of stock: taxed as LTCG. CG distr treatmt. AAA basically means the cumulative amt of S corp inc/loss (sep and non-sep stated items, excluding TE inc), since the corp most recently elected S status, less all cumulative distrs. Distrs may not reduce AAA below 0, but AAA may be negative from S corp losses. Book ex for taxability of distrs w/ C corp E&P: N corp was a C corp until it elected S status on 1/1/Y2. N had AE&P of 20k at 12/31/Y1. For the pd Y2 - Y8, N had ord inc of 100k and made SH distrs of 60k. So N's AAA balance at 12/31/Y8 was 40k (100k - 60k). In Y9, N corp has ord inc of 40k and made distrs to SHs of 110k. Tax result of these items: 1- to extent of AAA (40k + 40k = 80k): 80k tax free. 2- to extent of C corp E&P: 20k div. 3- excess: 10k reduction of stock basis, LTCG if in excess of basis.
Nonresident Alien (NRA) Withholding
Bc of the structure of the US tax system, a foreign person is subj to US tax on its US source inc. Most types of US source inc rec'd by a foreign person are subj to US tax at a rate of 30%. A reduced rate, incl exemption, may apply if there's a tax treaty btw the foreign person's country of residence and the US. The tax is gen withheld from the pmt made to the foreign person. A foreign person gen incl: -NRA indiv -foreign corp -foreign pship -foreign trust -foreign estate -any other person that doesn't meet the definition of a US person -foreign branch of a US financial institution (if the foreign branch is a qualified intermediary) -US branch of a foreign corp or pship
State Income Tax Considerations; Nexus and Federal Limitations on a State's Right to Impose Income Tax Continued
Bc this fed law limits the right of a state to tax NI that a person earns w/in the state, most, if not all, states: -narrowly define solicitation and -resolve in favor of the state all ambiguities under fed law. These are exs of activities that may trigger nexus in a state in which a co ops: -owning/leasing tangible personal/real prop. -sending employees into the state for training/work. -soliciting sales in a state. -providing installation, maintenance, etc. to customers w/in a state (even through a 3rd party). -accepting/rejecting sales orders w/in the state, or accepting returns. If these, now you're subj to state IT. Book ex for determination of nexus: H corp sells comps and is incorp'd and resides in CA. In addition to CA, H solicits sales in OR, AZ, and CO. It provides installation services to its customers in AZ, and conducts employee training at a facility in CO. Determine with which states H has nexus. -CA (state of residence and incorp). -AZ (provides installation services to customers). -CO (conducts employee training). -H is prop protected from nexus in OR by PL 86-272, as its only activity in the state is solicitation of sales for tangible personal prop.
The Securities Exchange Act of 1934; Antifraud Provisions: Rule 10b-5 Continued
Book ex for CPA liab for false stmts: B, a CPA, audited F/S of H. B intentionally gave an unqualified opinion on the F/S even though she discovered MMs. The F/S and B's unqualified opinion were incl in a registration and prospectus for an OG offering of H's stock. B can be held liable for a violation of Rule 10b-5 (and also under section 11 of the 33 act). It's key to recog the diff btw an action under section 11 of the 33 act and under Rule 10b-5. -Section 11 of the 1933 act reqs no proof of scienter, reliance, or negligence. The plantiff need only show that he *A*cq'd the stock and suffered a *L*oss, and that there was a *M*at *M*isrep or *M*at omission of fact in the registration stmt. -Rule 10b-5 of the 34 act reqs proof of both scienter and reliance. The plaintiff must show he bought/sold the stock (*I*nduced), suffered a loss (*D*amages), a *M*at *M*isrep/omission of fact, *S*cienter, and *A*ctual reliance. -proof of negligence is insufficient under Rule 10b-5! Under Rule 10b-5, it's illegal for a person to trade on the basis of inside info if the person would breach a duty of trust owed to the issuer of the sec or the SHs of the issuer. Basically, inside info is any mat, nonpub info abt the sec or issuer. Insider trading under Rule 10b-5 = fraud. Typically, a securities issuer's insiders, like directors, officers, controlling SHs, and employees of the issuer will be held to owe a duty of trust/confidence. Outsiders, like an issuer's CPAs, attorneys, and even printers, may also be held to owe a duty of trust. A private person injured by a violation of Rule 10b-5 can bring an action against the person violating the rule for any actual damages (not punitive damages) or seeking rescission of the trans. The SEC can impose fines and seek criminal penalties. SEC does *NOT* prosecute, just investigates and turns the info over to prosecutors.
Dividends-Received Deduction Continued Further
Book ex for DRD: D corp owns 30% of F corp (80% DRD). 3 alternative situations given, calc DRD and TI. 1. GR: [250 gross inc from ops + 100 divs rec'd] = 350. [350 - 200 deductions incl char contrs] = 150 B. -tentative DRD is (80% x 100 = 80). % limit is (80% x 150 = 120). Take smaller piece! -[150 B subtotal - 80 DRD] = 70 TI. 2. "B" limitation: [350 gross inc - 260 deductions incl char contrs] = 90 B. -tentative DRD is (80% x 100 divs = 80). % limit is (80% x 90 = 72). Take smaller piece! -[90 B subtotal - 72 DRD] = 18 TI. 3. Losers exception: [350 gross inc - 280 deductions incl char contrs] = 70 B. -tentative DRD is 80. % limit is (80% x 70 =56). Take larger piece bc it makes you a loser and losers don't follow the rules. -[70 B subtotal - 80 DRD] = -10 TI. -when subtracting the full 80% DRD, an NOL is created, so 80% of TI does not apply. The DRD doesn't apply to (personal): -personal service corps -personal holding cos -(personally taxed) S corps Don't take it personally. The DRD also doesn't apply to divs rec'd from certain banks/savings institutions, RICs, REITs, pub utilities, TE corps, cooperatives, and DISCs. The 100% DRD is for consolidated corps. These are affiliated corps (80%+ common oship) that file consolidated returns. A 100% deduction is also allowed for divs rec'd by a small bus investmt co (SBIC). A SBIC makes EQ and LT credit available to small bus concerns. DRD %s one more time: -oship 0 - <20%: 70% DRD. "Unrelated" is the term they'll use. -oship 20 - < 80%: 80% DRD. -oship 80%+: 100% DRD. Consolidated TR.
Formation of C Corporations; Shareholder Tax Consequences Continued
Book ex for liabs in excess of basis: The ABC co admits T as a 1/3 SH. T contrs a bldg worth 500k w/ a 100k basis. There's a mortgage of 225k on the bldg, assumed by the corp. -[100k rollover cost basis - 225k liabs assumed by corp] = -125k net basis (gain since below 0). -[-125k net basis + 125k gain taxable to SH T bc of excess liab, boot] = 0 basis of SH T's C/S. -basis corp has in asset is 225k (greater of SH asset basis/NBV or liab assumed). -GR is that, for corp, subtract 100% of liabs assumed by corp. For pship, subtract the % of other partners. This is for SH basis. -SH always starts w/ 0 basis when there's an excess liab. Book ex for SH and corp consequences of formation: O forms a corp and contrs equip w/ a basis of 40k, FMV 120k, bldg w/ a basis of 20k, FMV of 40k, and inv w/ a basis of 80k, FMV 100k. Total adjusted basis contr'd is 140k, total FMV contr'd is 260k. O gets 100 shs of stock (owns > 80%). -gain realized by O = [260k amt realized - 140k adjusted basis] = 120k gain realized (real world). -gain recog'd by O = 0 bc no boot. -O's stock basis = [140k old basis - 0 boot (excess liab) + 0 recog'd gain] = 140k. Nontaxable = NBV. -basis to corp = [140k transferor's basis + 0 gain recog'd] = 140k. Greater of SH's NBV or debt. Book ex for corp formation w/ contr of liab: G forms a corp and contrs prop w/ a basis of 140k subj to a 60k mortgage. FMV is 260k. G got 100 shs of stock. -gain realized by G = [260k amt realized - 140k adjusted basis] = 120k gain realized (real world). -gain recog'd by G = 0 bc no boot rec'd and liabs don't exceed basis. -G's stock basis = [140k OG basis - 60k liab assumed by corp (boot) + 0 recog'd gain] = 80k. [NBV asset - liab] = stock basis. -basis to corp = [140k transferor's basis + 0 gain recog'd] = 140k. Greater of SH's NBV or debt assumed.
Liquidation of a Partnership; Complete Withdrawal Continued
Book ex for liquidating distrs; impact on partner: The adj basis of T's int in the K pship is 24k. Upon retiremt, T gets a liquidating distr of 5k cash and 20k real estate w/ an adj basis to the pship of 10k. -T will have a basis in the real estate of 19k (his adj basis of 24k - 5k cash rec'd). Allocate entire amt to 0 out to get out (no G/L). -Alternative scenario: T got 25k cash and the real estate. Would recog a 1k gain (24k basis - 25k rec'd). The real estate rec'd would have a 0 basis to T. -Alternative scenario: if T had rec'd 20k in cash and no real estate, would recog a loss of 4k (24k adj basis - 20k rec'd), bc there were no other assets distr'd to allocate basis. The CPA exam will req candidates to understand the diff in basis rules for nonliquidating and liquidating ditrs: -nonliquidating: NBV asset taken as basis used, stop at 0 basis. -liquidating: pship int basis used, must 0 out acct (to get out). As a result of liquidation, the pship itself does *NOT* recog any entity level G/L on the distr of assets. Any G/L recog on liquidating distrs are made at the partner level. In addition, bc a pship itself is not subj to inc taxes and is a flow-through entity, all effects of winding-up the affairs of the pship and liquidating are passed on to the partners. This incl any G/L on sale of any assets sold off, exps of liquidating the pship, etc. All of these items will be incl in the partner's adj basis immediately before their liquidating distrs.
Secured Transactions Continued
Book exs for PMSI: -B buys a 1k stereo on credit from R and signs a security agreemt giving R a security int in the stereo. R has a PMSI in the stereo bc it supplied the credit that allowed B to buy the collateral. -B goes to the bank and asks for 1k to purch a stereo. Bank gives B the money, and B signs a security agreemt giving bank a security int in the stereo. bank has a PMSI in the stereo bc it advanced the money used to purch the collateral. -B wants to borrow 1k from bank. Bank agrees to give B the $$ if B will give the bank a security int in a stero B *already owns*. Bank has a security int, but it's not a PMSI bc B already owned the stereo (bank didn't advance funds used to purch the collateral). Qs abt PMSI creditors are common. Need to be able to spot PMSI creditors on exam. Remember, a PMSI creditor exists if: 1. the creditor sells the collateral on credit, retaining a security int OR 2. the creditor advances funds used by the debtor to purch the collateral. Ask yourself - did the debtor purch the collateral w/ the creditor's money/credit? Collateral is the prop subj to a security int. Under UCC article 9, there are 4 broad categories of collateral: goods, intangible and semi-intangible collateral, investmt prop, and proceeds. Need to know the type of collateral you're dealing w/ bc certain rules (how/where to perfect and priority) depend on the type of collateral involved. Goods incl: -consumer goods: used for personal, fam, or household purposes (like a tractor used to mow grass at home). -inv: goods held for sale/lease (tractor at a farm implement store) or goods used up quickly in bus, like RM used in mfg, goods to be furnished under a service contract, and WIP (partially built tractor). -equip: goods that don't fit into another category, incl durable goods used/bought for use primarily in bus (tractor used to mow lawn at a gardening store). Whether goods are consumer goods, inv, or equip is determined by how the debtor uses them, not the nature of the goods. Book ex for classifying goods: if debtor uses a car as a delivery vehicle for his bus, it's equip. If he uses the car for household purposes, it's consumer goods. If he buys a car to sell at his auto dealership, it's inv. Intangible collateral incl AR. An acct is any right to pmt for goods, services, real prop, or use of a credit card not evidenced by an instrument or chattel paper (like money you owe your doc after a checkup). Investmt prop incl stocks, bonds, mutual funds, etc. Proceeds incl whatever is rec'd upon the sale, exchange, collection, or other disposition of collateral. Trade-in.
Legal Liabilities
Breach of contract, tort, or violating statutes. Civil actions for tax malpractice are usually based on either traditional contract or traditional tort principles. Contract principles impose the obligation to prep the TR diligently/competently ($ damages). Tort principles provide that a professional has a duty to exercise the level of skill/care/diligence commonly exercised by other members of the profession under sim circumstances. To prove malpractice against a tax preparer, plaintiff must demonstrate *ALL* of these things: 1- the tax preparer owed a duty to the taxpayer (adhere to contract terms or certain std of care). 2- there was a breach of that duty. 3- the plaintiff suffered injuries. 4- there was a determinable cause btw the injury suffered and the duty of the tax preparer. 1. Breach of contract: best defense is client failure to cooperate. If a CPA does not fulfill the terms of his engagemt, the client can hold the CPA liable for breach. Contract liab gen reqs privity, so only a party to the contract (client and named third party beneficiary (TPB)) can sue under contract theory. Book ex for tax preparer and breach of contract: A has a signed engagemt letter (terms) from his CPA, J, stating that J's firm will prep A's indiv fed TR and 3 state TRs by 4/1 if A provides all requested documentation by 3/10. A wanted his TRs completed early bc he was taking a trip. A's TRs weren't completed until 4/30. -this could lead to a breach of contract claim as the preparer owed a duty to the taxpayer (to prep fed/state TRs), and there appears to be a breach of that bc the returns weren't completed at the agreed-upon date. -defense: client didn't give info by 3/10.
Deduction for Qualified Educational Expenses
Can't be taken if AOC or lifetime learning credit are taken for the same student in the same yr. NO double dipping!
Creation of the Agency Relationship Continued; Duties of Agent to Principal
Certain duties are implied in every agency relationship. The agent has whatever duties are expressly stated in the contract. Is a fiduciary. Also owes these duties: *LORA* 1. Duty of *L*oyalty: no self-dealing, no competing. Agent owes the principal a duty of loyalty; must act solely in the principal's int in connection w/ the agency. An agent breaches this duty when they have ints adverse to the principal (like getting kickbacks from 3rd party). Book ex for duty of loyalty: Petshop hired A as its store manager and gave A auth to purch pets for the store. A occasionally purch'd dogs from tremendous dogs. When he bought dogs from them, they paid him 5% of the purch price as an incentive to do more bus. Petshop was unaware of the pmts and A kept them. A breached his duty of loyalty and can be forced to turn over his profit to Petshop. 2. Duty of *O*bedience: agent must obey all reasonable directions of his principal. Book ex for duty of obedience: P hires A as his purch agent for TVs, but instructs A not to disclose to sellers that she's working for P. If A tells a seller she's working for P, breaches duty of obedience and will be liable to P for damages the disclosure caused. 3. Duty of *R*easonable care: agent owes principal a duty to carry out the agency w/ reasonable care (duty not to be negligent). 4. Duty to *A*ccount: unless otherwise agreed, agent has duty to acct to the principal for all prop/$ rec'd and paid out when acting on behalf of the principal. Agent can't comingle the principal's prop w/ their own. 5. Subagent: assistant. If an agent is auth'd to hire a subagent, subagent owes a duty of care to both the agent and the principal. If an agent breaches the duties owed to the principal, principal can recover money damages from the agent: 1. Tort damages: principal can recover these if agent negligently (accidentally) or intentionally breached a duty owed to the principal. Tort = wrongful act. 2. Contract damages: if agent was compensated, the principal can collect contractual damages. If the agent didn't receive consideration, contract wasn't formed so contract damages aren't available. 3. Recovery of secret profits: kickbacks. If the agent obtained a secret profit, principal can recover it, usually by imposing a constructive trust on the profit. 4. Withhold comp: if the agent committed an intentional tort or intentionally breached their duty to the principal, principal may refuse to pay the agent.
Common Features of Chapter 7 and 11 Cases; Property of the Bankruptcy Estate Continued Further
Definitions of key parts of preferential pmt definition continued: -insolvency: the debtor is presumed to be insolvent during the 90 days immediately preceding the date the bankruptcy petition is filed. -receipt of greater share: creditor rec'd more. A preference exists only if the creditor recs more than he would receive in a bankruptcy distr. Pmt to a fully secured creditor is not a preference, bc the creditor would have rec'd the collateral and been paid in full anyway. *Exceptions*; transfers that can't be set aside by trustee: -transfers in the ord course of bus: Ok. Not preferences. A transfer made to repay a debt the debtor incurred in the ord course of bus is not a voidable preference. Book ex for transfers in the ord course of bus: a regular monthly installmt pmt will not be set aside as a preference. Sim, pmt of a current utility bill or lease pmt doesn't constitute a preference. -PMSI perfected w/in 30 days: a PMSI isn't a voidable preference if it's perfected w/in 30 days after the debtor receives possession of the collateral, although it may be invalid under state law if not perfected w/in 20 days of the debtor's receiving possession. -consumer pmts under 600: the trustee may not void pmt or transfers of prop of < 600 by a debtor whose debts are primarily consumer debts. -domestic support obligations: bona fide pmts for domestic support obligations (spousal support or child support) are not voidable preferences.
Substantiation and Disclosure of Tax Positions Continued
Certain tax forms are used to disclose uncertain tax positions (UTPs) and can help the taxpayer avoid understmt penalties: 1. disclosure stmt (Forms 8275): -used to avoid the understmt penalty. -stmt used to disclose positions taken on a TR that are contrary to rev rulings/procs or other statutory provisions (except regs). -there are 3 parts to the form: (1) gen info, (2) detailed explanation, and (3) info abt pass-through entity. 2. regulation disclosure stmt (Form 8275-R): almost identical to Form 8275, but used to disclose postions taken on a TR that are contrary to treasury regs. 3. Reportable trans disclosure stmt (Form 8886): reportable trans are ID'd by the secretary of the US treasury. Any taxpayer that participates in a reportable trans (like tax shelters - tax avoidance on tax evasion) and is req'd to file a fed TR or info return must file Form 8886 disclosing the trans. The filing rqmt applies whether or not another party (related/otherwise) has filed a disclosure for that trans. Categories of reportable trans: -listed trans -confidential trans -trans w/ contractual protection -loss trans In addition to the various defenses available, a taxpayer can gen avoid any penalty by showing that the taxpayer: 1. had reasonable cause to support the TR position (>20%, reasonable basis). 2. acted in good faith and 3. didn't have willful neglect. This doesn't apply if: 1. tax shelter (>50%) or 2. substantial undisclosed (33-50%) Int on many penalties begins to accrue from the TR due date (or extended due date). Int on underpaid tax beings to accrue from the date the tax was due w/o extension of time to file.
Features of Reorganization Cases Under Chapter 11
Ch 11 can be IPC, voluntary/involuntary. In a ch 11 case, shortly after the order for relief is effective, a committee of unsecured creditors is appointed, usually consisting of willing persons holding the *seven largest unsecured claims* against the debtor. A person engaged in bus other than real estate w/ debts not exceeding ~ 2.6M can elect to be treated as a small bus. Such a debtor can request that a creditor's committee not be appointed. If the debtor is a corp, an equity security holders (stockholders) committee may be appointed consisting of the *seven largest holders of the EQ securities* to ensure that the EQ security holders receive adequate representation. The committees can consult w/ the debtor, investigate the debtor's finances, participate in preparing the reorg plan, etc. In a ch 11 reorg case committees are appointed to consult w/ and advise the debtor, but a trustee gen is *NOT* appointed. Instead, the debtor remains in possession of the debtor's assets bc the debtor is presumed to be in the best position to run the bus. The examiners like to ask abt the trustee in a ch 11 case. Remember the GR is that a trustee is not usually appointed in a ch 11 case. The debtor usually remains in possession of the estate's assets. The debtor may file a reorg plan under ch 11 any time during the bankruptcy case. Unless a trustee has been appointed, the debtor has an *exclusive right* to file a plan during the first 120 days after the order for relief is effective. Other interested parties (creditors) may file a plan if: -a trustee has been appointed. -the debtor has not filed a plan w/in 120 days after the order for relief became effective or -the debtor has filed a plan but hasn't obtained the acceptance of every impaired class (creditors whose claims are reduced by the plan or will be paid later than contracted for) w/in 180 days after entry of the order for relief.
Common Features of Chapter 7 and 11 Cases; Automatic Stay, Duties of Debtor, and Voluntary Cases
Ch 7 is liquidation, 11 is reorg. Both are IPC, voluntary/involuntary. Automatic stay: When a bankruptcy petition is filed in either a voluntary/involuntary case, an automatic stay becomes effective against most creditors. Stops all collection efforts (filing a lawsuit or demanding pmt). The auto stay doesn't apply to criminal prosecutions, paternity suits, and cases brought to establish/collect spousal or child support obligations. Duties of debtor: After a petition is filed, a debtor must file: -a list of creditors and their addresses. -a sch of A/Ls at FMV. -a sch of current inc/expenditures. -a stmt of the debtor's financial affairs. -copies of pay stubs rec'd w/in 60 days before filing. -copies of fed TRs from the last tax yr. If the debtor hasn't paid taxes for the previous tax yr, must do so before the bankruptcy may proceed. If an indiv debtor in a voluntary ch 7 case fails to file any of these items w/in 45 days after filing the petition, the case is auto dismissed on the 46th day. Voluntary cases: A voluntary case under ch 7 or 11 (13 voluntary only) is commenced by the debtor filing a petition for relief. The debtor need not be insolvent to file, but the case may be dismissed if the debtor has too much inc. Must pass inc tests if indiv. Bankruptcy can be filed if can't pay debts of *any* amt when due. Spouses may file jointly to avoid duplicate fees (often a correct answer on the exam). A filed voluntary petition constitutes an order for relief, meaning a case may proceed unless a ct orders otherwise. This is diff than involuntary.
Legal Liabilities Continued Further Still
Compensatory damages = money, for ord negligence and/or breach. Damages assoc'd w/ TR prep have multiple components, incl (all reasonably forseeable): -taxes: bc the filing of the TR and pmt of taxes is ultimately the responsibility of the taxpayer, the tax that a taxpayer owes is not normally a recoverable damage amt. In some situations, the tax practitioner can be held liable for the amt by which taxes were overpaid if the overpmt can't be repaid through the filing of an amended return. -penalties: cts often award damages assoc'd w/ penalties imposed bc of mistakes reported on TRs. -int: amts equal to the int owed by the taxpayer may be awarded by the cts to the extent that the taxpayer has suffered actual damages related to the int charged. -costs incurred to correct TRs: damages may incl fees that will be incurred to file amended returns and/or challenge penalties assessed. -consequential damages: this category of potential damages incl lost investmt/inc opps for taxpayers as a result of a tax preparer's mistake. Fraud would have punitive damages as well.
Defenses: Conditions and Prevention of Performance
Conditions: these can affect a party's duty to perform. They're permissible. A condition is an event, the occurrence/nonoccurrence of which will end a party's duty to perform. These have diff names depending on when they occur. Conditions are often preceded by "if," "subj to," etc. Book ex for condition: I will pay you $10 if you mow my lawn. Mowing the lawn is an express condition to getting the $10. A condition precedent (like qualifying for a mortgage) is a condition that must occur before the other party must perform. Conditions concurrent are those that must occur simultaneously. Ex: the pmt of $ and exchange of goods in most in-person sales contracts are conditions concurrent. The parties make the exchange simultaneously. A condition subsequent (engagemt ring) is a condition that will occur after a party's duty to perform has arisen and will cut off that duty. Book ex for condition subseq: if you promise to host a weekly football party, I will pay you 1k/yr until the bears win their 3rd super bowl. Upon the bears winning, the duty of pmt is cut off. Prevention of performance: this is a breach. Hindering or failing to cooperate (there's an implied duty of cooperation). If one party prevents the other from performing contract duties, a material breach has occurred. The non-breaching party is excused from performance.
Consolidated Taxable Income Calculation
Consol'd TI is determined w/ these steps: 1. Calc the stand-alone TI of each group member, as if the member were filing its own sep return. 2. Adjustmts are made to each member's TI to remove the effects of trans btw members of the consol'd group. These incl adjustmts for: -G/Ls deferred on interco sales btw group members. In the yr the asset is sold outside the group, a subseq adjustmt will need to be made. -inv adjustmts may be req'd for interco sales. -divs rec'd by 1 member from another are excluded. 3. G/Ls and deductions that are req'd to be determined at the consol'd level are removed from each member's TI. Incl: -cap G/Ls -section 1231 G/Ls -NOL -char contr deduction -DRD -domestic production deduction (Section 199) 4. Each member's resulting TI from the prev steps is combined to create the group's combined TI. 5. The group's combined TI is then adj for the items req'd to be determined at the consol'd level (items from step 3). Book ex for calc of consol'd TI: A, B, and C corps file a consol'd TR for the yr 20X6. B and C are wholly owned subs of A. Consol'd TI calc: 1. Calc each member's TI. 2. Make adjustmts to elim interco trans. Interco activity during the yr made by the group reqing adjustmts: -B and C paid divs to A of 60k and 30k (90k total). -B sold inv to A and recorded a 50k interco profit, which needs to be excluded from B's gross receipts and deferred (until the inv is sold to an outside party). -C sold a piece of equip to B and recorded a 10k section 1231 gain. -subtract all 3 of these items in step 2, so total TI reduced by 150k. Undo interco. 3. Remove the G/Ls and deductions that S/B determined at the consol'd level. -C's char contrs deduction: C paid 40k in contrs but was limited to 30,500 at the stand-alone level (10% of C's TI before the contrs deduction and other special deductions). -A's DRD: 90k of divs rec'd from B and C at 100% deduction; 110k from 30% owned domestic co at 80% deduction (110k x 80% = 88k). Total 178k (90k + 88k). -remove the 30,500 char contrs from deductions and add back the 178k DRD. Undo special calcs. 4. Calc the group's combined TI. Add across all columns. 5. Apply adjustmts for items determined at the consol'd level. -char contrs: at the consol'd level, the contrs limitation is now 95,700 (10% of 957k TI), so group can take the full 40k contrs deduction. -DRD: the DRD is now applied on the 110k divs from the 30% owned corp (110k x 80% = 88k DRD). Nothing for interco divs. -incl 40k char contrs in deductions and subtract 88k of DRD. Special calcs at consol'd level. Final column is the consol'd column, which adjusts 4 by the items in 5.
Corporation; Financing the Corporation
Corp capital comes from the issuance of many types of secs, incl EQ obligations (stock) and debt obligations (bonds). Bonds incl secured mortgage bonds and unsecured debentures, and even bonds that may be convertible into stock (convertible bonds). Bondholders are creditors. EQ secs incl shs of the corp, stock warrants (gen, options to purch shares granted by the corp), and stock options (gen, options to purch stock granted by one other than the issuing corp). SHs are owners of the corp. A corp may choose to issue only 1 class of stock, in which case each sh of stock will have the same rights. Alternatively, may choose to issue several classes or series of stock w/ varying rights (unless S corp). Unless the articles provide otherwise (by setting a par value for the stock) the BOD has discretion to issue stock at any price it thinks it approp. Under the RMBCA, stock may be issued in exchange for any benefit to the corp (money, prop, promises to perform services in the future, promissory notes, etc.).
Corporation; Formation
Corps are created by complying w/ a state incorp statute. A majority of states follow the revised model bus corp act (RMBCA). This outline is based on that act. A no of past corp Qs have simply asked which of 4 stmts is true, wherein a key to a no of these Qs was that corps are governed by statute. Promoters enter into contracts before the corp is formed to obtain financing and things the corp will need once formed (procure cap commitmts). Promoters are personally bound on the contracts they make. The corp isn't bound unless/until the corp adopts the contracts after it's formed, either expressly or by accepting the benefits of the contracts. Even if the corp adopts a promoter's contract, the promoter remains liable unless there's a novation (agreemt that the 3rd party will release the promoter and substitute the corp). Incorporators must file articles of incorp w/ the *state*. The articles may incl anything the incorporators consider approp, but, under the RMBCA, must incl: -name of the corp. -name/address of corp's registered agent (person on whom process may be served if corp is sued). -names/addresses of each of the incorporators. -no of shs auth'd to be issued. 1+ class of shares must have unlimited voting rights (unlike S corp). The examiners often ask what must be incl in the articles of incorp. Items not in the above list are unnecessary. Ex: the articles need not incl a stmt of the states in which the corp is to do bus/have offices, the names of the initial directors/officers, terms of office, etc. *Memorize* the list above and ignore the other choices. A corp may incl a clause in its articles stating the bus purpose for which the corp was formed. The purpose clause is optional. If a corp has a narrow purpose clause and undertakes bus outside the clause (or outside the bus permitted by statute), it's said to be acting ultra vires. A director/officer who auths an ultra vires act may be liable to the corp for damages caused by the act. Book ex for ultra vires act: if a corp was formed to accomplish the single purpose of operating a restaurant, any action to achieve some other purpose (like buying an oil and lube bus) W/B ultra vires.
Capitalize or Expense Continued
Cos can make a de minimis annual exp election regarding expenditures to acq/produce prop if they have a capitalization policy in effect as of the BOY. This election can also be applied to materials/supplies. The capitalization policy must be a written accting policy for nontax purposes that treats as an exp in the F/S: -prop purchases under a certain dollar amt and/or -prop w/ an economic useful life of 12 mos or less. If a co has an applicable F/S, the max amt allowed for fed tax purposes is 5k/asset (if written). If a co doesn't have an applicable F/S, the max amt is 2.5k/asset after 1/1/16 (before that it was 500/asset. If not written). Expense. Book ex for capitalize v exp: C corp has an applicable F/S and at the beginning of Y1 has a written accting policy to exp amts paid for tangible prop costing up to 10k. Pays 50k for 8 desks during Y1. Determine amt exps/capitalized for the desks for fed tax purposes. -for FR purposes, C can exp the entire 50k paid for the desks bc each desk costs < the 10k limit (50k/8 = 6,250/desk). -for tax purposes, must capitalize all of the purchases unless their economic life is < 12 mos bc the de minimis rule isn't met (since the purchases exceed 5k/asset).
The Surety's Rights Continued
Cosureties are 2+ sureties of the same obligation. These are jointly/severally liable (any 1+ may be liable for the entire obligation). Surety's rights against cosureties: 1. Exoneration: suit to compel pmt before surety pays. If it becomes necessary for the sureties to pay the creditor, 1 surety may compel his cosureties, by a suit in equity for exoneration, to pay their pro rata shares of the debt. 2. Contribution: this is after surety pays. On pmt, a surety is entitled to contr from his cosureties for their share of the pmt. Contr S/B distinguished from exoneration in that the right of contr arises only after the 1 surety has already paid more than his share. If the contract doesn't spec the liab of each surety, each surety is liable for a pro rata share determined by the no of solvent sureties. Book ex for cosureties (solvent v insolvent): there ae 3 solvent and 2 insolvent sureties. Each solvent surety is liable for 1/3 of the debt. Where cosureties are obligated for varying amts by their agreemts and the debt is reduced by partial pmt by the principal, each cosurety remains liable for the OG amt stated in his agreemt. Pmt of > his pro rata share of the reduced debt entitles a cosurety to contr from his cosureties for the excess in the proportion of the amts of their OG liab. Book ex for amts owed by cosureties: C loans D 9k and X, Y, and Z agree to be cosureties. The max liab of each is: X 6k, Y 3k, Z 9k. After making pmts, D defaults and Z pays the entire bal of 6k (default amt is settlemt amt here). -Z can collect a pro rata share from X and Y. -[6 + 3 + 9] = 18k. -X would have to contr 2k [(6/18) x 6k]. -Y would have to contr 1k [(3/18) x 6k]. -these are the default/settlemt amts. Equal here, aren't always equal. If a cosurety's obligation is discharged in bankruptcy, his agreed share should *NOT* be considered in determining the pro rata share of the remaining cosureties. The cosurety is elim'd from the calc bc nothing can be collected from him. Book ex for bankrupt cosurety: Same facts as above, but X's debts (incl his security obligation) were previously discharged in bankruptcy. -Z can't collect anything from X. -[3 + 9] = 12k. -Y would have to contr 1.5k [(3/12) x 6k]. -X was elim'd from the calc bc he was discharged in bankruptcy. If the default and settlemt amts aren't the same, *use the settlemt amt*. For ex if debtor defaulted on 10k loan but creditor agreed to let the surety pay 7k in full satisfaction of the debt, use the 7k settlemt amt, not the 10k default amt!
The Surety's Rights
Directly liable. After a default, a surety gen has *NO* right to a notice of default or to have the creditor (lender) try to collect from the principal debtor or apply to the debt any security that the creditor has. When a debtor defaults in a suretyship situation, the creditor may do any of these things in any order: -immediately demand pmt from the surety -immediately demand pmt from the debtor -immediately go after collateral, if there is any The surety does *NOT* have the right to req the creditor to taken any of these actions. A guarantor of collectibility would have the right to req a creditor to 1st proceed against the debtor or available collateral. Book ex for surety's rights/obligations: principal is in bankruptcy. Creditor holds a mortgage on principal's factory as security on obligation. Surety has also agreed to serve as a surety on the obligation. There will be considerable delay before creditor can realize on the security due to bankruptcy. Surety has no right to force creditor to go against the collateral, and must pay in full. Surety is then subrogated the creditor's rights against principal on the mortgage. Surety's rights against principal debtor: 1. Exoneration: suit to compel pmt, before surety pays the creditor. The principal debtor owes his surety a duty to perform. If the principal fails to pay the creditor (when the principal has assets), the surety may bring a suit for exoneration in equity to compel the principal to pay. Exoneration is also the right of a co-surety to bring a lawsuit to req the other co-sureties to pay their pro-rata share of the principal's debt. 2. Subrogation: enforcemt of creditor's rights against principal. This is after the surety pays the creditor. After paying the principal debtor's obligation, the surety may enforce/is subrogated to any rights that the creditor had against the principal debtor, incl the right to enforcemt of any security int and any priority in bankruptcy that the creditor had. 3. Reimbursemt: suit against principal after pmt. The surety is entitled to reimbursemt from his principal debtor for any amt the surety paid on behalf of the debtor. This is called a right to indemnification. Reimbursemt S/B distinguished from exoneration. In the latter, the surety compels the principal debtor to pay the creditor and the surety himself doesn't pay. Reimbursemt occurs after the surety has paid. If there's a reimbursemt clause in the surety contract, surety can recover from the debtor their exps associated w/ the security arrangemt.
General Partnership/Joint Venture; Termination: Dissociation and Dissolution of a General Partnership
Dissociation: Dissociation is a change in the relationship of the partners caused by any partner ceasing to be associated in the carrying on of the bus (change in partners). Dissociation of a partner does *NOT* necessarily cause a dissolution and winding up of the bus of the pship. A pship at will (one w/o a stated termination point) may be rightfully dissolved by a partner's notice of withdrawal/dissociation at any time. A partner is dissociated from the pship when the partner gives notice of withdrawal, dies, becomes bankrupt, is expelled, or if an event occurs that was set out in the pship agreemt as an event that would cause a dissociation. When a partner dissociates, his right to participate in mgmt ceases, although the dissociated partner's apparent auth to bind the pship will continue until 3rd parties are given notice of the dissociation. Gen, a dissociated partner remains liable for the debts incurred by the pship prior to dissociation unless there has been a release by the creditor or a novation. A dissociated partner may be held liable for debts incurred by the pship for up to 2 yrs after dissociation unless the partner gives notice of dissociation. If a new partner is admitted, isn't personally liable for debts incurred by the pship before becoming a partner (but can lose investmt in pship). Dissolution: gen, a pship is dissolved and its bus must be wound up if the pship is at will (has no expiration date) and a partner gives notice of withdrawal (just need 1), the partners agree to dissolution, or a ct orders dissolution. The death of a partner does *NOT* cause dissolution if the remaining parties agree to continue the pship w/in 90 days of the partner's death. The examiners often ask abt the basic chars of a pship. One that has been key in the past is that a pship is not of unlimited duration, bc any 1 of the above events can trigger a dissolution. A pship continues to exist after dissolution unless its bus is wound up, at which time the pship is terminated. Ex: each partner will continue to have apparent auth to bind the pship and will continue to be liable for the obligations of the pship. The pship is term'd only after the winding-up process is complete.
Corporate Distributions; Sources of Distributions
Distrs are deemed to come from current E&P first, then accum'd E&P. Any distr in excess of both current and accum'd E&P is a nontaxable ROC that reduces the SHs basis in the stock. After basis is 0, CG. Book ex for distr allocation: At 12/31/Y1, J corp has 20k accum'd E&P. For the taxable yr, Y1, J had current E&P (before distrs) of 25k. -if J makes distrs in Y2 of 25k or less, the distr W/B a div out of current E&P. -if J makes distrs >25k but <=45k, the distr W/B a div; 25k from current E&P and up to 20k from accum'd E&P. -if the distr is >45k, the distr would be a div of 45k (making both current/accum'd E&P 0), and the excess over 45k is a nontaxable ROC. It's sometimes necessary to allocate sep cash divs paid during the yr btw current/accum'd E&P to determine the TI for each pmt. When divs are in excess of E&P, this allocation applies: -current E&P: allocated on a pro rata basis to each distr, regardless of the actual date of the distrs. -accum'd E&P: applied in chronological order, beginning w/ the earliest distr. Book ex for multiple distrs in a yr: in Y1, L corp has current E&P of 15k and accum'd E&P of 10k. Paid 4 cash divs in Feb, Apr, Aug, and Nov of 7,500 each for a total of 30k. Half of each div (15k/4= 3,750) will be treated as being made from current E&P and taxable to the SH to that extent. The remaining 3,750 of each div will be taxable as follows: -Feb and Apr: paid from AE&P. Taxable div. -Aug: 2,500 paid from AE&P (10k - 3,750 - 3,750 = 2,500). Taxable div. 1,250 (3,750 - 2500) ROC. -Nov: entire amt is tax-free ROC (up to basis of stock, amt in excess of stock basis will be taxed as CG).
Corporate Distributions
Distrs from corps to SHs are taxable to such SHs if the distrs are classified as divs. A div is defined by the IRC as a distr of prop by a corp out of its E&P. There is a hierarchy showing how distrs are taxed, based on their source. In order, source of distr on left, tax consequence on right: 1. Current E&P (by YE): Taxable div. 2. Accum'd E&P (AE&P. Distr date): Taxable div. 3. Return of capital (ROC. No E&P): Tax free and reduces basis of C/S. 4. CG distr (no E&P or basis): TI as a CG. So distrs should 1st come out of any current E&P, then accum'd E&P, then basis, and any excess is CG. E&P (earnings and profits) is basically RE. The GR for netting is that current and accum'd E&P aren't netted. Divs come from current E&P and THEN accum'd E&P. -If current E&P is pos and accum'd E&P is neg, distrs are divs to the extent of current E&P only. -If both current and accum'd E&P are neg, distrs aren't divs at all. -If current E&P if neg and accum'd E&P is pos, the 2 amts *are netted* and distrs are divs if the net is positive. A div to a preferred SH is based on that SH's fixed % at purch. Preferred SHs aren't common EQ owners of a corp, and they only get paid based on their preferred %. Therefore, *any div pmts to a preferred SH are considered div inc to the SH*. Preferred SHs are paid in full before common SHs receive divs. Common SHs are residual owners of a corp and share in the E&P of the corp as well as the net assets.
Dividends-Received Deduction
Domestic corps are allowed DRD. The purpose of this is to prevent triple taxation of earnings. The amt of the DRD allowed depends on the % of the investee corp owned by the investor corp. The % allowed may be either 70, 80, or 100%. The corp SH must own the investee stock for at least 46 days during the 91-day pd beginning on the date 45 days before the ex-dividend date of the stock to qualify for the DRD. % deductions based on stock oship: -0 to <20% oship ("unrelated"): 70% DRD. -20 to <80% oship: 80% DRD. -80%+ oship (consol for tax): 100% DRD. Illustration of triple taxation issue and how DRD fixes it: -Big co has [inc - deductions] = TI. [TI - tax] = AT NI. Gives div. -Little corp has [inc + div inc from big co - deductions - DRD] = TI. [TI - tax] = AT NI. Gives div. -Little corp SH has [inc + div inc from little corp - deductions] = TI. [TI - tax] = AT NI. -without DRD at middle (little corp) level, there W/B triple taxation on the div from Big co. There's still some triple taxation if <80% oship, but much less. The DRD equals the *LESSER OF* (be polite and take the smaller piece): -70% or 80% of divs rec'd OR -70% or 80% of TI computed w/o regard to the DRD, any NOL deduction, CL CB, or domestic production activities deduction. This is the TI limitation. The TI limitation doesn't apply if, after taking into acct the full DRD, the result is a NOL (losers aren't polite).
Taxation of a C Corporation; Filing Requirements and Estimated Payments of Corporate Tax
Due date is 4/15 (YE 12/31). After changes made by the surface transportation and veterans health care choice improvemt act of 2015, a C corp must file a Form 1120 by the 15th day of the 4th month after the close of its tax yr. These changes were effective for 2016 corp returns. For C corps w/ fiscal yrs ending on 6/30, the new due dates will apply for tax yrs beginning after 12/31/25. Until then, the TR for them is due by the 15th day of the *3rd* mo after the close of the tax yr. When the due date falls on a legal holiday or weekend, the return is due on the next bus day. An extension of 5 mos is available by filing Form 7004 (6 mos after yr 2025). This is *NOT* an extension of paying tax due! Corps w/ a 6/30 YE have a 7 mo extension (6 mos after 12/31/25). Corps are req'd to pay estimated taxes on the 15th day of the 4th, 6th, 9th, and 12th mos of their tax yr. 1/4 of estimated tax is due w/ each pmt. Unequal quarterly pmts may be made w/ the annualized inc method. An underpmt penalty will be assessed if these pmts aren't made and the amt owed on the return is $500+ (after tax credits and AMT). Corps not classified as large corps (small corps) are req'd to pay the lesser of: -100% of the tax on the CY return OR -100% of the tax shown on the PY return The PY alternative can't be used if the corp had no tax in the PY or the PY was < 12 mos. A large corp (for which TI was $1M + in any of its 3 preceding tax yrs) must pay 100% of the tax on the CY return.
Depreciation; Expense Deduction in Lieu of Depreciation (Section 179 Expense)
Each tax yr, a taxpayer may deduct, as an exp in lieu of depr, a fixed amt of depreciable prop (machinery, equip, comp software, etc.). The limit of immediate expensing of machinery and equip is 510k for new or used personal prop that's acq'd from an unrelated party during the yr in 2017. -the max amt is reduced dollar for dollar by the amt of prop placed in service during the taxable yr that exceeds $2,030,000 in 2017. This amt will be indexed for inflation. -the deduction isn't permitted when a net loss exists or if the deduction would create a net loss. -section 179 limits the cost of a sports utility vehicle (SUV) that may be expensed to 25k. An SUV is defined as a 4-wheeled vehicle w/ a gross weight of > 6k lbs but < 14k lbs, not incl heavy pickup trucks, vans, and small busses. Book ex for section 179 deduction: N placed into service 50k of 5-yr prop. Assume N isn't subj to the TI limitation for a section 179 exp. Compare N's MACRS depr exp to its section 179 exp if N elects to take the full amt of section 179 exp against the prop. -MACRS = [50k x 20%] = 10k depr deduction. -section 179 = 50k. -the prop placed into service is w/in section 179 expensing and prop limits, so the entire amt is deductible this yr (given that N isn't in a net loss situation). -electing section 179 yields the greatest deduction. -if the taxpayer is in a loss position or sees the need for greater deductions in the future, depreciating the asset under normal MACRS convention W/B best.
Comparison of the Antifraud Provisions of the 1933 and 1934 Acts
Elements of proof listed below each. 1. 1933 act (sections 12 and 17): IPO. 11, 12, and 17. *LAM*. -source of misleading stmt/omission: must be in registration stmt. -trans covered: issuance of a security. -securities covered: those covered by the registration stmt. -plaintiffs: any person acqing the security, SEC. -defendants: every person who signed the registration stmt, directors, ppl named in the registration stmt, experts (incl acctants). -materiality: false stmt/omission must be material. -loss: must prove. -reliance: need *NOT* prove. -causation: need *NOT* prove. -scienter: need *NOT* prove. -knowledge of false stmt/omission: plaintiff can't know of false stmt/omission. -remedies: rescission or monetary damages (section 12); criminal damages (section 17). 2. 1934 act (section 10b): Fraud. *MAIDS*. -source of misleading stmt/omission: can be any written/oral stmt/omission. -trans covered: sale/purch of a sec. -securities covered: any secs, whether or not publicly traded or registered. -plaintiffs: any purchaser/seller of the security; SEC. -defendants: anyone responsible for the false stmt/omission, or who trades on the basis of mat, nonpub info and who breaches a duty of trust and confidence by so trading (latter is insider trading). -materiality: false stmt/omission must be mat. -loss: must prove. -reliance: must prove. -causation: must prove. -scienter: must prove. -knowledge of false stmt/omission: plaintiff can't know of false stmt/omission. -remedies: rescission or monetary damages. Misc additional info: -have to show the defendant signed the registration stmt for 33 but not 34 act. -*I* in MA*I*DS = bought OR sold stock. -*A* in L*A*M = bought/acq'd stock only.
The Estate Tax (Form 706); Gross Estate Continued
Estate transfer tax: 1. Gross estate: FMV prop, ins proceeds, incomplete gifts, revocable transfers, and inc in respect of decedent. - 2. nondiscretionary deductions: med exps and admin exps (option to deduct on IT return), outstanding debts, claims against the estate, *funeral exps*, indebtedness of prop, and certain taxes (taxes before death and state death taxes). = 3. Adjusted gross estate. - 4. Discretionary deductions: charitable bequests and marital deduction, both unlimited. = 5. Taxable estate. + 6. Adjusted taxable gifts: post-1976 gifts that were taxed. No double tax bc subtracted later in this calc. = 7. Tentative tax base at death. x 8. Uniform tax rates: apply to both taxable gifts and estates. = 9. Tentative estate tax. - 10. Gift taxes payable: reduction by gift taxes payable on gifts made after 1976. This eliminates double taxation of these gifts. = 11. Gross estate tax. - 12. Applicable credit: 2,151,800 for 2017. This credit amt is equal to the tax, before credits, on a 5,490,000 tentative tax base at death. = 13. Estate tax due. So summed up: [FMV assets - liabs] = net worth. [Net worth - transfers] = remainder. [Remainder x tax rate] = estate tax. [Estate tax - credit] = fed estate tax. Estates follow the same GR for taxable events and basis as in indiv and pship taxation: -for estate, event is taxable: taxed at FMV w/ a FMV basis. -for beneficiary, event is nontaxable: no tax, NBV basis (FMV from estate). Basis above carries over.
Income Taxation Rules for Estates and Trusts; Income Tax Returns, Distributable Net Income (DNI), Trust Definitions and Rules, and Income Distribution Deduction
Estates/trusts file inc TRs, like an indiv taxpayer. In contrast to indivs, the inc of an estate/trust is taxed at either the entity or beneficiary level, depending on whether it's allocated to principal or to distributable inc (fiduciary accting), and whether it's distr'd to the beneficiaries. DNI is a limitation on the amt the trust/estate can deduct (on ln 18 of Form 1041) w/ respect to distrs to beneficiaries. Gen calc of DNI: [estate/trust gross inc (incl all CGs) - estate/trust deductions] = Adjusted total inc (Form 1041, ln 17). [Adjusted total inc + adjusted TE int - CGs (attributable to corpus)] = DNI. Gen, adjusted TE int is the amt of TE int inc reduced by int exp, if any, related to the TE int, and all other investmt exps related to the TE int. Trust definitions/rules incl: 1. Gross inc: gen determined in the same manner as for indivs. Incl CGs. 2. Deductions: allowed for ord/necessary exps incurred in: -carrying on a trade/bus -production of inc -mgmt/conservation of inc-producing prop (incl the trustee's or executor's fees) -determination, collection, or refund of any tax -contrs to a charity (an unlimited char deduction is allowed if such contrs are provided for in a will) 3. Adjusted TE int: gen, adj TE int is the amt of TE int inc reduced by: -related int exp and -other invesmt exps related to TE int. 4. Tax credits: gen, tax credits allowed to indivs are allowed to fiduciaries (estates/trusts). The tax credits typically must be apportioned btw the fiduciary and the beneficiaries based on the inc allocable to each. 5. Inc distr'd to beneficiaries (and reported on sch K-1 of Form 1041): retains the same char (TE, portfolio, passive, etc.) as the inc has at the fiduciary level. The inc distr deduction is a deduction by the estate/trust. It's the LESSER OF: 1- actual distr to the beneficiary OR 2- DNI (less TE int). When the CPA exam tests on IT rules for trusts/estates, one of the most frequently tested concepts is DNI and the related inc distr deduction.
Agent's Power to Contractually Bind the Principal; Apparent Authority
Estoppel. Even though agent might not have actual auth, there are situations where the agent will nevertheless have the power (not right) to bind the principal, either bc the *principal's* conduct has caused 3rd parties to believe the agent had auth or bc the principal was negligent and so will be estopped from denying the agent had auth. This power to bind the principal is apparent auth. Apparent auth reqs a holding out by the principal or negligent inaction by the principal. The agent's mere rep that he is an agent is *NOT* sufficient to establish apparent auth. Apparent auth is based on the 3rd party's reasonable belief that the agent has the power to bind the principal. Actual auth arises from the agent's reasonable belief that he has the power to bind the principal, not the 3rd party's belief. Either way, principal is bound. If the agent lacked actual auth, the principal can hold the agent liable for acting w/o auth. Ways principal can give agent apparent auth: -from position (title): principal who holds another out as his agent vests the agent w/ the power to enter into all trans that a reasonable 3rd party would believe a person in the agent's position would have. Fancy titles like partner, officer, manager. Book ex for apparent auth from position: P hires A to manage pet store. A has apparent auth to hire/fire employees, make deposits, etc. -giving secret limiting instructions: no notice to 3rd parties. Principal who issues secret instructions to agent will limit the agent's actual auth, but not apparent auth. Apparent auth is based on the 3rd party's reasonable beliefs, and secret instructions are unknown to the third party. Book ex for apparent auth not affected by secret limiting instructions: P hires A to manage her pet store. It's customary in the area for managers to have actual auth to purchase pets. P tells A he may purch pets for the store, but not for > $200. Dog breeder offers to sell puppies for $250 and A accepts. A has apparent auth to purch the puppies, but not actual. P will have to pay the breeder, but can hold A liable for any loss that results.
Depreciation; Bonus Depreciation
Extended through 2019. Under these rules, a taxpayer can exp an additional percentage of qualified prop that's placed into service in the CY. Qualified prop is prop w/ a recovery pd of 20 yrs or less and the OG use of the prop commences w/ the taxpayer. A taxpayer can't take bonus depr on the purch of used prop, since its OG use wouldn't have commenced w/ the taxpayer. New prop only! The bonus depr % is 50% for prop placed in service during 2015-2017, then phases down to 40% in 2018 and 30% in 2019. The 8k additional 1st-yr depr for vehicles on which bonus depr has been claimed continues through 2019. Bonus depr isn't an adjustmt for, or a preference for, AMT purposes. Bonus depr is claimed after the section 179 exp deduction but before the regular depr exp deduction. For ways to take cost recovery deductions on depreciable prop (asset depr), remember this order: *IBM* -1st: *I*RC section 179 -2nd: *B*onus -3rd: *M*ACRS (regular) Calc basis after 179 and after bonus depr. Book ex for bonus depr and section 179: Co A places into service $2,220,000 (over 2,030,000) of 7-yr MACRS prop (all qualified under rules of section 179 and bonus depr). Determine the total expensing deduction for the yr on the prop, assuming that co A wants the max deduction possible for the CY. -1st: section 179. 320k section 179 deduction [510k deduction - 190k prop placed into service in excess of 2,030,000 (2,220-2,030)]. -2nd: bonus depr of 950k [(2,220,000 - 320k section 179 deduction) x 50% bonus rate]. -3rd: MACRS depr of 135,755 [950k remaining basis to exp x 14.29% 1st yr 7-yr asset factor from MACRS table]. -total exp deduction = [320k + 950k + 135,755] = 1,405,755. A taxpayer may elect to choose to depr prop on a SL basis (in lieu of accelerated depr). If a taxpayer chooses SL, may choose the regular recovery pd or a longer alternative depr system (ADS) recovery pd. Remember these concepts: -machinery and equip: half-yr convention and mid-quarter convention (if over 40% in last quarter). -real estate: mid-month convention.
Partnerships
Flow-through entities, which means the inc is taxed only once when it flows through to the partner. Unincorp'd business entities like gen pships, limited pships, and LLCs are gen treated as pships under the subchapter K rules of the IRC. When a pship is formed, the partners contr money, other prop, or services in return for their ints. A new partner may also obtain an int by making a contr after the pship is formed and has been operating. Gen, no G/L is recog'd on contr of prop to a pship in return for a pship int. Book ex for contr of prop in exchange for pship int: A taxpayer contrs land in exchange for a pship int. The land has an adj basis of 30k and FMV of 50k at the time of transfer. Determine the amt of G/L recog'd by the taxpayer. -no gain is recog'd by the taxpayer on the transfer. Nontaxable = NBV. A profits int in a pship reps the right to share in the future profits of the pship. It has no liquidation value when it's rec'd. A partner who receives a profits int in a pship in exchange for services rendered doesn't recog ord inc at the exchange. Profits int for services rendered = FMV = 0 = no inc. Book ex for profits int acq'd for services rendered: A taxpayer has no prop to contr to a pship. Receives a 20% profits int in exchange for services. On the day he's admitted to the pship, the pship's assets have a basis of 20k and liquidation value of 80k. Determine the amt of G/L recog'd to the taxpayer. -won't have to recog inc at the time the profits int is exchanged for the rendering of services.
Section 1231, 1245, and 1250 Assets Continued Further
Flowchart of G/L from section 1231 and 1245/1250 assets: At top: sale of depreciable prop/land, used in trade/bus and held for > 1 yr. This illustrates the GRs. Special rules are applicable to casualty/theft, involuntary conversion situations, and low-inc housing. For gain: -if personal prop, section 1245 determines the char of the gain. Gain = ord inc to the extent of *ALL* A/D. -if real prop, section 1250 determines the char of the gain. An amt equal to the LESSER of (1) the recog'd gain on the sale of the section 1250 asset or (2) A/D on the asset is taxed at a max rate of 25%. -the remaining gain after either section 1245 or 1250 gain is treated as a section 1231 gain. For loss: -the losses are to be netted w/ section 1231 gains. Next step is to compare G/Ls. -if the net result is a gain, treat it as a section 1231 (LT cap) gain. -if the net result is a loss, treat it as a section 1231 (ord) net loss. Treat it like the extra depr you should have gotten. Book ex for application of 1231, 1245, and 1250: R sold: -printing press for 4k, cost 6,800, A/D was 3,200 (NBV 3,600), recog'd 400 gain. -photocopier for 2,600, cost 2,500, A/D was 500 (NBV 2k), 600 gain. -van for 500, cost 15k, A/D 13k (NBV 2k), 1,500 loss. Step 1: calc G/L. [cost - A/D] = adjusted basis. [SP - adjusted basis] = G/L. Step 2: calc depr recapture. The printing press and photocopier are section 1245 personal prop sold at a gain, so for each, the lesser of gain recog'd or all A/D must be recaptured as ord inc. -for printing press: 400 ord inc (depr recapture). -for photocopier: 500 (this is for the A/D, 100 remainder {600 - 500} will be cap). Step 3: remaining G/L. Any remaining gain, after calcing the ord inc recapture, is then netted w/ all section 1231 net losses. -photocopier = 100 section 1231 CG, 0 section 1231 ord loss, 500 ord inc. -van = 0 section 1231 CG, 1,500 section 1231 ord loss, 0 ord inc. -printing press = 0 section 1231 CG, 0 section 1231 ord loss, and 400 ord inc. The net result when the section 1231 G/Ls are netted is a loss of $1,400 (1,500 loss - 100 gain), which is treated as a section 1231 net loss and deducted as an ord loss. Deduct like extra depr. Form 4797 (sales of bus prop) incl: -sales/exchanges of prop used in a trade/bus and involuntary conversions from other than casualty/theft - most prop held for > 1 yr. -ord G/Ls. -gain from disposition of prop under sections 1245, 1250, 1252, 1254, and 1255. -recapture amts under sections 179 and 280F(b)(2) when bus use drops to 50% or less.
Corporation; Fundamental Changes Continued
For *A*mendmts to the *A*rticles of incorp (D*A*MS): the corp may amend its articles of incorp in any/as many respects as desired, as long as the provisions, as amended, are lawful. For *M*ergers, consols, and sh exchanges (DA*M*S): -merger: [A + B] = A. Involves 1+ corps joining w/ another corp. *ONE* corp survives the merger and continues in existence, while the other merging corps cease to exist following the merger. Book ex for merger: X corp merges w/ A corp, and following the merger X ceases to exist. A survives, w/ all of the assets and SHs that formerly belonged to X. -consolidation: [A + B] = C. Involves 1+ corps joining together to form a new corp. Each constituent corp ceases to exist after the consol, only the new corp goes on. The new corp is liable for the debts of the old corp. -share exchange: trans in which 1 corp acqs all of the outstanding shs of 1+ classes of stock of another corp. *BOTH* corps continue to exist as sep entities. Both corps in a merger and all corps in a consol must follow the gen proc for fundamental corp changes above (board resolution, notice, approval by majority of shs, and filing). The notice must incl a summary of the plan of the merger, consol, sh exchange, etc. So the SHs of both corps must be given due notice of a special meeting, incl a copy/summary of the merger plan (unless short-form merger). In a sh exchange, only the corp whose shs are being acq'd need follow the fundamental change proc. The plan of merger or sh exchange must incl the terms/conditions of the plan and the manner of converting the corp's securities.
Calculation of AMT; Regular Taxable Income: Preferences
For AMT purposes, preferences are items typically not taxed for regular tax purposes, but added back for AMT purposes. While adjustmts may be added/subtracted from TI in calcing AMTI, preferences are always added back to TI. These add-backs ensure the corp pays a min amt of tax. Adjustmts can be thought of as related to timing diffs, while preferences are related to perm diffs. Once you add/subtract adjustmts and add preferences, get unadjusted AMTI. Preferences: -*P*ercentage depletion: preference exists for the excess of % depletion over the adjusted basis of the prop. -*P*rivate activity bonds: preference exists for TE int from certain private activity bonds issued after 8/7/86. TE int on private activity bonds issued after 2009/10 is not an AMT preference item. -*P*re-1987 ACRS depr: a preference exists for the excess of ACRS accelerated depr over SL on pre-1987 prop. Book ex for preference item: C corp owns a bond that has been issued by the city of A in a yr after 2010 to fund a privately owned mfg plant that would bring new jobs to the area. While the bond was issued by a muni, the int wouldn't be exempt from AMT bc the bond is considered a private activity bond. Int earned in the current tax yr on the bond was 800. Excludable for regular taxes, add-back for AMT. Determine if there will be an adjustmt to TI for the calc of unadjusted AMTI. -this int is TE for calcing TI but must be added back to TI when calcing unadjusted AMTI. Hmm I thought the notes said it isn't a preference if issued after 2010, but this ex was also in there, so I guess I'd assume you always treat it as a preference for now.
Individual Capital Gains and Losses Rules
For net CGs, tax rate is 20% if rich, 15% if avg, 0% if poor. -LT: HP is > 1 yr. Tax rate is 20% max, use 15% if taxpayer is in the 25, 28, 33 or 35% IT brackets, use 0% if the taxpayer is in the 10 or 15% IT brackets. -ST: HP is 1 yr or less. Tax rate is ord IT rate. -any unrecaptured section 1250 gain from depr of real prop that isn't treated as ord inc is taxed at 25% for taxpayers not in the 10 or 15% IT brackets. -LT gains on collectibles, antiques, and small co (Section 1202) stock are taxed at 28% (for taxpayers not in the 10, 15, or 25% IT brackets). For net CLs (loss deduction and carryover rules), there's a 3k/yr max deduction for indivs only. -Indiv taxpayers realizing a net LT or ST CL may only recog/deduct a max of 3k of the amt realized from other types of gross inc (ord, passive, portfolio). A joint return is treated as 1 person. If MFS, the loss deduction is limited to 1/2 (1,500). -CLs are also limited to TI before personal exemptions. -CF excess net capital loss (>3k) an unlimited time until exhausted. It maintains its char as LT/ST in future yrs. No CB, CF forever. Can't change the past but your mistakes could haunt you forever. -a personal/nonbus bad debt loss is treated as a ST CL in the yr the debt becomes totally worthless. -the cost/other basis of worthless stock/secs is treated as a CL, as if they were sold on the last day of the taxable yr in which they became *totally worthless* (0). Specific netting procs for cap G/Ls are outlined in the IRC. G/Ls are netted w/in each tax rate group (like 15%), creating net ST and LT G/Ls by rate group. Resulting ST and LT losses then offset ST and LT gains (respectively) beginning w/ the highest tax rate group and continuing to the lower rates. ST cap G/Ls: -if there are any ST CLs (incl any ST CL carryovers), they first offset any ST gains that W/B taxable at ord inc rates. -any remaining ST CL is used to offset any LT CGs from the 28% rate group (like collectibles). -any remaining ST CL is then used to offset any LT CGs from the 25% group (like unrecaptured section 1250 gains). -any remaining ST CL is used to offset any LT CGs applicable at the lower (15 or 20%) rate group. LT cap G/Ls: -if there are any LT CLs (incl LT CL carryovers) from the 28% rate group, they 1st offset any net gains from the 25% rate group, then net gains from the 15% or 20% rate group. -if there are any LT CLs (incl LT CL carryovers) from the 15% or 20% rate group, they 1st offset any net gains from the 28% rate group, then net gains from the 25% rate group.
Unrelated Business Income (UBI); Return for Tax-Exempt Organization
Form 990 (return of org exempt from IT) incl: -info abt org (name, address, TE status, etc.). -brief descr of the org's mission or most sig activities. -activities and governance. -rev and exps for CY and PY. -net assets or fund bals (RE). -signature. -paid preparer info.
Amortization
GAAP doesn't = tax. Tax = 15 yr SL. GAAP = impairmt test/not amortized for public, option to amort over 10 yrs for private. Intangibles like GW, licenses, franchises, and TMs may be amortized using SL basis over a pd of 15 yrs, starting w/ the mo of acq. For GAAP purposes, intangibles w/ *indefinite* lives are subj only to an impairmt test, and intangibles w/ *finite* lives are amortized over those lives and also subj to an impairmt test. Certain items can be expensed and/or amortized on a SL basis over a pd of yrs upon election to do so, regardless of their useful life. These incl.: -bus org and start-up costs. Each is permitted to 1st take off 5k to be expensed, and the rest is amortized over 180 mos (the 5k is reduced as total cost exceeds 50k for each item). GAAP = exp, tax = 5k deduct + remainder over 180 mos (15 yrs). -research exps (existing trades/businesses may amort research exps over a 60 mo pd). -pollution-control facilities (amortized over 60 mos). -reforestation costs (amortized over 84 mos). -geological and geophysical costs (amortized over 24 mos). Book ex for amortization: R corp acq'd a patent w/ a cost of 50k in August of Y1. Determine the amort on the patent in Y1. -[50k/180 mos] = $278 amort/mo (over 15 yrs). -[278 x 5 mos left in yr] = $1,390 amort on patent in Y1.
Effect of S Corporation Election on Corporation
GR is that 12/31 is req'd YE. S corps file Form 1120S and must adopt the calendar yr, unless a valid bus purpose for a diff tax yr (fiscal yr) is established. The return is due by the 15th day of the 3rd mo (3/15) after the close of the tax yr. Gen, there's no tax at the corp level. All earnings are passed through to SHs, w/ certain exceptions. SH reports inc and pays tax. There are certain corp-level taxes. 3 taxes imposed on S corps: 1. LIFO recapture tax: C corps that elect S status must incl in TI for the last C corp yr the excess of inv computed under FIFO over LIFO (cumulative basis). The resulting tax on the C corp may be paid in 4 equal installmts, the 1st of which is due w/ the final C corp return. The remaining installmts are paid by the S corp. 2. Built-in Gains (BIG) tax: a distr/sale of an S corp's assets may result in a tax on any BIG at the corp level. An unrealized BIG results when these 2 conditions occur: -a C corp (in PYs) elects S corp status and -the FMV of the corp assets exceeds the adj basis of corp assets on the election date. FMV > basis. Tax on S corp if BIG. The net unrealized BIG is the excess of the FMV of corp assets over adj basis of corp assets at the beg of the yr in which S corp status is elected. The amt of BIG recog'd in any 1 yr is limited to the net unrealized BIG less any BIG prev recog'd. An S corp is exempt from a tax on BIG under any of these circumstances (no S corp tax on BIG): -the S corp was never a C corp. -the sale/transfer doesn't occur w/in 10 yrs (5 yrs through the pd ending 12/31/14) of the 1st day of the 1st yr that the S election is made. -the S corp can demonstrate that the appreciation occurred after the S election. -the S corp can demonstrate that the distr'd asset was acq'd after the S election. -the net unrealized BIG has been completely recog'd in prior tax yrs. The tax is calc'd by multiplying 35% (highest corp tax rate) by the LESSER OF: -recog'd BIG for the CY or -the TI of the S corp if it were a C corp. 3. Tax on passive investmt inc: an S corp is subj to an inc tax imposed at the highest corp rate (35%) on the lesser of NI or excess passive investmt inc if these 2 tests are met (S corp taxed on current inc at 35% rate): -the S corp has accumulated C corp E&P (from PYs. Accumulated earnings attributable to prior pds in which the corp was a C corp) and -passive investmt inc (royalties, divs, int, rents, and annuities but *not* gains on sales of secs) exceeds 25% of gross receipts. Taxed as C corp.
Partnership Tax Year
GR: calendar yr. If not, must be the same taxable yr as the common taxable yr of the partners that, in the aggregate, have int >50%, determined based on the testing day (1st day of the pship's tax yr, not considering the majority int rule). After a change is made to the majority-int tax YE, the pship doesn't have to change to another tax yr for 2 yrs after the yr of change. Exceptions to the rule: 1. If there's no majority-int tax yr, the tax yr is that of all of the principal partners (those owning 5%+ of the inc or capital of the pship). 2. If the pship is still unable to determine a tax yr using the GR and 1st exception, the tax yr that causes the lease aggregate deferral of inc to the partners must be adopted. A pship may be able to avoid these rules if it has a bus purpose for selecting a diff tax yr and this can be established w/ the IRS.
Unified Estate and Gift Tax (Transfer Tax)
GR: prop transfers (by gift during life or by will at death) = taxable = FMV. The estate and gift tax have been unified into a single transfer tax. Not all gifts are subj to the gift tax. Lifetime gifts: certain gifts qualify for an unlimited exclusion. Gifts of 14k or less per yr per donee are excluded. For 2017, a 2,141,800 (indexed annually) unified estate and gift tax credit effectively exempts from the gift tax cumulative, nonexcluded gifts having a value of 5,490,000. Death time transfers: excluded from the estate tax. The unified estate and gift tax credit of 2,141,800 (2017) effectively exempts from estate/gift tax the first 5,490,000 (2017) of otherwise taxable cumulative gifts and death time transfers.
Basis; Partnership's Basis for Contributed Property
GREATER of NBV or debt assumed. The pship's basis in the contr'd prop is the contributor's basis, or carryover basis (+ any gain recog'd by incoming partner, if a special election is made). If the prop was a cap asset or section 1231 asset in the hands of the partner, the pship's holding pd for contr'd prop incl the time held by the partner. If, however, the prop was an ord inc asset (inv), the HP starts on the date of contr to the pship. Outside basis is a pship concept that refers to the basis a partner has in the oship int in the pship. This pship int has a tax basis sim oship ints in other prop. Inside basis refers to the basis the pship itself has in the assets it owns. As a GR, the basis of an asset contr'd by a partner would carry over and be the basis of the asset in the hands of the pship. Also, inside basis can come from purchases the pship makes w/ pship funds. Book ex for calc of inside and outside basis: In Y1, J contrs these items for a 1/3 int in K pship: -10k cash -bldg w/ FMV of 300k and adj basis to J of 100k. This is subj to a liab of 90k. -in Y2, J contrs another bldg w/ FMV of 600k and an adj basis to J of 300k. -the pship had 150k NI in Y2. Determine J's initial outside basis in the pship at Y1, and his outside basis at the end of Y2. Also determine the pship's inside basis and HP in J's contr'd assets. -J's initial outside basis = [10k cash + 100k adj basis of bldg - 60k (90k x 2/3. Liabs assumed by other partners)] = 50k. -K's inside basis in the bldg = 100k carryover (> of NBV or debt assumed). K's HP will start when the prop was OG purch'd by J. -J's outside basis at the end of Y2 = [50k BB + 300k adj basis new bldg + 50k (1/3 share of NI)] = 400k. -the pship will again take a carryover basis of 300k and a carryover HP in the new bldg. Overall calc of J's pship basis = [10k cash + 100k NBV bldg - 60k liabs others assume] = 50k Y1 basis. [50k Y1 basis + 300k NBV 2nd bldg + 50k sh of inc] = 400k Y2 basis.
Circular 230; Standards With Respect to Tax Returns and Documents, Affidavits, and Other Papers Continued
Gen, a practitioner who signs the TR/other doc can rely in good faith w/o verification on client-furnished info. Can't ignore the implications of such info and contradictory info known to the practitioner, and must make reasonable inquiries if the client-furnished info appears questionable/incomplete. The practitioner must advise the client promptly of any noncompliance, errors, or omissions in TRs/other docs and the consequences under the law. Don't notify IRS. Consider withdrawing if client won't rectify. The practitioner must exercise due diligence in prepping TRs/other docs and determining the correctness of their reps to the IRS. If the practitioner relies upon the work product of another, there's a presumption that the practitioner exercised due diligence if the practitioner took reasonable care w/ respect to the reliance. Gen, at the request of the client, practitioner must return all records. May retain copies of the records returned to the client. -exception: if state law allows the practitioner to retain the records in the case of a fee dispute, can do so. However, must return to the client those records that must be attached to the TR and allow the client to review/copy the practitioner-related client records related to the client's fed tax obligations.
Net Operating Losses (NOLs); Forgoing Carryback and NOL Planning
Gen, if a corp has a NOL for the CY, it must CB the entire amt of the NOL to 2 yrs before the NOL yr (CB pd) and then CF the remaining NOL for up to 20 yrs after the NOL yr (CF pd). Hindsight is 2 x 20! A corp may elect to forgo the CB pd and only carry the NOL fwd. In this case, although there's no special form to file, an election to forgo the CB must be made on the TR for the yr of loss. A corp must weigh the tax savings assoc'd w/ carrying the loss back vs carrying it fwd. If the CB will be offset against inc already taxed at a low MTR, the better decision will be to CF the NOL and apply it against inc that will be taxed at a higher MTR. If the corp has an urgent need for cash, it may want to carry the NOL back bc carrying losses back results in immediate cash while forgoing the CB doesn't result in immediate cash.
Partnership Tax Returns Continued
Gen, if a partner enters into a trans (other than in his capacity as a partner) w/ his pship (like rendering services to the pship, or sales btw a partner and pship), the trans is deemed to have occurred btw the pship and an outsider, subj to these limitations: -related party loss (W*R*aP) is disallowed: losses (directly/indirectly) btw a controlling partner (over 50% int in cap or profits) and his controlled pship from the sale/exchange of prop are not allowed. -related party gain is ord inc: gains (directly/indirectly) btw a controlling partner (over 50% int in cap or profits) and his controlled pship, or btw 2 controlled pships, from the sale/exchange of assets shall be treated as ord inc if the prop is depreciable in the hands of the transferee or if it isn't a cap asset in the hands of the transferee. Oship of cap or int in the profits of a pship shall be determined by certain rules of constructive oship as defined in Section 267 of the IRC. Form 1065 (pship TR) incl: -info return (no taxes). -inc, deductions, ord bus inc/loss. -sch B; other info. Checklist of Qs. -sch K; partners' distributive share items. Incl inc/loss, deductions, SE, credits, foreign trans, AMT items, and other info. Gives totals for whole pship, each partner gets own K-1 w/ their pro rata share of these items. -analysis of NI/loss above sch L. -sch L; B/S per books. Gives BOY and EOY amts. -sch M-1; reconciliation of inc/loss per books w/ inc/loss per return. -sch M-2; analysis of partners' cap accts (sim RE analysis for corps).
The Gift Tax (Form 709); Gifts: Present v Future Interest
Gift issues incl: 1. present v future and 2. complete v incomplete. This is 1 of 2. The postponemt of a right to use, possess, or enjoy the prop distinguishes a future int from a present int. A present int qualifies for the annual exclusion and in most circumstances W/B removed from the estate. A future int (or present int w/o ascertainable value) does *NOT* qualify for the annual exclusion and, unless the req'd time pd has passed, will not be removed from the estate. Bc a gift of future int doesn't qualify for the annual exclusion, the donee is gen req'd to file Form 709, regardless of the amt of the future int. Exs of future int gifts (not gifts!): -reversions (gifting assets and later getting the prop back). -remainders (distr'd at some future time). -trust inc ints where accumulation of inc by a trustee is mandatory and accumulations are distr'd at some future time at the discretion of the trustee and -present ints w/o ascertainable value Exs of present int gifts (gifts!): -outright gifts of cash/prop. -trust inc ints where annual or more frequent distr is mandatory. -life estates (oship of the right to use prop presently but not oship of the prop itself). -estates for a term certain. -bonds/notes (even though int isn't payable until maturity) and -unrestricted transfers of life ins policies.
Income Taxation Rules for Estates and Trusts; Annual Trust Income Tax Return (Form 1041) Continued
Grantor Trusts: -the grantor (indiv who established the trust) retains control over the trust assets. -grantor trust is considered a disregarded entity for IT purposes. Any TI or deduction of a grantor trust is reported on the IT return of the grantor. -grantor trust can be a qualified SH of an S corp. -grantor trust is gen not incl in the taxable estate of the grantor upon his/her death. Book ex for grantor-type trust: the B trust is a grantor-type trust. In the CY, it sold 500 shs of X stock for $60/sh in which it had a basis of $40/sh. Determine the amt of inc from the sale of X stock, which must be reported on the B trusts' 1041 TR. -the inc in connection w/ the sale of the X stock will not be reported on a trust TR, Form 1041. -instead will be reported on the indiv tax return of the grantor, bc the grantor trust is a disregarded entity. Complex trusts: all trusts that aren't simple trusts are complex trusts. A trust may be simple 1 yr and complex the next. A complex trust: -may accumulate current inc. -may distr principal. -may deduct char contrs. -is permitted an exemption of $100 in arriving at TI. -a simple trust is complex in the yr of termination bc the corpus is distr'd. Book ex for complex trust: G trust, a complex trust, had gross rental inc of 25k and taxable int inc of 10k for Y1. The trust also incurred a deductible trustee fee of 1k and rental prop exps of 3k. The trust plans to make a 28k distr to its beneficiaries in Y1. Calc the trust's TI for Y1. -[25k rental inc + 10 taxable int inc] = 35k. [35k - 1k trustee fee - 3k rental prop exps] = 31k adj total inc. [31k - 28k inc distr deduction - 100 exemption] = 2,900 TI. -inc distr deduction is the LESSER OF 31k DNI (less adjusted TE int) or 28k distrs (less TE inc). A trust's accumulated inc is taxed w/ this rate schedule: -if TI is 0-2,550: 15% tax rate of the amt over 0. -if TI is 2,550-6k: 382.50 + 25% of the amt over 2,550. -if TI if 6k-9,150: 1,245 + 28% of the amt over 6k. -if TI is 9,150 - 12.5k: 2,127 + 33% of the amt over 9,150. -if TI is 12.5k +: 3,232.50 + 39.6% of the amt over 12.5k. This is the highest indiv tax rate. These rates don't reflect the 20% max tax rate on net CGs (net LT CGs - net ST CLs). Form 1041 (inc TR for estates and trusts) incl: -inc -deductions -tax and pmts -char deduction (don't complete for a simple trust) -inc distr deduction -tax computation -other info (checkboxes)
Gains (Excluded or Deferred); Involuntary Conversions
H*I*DE IT. Nonrecognition treatmt is given to gains realized on involuntary conversions of prop (destruction, theft, condemnation) on the rationale that the taxpayer's reinvestmt of the involuntary rec'd proceeds restores him to the position he held prior to the conversion. To tax him under such circumstances would produce undue hardship. If the taxpayer doesn't reinvest all the proceeds, his gain on the trans will be recog'd to the extent of the amt not reinvested. This is like ins proceeds. Any amt not reinvested is considered boot/loot. When no gain is recog'd bc of the direct conversion of the prop into other sim prop, the basis of the new asset is the same as that of the old asset (incr'd by any additional amts invested). For personal prop, the reinvestmt must occur w/in 2 yrs after the close of the taxable yr (YE) in which any part of the gain was realized and be in "sim or related service in use" (the replacemt prop must serve the same function in the taxpayer's bus as did the old prop. Narrower std than the like-kind test). For principal residences destroyed in a federally declared disaster area, the replacemt pd is 4 yrs instead of 2. For condemned bus prop, the reinvestmt must occur w/in 3 yrs of the close of the taxable yr (YE) in which any part of the gain was realized and be in prop "sim or related in service/use" (the replacemt prop must serve the same function in the taxpayer's bus as did the old prop, narrower std than the like-kind test). The basis of prop acq'd as a result of an involuntary conversion will be the cost of the prop decr'd by the amt of any gain not recog'd upon such conversion. Basis = nontaxable = NBV. Book ex for condemnation: land owned by M had an adjusted basis of 30k. It was condemned by the state and M rec'd sim prop from the state to replace the condemned land. -basis of the new prop = 30k.
Gains (Excluded or Deferred); Exchange of Like-Kind Business/Investment Assets
HID*E* IT. Tangible assets. Nonrecog treatmt is given to gains realized on like-kind exchanges of prop used in the trade/bus or held for investmt except inv, stock, secs, pship ints, goodwill/going concern value, and real prop in diff countries. So not most things that are "on paper" and intangible. Whether or not prop qualifies as like-kind depends on its status as real or personal prop. -real prop: real prop used in a trade/bus or for investmt that's exchanged for other real prop used in a trade/bus or investmt qualifies as like kind. Does *NOT* have to be the same general use. -personal prop: more restrictive rules. To receive deferral treatmt assoc'd w/ like-kind exchanges, must be exchanged for other personal prop that has the *same general use* (in the same asset class). These are things like bus trade-ins or swapping real estate. Book ex for prop qualifying for nonrecog treatmt: taxpayer owned a bldg for her clothes store. When she retired, sold it and purch'd an apartment bldg, held as an investmt. Determine whether the trans qualifies as a like-kind exchange. -bc exchanged real prop used in a trade/bus for other real prop used in a trade/bus or for investmt, the exchange should qualify for the nonrecog treatmt available to like-kind exchanges. -office bldg to apartment bldg is ok! Book ex for prop not qualifying for nonrecog treatmt: in his bus, a taxpayer owned several laptops and decided to exchange them (comp and peripheral equip asset class) w/ another bus owner for a new desk and filing cabinet (office furniture, fixtures, and equip asset class). Determine whether the trans qualifies as a like-kind exchange. -even though both the comps and office furniture are personal prop, they don't have the same gen use and asset class, so the exchange wouldn't qualify for the nonrecog treatmt for like-kind exchanges. -PP&E not the same general use. There are also timing rqmts that must be met for a like-kind exchange to receive deferral treatmt. 1st, the taxpayers must ID like-kind replacemt prop w/in 45 days of giving up their prop. 2nd, like-kind prop must be rec'd by the earlier of (1) 180 days after the taxpayer transfers prop in a like-kind exchange OR (2) the due date of the taxpayer's inc TR (incl extensions) for the yr in which the transfer occurs. So ID w/in 45 days and rec'd/acq'd at earlier of 180 days after transfer or TR filed.
Installment Sale
HIDE *I*T. The installmt method is the tax method of reporting gains (NOT losses) for sales made by a nonmerchant in personal prop and nondealer in real estate when part of the pmts are rec'd in a tax yr after the yr of sale. This method isn't available for sales of stocks/secs traded on an established mkt. Immediate recognition can be elected by reporting all of the gain on the sale on the seller's return for the yr of disposition. Under the installmt method, rev is reported over the pd in which the cash pmts are rec'd (even if the accrual basis is used for TR!). This method doesn't alter the type of gain to be reported (CG or ord inc). TI is calc'd by multiplying the annual cash collections by the GP %. GP = [sale - COGS]. GP % = [GP/SP]. Earned rev (TI) = [cash collections x GP %]. This is for each pmt rec'd. Book ex for installmt sale reporting: Assume a taxpayer had 400k in installmt sales in Y1 and a 12/31/Y1 bal in installmt AR of 150k. 300k COGS. Calc realized profit, GP %, and profit recog'd in Y1 under the installmt method. -realized profit = [400k installmt sale - 300k COGS = 100k GP. -GP % = [100k GP/400k installmt sales] = 25%. -earned GP (recog'd) = [400k installmt sales - 150k EB installmt AR] = 250k collections in Y1. [250k collections x 25%] = 62,500 GP recog'd in Y1. TI this yr. The seller is req'd to charge int on an installmt sale. The int is reported sep from each installmt pmt as ord inc. If no int or inadequate int is reported by the seller, a portion of each installmt pmt will be treated as imputed int and taxed at ord rates. Misc: -all depr recaptured shall be reported in inc in the yr of sale. -net proceeds from loans that are secured by the installmt obligation shall be reported as amts rec'd/collected. -gain from the sale of depreciable prop to a related person is gen ineligible for installmt sale reporting. Installmt sale treatmt of gains is allowed btw related parties (unless gains from depreciable prop, then disallowed). Under a special exception for installmt sales to a related party w/ a subseq sale by the related party before all the installmt pmts are made, the OG seller shall treat the amts rec'd by the second seller as rec'd by the OG seller. So in yr of sale [(installmt pmts for that yr + amt rec'd on sale) x GP %] = gain recog'd in yr of sale.
Net Operating Losses (NOLs)
Hindsight is 2 x 20! Corps are entitled to the same NOL rules as indivs. The CB pd is gen 2 yrs, and the CF pd is 20 yrs. A Form 1120X (amended corp inc tax return) must be filed w/in 3 yrs of the due date (incl extensions) of the return for the loss yr. Alternatively, by the end of the tax yr immediately following the loss yr, the corp can file Form 1139, corp application for tentative refund. These additional points S/B noted when calcing the corp NOL (stuff that's not allowed): 1. No char contr deduction is allowed in calcing the NOL. 2. The TI limitation normally imposed on the DRD doesn't apply if, after taking into acct the full DRD, the corp has an NOL for the yr. 3. The domestic production activities deduction under Section 199 is gen not allowed when calcing an NOL. 4. The NOL deduction for an NOL CB or CF from another yr isn't allowed in determining a CY NOL. 5. A corp may deduct a CL carryover from a CY CG in calcing an NOL, but can't deduct a CL CB against a net CG in determining a CY NOL. (CL CFs allowed, *NO* CL CBs). The CPA exam often provides answers, which relate to CL rules, to questions concerning NOLs. It's important to be able to distinguish these tax rules. -NOL: doesn't offset other inc, CB 2, CF 20. -Corp net CL: doesn't offset other inc, CB 3, CF 5 (3/5 rule). -Indiv net CL: offsets other inc up to 3k max, no CB, CF indefinitely (can't change the past, but your individual mistakes might haunt you forever). Remember to look at the dates!! On a consol'd return you can use the NOL of a sub to offset the inc of another sub.
Limited Liability Company (LLC)
Hybrid btw a corp and pship. An LLC is designed to provide its owners, called members, w 2 main features: -the limited liab that SHs of a corp enjoy (owners aren't personally liable for obligations of the bus entity). -the ability to be taxed like a pship (P/Ls flow through the LLC and are treated as the owners' personal P/Ls, unlike profits of a corp, which are taxed at the corp level and again when distr'd to the SHs). Under tax laws LLCs are treated as a pship unless they elect to be taxed as a corp. LLC members may, but need not, adopt operating agreemts w/ provisions diff from the LLC statute, and gen the op agreemts will control. The op agreemt is an agreemt among members regarding how they will op/run their bus. Its intent is to forestall and resolve disputes among the members. These agreemts are not filed w/ the state. Under the uniform LLC act (ULLCA), such op agreemts need not be in writing. An LLC is formed by filing articles of organization w/ the secretary of state. Diff than articles of incorp (for corp). Most states req the articles to incl: -a stmt that the entity is an LLC. -the name of the LLC, which must incl an indication that it's an LLC. -the street address of the LLC's registered office and the name of its registered agent. -if mgmt is to be vested in managers, a stmt to that effect (important) and -the names of the persons who will be managing the co. Most states now allow 1 person to form an LLC.
The Securities Act of 1933; Timetable of Sales Activity
IPO - 33 act. 1. 30 days before registration (prefiling pd): Gen, no sales activity is allowed w/in the 30 days before registration (prefiling pd), unless the issuance is exempt. However, an issuer is permitted to negotiate w/ an underwriter. Comms made > 30 days before a registration gen don't constitute sales activity. 2. After registation but before effectiveness (waiting pd): There's a 20 day waiting pd btw registration and the filing date. Sales are gen prohibited during this pd, but some sales activities are allowed: -oral offers to sell (no written) can be made. -tombstone ads can be made (ad IDs the sec, its price, and who will execute orders). -prelim (red herring) prospectus can be made (sim the statutory prospectus, but contains a stmt in red ink that it's not yet final). -summary prospectuses are allowed (but these are outmoded and seldom used). 3. After effective date (post-effective pd): after the registration is effective (20 days after filing or as the SEC directs), the secs may be sold. All investors must receive a prospectus before or w/ the sale. There are special rules for some 1934 act reporting cos: -WKSIs: there are special rules for seasoned issuers and well-known seasoned issuers (WKSIs). These rules haven't been tested beyond the gen notion that the normal timetable doesn't apply to WKSIs and there's a doc called a free writing prospectus. -free writing prospectus: WKSIs and seasoned issuers may issue a free writing prospectus. Must incl a legend that a registration stmt has been filed and advising how a reader can obtain a prelim prospectus. Copies of a free writing prospectus must be filed w/ the SEC before 1st use and be retained for 3 yrs.
The Securities Act of 1933; Liability Under the 1933 Act
IPO. Gen liab under sections 11, 12, and 17: -section 11: civil liab for misstmt. Imposes civil liab for misstmts, whether or not intentional, in registration stmts. -section 12: civil antifraud section of the 1933 act. Imposes civil liab if a req'd registration was not made, if a prospectus was not given to all investors, or if mat false stmts were made/omitted in connection w/ sales or offers to sell. The immediate purchaser may sue for damages or rescission (purchaser may sell the sec back to the issuer and recover the price paid). The purchaser need not prove scienter or reliance. -section 17: criminal antifraud section of the 1933 act. Imposes criminal penalties against anyone who uses any type of fraud in connection w/ the issuance of a sec. Enforced by the SEC and prosecuted by the US dptmt of justice. Examiners have focused their attention on section 11 (so rest of this card is section 11). Section 11 makes anyone who signs a registration stmt liable for all damages caused by any misstmt of mat fact in the registration stmt. A person wishing to sue under section 11 need only show: *LAM* -plantiff suffered a *L*oss (suffered damages). -plaintiff *A*cq'd the stock (need not be the initial purchaser) -the registration stmt contained a *M*aterial *M*isrep or mat omission of fact. The plaintiff need not prove an intent to deceive or negligence on the part of the defendant, nor reliance. Note that damages are the only remedy, rescission isn't available. Section 11 is heavily tested. Key is to remember that the plaintiff need only prove that he acq'd the stock, suffered a loss, and a MM or mat omission of fact. The plaintiff need not prove any type of intent (scienter) or negligence, nor reliance on the false stmt. Anyone who signs a registration stmt may be liable under section 11. Indep CPAs audit the F/S in a registration stmt and attest to their accuracy. Thus, the signing CPA is liable for MMs in the registration stmt that result in loss. Book ex for who is liable: while conducting an audit, A, CPA, failed to detect MMs incl in the client's F/S. A's unqualified opinion was incl in the F/S in the registration stmt for a pub offering of securities. A knew the F/S would be used for this purpose. P purchases the securities and incurs damages. P can sue A for damages. Defendants, other than issuers, aren't liable if they can prove that they used due diligence (due diligence defense). Due diligence means the defendant had reasonable grounds to believe the facts in the registration stmt were true and no mat facts were omitted (ex: an auditor can defend that he complied w/ GAAS). This is an affirmative defense. GAAP/GAAS, WPs. This has often been tested, especially w/ regard to the activities of CPAs. It also is a defense to liab under section 11 if the defendant can prove that the misstmt didn't cause the plaintiffs damages. This incl cases when the misstmt wasn't mat or the plaintiff knew of the untruth/omission in the stmt at the time he purch'd the secs.
The Securities Act of 1933; Purpose and Registration Statement
IPO. The goal of the secs act of 1933 is to *assure that investors have sufficient info* on which to make an informed investmt decision. It accomplishes this goal by reqing most issuers to register new issues of secs w/ the SEC (unless an exemption applies) and provide prospectuses containing mat info regarding the secs to prospective investors. The SEC does *NOT* guarantee the accuracy of this info, evaluate the offering's financial merits, or give assurances against loss. A no of Qs on the exam have asked abt the purpose of the 1933 act. Remember that the SEC does not assure the accuracy of the info filed or eval the financial merits of the secs being offered. It merely assures the presence of info necessary for investors to make informed decisions. Completeness. The registration rqmts of the 1933 act only apply to issuers, underwriters, and dealers. -issuer: the entity whose secs are being sold. -underwriter: an intermediary who sells the issuer's secs to the gen public or to dealers. -dealer: one who sells/trades secs on a full/part-time basis. Most secs can't be sold unless they're 1st registered w/ the SEC. The registration stmt consists of 2 parts. Part I is the prospectus and Part II contains detailed info regarding the secs to be issued. Part I; the prospectus: a written offer to sell secs. The 1933 act defines prospectus as any written, radio, or TV offer to sell secs. The prospectus in Part I of the registration stmt (statutory prospectus) summarizes important info contained in Part II. Unless an issuance is exempt, each investor much receive a copy of the prospectus before/contemporaneously w/ every sale of the sec.
Corporation Liquidation
If a corp is liquidated, the trans is subj to double taxation (the corp and the SHs must gen recog G/L). Note that the corp gen deducts its liquidation exps (like filing fees and prof fees) on its final TR. Corp liquidation takes 2 gen forms: 1. Corp sells assets and distrs cash to SHs: result of this trans is: -corp recogs G/L (as normal) on the sale of the assets. [SP - basis] = taxable G/L. 1st tax. -SHs recog G/L to the extent that cash distr'd exceeds adjusted basis of stock. [Proceeds - stock basis] = taxable G/L. 2nd tax. 2. Corp distrs assets to SHs: result of this trans is: -corp recogs G/L as if it sold the assets for FMV. [FMV - basis] = taxable G/L. 1st tax. -SHs recog G/L to the extent that the FMV of assets rec'd exceeds the adjusted basis of the stock. [FMV - stock basis] = taxable G/L. 2nd tax. Same result, 2 taxes either way.
Unrelated Business Income (UBI); Resuming Tax-Exempt Status After Revocation
If an org has had its TE status revoked and wishes to have that status reinstated, must file an application for exemption and pay the approp user fee, even if it wasn't req'd to apply for TE status initially. If the IRS determines that the org meets the rqmts for TE status, it will issue a new determination letter. In most cases, the effective date of reinstated exemption will be the date that the org's exemption application was submitted to the IRS. However, orgs that have had their TE status auto revoked bc they didn't file their returns for 3 consecutive yrs may choose to request that reinstmt be retroactive to the effective date of revocation. The IRS will grant retroactive restmt of exemption under certain limited circumstances. W/in 15 mos of auto revocation, the org must complete 1+ of these (depending on the severity of the missed filings): -file all req'd documents for reinstmt (Form 1024 or 1023). -file all annual returns that were req'd and caused revocation. -submit a stmt citing reasonable cause for not filing 1 of the 3 consecutive yrs of missed TRs. If the org applies for retroactive reinstmt after 15 mos, it may only be granted retroactive reinstmt if it establishes in the stmt reasonable cause for not filing all 3 yrs' TRs.
Solving for Section 1231 Gain for Office Furniture Sold
If depr recapture is < the CY depr, entire gain is depr recapture and there is no section 1231 gain.
Gains (Excluded or Deferred); Exchange of Like-Kind Business/Investment Assets Continued
If prop other than prop qualifying for like-kind exchange treatmt is rec'd (cash, relief of liabs, or nonqualifying prop), the trans produces recog'd gain, which is the lower of the realized gain or boot rec'd. Boot/loot + FMV non-like-kind prop. Book ex for gain when boot rec'd: taxpayer owns investmt realty worth 40k and it has an adjusted basis of 25k. Taxpayer exchanges this prop for other realty worth 35k and 5k in cash (boot/loot). Determine realized/recog'd gain from the like-kind exchange. -realized gain = 15k (40k proceeds - 25k basis). -recog'd gain is 5k cash rec'd (this is the amt of the 15k realized gain that will be recog'd). -the amt of gain deferred is 10k (15k realized gain - 5k recog'd gain). The basis of the prop rec'd in a like-kind exchange in which gain is deferred is ord the same as the basis of the prop given up. In an exchange in which boot is rec'd, the basis is equal to the FMV of the prop rec'd less any deferred gain + any deferred loss. This formula is used when boot/loot is involved. Basis in like-kind prop rec'd when boot is rec'd = [FMV of like-kind prop rec'd - deferred gain + deferred loss]. GR = nontaxable = NBV. Book ex for basis calc: same facts as prior ex. -Basis = [35k FMV prop rec'd - 10k deferred gain + 0 deferred loss] = 25k new basis (same as that of prior prop. NBV = nontaxable). Realized losses are *not recog'd* in a like-kind exchange. Form 8824 is used to report like-kind exchanges. Incl: -info abt the like-kind exchange -related party exchange info -realized G/L, recog'd gain, and basis of like-kind prop rec'd -deferral of gain from section 1043 conflict-of-int sales
Defenses: Impossibility
If, after the parties enter into a contract, an event occurs that will make performance of the contract objectively impossible (impossible for anyone to perform), impossibility is available as a defense. The defense discharges the adversely affected party from any further duty to perform. A mere incr in the cost of performance doesn't make performance impossible. Book exs for impossibility: -A contracts w/ P to have P manufacture at his factory 1,500 wrenches. Fire then destroys the factory. P has the defense of impossibility bc no one can make wrenches at his factory since it's destroyed. -A contracts to buy 1,500 wrenches from P, a tool wholesaler. P's warehouse, full of tools, is then destroyed by fire. P must still supply A bc performance isn't objectively impossible. P can purch more wrenches to sell to A. If the subj matter or the spec'd source of the subj matter of the contract has been destroyed, the contract may be avoided due to impossibility. Book ex for impossibility: -T enters into a contract to repair J's boat. Before it can be repaired, the boat is destroyed by fire. The parties can avoid the contract on impossibility grounds. Death or incapacity of a person to perform a personal service contract will discharge the contract due to objective impossibility. Book ex for impossibility: D contracts to have B, a famous ball player, sign autographs at D's store. B then dies. B (or his estate) has the defense of impossibility. This is objective, not subjective, impossibility bc the contract called for B to sign, but he no longer exists.
State Income Tax Considerations; Nexus and Federal Limitations on a State's Right to Impose Income Tax
In addition to FIT, a co is also subj to tax in its state of residence, as well as in any state in which it has nexus. Nexus is the min level of contact a taxpayer may have w/ a jurisdiction to be subj to its tax. This is typically caused by a co having prop, payroll, or sales w/in a state and is determined under the laws of each state, which may vary as to what particular activity will trigger nexus in the state. However, fed law offers some protection to cos where state taxation is concerned. Under pub law no 86-272, fed law prohibits a state and its political subdivisions (counties, cities, etc.) from imposing a net IT on a person's NI derived from interstate commerce occurring w/in the state's borders when these 3 circumstances are present: -the only bus activity of the person w/in the state consists of the solicitation of orders for sales of tangible personal prop. -those orders are sent outside the state for acceptance/rejection and -if those orders are accepted, they're filled by shipmt/delivery from a point outside the state. Think of this like sales tax. Person incl indivs, corps, pships, and LLCs. The prohibition against the state's imposing a net IT doesn't apply to: -indivs domiciled in or residents of the state and -corps which are incorped under the laws of that state (the prohibition-doesn't-apply portion of this fed law doesn't address either pships or LLCs org'd under the laws of that state). -cos that are soliciting sales of service/other products that don't qualify as tangible personal prop. The fed law applies only to prohibit a state from imposing a net IT if the three circumstances above are present. This law doesn't apply to: -sales/use taxes -franchise taxes -gross receipts taxes (sometimes called bus and occupation taxes or commercial activity taxes)
Creation of the Agency Relationship Continued; Duties of Principal to Agent
In addition to duties expressed in the agency agreemt, principal owes the agent these duties: 1. Compensation: unless agent has agreed to act gratuitously, principal has an *implied* duty to give the agent reasonable comp. 2. Reimbursemt/indemnification: principal also has an *implied* duty to reimburse/indemnify the agent for all reasonable exps incurred in carrying out the agency. 3. Remedies of the agent: if the principal breaches her duties to the agent, agent can bring an action against the principal for any damages caused. If the relationship isn't contractual, agent may not seek the contract remedy of specific performance. Agent has a duty to mitigate damages (like wrongfully fired agent must seek comparable work to replace lost inc). Bc an agency relationship is consensual, either party gen has the power to terminate the relationship at any time. However, they don't necessary have the right to terminate at any time. Book ex for termination at will: P hires A as his purch agent for 9 mos at a salary of 2k/mo. Either party can term the agency the next day, but a wrongful termination will be a breach of contract. Power, but not right to term. The exception to this GR is agency coupled w/ an int, where the principal has *NO* power OR right to terminate. Only the agent can terminate an agency coupled w/ an int. This comes up where the agent has an int in the subj matter of the agency, like when agency power is given as a security. Basically, the agent has paid for the right to be appointed as the agent, usually by giving credit. Death, incapacity, or bankruptcy of the principal will *NOT* end an agency coupled w/ an int. Book ex for agency coupled w/ an int: P borrows 20k from A, promising to pay w/in 1 yr and appointing A as his agent to sell the land if P doesn't pay. A's agency is coupled w/ an int. However, if P hires A to sell the land for a 5% commission, P has the power to term the agency at any time bc A has not acq'd an int in the land.
Corporation; Formation Continued
In addition to the articles of incorp, a corp gen will have bylaws containing rules for running the corp (they may set out the auth of the corp's officers). They're not fundamental. Bylaws are adopted by the incorporators or the board and may be repealed/modified by the BOD. They are *NOT* part of the articles of incorp and are *NOT* req'd to be filed w/ the state. Cts will sometimes hold the SHs, officers, or directors of a corp personally liable bc the privilege of conducting bus in corp form is being abused. This disregard of the corp entity is called piercing the corp veil. Cts will gen do this for any of 3 reasons: 1. SHs commingle personal funds w/ corp funds or use corp assets for personal use. 2. the corp was inadequately/thinly capitalized at the time of formation (SHs must start the corp w/ sufficient cap to reasonably meet the corp's prospective liabs). 3. the corp was formed to commit fraud on existing creditors (like a sole proprietor transfers all of his assets to a newly formed corp so they aren't available to pay his existing creditors). Piercing the corp veil is one of the examiners' fav corp issues. *Memorize* the 3 reasons for piercing: commingling personal w/ corp funds, inadequate capitalization, and committing fraud on existing creditors. Be mindful of what's *NOT* on the list, like incorporating as an S corp, incorporating a pship, and bankruptcy of a corp that was adequately capitalized at the outset.
Circular 230; Written Advice Continued
In evaluating whether a practitioner giving written advice abt 1+ fed tax matters complied w/ these rqmts, the commissioner/delegate will apply a reasonable practitioner std, considering all facts/circumstances, incl, but not limited to, the scope of the engagemt and the type/specificity of the advice sought by the client. In the case of an opinion the practitioner knows/has reason to know will be used/referred to by a person other than the practitioner in promoting, mkting, or recommending to 1+ taxpayers a pship/other entity, investmt plan, or arrangemt a sig purpose of which is tax avoidance/evasion of any tax imposed by the IRC, the commissioner/delegate will apply a reasonable practitioner std, considering all facts/circumstances. A practitioner must possess the necessary competence to engage in practice before the IRS. Reqs the approp level of knowledge, skill, thoroughness, and prep necessary for the matter for which the practitioner is enagaged. May become competent through various methods, like consulting w/ experts in the relevant area or studying the relevant law. Due diligence.
Federal Insurance Contributions Act (FICA)
Incl self-employed. Provides workers and their dependents w/ benefits in case of death, disability, or retiremt. Almost everyone participates. All full-time/part-time employees must participate in the program. The SE must also participate if their net profit exceeds $400 in a yr. Very few workers are exempt (like certain govt workers and ministers). FICA is funded by taxing inc earned from labor (wages, salaries, bonuses, commissions, etc.). Funded by *both* employers/employees, incl SE indivs. Unique to FICA and ACA. Employers must match their employees' contrs to FICA. Employers are responsible for paying the tax and withholding the employee's contr. -an employer that fails to withhold the employee's contr is liable to pay the employee's half, but has a right to reimbursemt from the employee. If the employer voluntarily pays the employee's share, it's deductible for the employer and TI for the employee. -penalties apply to employers who fail to make timely FICA deposits or supply their fed taxpayer ID no. For 2016, employees were liable to make FICA contrs of 6.2% of their gross wages (it's gross!) of up to 118,500 and medicare contrs of 1.45% of their entire gross wages. Indivs w/ inc exceeding a threshold (200k for single, 250k for MFJ) are liable for an additional medicare tax of 0.9% of their entire gross wages. Gross wages incl all earned inc, like salary, bonuses, and commissions. Gifts, int, divs, etc. aren't wages. SE indivs pay into FICA through the SE tax, which is equal to the employer's and employee's contr (15.3%, double). It's imposed only on the net profits (*NOT* gross sales) and only if they exceed $400 in a yr. Board members. The examiners often ask what inc is subj to FICA. Remember that an employee's gross wages are subj, and a SE person's net profits are subj.
Tax Return Preparer Compliance Penalties; Key Terms
Indivs who meet the qualification of TR preparers (fee) are subj to certain penalties under the IRC. The assessmts under IRC section 6694 are intended to ensure the TR preparers are in compliance w/ fed tax laws. Key terms: 1. Authority: Only these things are auth for the purposes of determining whether there's substantial auth for the tax treatmt of an item (incl as inc or allowable deduction). Note conclusions reached in treatises, legal periodials, legal opinions, or opinions rendered by tax profs aren't auth): -applicable provisions of the IRC and other statutory provisions. -proposed, temp, and final regs construing such statutes. -rev rulings and procs, tax treaties and regs thereunder, and US treasury dptmt and other official explanations of such treaties. -ct cases. These top 4 are primary auth sources. -congressional intent as reflected in committee reports, joint explanatory stmts of managers incl in conference committee reports, and floor stmts made prior to enactmt by 1 of a bill's managers. -gen explanations of tax legislation prepped by the joint US senate and house of reps committee on taxation (the blue book). -private letter rulings and technical advice memoranda issued after 10/31/76. -actions on decisions and gen counsel memoranda issued after 3/12/81 (as well as gen counsel memoranda published in pre-1955 volumes of the cumulative bulletin). -IRS info or press releases and notices, announcemts, and other admin pronouncemts published by the service in the internal rev bulletin. IRS pubs are *NOT* primary auth. 2. Disregard: any careless, reckless, or intentional disregard of rules/regs. 3. Listed trans: a reportable trans, same as, or subst similar to, a trans specifically ID'd by the secretary of the US treasury dptmt as a tax avoidance trans. 4. More-likely-than-not std: >50%. Met when there's a >50% likelihood of a tax position being upheld by the cts. More stringent std than the subst auth std.
Circular 230; Duties and Restrictions
Info to be furnished incl any IRS requested info/records. The practitioner may withhold info/records he believes in good faith and on reasonable grounds to be privileged. If the practitioner doesn't possess the IRS-requested info/records but known who does, must tell the IRS. No practitioner may unreasonably delay any matter before the IRS (prompt disposition of pending matters). W/ respect to a matter before the IRS, no practitioner can knowingly and directly/indirectly accept help from/assist anyone who is under disbarment or suspended from practice before the IRS or accept assistance from any former govt (IRS) employee where either the provisions of Circular 230 or any fed law W/B violated. No member of a firm in which a former govt employee works can rep a taxpayer where a conflict of int may exist, unless the firm isolates the former govt employee to ensure they can't assist in the representation. -if an indiv, while a govt employee, personally and substantially participated in a particular matter involving specific parties, can *NEVER* represent/assist those parties w/ respect to that matter. -if an indiv, while a govt employee, has official responsibility for a particular matter involving specific parties, that indiv, w/in *2 yrs* after leaving govt employmt, can't rep those parties for that matter. The cannot assist language doesn't apply. -w/in *1 yr* after leaving govt employmt, the indiv can't appear before the IRS to influence any US treasury dptmt employee regarding any rule if either (i) the indiv at any time participated in the developmt of the rule or (ii) w/in the 1 yr pd prior to leaving govt employmt, the indiv had official responsibility w/ respect to that rule.
Defenses: Innocent Misrepresentation, Duress, Undue Influence, and Mutual Mistake
Innocent misrepresentation: No punitive damages. Has all the elements of fraud except scienter (MAID*S*). The misrep is made innocently, not intentionally. Innocent misrep makes the contract voidable by the party who relied on the misrep. Duress: arises when a party's free will to contract is overcome by *unlawful* use of a threat of harm. If the harm threatened is physical force, the contract is *void*. If the harm threatened is economic or social (I'll fire you if you don't sign...), the contract is voidable. Merely taking advantage of another person's economic condition to negotiate a favorable contract (if no threat is involved) doesn't constitute duress. Undue influence: not arms-length (there's a relationship), fairness req'd. A party's free will to contract is overcome by the defendant's abuse of a position of trust/confidence. The person in the position of trust/confidence (spouse, trustee, guardian, attorney, etc.) uses the position to take advantage of the other's weakness, infirmity, or distress. Undue influence makes a contract voidable. Book ex for undue influence: lawyer convinces client, a mentally infirm person, to sell lawyer client's personal prop. Undue influence defense will likely succeed. Mutual mistake: if both parties to a contract are mistaken as to a material fact regarding the contract, the adversely affected party can *void* the contract. This rule gen does *NOT* apply to mistakes as to value, bc value gen is considered a matter of opinion. Book ex for mistake as to quality: A and B enter into contract for A to buy B's designer watch for $200. Before the sale is complete, the parties discover the watch is fake. A may avoid the contract. If the subj matter of the contract is not in existence when the contract is made and neither party knows this, the contract is void. Book ex for mutual mistake as to existence: A enters into a contract to purch B's car for 1k. Unbeknownst to either party, the car was destroyed by a fire earlier in the day. Contract is void.
Reporting Partnership Income and Losses
K-1. Each partner gets one. A partner must incl on his personal inc TR his distr share of each sep pass-through item. This chart (from R1) shows which pship items will be reported on form 1065 and which will pass through to each indiv partner's inc TR as sep line items to be treated by each indiv partner according to their own circumstances. [Bus inc - bus exps - GPs] = net bus inc/loss. The bus inc/exps/GPs all show up on the 1065. 1. Net bus inc/loss: on 1065, sch K, sch K-1, and sch E (1040). Each partner reports their share of NI/loss on sch E. Net bus loss limitations will have to be considered 2. GPs to partners: on 1065, sch K, sch K-1. To that partner. 3. Net active rental real estate inc/loss: on sch K and K-1. Sch E on 1040. 4. Net passive rental real estate inc/loss: on sch K and K-1. Sch E on 1040. 5. Int inc: on sch K and K-1. Sch B on 1040. 6. Div inc: on sch K and K-1. Sch B on 1040. 7. CG/Ls: on sch K and K-1. Sch D on 1040. 8. Char contrs: on sch K and K-1. Sch A on 1040. 9. Section 179 (exp election): on sch K and K-1. 10. Investmt int exp: on sch K and K-1. 11. Partners' health ins premiums (reported as part of GPs): on 1065, sch K, and K-1. 12. Retiremt plan contrs (keogh plan): on 1065, sch K, and K-1. 11 and 12 are fringe benefits to partners. Contrs made on behalf of employees are deductible on Form 1065 and not reported on schs K and K-1. Contrs for partners are not deducted on Form 1065 but are reported on schs K and K-1. 13. Tax credits (reported by pship but claimed by partners): on sch K and K-1. Net bus loss limitations will have to be considered. Book ex for ord inc calc and other sep stated items: A pship had a bunch of items of inc/deductions for the yr (all listed). Determine the pship's ord bus inc/loss and sep stated items for the yr. -ord bus inc = [250k gross bus inc - 50k salary exp - 15k rent exp - 10k depr exp] = 175k. -sep stated items are 8k div inc, 30k section 179 exp, and 20k char contrs.
Business Structures; Summary of Entities
Know this. Nearly half of the recent bus structures Qs on the exam simply req the examinee to differentiate the attributes of the various bus structures. The major attributes are summarized below. Note that the taxation descr'd is the default treatmt for these entities, but they may elect to be taxed differently under the check the box rules. 1. Sole prop: -formation: no formalities. Owner simply ops a bus. -liab of owners: unlimited personal liab for all bus obligations. -mgmt: sole proprietor manages directly or can appoint a manager. -transferability: sole proprietor can sell bus at will. -taxation: flow through. 2. Gen pship/JV: -formation: no formalities. Can be formed by verbal/written agreemt, or mere conduct. -liab of owners: unlimited personal liab for all pship obligations. -mgmt: owners manage directly or can agree to appoint managing partner. -transferability: partners can't transfer oship int w/o unanimous consent. -taxation: flow through. 3. LLP: -formation: file stmt of qualification w/ state. -liab of owners: partners are gen not liable for pship obligations, unless caused by their own negligence. -mgmt: partners manage directly or can agree to appoint a managing partner. -transferability: partners can't transfer oship int w/o unanimous consent. -taxation: flow through, but partners not managing have passive loss restrictions. 4. Limited pship: -formation: file certificate of limited pship w/ state. -liab of owners: GP has unlimited personal liab, LP has only their investmt at risk. -mgmt: GPs are exclusive managers, LPs ord do not manage. -transferability: partners (gen or limited) can't transfer oship int w/o unanimous consent. -taxation: flow through, but limited partners have passive loss restrictions.
Nonliquidating Distributions
Like bank acct withdrawal. In gen, a nonliquidating distr to a partner is nontaxable, both to the partner and pship. In gen, distrs of cash or prop to a partner reduce the partner's basis by cash or the adjusted basis (NBV = nontaxable) of the prop distr'd. In a nonliquidating distr, the basis of prop rec'd will be the same as the basis in the hands of the pship immediately prior to the distr. The basis of distr'd prop assigned may not exceed the basis of a partner's entire int in the pship (reduced by the amt of cash distr'd in the same trans). If the pship basis is > the book value of the asset rec'd, no gain is recog'd bc the partner's basis in the pship is simply reduced by the NBV of the prop distr'd (and a pos basis in the pship still remains). The basis of the distr'd asset to the partner will be the prior basis to the pship (asset = NBV). If the pship basis is < the book value of the asset rec'd, there's a limit to the pship basis reduction under the GR. Although no gain is recog'd in this case either, the partner's basis in the pship cant go below 0. This means the partner's basis in the asset rec'd as a distr will equal his basis in the pship just before the distr (after any cash paid in the same trans). The partner's remaining basis in the pship will be 0. No gain recog'd, stop at 0 basis. Gain is recog'd to the partner only to the extent that cash (incl pship liab assumed by a partner) distr'd exceeds the adj basis of the partner's int in the pship immediately before the distr. In a complete liquidation, the partner's basis for the distr'd prop is the same as the adj basis of the partner's pship int, reduced by any monies actually rec'd. Gain recog'd for excess cash, loot/boot. [Cash - basis] = gain. Book ex for basis determination in nonliquidating distr: O's adj basis of his int in a pship was 30k. He got a nonliquidating distr of 24k cash + a parcel of land w/ a FMV of 12k and pship basis of 9k. Determine O's basis for the land distr'd. -the basis of prop rec'd in a distr, other than in liquidation of a partner's int, ord will be the same as the basis in the hands of the pship immediately prior to the distr. However, in no case may the basis of prop in the hands of the partner exceed the basis of his pship int reduced by the amt of money distr'd to him in the same trans. -[30k pship int adj prior to distr - 24k cash distr'd] = 6k remaining basis after cash distr. [6k remaining basis - 6k distr of land w/ basis of 9k (limited)] = 0 remaining pship int/basis. Stop at 0! -the pship int may not be reduced below 0, so the land has a basis of 6k in the hands of the partner. -note, *NO GAIN*! This is bc cash distr'd wasn't in excess of basis.
Effect of S Corporation Election on Shareholders; Pass-Through of Income and/or Losses (to Shareholder K-1)
Like pships, S corps report both sep stated items of inc and deductions and non-sep stated items of bus inc/loss. Sep stated inc items incl divs, int, CG/Ls, section 1232 G/Ls, etc. Sep stated deductions incl char deductions, section 179 exps, etc. Allocations to SHs are made on a per-share, per-day basis and losses are limited to basis. Pship rules are diff, liabs incr the partner's basis. Book ex for allocation on a per-share, per-day basis: D corp, an S corp, is owned equally by 3 SHs, R, T, and P. The corp is on a calendar-yr basis. On 2/1/Y5, P sold his 1/3 int in D corp to G. For the yr ended 12/31/Y5, the corp had non-sep stated ord inc of 120k. Calc each SHs ord inc allocation for the yr. -R and T: each get [120k x (1/3)] = 40k. -P: gets [40k x (31/365)] = 3,397. Per-share, per-day. -G: gets [40k x (334/365)] = 36,603. Per-share, per-day. -total sums to 120k. For pass-through of losses, deduct up to basis + direct loans. Losses are limited to a SH's adj basis in S corp stock plus direct SH loans to the corp. SH guarantees do *NOT* incr basis. Any losses disallowed may be CF indefinitely and will be deductible as the SH's basis is incr'd. Losses are additionally limited to an S corp SH's at-risk amt in the corp. The at-risk loss limitation rules for S corps are sim those for pships. -the rules limit the SH's loss to the amt of the risk of financial loss in the bus. -the at-risk amt is gen equal to the SH's stock and debt basis. -a nonrecourse loan (where SH isn't personally liable) can create stock basis for the SH but won't be considered in the at-risk amt. The taxpayer's at-risk amt W/B incr'd by: -contr of cash/other prop to the corp -loans to the corp -allocable share of inc distr'd The taxpayer's amt at risk W/B reduced by: -allocable sh of losses -distrs of cash/other prop The taxpayer's amt at risk in the bus entity would only incr by recourse loans (not nonrecourse loans). Book ex for at-risk basis calc: Taxpayer A's stock basis in S corp stock is 60k. Incl in this is 10k attributable to a nonrecourse loan. Determine taxpayer A's at-risk basis in the S corp. -50K. Can only deduct a loss from the S corp up to this amt. This is the [60k basis - 10k nonrecourse loan]. -if the loan had been recourse, could deduct losses up to the full 60k.
Determination of Partner's Share of Income, Credits, and Deductions; Tax Losses
Limited to tax basis/at risk and must clear passive loss hurdle. [cap acct + % liabs] = basis. Tax losses generated by a pship are deductible by the partners and can be used to offset ord inc. For the partner to deduct the losses, they must clear 3 hurdles: 1. tax basis. 2. at-risk amt and 3. passive activity. 1. Tax basis: The pship tax loss deduction is limited to the partner's adj basis in the pship, which is incr'd by any pship liabs for which he's personally liable or additional cap contrs to the pship. 2. At-risk amt: the ability to deduct losses is limited to the partner's at-risk amt in the pship. This is calc'd in a manner sim a partner's tax basis, but the at-risk amt in the pship does *NOT* incl certain nonrecourse liabs. A pship liab is nonrecourse if no partner/related person has an economic risk of loss for that liab. This is the case for a loan secured by prop, where the lender's only cause for remedy if the co defaults is to foreclose on the prop. In addition, all liabs to a limited partner are nonrecourse liabs, bc the limited partner will not be personally liable for that liab w/ certain exceptions. Recourse liabs are those for which a partner is personally liable. In traditional pships, 1+ gen partners are responsible for all recourse liabs. Recourse liabs may also incl any loans made directly by a partner to the pship, or those guaranteed by a partner (whether a limited partner or not). For basis calc purposes, recourse liabs are allocated only to the partner/partners w/ liab for the debt. Book ex for nonrecourse and recourse liabs: a pship has 60k in nonrecourse liabs and 30k in recourse liabs. It had 3 partners (A, B, and C), each w/ a 1/3 int in the pship. A is the gen partner, B and C are limited partners. Calc each partner's basis in the pship's liabs, incl their at-risk amts. -A: 50k total basis in pship liabs (20k (1/3) of nonrecourse liabs + 30k recourse liabs assumed as the GP). 30k is the at-risk amt. -B and C: 20k total basis in pship liabs (1/3 of 60k nonrecourse liabs), none of which are at-risk.
Dismissal or Conversion of a Chapter 7 Case
Liquidation. A ch 7 case by an indiv consumer debtor may be dismissed or (w/ debtor's consent) converted to a case under ch 13 upon finding that granting relief under ch 7 would constitute abuse. Abuse may be determined by a specific means test or gen abuse test. Step 1; determine whether inc is lower than the state median: if yes, ch 7 is ok. If an indiv filing for ch 7 liquidation and his spouse have monthly inc > the state median inc for a fam of the same size, the state, any int creditor, or the ct may file a motion to dismiss, either under the means test or gen abuse. Step 2; means test: used to determine whether creditors W/B better off under a ch 13 5-yr reorg. 60x the debtor's avg monthly inc, less allowable exps, is compared w/ a high and low threshold (7,700 and 12,850). -formula = [(avg monthly inc - allowed exps) x 60]. -if the amt is < 7,700, the debtor may continue under ch 7. -if the amt is 12,850+ (almost 13 = bad luck for you), there's a presumption of abuse and the debtor usually will have to convert the case to ch 13 or be dismissed. -if the amt is < 12,850 but >= 7,700, a presumption of abuse will arise if the amt equals at least 25% of the debtor's unsecured claims not entitled to priority pmt. Allowable living exps incl the costs of food/clothing/shelter as set by the IRS, exps for health ins and health savings plans, health care costs for fam members, exps for attending elementary or high school, and exps related to keeping the debtor safe from fam violence. The debtor may rebut the presumption of abuse by showing special circumstances (serious illness or call to active military duty) that create additional exps or a need to adj current monthly inc. Even if the debtor qualifies for ch 7, relief may be denied by showing the debtor acted in bad faith or that under the totality of circumstances there's abuse. If the debtor's avg monthly inc or the monthly inc of the debtor and their spouse in a joint case is <= the median inc in the debtor's state, a ch 7 filing can only be dismissed by the gen abuse test and only on motion of the ct, trustee, or bankruptcy administrator (not a creditor). A ct may dismiss a ch 7 filing by a debtor convicted of a crime involving violence or drug trafficking. As a benchmark, the lowest state median inc in the US is ~38k.
Corporation Tax Summary
Lists common items of inc/exp on an I/S and TR and which ones will result in a book/tax diff. Temp/perm diffs are M-1/M-3 items. Temp diffs create deferred taxes. Gross inc: 1. Gross sales: -GAAP F/S: inc -IRC TR: inc -Diffs: none 2. Installmt sales: -GAAP F/S: inc -IRC TR: inc when rec'd -Diffs: temp 3. Rents/royalties in advance: -GAAP F/S: inc when earned -IRC TR: inc when rec'd -Diffs: temp 4. State tax refund: -GAAP F/S: inc -IRC TR: inc -Diffs: none 5. (A) Divs; EQ method: -GAAP F/S: inc is subs earnings -IRC TR: inc is divs rec'd -Diffs: temp (B) Divs; 100/80/70% exclusion: -GAAP F/S: no exclusion -IRC TR: excluded forever -Diffs: perm Items not includable in TI: 1. State and muni bond int: -GAAP F/S: inc -IRC TR: not TI -Diffs: perm 2. Life ins proceeds: -GAAP F/S: inc -IRC TR: gen not TI -Diffs: perm 3. G/L on treasury stock: HIDE I*T* -GAAP F/S: not reported -IRC TR: not reported -Diffs: none Ord exps: 1. COGS: -GAAP F/S: currently expensed -IRC TR: uniform capitalization rules -Diffs: none 2. Officers' comp (top): -GAAP F/S: exp -IRC TR: 1M limit -Diffs: none 3. Bad debt: -GAAP F/S: allowance (estimated) -IRC TR: direct write-off -Diffs: temp 4. Estimated liab for contingency (warranty): -GAAP F/S: exp (accrue estimated) -IRC TR: no deduction until paid -Diffs: temp 5. Int exp; bus loan: -GAAP F/S: exp -IRC TR: deduct -Diffs: none
Mechanic's and Materialman's Liens and Fraudulent Conveyances
Mechanic's liens and artisan's liens: under common law, a mechanic or artisan who works on prop and either improves/repairs it auto has a lien on the prop, for the price of the repairs, for as long as the prop is in the lienor's possession. These liens are possessory, they dissolve as soon as the lienor lets the owner have the prop back. If a mechanic, artisan, innkeeper, etc. goes unpaid, he may give the owner notice of the intention to sell the retained prop to the pay the owner's bill. Alternatively, the lienor may foreclose on the prop by filing suit. Materialman's lien: these liens are often imposed in favor of contractors who perform work on/provide supplies for real prop improvemts. The unpaid materialman must file a notice w/ the local recorder of deeds to preserve his lien. Fraudulent conveyances: these occur when a debtor transfers prop w/ the intent to hinder/delay/defraud any of his creditors ("selling" your bro your car). A fraudulent conveyance is void/voidable and will be set aside in a proper proceeding. In determining if a fraudulent conveyance occurred, a ct will consider whether: 1. the transfer was to an insider (relative, partner, co-employee, etc.). 2. the debtor retained possession/control of the prop transferred. 3. the transfer was not disclosed or was concealed (done secretly). 4. the transfer was of substantially all the debtor's assets. 5. the value rec'd by the debtor for the asset was not reasonable and 6. the debtor was insolvent or became insolvent shortly after the transfer.
Unrelated Business Income (UBI); Membership Organizations, Feeder Organizations, and Annual Return Requirement
Memberships orgs: certain membership orgs (social clubs, homeowners associations, etc.) are usually taxed on gross inc less deductions for "exempt function inc" (dues, fees, and charges for providing facilities and services for members, dependents, and guests). So, if a social club makes a profit, that profit is gen taxable. Feeder orgs: an org operated primarily for the purpose of carrying on a trade/bus for profit can't claim tax exemption on the grounds that all of its profits are payable to exempt orgs. It must rely on its own activities and exempt nature to gain tax exemption. This type of feeder org is taxed on its entire inc, not just the portion it designates as UBI. Annual return rqmt: Due on 5/15. An annual info return (Form 990) stating gross inc, receipts, contrs, disbursemts, etc. is req'd of most orgs exempt from tax under section 501 and is open to public inspection. Section 501(c)(3) orgs must also incl a Sch A - supp info. Form 990-EZ may be filed if the exempt org has gross receipts < 200k and total YE assets of < 500k. Other than 501(c)(1) orgs, 3 primary types of exempt orgs do *NOT* have an annual filing rqmt of a Form 990/990-EZ info return w/ the IRS: -Religious or internally supported orgs: churches and exclusively religious activities of a religious order or internally supported auxiliaries are exempt. -Certain orgs that normally have < 5k in gross receipts: certain orgs w/ < 5k in gross receipts (and it's normal for that to be the case) for the yr are exempt from filing an annual info return. Those orgs incl educational orgs, religious orgs, pub-type charities, fraternal orgs, and those org'd to prevent cruelty to children/animals. Although they don't have an annual info filing rqmt of a Form 990/990-EZ, there may be other reporting rqmts (sim to those for Form 990-N) w/ which they must comply. -Orgs that normally have < 50k in gross receipts: If an org has gross receipts of <50k, a Form 990/990-EZ isn't req'd. A simple electronic postcard (Form 990-N) is filed w/ the IRS and reqs only this info: (1) tax ID no of the org, (2) the tax yr of the org, (3) the legal name, physical address, and internet address (if applicable) of the org, (4) the name/address of the principal officer of the org, and (5) a stmt that the annual gross receipts of the org regularly don't exceed the 50k limit. Summary: *NOT* req'd to file Form 990/990-EZ if 50k or less in gross receipts or *CHRIST*. *C*hurches *H*igh school - religious *R*eligious societies *I*nternal support auxiliaries *S*ocieties - missionary related *T*E - organized by congress
Defenses: Minors, Intoxication, and Adjudicated Mental Incompetency
Minors: gen may disaffirm (cancel) contracts bc they lack capacity. A minor (under 18) may disaffirm a contract anytime while a minor, or even w/in a reasonable time after becoming an adult. Must gen return whatever he possesses when he disaffirms. Exception is necessities (food, clothing, shelter, etc.). Minority is a defense for the minor - the other party can't raise the minor's minority as a defense to avoid performance. Book ex for contract w/ minor: B, a 16 YO, purch'd a used car from P. 10 mos later, the car was stolen and never recovered. B may disaffirm and get his $$ back. A person can become bound on contracts he entered into as a minor upon reaching the age of majority by ratifying the contract. This can be done by: -failing to disaffirm w/in a reasonable time after reaching majority. -expressly ratifying the entire contract orally/in writing. -retaining or accepting the benefits. Ratification is all or nothing. Can't ratify part and reject part. Also, ratification doesn't req consideration. It's a minor who has the right to disaffirm- the adult doesn't have the right to rescind merely bc the minor may disaffirm. Intoxication: this is a defense to a contract only if the intoxication prevents the promisor from knowing the nature/sig of his promise and the other party knew of the impairmt. Book ex for intoxication: R and S have a drink at lunch and then enter into a contract. Neither party is impaired, contract is enforceable. Adjudicated mental incompetency: adjudicated = *void*. Otherwise, voidable. A contract made by a party after he is adjudicated mentally incompetent is *void*.
State Income Tax Considerations; State Income Taxes and Controlled Taxpayers
Most states don't have a statute sim the IRC's statute authorizing the IRS to make controlled taxpayer adjustmts w/ respect to transfer pricing issues. However, many states do have a statute allowing the state taxing auth to req a combo of inc of related members if such combo will better reflect the extent of bus done w/in the state. Book ex for state taxing auth combining inc of related members: H co, located solely in Delaware, owns 100% of the stock of OP co (related parties), operating solely in state X. H co's only bus is owning the stock of OP co and lending money to OP co. H and OP file a US consol'd inc TR. Bc of H co's limited activities, under Delaware and state X law, H co isn't liable for IT to either state. Bc OP ops solely in state X, OP isn't liable for state IT in Delaware. At the end of each bus day, OP declares/pays a div equal to all of its cash on hand at the end of the day. At the beginning of each next bus day, H co lends to OP co sufficient cash for OP co's ops for that day. The int rate is an arm's-length rate. Under the terms of the loan agreemt, OP co doesn't have to repay any principal for 10 yrs. As a result of H co's daily loans to OP, each yr OP incurs deductible int exp of 10M. Bc H and OP file a consol inc TR, the int exp incurred by OP and the int inc recog'd by H offset each other. Bc the int rate H charges OP is an arm's-length rate and bc the 2 corps file a consol'd inc TR, the IRS makes no transfer pricing, controlled taxpayer adjustmts. Bc of the daily divs paid to H co followed by the daily loan from H co to OP co, on a "sep return" basis, OP's ln 28 inc has been reduced by OP's 10M int exp, so OP co's inc subj to tax by state X has also been reduced by 10M (state X bases its state IT on the taxpayer's sep return ln 28 amt). However, if state X taxing officials have the auth to combine OP and H, the state tax benefit of OP's 10M int exp deduction will be offset by H's 10M int inc. The combined ln 28 amt will now reflect the true inc of OP, and OP will pay to State X the approp amt of state IT.
Features of a Chapter 15 Case
Multinational. A ch 15 ancillary case is commenced by a foreign representative filing a petition for recog of a foreign proceeding. This operates as the principal door of a foreign rep to US cts. The petition must show the existence of the foreign proceeding and the appointmt and auth of the foreign rep. After notice and a hearing, the US ct is auth'd to issue an order recognizing the foreign proceeding as either a foreign main proceeding (country where debtor's main interests are located) or a foreign non-main proceeding (country other than one where the debtor's main ints are located). Upon recog of a foreign main proceeding, the automatic stay and other provisions of the bankruptcy code take effect in the US. The US ct is auth'd to issue preliminary relief as soon as the petition for recognition is filed. The foreign rep is auth'd to op the debtor's bus. Once recog'd, a foreign rep may seek additional relief from the bankruptcy ct and is auth'd to bring a full-blown (instead of ancillary) bankruptcy case under chs 7 or 11. The foreign rep may participate in a pending US insolvency case and may intervene in any other US case in which the debtor is a party. Goals of ch 15: -prohibition against discrimination: ch 15 prohibits discrim against foreign creditors (except certain foreign govt and tax claims, which may be governed by a treaty). -rqmts of notice and cooperation: ch 15 reqs notice to foreign creditors concerning a US bankruptcy case, incl notice of the right to file claims. Under ch 15, US cts and trustees must cooperate to the max extent possible w/ foreign cts and foreign reps.
Corporation; Fundamental Changes
Need BOD and SH approval - *NOT* unanimous. Unlike a pship. Decisions regarding issues that might fundamentally change the nature of the corp req SH approval through a special proc. Such fundamental corp changes incl some amendmts to the articles of incorp, dissolutions, mergers, consols, sh exchanges, and sales of all/subst all of the corp's assets. To remember the fundamental changes that req SH approval: *DAMS* -*D*issolution. -*A*mendmts to the articles of incorp (not bylaws) that materially and adversely affect the SHs' rights. -*M*ergers, consols, and compulsory sh exchanges. -*S*ale of substantially all the corp's assets outside the reg course of bus. Gen proc for fundamental changes: -board resolution: initiates the process. A majority of the BOD must adopt a resolution setting forth the proposed action and submitting it for a vote at a SHs' meeting. -notice: corp must notify all SHs even if they're not entitled to vote. -SH approval: the change must be approved by a majority of the shs voted at the meeting. -filing of articles: a doc setting forth the action taken (articles) must be executed by the corp and filed w/ the state. -right to dissent/appraisal rights: SHs who have a right to vote on a fundamental corp change typically have a right to dissent/appraisal right (the right to have the corp purch their shs at a fair price) if the SH votes against the fundamental change and it's nevertheless approved. The examiners often ask abt fundamental corp changes. Key points to remember: -the BOD must approve a resolution, but there's *NO* rqmt of unanimity. -the SHs must be given notice and an opp to vote on the change. Approval reqs a majority of the votes cast.
Corporation Capital Gain and Loss Rules (Applies to C Corporations Only)
Net CGs (LT or ST) get no lower (special) tax rate. Net CGs (net of ST and LT cap G/Ls) of a corp are added to ord inc and taxed at the regular tax rate. Corp's don't get the benefit of lower CG rates. Section 1231 gains are entitled to CG treatmt (used against CLs). Net CLs (LT or ST) may not be deducted from ord inc. Can only be used to offset CGs. Net CLs are carried back 3 yrs and fwd 5 as a ST CL. Net CLs are deducted from cap or section 1231 gains (section 1231 gains are treated as cap assets used in the bus and section 1231 losses are treated as ord losses). Loss rules summary (not just for corps): -NOLS: offset inc, CB 2, CF 20. Hindsight is 2 x 20. -indiv CLs: offset inc up to 3k, no CB, CF forever. -corp CLs: don't offset inc, CB 3, CF 5 (3/5 rule). Taxpayer can elect to forgo the CB on NOLs!
Features of a Chapter 7 Liquidation; Distribution of the Debtor's Estate: Payment and Priorities Continued Further
Nonpriority claims are last! Any money that's left after paying the secured creditors and the priority claimants is used to pay the gen unsecured creditors who timely filed, pro rata. If any assets are remaining after paying gen creditors who timely filed, creditors who filed late receive pmt. Book ex for calc of cash distr: R has been involuntarily petitioned into bankruptcy. Claims/exps against R's estate incl 15k admin fees earned by bankruptcy trustee, 5k claims by secured creditors, 10k attorney fee for bankruptcy estate, and 2k employee wage claims earned w/in 180 days of filing. Calc the amt to be distr'd to the trustee if cash available for distr is 15k. -[15k cash available for distr - 5k secured claims] = 10k cash available to priority claimants. -both the attorney and trustee exps are admin claims (come before employee wage claims for priority claimants). The employees would receive nothing. -since total admin exps of 25k (15k trustee fee + 10k attorneys' fees) are > 10k cash available, the cash available is prorated btw the administrative claimants. -trustee distr = [(15k trustee's claim/25k total admin exp) x 10k remaining cash available] = 6k. 60% of remaining cash. -attorney would get 4k, 40% of remaining cash. It's important to understand the relationship btw the exceptions to discharge and pmt priorities. Some items are both a priority and an exception, other items are 1, but not the other. Pmt is made according to the priority rules (w/o regard to whether the debt is excepted to discharge). After all possible pmts have been made, any remaining debts are discharged unless they're one of the exceptions to discharge (*FAT WED*). In some cases, a debt that's an exception to discharge will have been paid in the distr process. Ex: -if creditors are paid in full through the 8th priority (tax claims), the fact that a tax claim is an exception to discharge is irrelevant bc it has been paid. -if pmt is made only through the 6th priority, then any unpaid 7th priority (consumer deposits) claims are discharged (bc they're not on the exception list). Any unpaid 8th-priortiy (tax) claims aren't discharged bc they're an exception to discharge. Same w/ 9th-priority (DWI injury claims).
Circular 230; Sanctions by the Secretary of the Treasury for Violations of the Regulations
Not acting in good faith. The secretary of the treasury may sanction a practitioner practicing before the IRS for being incompetent/disreputable. Such conduct incl: -being convicted of any fed tax law crime, any criminal offense involving dishonesty or breach of conduct, or any felony under fed/state law for conduct indicating the practitioner is unfit to practice before the IRS. -giving false/misleading info (stmts, TRs, etc.) to US dptmt of the treasury employee or to any tribunal auth'd to hear fed tax matters. -carrying out any solicitation of bus prohibited by circular 230. -willfully failing to file a TR or willfully evading/attempting to evade any assessmt/pmt of fed tax. -willfully counseling/assisting others to evade/attempt to evade any assessmt/pmt of fed tax. -failing to timely remit to the IRS any funds rec'd from a client for the purpose of paying any tax/other obligation owed to the US govt. -using threats/false accusations or offering gifts, inducemts, or favors to influence any action by an IRS employee (bribe). -being disbarred/suspended from practice as an attorney, CPA, public acctant, or actuary. -knowingly helping another person practice before the IRS while that person is suspended, disbarred, or otherwise ineligible to practice before the IRS. -being contemptuously abusive, making false accusations/stmts, or circulating malicious/libelous matters. -knowingly, recklessly, or through gross incompetence giving false opinions on Qs arising under tax laws. Fraud. -willfully failing to sign a TR when fed tax law reqs the pracititoner to sign the return (practitioner is a paid preparer), unless the failure is due to reasonable cause and not due to willful neglect. -willfully disclosing/otherwise using a TR or TR info where such disclosure is: (a) not auth'd by the IRC. (b) contrary to the order of any ct or (c) contrary to the order of an administrative law judge in connection w/ a disciplinary proceeding. GR: duty of confidentiality. -willfully neglecting to file an e-return when req'd to do so. -willfully prepping/signing a TR w/o a valid tax preparer ID. -willfully repping a taxpayer before the IRS w/o auth to do so.
Common Features of Chapter 7 and 11 Cases; Involuntary Cases
Not ch 13! Unsecured creditors may petition a debtor involuntarily into bankruptcy proceedings under chs 7 and 11. For an involuntary petition, creditors must show that the debtor is gen not paying debts as they become due (in default). Farmers and NFP charitable orgs may not be petitioned involuntarily into bankruptcy. Only creditors who are owed, indiv or in aggregate, at least 15,775 in unsecured, undisputed debt may petition a debtor involuntarily into bankruptcy. No of creditors who must file depends on debtor's total no of creditors. If a debtor has < 12 creditors, any 1+ creditors owed at least 15,775 in unsecured debt may file. If debtor has 12+ creditors, at least 3 creditors owed at least 15,775 in aggregate in unsecured, undisputed debt must join in involuntary petition. Book ex for who must join petition: D has 4 creditors she isn't paying (just 1 need file). A is owed 15k, B is owed 4k, C is owed 4k, and E is owed 17k secured by D's 20k car. A must join in an involuntary petition; B and C's claims aren't sufficient. E may not file bc claim is adequately secured. The no of creditors and amts owed necessary to file a voluntary petition is a favorite exam issue. 2 key points: -usually this info is used to create distracters/wrong answers like "to file a voluntary petition, must owe at least 15,775" or "have at least 12 creditors." Memorize the 15,775 and 1 and 3 creditor minimums. These apply only to *involuntary* petitions! -if a prob says the no of creditors a debtor has, the examiners have often asked the no needed to file an involuntary petition. Ex: Q says debtor has 19 creditors, 3+ must file. If 8 creditors, only 1 need file. Unlike a voluntary petition, an involuntary petition does *NOT* constitute an order for relief. There's a gap btw the filing and the order of relief called the involuntary case gap. The ct will enter into an order for relief if the debtor doesn't object to the petition w/in 20 days. If the debtor objects, a hearing is held to determine the debtor's solvency. The test for solvency is whether the debtor is gen paying debts as they become due. Persons who become creditors of the debtor during the involuntary case gap pd are given high priority in recovering against the debtor's estate. If creditors improperly filed an involuntary petition (insufficient no of creditors, insufficient unsecured claims, debtor was paying debts as they became due, etc.) a ct may award the debtor compensatory damages, ct costs, attorney's fees, and punitive damages (if bad faith can be shown). The bankruptcy code does *NOT* req a debtor to be insolvent to file for bankruptcy. A voluntary petition may be filed by anyone who owes debts and an involuntary petition may be filed if the debtor is gen not paying debts as they become due, regardless of the debtor's ability to pay. An answer choice suggesting the debtor must be insolvent to file for/be petitioned into bankruptcy is wrong, but remember that an indiv consumer debtor's ch 7 case may be dismissed or converted to ch 13 if his inc is too high.
Tax Return Peparer Penalties for Unethical Behavior
Note that all practitioners are preparers, but not all preparers are practitioners. Penalties assessed under IRC section 6695 are intended to protect the taxpayer from unethical behavior. 1. Failure to provide copy to taxpayer (IRC section 6695, 6701): preparer is req'd to provide to client a copy of the TR/refund claim no later than the time the preparer gives the taxpayer the completed return/claim. Penalty doesn't apply to the extent that failure is due to reasonable cause and not willful neglect. Penalty is $50 for each failure (max $25,500 per calendar yr). 2. Failure to sign return (IRC section 6695): penalty is $50/failure (max $25,500/calendar yr). 3. Failure to furnish ID no of preparer (IRC section 6695): penalty is $50/failure (max $25,500/calendar yr). 4. Failure to properly retain records (IRC sections 6695, 6107, 6060): TR preparer is req'd to keep, for 3 yrs (tax) following the last day of the return pd, either a copy of the return/claim or a listing of the name/ID of each taxpayer for whom the preparer prepared a return/claim. Penalty is $50/failure (max $25,500/return pd). 5. Failure to file correct info returns (IRC sections 6695, 6060): any person who employed a TR preparer at any time during that return pd must file an info return w/ the IRS by 7/31 immediately following the end of the return pd containing the name, taxpayer ID no, and place of work of each TR preparer so employed by that person. Penalty is $50/failure (max $25,500/return pd). 6. Negotiation of IRS refund check (IRC section 6695): gen, any TR preparer who endorses/otherwise negotiates an IRS refund check issued to a taxpayer other than the TR preparer shall pay a penalty of $510/check (worse). This rule doesn't apply to banks if the bank deposits into the taxpayer's acct at such bank the full amt of the IRS refund check. 7. Failure to be diligent in determining a client's eligibility for the earned inc credit (EIC. IRC section 6695(g)): penalty for failure to comply w/ IRS due diligence rqmts w/ respect to determining eligibility for, or the amt of, the EIC is $510/failure. The due diligence rqmts address eligibility checklists, computations wkshts, reasonable inquiries to the taxpayer, and record retention. The penalty won't apply w/ respect to a particular return/claim if the TR preparer can demonstrate the preparer's normal office procs are reasonably designed and routinely followed to ensure due diligence compliance and the failure to meet due diligence rqmts was isolated and inadvertent.
Worker Classification
Note that the laws discussed on the coming cards aren't state laws, even if they're state-run programs. All fed laws/regs. It's important for a bus to prop determine whether a person performing services for it is an employee or indep contractor. All of the payroll issues discussed in the coming cards arise only in an employer-employee setting, *NOT* when dealing w/ an indep contractor. When determining whether a worker is an employee or indep contractor, no one factor is determinative. It's a weighing process. Bus must consider: -whether the bus controls (or has the right to control) what the worker does and how he performs the work (right to control the manner and method of work indicates an employee). Primary consideration. -whether the worker owns his own bus, tools, etc (indicative of indep contractor). -whether the worker is paid by the job (indep contractor) or hourly or by salary (employee). -whether the job is of limited duration (indep contractor) or ongoing/continuous (employee). -whether the worker receives benefits (employee). For the rest of the cards related to other fed laws/regs, assume employee. Otherwise the laws don't apply.
Novation v Substituted Contract
Novation= agreemt is unchanged but one of the parties is released and a new party is substituted into their place. New contract substitutes a new party for an old party in an existing contract, and all parties agree to release the party who was substituted out. Substituted contract= OG parties are both released from the OG agreemt but *both* are bound by a new agreemt.
Corporation; Officers: Rights, Duties, Obligations, and Authority
Officers are indiv agents (and employees) of the corp who ord conduct its day-to-day ops and may bind the corp to contracts made on its behalf. A person may hold > 1 office. Officers are selected by the BOD and may be removed by the BOD w/ or w/o cause. *NOT* elected by the SHs. Officers are corp agents and agency rules determine their auth (actual and apparent) and power. A corp pres will gen have apparent auth to enter into contracts and act on behalf of the corp in the ord course of bus. Corp officers, like corp directors, are subj to fiduciary duties and must discharge their duties in good faith and w/ the same care as an ordinarily prudent person in a like position. Like directors, officers may be indemnified for exps/judgmts from litigation brought against them in their corp capacity (unless bad faith), and they're protected by the bus judgmt rule. Officers may also serve as directors of the corp. An officer isn't req'd to be, but may be, a SH of the corp. The key to several past Qs has been the power structure of corps. Remember, the SHs gen have no direct power to manage the corp. They elect the BOD, but gen, the BOD doesn't manage the corp. Instead, it appoints officers to manage on a day-to-day basis. The SHs do not elect the officers, and neither do the SHs have the power to remove them. Officers serve at the discretion of the BOD.
State Income Tax Considerations; Allocation and Apportionment of Federal Taxable Income
Once nexus is established, the next step is for the co to determine how much of its total fed inc/loss S/B taxable by each state. This is accomplished through the allocation/apportionment rules. Although the terms allocation/apportionment are almost always used in the same phrase, they each perform a sep function, and need to note the diff btw them. Gen, most states req that corps (and sometimes pships) use fed TI before NOL deductions and DRD as the starting point for allocation/apportionmt calcs. For corps, this amt is on ln 28, pg 1 of Form 1120. Gen, allocable items are nonbus inc, the inc that doesn't relate to the primary bus activities of the corp w/in the state. Allocation refers to the process of removing the nonbus activities from the ln 28 total and assigning it entirely to the state where it S/B taxed, gen the state of the taxpayer's commercial domicile (or residence). Book ex for allocation of nonbus inc: a corp selling shoes in 2 states has invested excess cash, which isn't working cap, in high-grade stocks/bonds. The corp plans to liquidate the investmt in 10 yrs and use the proceeds to pay for the construction in 10 yrs of a planned distr center. Determine whether the investmt inc from the stocks/bonds S/B classified as bus inc or allocated as nonbus inc. -bc the investmt in stocks/bonds doesn't relate to the primary bus activities of the corp, in this situation, the corp may be able to allocate entirely to the corp's home state all div inc and int inc (and CG/L from the liquidation). No other state W/B able to tax these items of nonbus inc.
Taxation of Foreign Entities; Calculating the Foreign Tax Credit Limitation by Category
Once the inc is sourced, the co applies a sep FTC limitation to each category of inc. The formula for calcing the sep category limitations is the same as that for calcing the overall limitation, except the numerator is now the sep category of foreign inc. FTC limitation per category = [pre credit US tax on total TI x (sep category foreign inc/total TI)]. The FTC is allowed only for foreign taxes that the US deems to be an inc tax. This doesn't incl sales taxes, VATs, prop taxes, or customs taxes. The credit allowed for that category is the LESSER OF the limitation for that category OR the foreign taxes related to the category. The total FTC is the sum of the credits allowed for all categories. Sourcing foreign inc into sep categories is done to prevent a co from using excess credits from high-tax foreign bus profits to offset more lightly taxed foreign passive investmt inc. A corp calcs/reports its FTC on Form 1118 - FTC - corps. Taxpayers can elect to deduct foreign taxes rater than claiming the credit, which can be a good decision if the taxpayer doesn't expect to utilize the credit in the 10-yr CF pd.
Capital Losses
Only offset CGs of corp. The 3k deduction for net CLs available to indivs isn't allowed to corps. Thus, a corp can only use CLs to offset CGs. Net CLs are CB 3 yrs and CF 5 yrs (3/5 rule). They're carried over as ST CLs (regardless of OG character) and are applied only against CGs. 3 back and 5 fwd... is a ST. CLs are taxed at ord tax rates (for corps). No lower tax rate (like indivs get). Book ex for CL carryover w/ NOL: L corp has gross inc of 400k (incl 150k CG) and op exps of 500k. Unexpired CL carryover of 20k. Determine L corp's NOL. -L is able to offset its CG of 150k by the CL carryover of 20k (net 130k CG). Gross inc after deducting the CL carryover will now be 380k (400k - 20k). -CY NOL = [380 gross inc - 500k op exps] = 120k. Basically the CL carryover incr'd the CY NOL. Book ex for NOL calc, utilization of NOL, and CL CFs: L co had 250 gross inc from ops, 50k divs rec'd from 40% owned co, 10k CGs, and 280k other deductions (not incl DRD). Gives CL and NOL CF schedules. Total CL CF is 12k, total NOL CF is 70k. -Y2 TI before DRD = [250k gross inc from ops + 50k divs + 10k CGs - 10k CL CF (limited to offsetting CGs) - 280k other deductions] = 20k TI before DRD. -tentative DRD = [50k x 80%] = 40k. -DRD TI limitation = [20k TI x 80%] = 16k. -taking the full DRD deduction creates a loss. Losers don't follow the rules, so be impolite and take the bigger piece. -NOL = [20k TI before DRD - 40k DRD] = -20k. -NOL CFs from PYs weren't used (even though they were available) as an NOL deduction from a PY isn't allowed in the calc of the CY NOL. -CL CF schedule is updated to show 2k remaining CF (12k BOY - 10k used). Use oldest bal 1st. -NOL CF schedule is updated to show 90k CF amt (70k BOY + 20k CY NOL). -if, next yr, the co is in a NI position, it would need to use its NOLs from the earliest yr in which NOLs were generated, as they would expire after 20 yrs.
Substantial Authority
Only these things are auth for purposes of determining whether there's substantial auth for the tax treatmt of an item (note that conclusions reached in treatises, legal periodicals, legal opinions, or opinions rendered by tax professionals aren't authority): Primary: -applicable provisions of the IRC and other statutory provisions. -proposed, temp, and final regs construing such statutes. -rev rulings/procs, tax treatises and regs thereunder, and US treasury dptmt and other official explanations of such treaties. -ct cases. Others: -congressional intent as reflected in committee reports, joint explanatory stmts of managers incl in conference committee reports, and floor stmt made prior to enactmt by one of a bill's managers. -general explanations of tax legislation prepped by the joint (US senate and house of reps) committee on taxation (the blue book). -private letter ruling and technical advice memoranda issued after 10/31/76. -actions on decisions and gen counsel memoranda issued after 3/12/81 (as well as gen counsel memoranda published in pre-1955 volumes of the cumulative bulletin). -IRS info or press releases and notices, announcemts, and other admin pronouncemts published by the service in the internal rev bulletin.
Corporate Taxable Income; Trade or Business Deductions
Ord and necessary exps. All of the ord/necessary exps paid/incurred during the taxable yr in carrying on a bus are deductible. Ord/necessary means the exps are common/accepted in a particular bus/profession and they relate to producing the CY's inc. -book ex for trade/bus deductions: reasonable salaries, office rentals, office supplies, and traveling exps are all deductible when incurred for bus purposes. 1. Domestic production deduction: a bus may deduct a specific % of their qualified production activities inc. The deduction may not exceed 50% of the W-2 wages paid by the corp for the yr (limitation). The deduction is 9% of the *LESSER OF*: -qualified production activities inc (QPAI) or -TI (disregarding the QPAI deduction). QPAI = [domestic production gross receipts - COGS - other directly allocable exps/losses - proper share of other deductions]. Domestic production gross receipts gen are those derived in sig part w/in the US from any disposition of qualified production prop that's manufactured, produced, grown, extracted, constructed, engineering services, or architectural services. 2. Executive comp: Max 1M. A publicly held corp may not deduct comp exps in excess of 1M paid to the CEO or the 4 other most highly comp'd officers, unless based upon qualifying commissions or performance-based plan of the co. Entertainmt exps for officers, directors, and 10% or greater owners may be deducted only to the extent they're included in the indiv's gross inc. 3. Bonus accruals (non-SH/employees): pay by 4/15. Bonuses paid by an accrual basis taxpayer are deductible in the tax yr when all events have occurred that establish a liab w/ reasonable accuracy, and provided they're paid w/in 2.5 mos of YE (4/15). 4. Bad debts: specific charge-off method. -accrual basis: tax deductible when specific AR is written off. Accrual method taxpayers must use the specific charge-off method (direct write-off method) for tax purposes. Most taxpayers will write off bad debts when they become worthless/partially so. The allowance method is still req'd for fin accting purposes, but not allowed for calcing the IT deduction. -cash basis: *NO* deduction (it was never inc!). Important to be aware of bad debts of cash basis taxpayers. Bc a cash basis taxpayer hasn't incl the amt in gross inc, a bad debt isn't deductible, except in the case of an uncollectible check that has been deposited and recorded as inc.
Corporation Tax Summary Continued
Ord exps continued: 6. Tax-free investmt (and related int exp): -GAAP F/S: exp -IRC TR: not deductible -Diffs: perm 7. Contrs: -GAAP F/S: all expensed -IRC TR: limited to 10% of AGI (A subtotal) -Diffs: temp, perm, or none 8. Loss on abandonment/casualty: -GAAP F/S: exp -IRC TR: deduct -Diffs: none 9. Loss on worthless sub: -GAAP F/S: exp -IRC TR: deduct -Diffs: none 10. Depr; MACRS v SL: -GAAP F/S: slower SL -IRC TR: faster MACRS -Diffs: temp 11. Section 179 depr: -GAAP F/S: not allowed (must depr) -IRC TR: 2017 limit is 510k -Diffs: temp 12. Diff basis of asset: These bases come from donating assets when starting a co -GAAP F/S: use GAAP basis (FV) -IRC TR: use tax basis (NBV) -Diffs: perm 13. Amort; start-up/organizational exps: -GAAP F/S: exp -IRC TR: 5k max, amort rest over 15 yrs -Diffs: temp 14. Franchise: -GAAP F/S: amort -IRC TR: amort over 15 yrs -Diffs: temp 15. GW: -GAAP F/S: impairmt test (annually) -IRC TR: amort over 15 yrs -Diffs: temp 16. Depletion; % v SL: -GAAP F/S: cost over yrs -IRC TR: % of sales -Diffs: temp 17. Percentage in excess of cost: -GAAP F/S: not allowed -IRC TR: % of sales -Diffs: perm 18. Profit sharing and pension exp: -GAAP F/S: exp accrued -IRC TR: no deduction until paid -Diffs: temp 19. Accrued exp (50% owner/family): -GAAP F/S: exp accrued -IRC TR: no deduction until paid -Diffs: temp 20. State taxes (paid): -GAAP F/S: exp -IRC TR: deduct -Diffs: none 21. M&E: -GAAP F/S: exp -IRC TR: gen 50% deductible -Diffs: perm
The Securities Act of 1933; Registration Statement Continued
Part II; Info that must be incl abt the secs being issued: -audited B/S and P/L stmt: the registration stmt must incl a B/S dated not > 90 days before the filing and a P/L stmt of the issuer's NI/L for the preceding 5 yrs. The F/S must be certified by a pub accting firm registered w/ the PCAOB. -other mat facts reqing disclosure: the registration stmt must also incl a descr of the issuer's bus and the following (if available): (a) the names/addresses of the directors, officers, underwriters, and SHs who own 10%+ of the co's shs. (b) the amt of stock/debt the issuer has outstanding. (c) the principal purposes for which the offering proceeds will be used. (d) anything that might affect the value of the secs being issued (absence of an earnings history, pending litigation, etc.). Many issuers are almost constantly involved in issuing new secs. It W/B helpful if they could prep just 1 registration stmt for all secs that they will offer in the future (shelf registration). This is a registration stmt for future issuances. Although gen prohibited, shelf registration is permitted if the issuer has continuously filed under the 1934 act for 1 yr (not a first-time issuer) and the info is continuously updated. The registration stmt becomes effective on the 20th day after its filing w/ the SEC unless the SEC issues a refusal or stop order. State laws governing stock sales are called blue sky laws. Much of state blue sky law has been preempted by fed law.
Unrelated Business Income (UBI); Penalties and Retaining Tax-Exempt Status
Penalties: apply for failure to file a req'd tax form (incl 990-N) and failing to comply w/ the rqmts/disclosures of the exempt org. If an org fails to file the req'd return for 3 consecutive yrs, the TE status of the org will be revoked, effective on the OG filing due date of the 3rd annual return/notice. This is called auto revocation of TE status. 3 strikes and you're out! Retaining TE status: to protect its TE status, an exempt org must timely file its req'd annual returns and shouldn't: -org or op for the benefit of any private ints. -devote a substantial part of its activities to attempting to influence legislation. -participate/intervene in any political campaign on behalf of, or in opposition to, any candidate for pub office and -be org'd for or conduct activities that are illegal or violate fundamental pub policies. Any of these activities could result in harsh penalties or revocation of TE status. Revocation may also occur in the event of new legislation which deems the activities of the previously TE org ineligible.
Tax Credits; Credit for the Elderly and/or Permanently Disabled
Personal tax credit (reduces TI but no refund). This credit of 15% of eligible inc is available to indivs who are: 1. 65 years of age or older OR 2. under 65 and retired due to perm disability. The base amt used to figure the credit is: -5k for single person, widow, or widower. -5k if MFJ and only 1 spouse is a qualified indiv. -7,500 if MFJ and both are qualified indivs. -3,750 for a qualified indiv who is MFS. -if a qualified indiv is under age 65 and has disability inc of <5k, the base amt is limited to 5k. Eligible inc is reduced by: 1. any social sec pmts and other excludable pensions or annuities rec'd by the taxpayer and 2. 1/2 of the taxpayer's AGI that exceeds these levels: -single taxpayers: 7,500 -MFJ: 10k -MFS: 5k This is the AGI limit (reduce)! Summary: A taxpayer who is 65 YO + starts w/ a tax credit for the elderly based on a spec'd amt that is reduced by (1) any social sec pmts and other excludable pensions and (2) by 50% of any AGI over the stated maximum. The results, if any, are multiplied by 15% to arrive at the allowable tax credit. The credit is limited to the amt of tax. -calc for single: [5k gross given - all social sec - 50% of AGI over 7,500] = balance. [Bal x 15%] = credit. -calc for MFJ: [7,500 gross given - all social sec - 50% of AGI over 10k] = balance. [Bal x 15%] = credit. Book ex for credit for the elderly and/or perm disabled: P is single and 68 YO. He rec'd 3,120 social sec, 215 taxable int, 3,600 taxable part of pension, and 4,245 wages from a part-time job as inc this yr. Calc P's credit for the elderly and/or perm disabled. -P's AGI = [4,245 wages + 3,600 partly taxable pension + 215 taxable int] = 8,060. -excess AGI = [(8,060 - 7,500) x 50%] = 280. -credit = [5k base - 3,120 social sec - 280 excess AGI] = 1,600. [1,600 x 15%] = 240 tax credit.
Tax Credits; Child and Dependent Care Credit
Personal tax credit (reduces tax but no refund). GR: both parents work, pay someone to take care of jr. This is a tax credit of 20-35% of eligible expenditures. 2017 max expenditures (must be multipled by %s to get the actual credit!): -3k for 1 dependent -6k for 2+ dependents The child and dependent care credit is available to taxpayers who maintain a household, work, and incur eligible exps for the care of: -a qualifying child under age 13 or for whom an exemption may be claimed. -any disabled dependent of any age who's unable to care for himself, whether or not he can be claimed as a dependent, but who must meet the support test of a dependent (1/2 of support provided by the taxpayer). -a spouse who is disabled and not able to take care of his/herself. Married taxpayers must both produce earned inc from wages, salary, or net SE inc to be eligible for the child and dependent care credit (unless 1 is a full-time student or physically/mentally incapacitated). The credit is computed by using the lowest of (1) the earned inc of the spouse w/ the lesser amt, (2) the actual child care expenditure, or (3) the max amt (3k or 6k for 2017). This lowest amt W/B multiplied by the applicable % to get the amt of the credit. Eligible expenditures must be for the purpose of enabling the taxpayer to be gainfully employed (allowing them to work or look for work). Incl: -babysitter -nursery school -day care -*NOT* grammar school The max child care credit against the tax liab is 35%. To obtain the max credit, the taxpayer's AGI must be <= 15k. The credit decrs by 1% for each 2k (or fraction of it) of AGI over 15k, but not below 20%. The child care credit at the minimum rate of 20% for indivs w/ AGI of >43k is 600 (20% of 3k) or 1,200 (20% of 6k) if the taxpayer has 2+ qualifying dependents. Book ex for the child and dependent care credit: V is a widow w/ 2 kids. In 2017, her AGI is 43,500, for which the applicable TR is 20%. Her work-related exps for a housekeeper for the children are 3,600, and 3,800 for child care at nursery school. Calc the amt of the child and dependent care credit for V. -calc: [3,600 work-related exps + 3,800 nursery school exps] = 7,400. The max allowable for 2 dependents is 6k. [6k x 20%] = 1,200. -V can take a child care credit of $1,200.
Circular 230; Written Advice
Practitioner may give written advice (incl electronic comm) concerning 1+ fed tax matters. Practitioner must: -base the written advice on reasonable factual and legal assumptions (incl assumptions abt future events). -reasonably consider all relevant facts/circumstances that the practitioner knows/reasonably should know. -use reasonable efforts to ID/ascertain the facts relevant to written advice on each fed tax matter. -not rely upon reps, stmts, findings, agreemts (incl projections, forecasts, or appraisals) of the taxpayer/any other person if reliance on them W/B unreasonable. -relate applicable law/authorities to facts and -*NOT*, in evaling a fed tax matter, take into acct the possibility that a tax position won't be audited or that a matter won't be raised on audit. A fed tax matter is any matter concerning the application/interpretation of: -a rev provision of the IRC. -any provision of law impacting a person's obligations under the internal rev laws/regs, incl but not limited to the person's liab to pay tax or obligation to file returns or -any other law/reg administered by the IRS. A practitioner may only rely on the advice of another person if the advice was reasonable and the reliance is in good faith considering all the facts/circumstances (ok if competent and no conflicts). Reliance isn't reasonable if practitioner knows/reasonably should know: -the opinion of the other person shouldn't be relied on. -the other person isn't competent or lacks the necessary qualifications to give the advice or -the other person has a conflict of int in violation of the rules under circular 230.
Effect of S Corporation Election on Shareholders; Accumulated Adjustments Account (AAA)
Prior S corp inc which can now be withdrawn tax-free. Tax effects of distrs paid to SHs of an S corp that has accum'd E&P since inception (or since the most recent electing of S status) are computed by using the AAA. The AAA is 0 at the inception of the S corp. The AAA is essentially incr'd by sep and non-sep stated inc and gains (except TEI and certain life ins proceeds). The AAA is essentially dec'rd by corp distrs (which can't reduce it below 0), sep and non-sep stated exp items and and losses (except certain nondeductible items that don't affect the cap acct), and nondeductible exps (except life ins premiums on a contract owned by the corp that IDs the corp as the beneficiary) that relate to inc other than TE inc. The other adjustmts acct (OAA) is a bookkeeping acct designed to keep a cumulative record of items which affect S corp SHs' basis but don't affect the AAA. These primary diffs are: -TE int and related exps and -fed taxes attributable to C corp yrs. Exs of items incl in the OAA incl: -TE int on muni bonds and related exps -TE life ins proceeds and related nondeductible premiums -fed taxes paid/accrued in an S corp yr that relate to C corp yrs. After these adjustmts are made, the acct is reduced for any distrs made during the yr. The OAA is purely an administrative acct to reconcile SH stock basis w/ the AAA and has no impact on the taxability of an S corp's distrs. Sch K-1 for S corp SHs: -each SH gets their own K-1. -goes w/ Form 1120S. -incl info abt corp. -incl info abt SH. -incl SH's share of CY inc, deductions, credits, and other items. Listed according to schedule: (1) Sch E: ord bus inc/loss and net rental real estate inc/loss. (2) Sch B: int inc and ord divs. (3) Net ST CG/L and LT CG/L.= (sch D?) -also incl section 179 deduction and other deductions. -indivs report S corp ord inc on sch E of their 1040. -incl list of codes on sch K-1 and where those items are reported on the 1040.
General Partnership/Joint Venture; Rights of Partners
Pship prop incl inv, PP&E, etc. A pship owns all money/prop contr'd to it by the partners and all other prop acq'd by it. Partners do *NOT* own pship prop. As a GR, partners have no right to possess or use pship prop other than for pship purposes. Thus: -an indiv partner may not assign/sell pship prop for his own benefit and -a partner's personal creditors can't attach pship prop to satisfy an indiv partner's debt. Book ex for pship prop v personal prop: A and B agree to form a pship to sell antique cars. A contrs 10 antique cars from his collection and B contrs 200k. The cars and cash are pship prop. A may no longer use the cars for personal use - even if they're titled in his name - and B may no longer freely spend the 200k. The cars/cash can be used only for pship purposes. A partner may assign his int (pship int is like owner's EQ) in the profits/surplus at any time. The assignee obtains the right to receive the partner's share of the profits. Does *NOT* become a partner so has *NO* right to attend pship meetings, inspect the pship books/records, vote, etc. An assignee can obtain such rights only if admitted to the pship as a partner, which gen reqs the approval of all the partners. The examiners like to ask abt the effect of a partner transferring his int in the pship w/o the consent of the other partners. Remember that such a transfer doesn't make the assignee a partner (can only be done w/ the consent of all partners). So the transferee has no power to manage the pship, inspect the books/records, vote, etc. Gen, the assignee's only right is to get whatever distr the assignor would have gotten. Same rule applies to a creditor w/ a charging order and an heir who receives a deceased partner's int. A creditor of an indiv partner may obtain from a ct a charging order against an indiv partner's share of profits (personal creditor attaching a partner's int). Remember that a personal creditor can't attach to pship prop though! Just the partner's int in profits from the pship. When a partner dies, his right to profits/surplus vests in his heirs. The partner's right to pship prop vests in the surviving partners (heirs don't get the prop bc it belongs to the pship). Every partner has the right to inspect/copy the books/records of the pship.
Affordable Care Act (ACA)
Purpose is to improve access to health care in the US by providing workers w/ access to affordable health care coverage. Health care coverage may be offered through: -a plan provided by the employer. -plan purch'd through the health ins mktplace, where employees may qualify for financial assistance. -coverage provided under a govt-sponsored program, like medicare, most medicaid, and health care programs for veterans. -direct purch by the employee from an ins co. Both employers and employees are req'd to participate. Certain employers must offer health care coverage or pay a penalty. An indiv must obtain health care coverage for himself, a spouse, and tax dependents, or pay a penalty. Both the employer and employee contr to the purch of affordable coverage (like FICA). The employer may subsidize the cost of the coverage in order to ensure it's affordable. The employee will pay a certain amt for coverage, whether purch'd through the employer or another source. Under the ACA, employers w/ 50+ full-time employees are called applicable large employers (ALEs). ALEs are req'd to provide full-time employees the opp to purch affordable min essential health care coverage for themselves and their dependents under an eligible employer-sponsored health care plan. -all types of employers can be ALEs, incl TE orgs and govt entities. -an employee is full-time if he was employed on avg at least 30 hrs/week or 130 hrs/mo. -coverage is considered affordable if the employee's contr to the plan doesn't exceed 9.5% of the employee's household inc for the taxable yr. -a dependent is an employee's child who has *NOT* reached the age of 26. -employers who do *NOT* comply w/ the ACA will pay a penalty for failure to do so. -employers are req'd to file annual info returns w/ the IRS and must also provide info to employees abt coverage. The ACA comes w/ an indiv mandate (a tax) reqing all Americans to buy health coverage or pay a fine. For low-inc indivs, the fed govt subsidizes the cost through a tax rebate, even if the indiv paid no inc taxes. Employees who have min essential coverage will report this fact on their TR each yr. The ACA does *NOT* create a national health ins plan. Sets national stds for how health ins is structured/priced and places new rqmts on indivs and employers. Bc purchasing coverage is mandatory, the ACA makes it illegal for an insurer to deny coverage to indivs w/ preexisting conditions or to charge more for their coverage.
Formation of C Corporations; Corporation Tax Consequences
Realized = real world. Recog'd = record on records. C corps are the only type of entity whose earnings are subj to double taxation (taxed once at corp level, again at SH level when divs distr'd). Primary disadv is double taxation, primary adv is protection for SHs from liabs of the corp. A corp is solely responsible for its liabs under state law. There's no G/L to the corp issuing stock in exchange for prop in these trans: -formation (issuance of C/S) -reacquisition (purch of treasury stock) -resale (sale of treasury stock) The GR is that the basis of the prop rec'd from the transferor/SH is the *GREATER OF*: 1. adjusted basis (NBV) of transferor/SH (+ any gain recog'd by transferor/SH). 2. debt assumed by corp (transferor may recog gain to prevent a negative basis). Nontaxable = NBV. If the aggregate adjusted basis of prop contr'd to a corp by each transferor/SH in a tax-free incorp exceeds the aggregate FMV of the prop transferred, the corp's basis in the prop is limited to the aggregate FMV of the prop (this prevents the transfer of prop w/ built-in losses to the corp). Corp can either exp or capitalize and amort as part of organizational expenditures stock provided for services. Depends on facts.
Tax Credits; Earned Income Credit
Refundable (reduces tax liab and get refund). To be eligible, taxpayer must: -live in the US (main home) for > 1/2 of the taxable yr. -meet certain earned low-inc thresholds. -not have more than a spec'd amt of disqualified inc. -be over the age of 25 and under 65 (spouses apply as well) if there are no qualifying children and -file a joint return w/ one's spouse w/ certain exceptions (which means the spouse can't be a dependent of another). Earned inc is wages, salaries, tips, other employee comp, and earnings from SE. The lower, the bigger the credit. It doesn't incl pension and annuity inc. An AMT liab will not affect an indiv's earned inc credit. The most frequently tested issue w/ the earned inc credit is that it's refundable! A qualifying child isn't a rqmt to be eligible for the earned inc credit. However, if the taxpayer has one, the earned inc credit % is higher. A qualifying child is one who: -is the taxpayer's son/daughter, adopted child, grandchild, stepchild, foster child, brother/sister, step-brother/sister, or a decedent of these indivs. -was (at the end of the yr) either under 19 or under 24 and a full-time student, or any age and perm and totally disabled. -lived w/ the taxpayer in the taxpayer's main home in the US for > 1/2 of the taxable yr. -is the taxpayer's dependent (if the child is married).
The Securities Act of 1933; Exemption from Registration: Regulation D
Regulation D exempts private offerings and the SEC has 3 private offering exemptions under reg D; Rules 504, 505, and 506. The exemptions share certain gen conditions, but each also has specific conditions. Gen conditions that apply to all 3: -general solicitation sometimes prohibited: limitation of gen ads. Reg D is intended for private offerings, so the reg has a GR prohibiting gen advertising of the secs sold under reg D. However, there are exceptions under rules 504 and 506. -immediate resale to public prohibited: the purchasers may not immediately reoffer secs issued under reg D to the public. The issuer must insure that purchasers will hold for LT investmt (2 yrs +), not resale. Before 2 yrs is up, such secs are restricted, and the buyer can't resell them unless the resale falls under reg D or another exemption. -SEC must be informed w/in 15 days: the SEC must be notified of the issuance of secs under reg D w/in 15 days after the 1st sale. Rqmts of rule 504: $1M limit. To be exempt under rule 504, the issuance of secs may not exceed $1M w/in a 12-mo pd. Rule 504 has no limitation on the no/type of purchasers and gen doesn't req any specific disclosure to investors prior to the sale. If the rule 504 offering is registered under state law, the gen prohibition against gen advertising doesn't apply. Rqmts of rule 505: $5M limit. To be exempt under rule 505, the issuance of secs may not exceed $5M w/in a 12-mo pd. -secs issued under Rule 505 may be sold to any no of accredited investors and 35 or fewer unaccredited investors. An accredited investor is one such as an institutional investor, bank, officers/directors of the issuer, or an indiv w/ a 4-yr avg net worth of at least $1M excluding the value of the indiv's home. -bc of the limitation on unaccredited purchasers, the issuer must also make reasonable efforts to ensure that the purchasers are buying for themselves and not others. -if only accredited investors purchase, no disclosure is req'd. If there are *ANY* unaccredited investors, *ALL* investors must be given at least an annual report containing audited F/S. The examiners often try to trick you w/ the 35 unaccredited investor limit. Watch for fact patterns that state that reg D offerings can't be made to > 35 investors. Such a choice is incorrect bc gen there's no limit on the no of unaccredited investors under Rule 504. Moreover, the 35 investor limit under Rules 505 and 506 applies only to unaccredited investors. There can be any no of accredited investors. Note that the limitation goes to the no of actual purchasers, not the no of offerees.
The Securities Exchange Act of 1934; Reporting Requirements Continued
Report *5% TIP*: -*5%* or more owners: Any person acqing 5%+ beneficial oship in any EQ sec registered under the 34 act must file a report w/ the SEC, the issuer, and the exchange on which the sec is traded. The report must incl background info abt the purchaser, the source of his funds, and his purpose in buying. -*T*ender offers: tender offer is an offer to all SHs to purch stock for a spec'd price for a spec'd pd of time. Any party making a tender offer to purch 5%+ of the shares of a class of secs registered under the 34 act must file a report w/ the SEC, the issuer, and the exchange on which the shares are traded. The report must incl background info abt the purchaser, the source of his funds, and his purpose in buying. -*I*nsiders: officers, directors, > 10% SHs, acctants, or attorneys of a co registered under the 34 act. Must file a report w/ the SEC disclosing their holdings in the reported co and making monthly updates. The 34 act also limits insider trading by imposing absolute liab on any insider who makes a profit on the purch/sale of a reporting co's stock w/in a 6 mo pd (short swing profits). Have to give the $ back. -*P*roxy: written request for permission to vote a SH's shares at a SH meeting. Proxy solicitations in reporting cos must be reported to the SEC. If directors are to be elected at a meeting for which mgmt is seeking proxies, an annual report w/ an audited B/S and P/L stmt must be sent to all SHs entitled to vote. Proxy stmts must be sent to all SHs disclosing all facts pertinent to the matter on which the SHs will vote. Proxy stmts and any other docs that will be sent to SHs as part of the proxy solicitation must be filed w/ the SEC. SHs have a right to have proposals proper for consideration at the SHs' meeting incl in mgmt's proxy solicitation. Under section 18, a person can be held liable for intentionally making false/misleading stmt in a registration stmt or any report req'd under the 34 act. Bc liab is imposed only for intentional misconduct, good faith and a lack of knowledge of a stmt's falsity are defenses to an action under section 18. Must know the 3 periodic reports (10-K, 10-Q, 8-K). Often, examiners only ask the names of the other req'd reports, 5% TIP. *5%*+ owners must report, *T*ender offers must be reported, *I*nsider trading must be reported, and *P*roxy solicitation and stmts must be reported.
The Securities Act of 1933; Exemption from Registration: Regulation D Continued
Rqmts of rule 506: unlimited dollar amt. Under rule 506 there's no limit on the amt (dollar value) of stock that may be sold. -secs issued under Rule 506 may be sold to any no of accredited investors and 35 or fewer unaccredited *but sophisticated* investors (the issuer must reasonably believe the unaccredited investor has sufficient knowledge/experience in financial matters to be capable of evaluating the risks of the investmt). Like 505 but sophisticated. -if only accredited investors purch, no disclosure is req'd and the prohibition on gen advertising doesn't apply if the issuer takes reasonable steps to verify that the purchasers are accredited. If there are *ANY* unaccredited investors, *ALL* investors must be given at least an annual report containing audited F/S. Like 505. The examiners ask picky Qs abt rules 504, 505, and 506, so need to know the info, especially concerning limitations on amts and investors. Remember that gen solicitation gen is prohibited under all 3 rules. Summary chart for regulation D: 1. Rule 504: -gen advertising allowed? sometimes, if registered under state law. -notice req'd to SEC? 15 days. -reoffers to public prohibited? yes. -dollar limitation: $1M. -limits on unaccredited buyers? no limit. -limits on accredited buyers? no limit. 2. Rule 505: -gen advertising allowed? no. -notice req'd to SEC? 15 days. -reoffers to public prohibited? yes. -dollar limitation: $5M. -limits on unaccredited buyers? up to 35. -limits on accredited buyers? no limit. 3. Rule 506: -gen advertising allowed? sometimes, if only accredited investors purch. -notice req'd to SEC? 15 days. -reoffers to public prohibited? yes. -dollar limitation: none. -limits on unaccredited buyers? up to 35, who must be sophisticated. -limits on accredited buyers? no limit.
Corporation; Shareholders: Rights, Duties, Obligations, and Authority
SHs have the right to vote to elect (typically annually) or remove directors. Also have the right to vote on whether to approve fundamental changes to the corp, like dissolution. GR: 1 sh, 1 vote, unless the articles of incorp provide otherwise. Exception is cumulative voting for directors. The articles can give SHs the right to cumulative voting w/ respect to electing directors. In cumulative voting, each sh is entitled to 1 vote for each director position that's being filled, and the SH may cast the votes in any way, incl casting all for 1 candidate. Helps minority SHs get rep on the BOD. Gen, SHs do *NOT* have the right to a distr (incl cash divs and repurchases of shares) unless/until it's declared by the BOD. Once the BOD declares a distr, the SHs are treated as unsecured creditors of the corp to the extent of the div. Distrs decr the corp's SHs' EQ. The fact that SHs have the status of unsecured creditors once a div is declared has often been a correct answer choice on past exam Qs. A corp need not give each SH an equal right to receive distrs. Shs may be divided into classes w/ varying rights. Preferred SHs get a preference for divs. -noncumulative preferred shares: shs w/ a preference usually are entitled to a fixed amt of $$ (like $5/yr if the preference is a div preference) before distrs can be made w/ respect to nonpreferred shs. -cumulative preferred shs: w/ these, if a div is not declared in a particular yr, the right to receive the preference accumulates and must be paid before nonpreferred shs may be paid any div. Divs carry over to future yrs. Cumulative preferred divs are an exam fav. Key is to remember that although these divs accumulate even if not declared, no div can be paid to common SHs until all cumulative divs are paid (even for yrs where divs weren't declared). No div is due until it's declared by the BOD. Stock divs are issued from a corp's own auth'd but unissued shs. Bc no assets are distr'd, the SHs receiving the stock gen do *NOT* owe any taxes on it, the solvency of the corp remains the same, and there's no damage to creditors and SHs (unlike cash divs). A stock div is *NOT* a distr of corp assets.
Depreciation; MACRS: Real Property
SV ignored, subtract land cost. Bldg only. Residential rental prop is 27.5 yr SL. Exs of this incl apartments and duplex rental homes. Nonresidential real prop is 39 yr SL. This is real prop that isn't residential real prop and doesn't have an ADR midpoint of > 27.5 yrs. Exs of this incl office bldgs and warehouses. SL depr is computed based on the no of mos the prop was in service. 1/2 mo is taken in the mo the prop is placed in service (mid-month convention). 1/2 mo is taken for the month the prop is disposed of. Exam trick: carefully look to see which month the bldg is put into service. Book ex for mid-month convention: L corp placed a new office bldg into service on 4/6/Y1. The adjusted basis of the office bldg is 100k. Calc the depr on the office bldg for Y1. -L gets the SL depr rate on the bldg by dividing 1 by 39 yrs to get .02564. -depr for a full yr = [100k x .02564] = $2,564. -under mid-mo convention, treat the prop as placed in service in the middle of April. Get 8.5 mos of depr for the yr. -as a decimal, the fraction of 8.5 mos/12 mos is .7083. -1st yr depr for the bldg = [2,564 x .7083] = $1,816. -could also just divide 2,564 by 12 and then multiply by 8.5.
Capitalize or Expense Continued Further
Safe harbors: 1. There's an elective safe harbor allowing taxpayers to exp routine maintenance that they reasonably expect to occur > once during the class life of the asset and that doesn't result in betterment. 2. Qualifying small taxpayers can exp costs related to an eligible bldg if they don't exceed the LESSER of 2% of unadjusted basis of the bldg OR 10k. -a qualifying small taxpayer is one w/ avg annual gross receipts of 10M or less during the 3 preceding tax yrs. -an eligible bldg is any bldg w/ an unadjusted basis that doesn't exceed 1M. Relief for small bus taxpayers: Effective for tax yrs beginning in 2014, small businesses can change the method of accting under the repair regs on a prospective basis rather than a retroactive basis (small businesses are those w/ < 10M in assets or <10M in avg annual gross receipts). For small businesses, the rqmt to file Form 3115, Application for Change in Accting Method, is elim'd. Form 3115 reqs the taxpayer to go back in time and acct for items of inc/deduction as if they had always used the new method of accting. This can be a sig amt of work for the taxpayer.
Miscellaneous Notes from Chapter
Scienter = fraud. Intent, reckless, or gross negligence. If no intent/recklessness, ord negligence. This is good faith but failure to exercise reasonable care. Being late for a good reason isn't a material breach if the contract doesn't say "time is of the essence."
Additional Information for Section 1250 Property
Section 1250 recapture applies to recog'd gain attributable to the amt of A/D in excess of SL A/D. All remaining gain would qualify as a section 1231 gain for indivs, estates, and trusts. However, the amt of gain up to the amt of SL A/D is referred to as unrecaptured section 1250 gain, and is taxed at a max 25% rate instead of the lower rates assoc'd w/ net CGs. For C corps only, ord inc treatmt will apply to 20% of the gain from the disposition of section 1250 prop that hasn't been treated as ord inc under the section 1250 recapture rules.
Common Features of Chapter 7 and 11 Cases; Section 341 Meeting and Property of the Bankruptcy Estate
Section 341 meeting: creditor's meeting. Ord, w/in 20-40 days after the order for relief, a meeting of the creditors (a section 341 meeting) is held. *ALL* interested parties, incl creditors, the bankruptcy trustee, and the debtor must be given notice of the meeting. Prop of the bankruptcy estate: the debtor's estate (assets available to pay off creditors) gen incl all of the debtor's real/personal prop at the time of filing. The estate also incl: -inc generated from estate prop (like int from bonds that are part of the estate) rec'd w/in 180 days (6 mos) after the filing of the petition for relief. -prop the debtor receives from *DII*; *D*ivorce, *I*nheritance, or *I*nsurance w/in 180 days after the filing of the petition. The fact that an inheritance rec'd w/in 180 days after filing a petition for relief is incl in the debtor's estate has been tested often. -leases of prop may be assumed/retained by the trustee, assumed/assigned to another, or rejected by the trustee. Prop excluded from the estate: -post-petition earnings of an indiv debtor, spendthrift trusts, contrs to educational IRAs and qualified state tuition programs made at least 365 days before the petition was filed, and contrs by employees to qualified employee benefit plans are excluded from the estate. -an indiv debtor is entitled to exempt certain prop under the bankruptcy code, gen things necessary to live unless specific lien on prop. The code also allows states to adopt their own exemptions. ~ 2/3 of states have opted out of the fed exemption system in favor of their own. The trustee is a hypothetical lien creditor as of the filing date, treated as having a lien on all of the debtor's prop the instant the bankruptcy petition is filed. This means the trustee has priority over all creditors except those w/ prior perfected security ints or prior statutory or judicial liens. The trustee will not prevail against PMSIs in noninv collateral that are validly perfected under state law and w/in 30 days after the debtor receives possession of the collateral. Recall that in most states such perfection isn't valid under state law unless it occurs w/in 20 days after the debtor receives possession of the collateral. Book ex for PMSI and bankruptcy filing: on 7/1, S sells and delivers to D on credit certain equip and properly reserves a sec int in the equip. On 7/5, D files a petition in bankruptcy. On 7/9, S perfects his int in the equip by proper filing. S' PMSI prevails over the bankruptcy trustee's int.
Below-Market Loans and Imputed Interest
Section 7872 of the IRC seeks to prevent parties from offering below-mkt int rates on loans that C/B particularly appealing to related parties. If this section applies, the loan is re-characterized as an arm's-length trans in which the lender made a loan to the borrower in exchange for a note reqing pmt of int at the applicable federal rate (AFR; these are published regularly by the IRS). Indivs who make a below-mkt loan gen must report any foregone int as int inc. The borrower may be able to deduct the foregone int, unless it's personal int. The below-mkt loan provisions apply to these loans: -gifts: any below-mkt loan which is a gift loan. -compensation-related loans: any below-mkt loan directly/indirectly btw an employer/employee or an independent contractor and a person for whom the indep contractor provides services. -corp-SH loans: any below-mkt loan directly/indirectly btw a corp and any SH of such corp. These top 3 are when there's a "close" relationship. -tax-avoidance loans: any below-mkt loan for which a principal purpose of the int arrangemt is the avoidance of any fed tax. -other below-mkt loans: to the extent provided in regs any below-mkt loan that's not otherwise descr'd, if the int arrangemts of the loan have a sig effect on any fed tax liab of the lender/borrower. -loans to qualified continuing care facilities: any loan to a qualified continuing care facility, pursuant to a continuing care contract.
Gains (Excluded or Deferred); Exchange of Like-Kind Business/Investment Assets Continued Further
Several book exs. 1. Like-kind exchange; realized gain/no boot: taxpayer trades in an auto used solely for bus purposes for another auto to be used in his bus. The auto OG cost 35k and is currently worth 20k. Taxpayer has taken 18k of depr on his old auto (17k NBV = 35k - 18k). Assume the auto the taxpayer wants in exchange is worth 20k. -G/L realized on the exchange = [20k FMV of new auto - 17k adjusted basis of old auto (35k cost - 18k depr)] = 3k realized gain. -amt realized = [FMV new prop rec'd + FMV boot rec'd - FMV boot paid]. -G/L recog'd on the exchange = 0. This is the lesser of the gain realized (3k) and the boot rec'd (0). No boot/loot, so no gain. -boot rec'd = [cash rec'd + FMV non-like-kind prop rec'd + net relief from liab]. -boot paid = [cash paid + FMV non-like-kind prop paid + net liab assumed]. -G/L deferred = 3k (3k realized gain - 0 recog'd). -basis of new prop = [20k FMV prop rec'd - 3k deferred gain + 0 deferred loss] = 17k. NBV = nontaxable. Same as prior auto. 2. Like-kind exchange; realized loss: same facts as OG ex, but taxpayer has only taken 12k depr on old auto. NBV 23k (35k - 12k). -realized G/L = [20k FMV new auto - 23k adjusted basis of old auto] = 3k realized loss. -recog'd G/L = 0 (*realized loss is never recog'd in a like-kind exchange*). -G/L deferred = 3k loss deferred (3k loss realized - 0 recog'd). -basis in new prop = [20k FMV prop rec'd - 0 deferred gain + 3k deferred loss] = 23k. Same as prior auto. NBV = nontaxable. 3. Like-kind exchange; boot rec'd > gain realized: same facts as OG ex (incl 18k depr, so 17k NBV of {35k - 18k}), but auto taxpayer wants in exchange is only worth 16,500, so other party agrees to pay taxpayer 3,500 in cash (boot/loot) in addition to the new auto. -realized G/L = [20k amt realized (16.5k + 3.5k) - 17k adjusted basis old auto (35k cost - 18k depr)] = 3k realized gain. -recog'd gain = 3k (lesser of 3k realized gain or 3.5k boot rec'd). -G/L deferred = 0 (3k realized - 3k recog'd). -basis in new prop = [16.5k FMV prop rec'd - 0 deferred gain + 0 deferred loss] = 16,500 basis. This is the 17k OG basis - the $500 not taxed. Diff than OG basis bc boot/loot involved. 4. Like-kind exchange; boot rec'd < gain realized: same facts as OG ex except new auto taxpayer wants in exchange is only worth 17.5k, so other party agrees to pay 2.5k in cash (boot/loot) in addition to the new auto. -realized G/L = [20k amt realized (17.5k FMV new auto + 2.5k cash) - 17k adjusted basis of old auto (35k - 18k)] = 3k realized gain. -recog'd G/L = 2.5k (lesser of 3k realized gain or 2.5k boot rec'd). -G/L deferred = $500 (3k realized gain - 2.5k recog'd). -basis in new prop = [17.5k FMV prop rec'd - 500 deferred gain + 0 deferred loss] = 17k basis. Boot/loot involved. 5. Like-kind exchange; realized gain, boot paid: same facts as OG ex, but new auto taxpayer wants in exchange is worth 22k, so taxpayer agrees to give the other party 2k in cash in addition to the old auto. [17k NBV + 2k cash] = 19k given up. -realized G/L = [22k FMV of new auto - 19k given up (17k adjusted basis of old auto + 2k cash paid)] = 3k realized gain. -recog'd G/L = 0 (lesser of 3k realized gain or 0 boot rec'd). -G/L deferred = 3k (3k realized gain - 0 recog'd). -basis in new prop = [22k FMV prop rec'd - 3k deferred gain + 0 deferred loss] = 19k basis of new prop (same as 17k + 2k given up).
Limited Liability Partnership (LLP)
Sim gen pship. GR: to limit liabs. Must file w/ state. A LLP is sim a gen pship in most respects, incl the sharing of P/Ls, and gen all of the advantages/disadvantages of a gen pship mentioned previously apply to a LLP. Major diffs incl personal liab and formation. 1. Diff; personal liab: -partners are gen not liable for acts of fellow partners, employees, or agents: an LLP differs from a GP in that a partner in an LLP isn't personally liable for the obligations/liabs of the pship arising from errors/omissions/negligence/malpractice/wrongful acts committed by another partner or an employee/agent/rep of the LLP. -personally liable for own negligence and that of people under direct control: LLP partners are liable for their own negligence/wrongful acts and for the negligence/wrongful acts of those under their direct supervision/control. -gen not personally liable for debts and contractual obligations of the LLP. 2. Diff; formation: -LLP must file w/ the state: gen, to become an LLP the pship must file a doc w/ the state (called a registration, stmt of qualification, application for registration, or certificate of LLP). Some states restrict LLPs only to the learned professions, like accting or law. -contents of certificate of LLP: gen, registration must provide info like the LLP's name, the name/location of its registered office, the no of partners, a descr of the pship bus, etc.
Sole Proprietorship
Simplest form of bus oship. One person owns the bus and manages all of its affairs, and the sole proprietor isn't considered an entity sep from the bus. No formality is req'd to form a sole prop, and nothing need be filed w/ the state in which the bus ops (unless the state/city reqs a bus license). -personal liab: sole proprietor is personally liable for all obligations of the bus. -duration: limited. A sole prop can't exist beyond the life of the sole proprietor. May be terminated at any time by its owner. -tax treatmt: P/Ls from the bus flow through the bus to the sole proprietor. -transferability: a sole proprietor is free to transfer his int in the sole prop at will. The sole prop may be a good choice of bus entity when an indiv wants to form a bus he/she will manage, wants to claim the inc/losses from the bus on personal taxes, and doesn't want to bother w/ a lot of formality. The indiv risks all of his personal assets, however, when this type of bus entity is formed.
The Securities Act of 1933; Exemption from Registration: Regulation A
Simplified filing, short form registration. Reg A was modified in 2015, and the mod reg is often referred to as reg A+. Unlike reg D, reg A is *NOT* a registration exemption, but rather is a simplified form of registration designed to allow small cos to make pub offerings more quickly and w/ less cost than is req'd using full registration. Cos using reg A file an offering stmt, which consists of a notification and an offering circular. Cos may test the waters (TTW) 1st before filing, if offers are preceded or accompanied by a preliminary offering circular. Reg A is intended to allow small cos to make IPOs. These cos may not use reg A: 1. SEC reporting cos. 2. Cos planning to merge w/ or acq an unidentified co. 3. Cos seeking to sell ints in oil, gas, or other mineral rights and 4. Cos disqualified by the SEC. There are 2 offering tiers under reg A: tier 1 and 2. Summary of sims and diffs btw them: Tier 1: -dollar limitations: up to $20M w/in a 12-mo pd; not > $6M of the offers to sell can be from sec holders who are affiliates of the issuer. -investor limitations: none. -states may req review: yes; in coordination w/ SEC review. -is gen solicitation allowed? Yes. -must F/S be audited? No, just reviewed. -must filings be updated? no. Tier 2: -dollar limitations: up to $15M w/in a 12-mo pd; not > $15M of the offers to sell can be from sec holders who are affiliates of the issuer. -investor limitations: unaccredited investors may *NOT* invest more than the greater of 10% of their inc or 10% of their net worth; unaccredited entities may not invest > 10% of their rev/assets, whichever is greater. Not 35 rule. -states may req review: no; state review is preempted by reg A. -is gen solicitation allowed? yes. -must F/S be audited? yes, audited F/S and B/S from the past 2 yrs are req'd. -must filings be updated? yes, annual, semiannual, and current event reports must be filed. Gen solicitation is allowed for both bc simplified, not private offering.
Defenses: Statute of Limitations and Statute of Frauds
Statute of limitations: provides that a legal action must be commenced w/in a certain pd of time. Gen, if the statute of lims pd has expired on a contract, it's unenforceable. Doesn't make the contract void, but merely bars access to judicial remedies. Although contracts' statutes of lims vary, 4-6 yrs is typical. Actions for breach usually are measured from the time the cause of action accrued (date of breach). Statute of frauds: Although the GR is that contracts need not be in writing, 6 contracts req some type of writing to be enforceable. Both parties need not sign the writing, only the party to be charged (defendant, trying to avoid the contract) must have signed. 6 contracts under the statute of frauds: *MY LEGS* -contracts in which the consideration is *M*arriage (if you get married, I'll buy you a house). -contracts w/ terms that can't be performed w/in a *Y*ear (I'll coach your team for 5 yrs). -contracts involving an int in *L*and (incl all contracts for the sale of an int in real prop - like for sale of house or warehouse - and *L*eases of real prop of > 1 yr). -contracts by *E*xecutors or sim reps to pay estate debts out of personal funds. -contracts for the sale of *G*oods for $500+. Services can be oral regardless of price if possible to complete w/in 1 yr. -contracts to act as *S*urety (pay the debt of another). It's important to memorize these! Frequently tested. *M*arriage, *Y*ear, *L*and/*L*ease > 1 yr, *E*xecutors, *G*oods, *S*uretyship. Contracts for services can be oral regardless of price so long as they can be completed w/in 1 yr. -for *Y*r contracts (M*Y* LEGS): contracts that can't be performed in 1 yr (or multiyr contracts) must be evidenced by a writing. In determining if a writing is req'd, the 1 yr pd runs from the date of contract, not from when performance begins. So a contract to wash a car 2 yrs from now reqs a writing. Only contracts impossible to perform w/in 1 yr from their making req a writing (ex: a contract to work for an employer for life need not be in writing bc employee could die the next day). -for *L*and contracts (MY *L*EGS): or *L*ease > 1 yr, must be evidenced by a writing. Leases of land for < 1 yr don't req a writing.
Role of State Boards of Accountancy
Statutes in all 50 states grant state boards of acctancy the sole power to license/revoke licenses of CPAs. Rqmts for licensure vary btw states. Req successful completion of the CPA exam and all/some of these things: -residency rqmt -education rqmts -experience rqmts Since a state board is the only entity that can license a CPA, it's also the only entity w/ the power to suspend/revoke a CPA's license. Although each state determines what constitutes prof misconduct by a CPA sufficient to subject them to disciplinary action, there are 3 broad categories of misconduct: -misconduct while performing accting services (negligence, fraud, dishonesty, etc.). -misconduct outside the scope of accting services (intoxication from alcohol/drugs that sig impairs the acctants ability to perform accting services, insanity, etc.). -criminal conviction (commission of felony, failure to file TRs, crimes relating to the practice of accting, etc.). After investigation of prof misconduct, the state board can conduct a formal hearing for possible disciplinary action. -must find it more likely than not that the acctant's actions constituted prof misconduct. Proof beyond a reasonable doubt (std in criminal cases) is *NOT* req'd. -the acctant is entitled to due process of law. -all adverse state board decisions are subj to judicial review. This is for license, money, or jail. There are 5 penalties that a state board of acctancy may impose for prof misconduct (no jail): -suspension/revocation of license (only state board) -monetary fine -reprimand/censure -probation -rqmt for continuing prof education (CPE) courses
Creation (Attachment) of the Security Interest
Step 1. Establishes the right of a creditor in collateral vis-a-vis (in relation to) the debtor. There are 3 requisites for attachment: 1. Agreemt: parties must have an agreemt creating the security int evidenced by either an authenticated record of the security agreemt OR the creditor's taking possession (pledge) or control of the collateral (oral). Before computers, article 9 req'd a security agreemt to be written/signed. The term authenticated record incl such writings and their modern electronic equivalent. A security int in investmt prop, nonconsumer deposit accts, and electronic chattel paper may be evidenced by control. Gen, a creditor has control over an item if the creditor has power to make/prevent dispositions of the collateral. Ex: the bank in which a nonconsumer deposit acct is maintained has control over it. 2. Value: lend $$/sell on credit. Value must be given by the secured party in exchange for the security int (ex: the creditor gives the debtor a loan for a security int in the debtor's equip - the loan is value. This is true even if the loan was made earlier - an antecedent debt is value too). 3. Rights: the debtor must have rights in the collateral (usually outright oship, but C/B something less, like a possessory right under a rental agreemt). These three elements must coexist for the security int to attach. Attachmt will be effective when all 3 requisites are satisfied. Book ex for attachmt: on 5/1, A fills out a loan application, incl a security agreemt, from bank to borrow 1k to buy a stereo. Bank tells A it will take 5 days to process the loan. On 5/6, A gets the money from bank. Buys stereo on 5/7. The security int attaches on 5/7 bc it's the earliest date on which all 3 rqmts for attachmt were met. The agreemt was made on 5/1, value was given 5/6, and A obtained rights in the collateral on 57. A frequently tested secured trans issue on the CPA exam is what is/isn't a rqmt of attachmt. Key points to remember: -bc the creditor must either take possession or control of the collateral or obtain an authenticated record of a security agreemt, neither is specifically req'd (either will do, but 1 must be present). -if there's a record of the security agreemt, it must be authenticated (signed) by the debtor, not the creditor. -the debtor must have rights in the collateral, but need not necessarily own it. -a financing stmt is not req'd (step 2). It's related to perfection, not attachmt. A secured party will sometimes want to obtain an security int not only in the debtor's present prop, but also in prop the debtor will obtain in the future (after-acq'd prop). This is permissible. The security int attaches to the prop as soon as the debtor acqs an int in the prop. A secured party has a duty to file or send the debtor a termination stmt when the debt is paid, confirm for the debtor the unpaid amt left on the secured debt, and use reasonable care to preserve any collateral in the secured party's possession.
Perfection of the Security Interest
Step 2. Against 3rd parties. To acq the max priority in collateral over other/3rd parties who may have an int in it (like subseq purchasers of the collateral, unsecured creditors, and other priority creditors), the secured party must perfect. 5 methods of perfection. 1. Filing 2. Taking possession of the collateral 3. Control 4. Automatic perfection and 5. Temporary perfection The examiners like to ask abt the relationship btw perfection and attachmt. Key point to remember is that a security int can't be perfected before it attaches to the collateral, but attachmt and perfection can occur at the same time (like by taking possession of the collateral). 1. Perfection by filing: a security int may be perfected as to all kinds of collateral except deposit accts and money by filing a financing stmt. The law simply reqs notice filing, doesn't req filing a copy of the security agreemt. Notice is given by filing a financing stmt, which contains these elements: -name/address of the debtor and secured party. -indication of the collateral covered by the financing stmt. -if the financing stmt covers collateral related to real prop (like minerals, crops, or fixtures), a descr of that real prop. A gen descr of the type of collateral (inv or equip) is sufficient in the financing stmt. A descr of particular collateral is not necessary. The debtor must auth (sign) the filing of a financing stmt in an authenticated record (the auth can't be oral). A debtor will be deemed to have auth'd the filing if the debtor authenticates a security agreemt covering the collateral that's covered by the financing stmt. Gen, financing stmts are filed centrally, w/ the secretary of state (SoS). A financing stmt is effective for 5 yrs. Can be renewed for additional 5-yr pds by filing a continuation stmt. A creditor can file a financing stmt before all of the steps for attachmt are complete. In that case, the security int isn't perfected until it attaches to the collateral. However, *priority will date back to the date of filing*.
Tort Liability Continued
Step 2: scope of employmt. An employer isn't liable to an injured party merely bc an employee caused the injury - the injury must have occurred w/in the scope of employmt (while the employee was working for the employer w/in the time and geographic area in which the employee was to work). 1. Activities: the conduct causing the injury need not actually have been auth'd by the employer; rather the conduct need only be (i) the same gen type the employee was hired to perform and (ii) actuated, at least in part, by a desire to serve the employer. -Book ex for liab of employer for employee: although bar owner might not auth a bouncer to beat up boisterous customers, the owner can still be held liable if this conduct occurs bc it's of the same gen nature as the bouncer's job. -the employer is usually only liable for an employee's negligence and *NOT* for intentional torts, since intentional torts are seldom w/in the scope of employmt. However, where the tort or use of force is auth'd (like a bouncer), the employer can be liable. -an employer gen isn't liable in torts for an employee's conduct constituting a serious crime (like carrying an illegal weapon). The examiners often ask abt a principal's liab for its agent's torts. Remember, if the agent is an employee and committed the tort while trying to serve the principal/employer, the principal/employer will gen be liable unless the tort was unexpected (like illegal conduct). 2. Time and geo area: it's not enough that the conduct that caused the injury was of the same gen type the employee was hired to perform. Must also have occurred w/in usual employmt time and space limits. -small detours from employer's directions (driving a little out of the way, stopping for lunch, etc.) fall w/in the scope of employmt. -Major deviations (frolic) from an employer's directions (driving 15 miles out of the way to go to a party) fall outside the scope of employmt. 3. Cannot limit liab by agreemt w/ employee: an agreemt btw the employer/employee that the employer won't be liable for employee torts does *NOT* prevent a 3rd party from holding the employer liable. The employer can seek reimbursemt from the employee.
Corporation; Fundamental Changes Continued Further
Still on DA*M*S. An exception is the merger of a sub (short-form merger). A parent corp owning 90% + of a sub corp may merge the sub into the parent w/o the approval of the SHs of either corp or the approval of the sub's board. Neither entity. The parent must mail a copy of the plan to each SH who has not waived his right. A corp merged into a surviving corp ceases to exist as a sep entity. The surviving corp has all rights, liabs, and obligations of the merged corps. When a sh exchange takes place, the shs are exchanged as the plan provides, and holders are entitled only to the rights of the exchanged shs. If a corp is faced w/ the prospect of being taken over and the BOD wants to resist the takeover attempt, may do so in a no of ways, incl: -persuading SHs to reject the offer. -suing the person/co attempting the takeover for misrep or omission and obtaining an injunction against the takeover. -merging w/ a white knight (co w/ which the directors want to merge). -making a self-tender (offer to acq stock from its own SHs and thus retain control to prevent a takeover). -paying greenmail (pay the person/co attempting the takeover to abandon the takeover attempt). -locking up the crown jewels (giving a 3rd party an option to purch the co's most valuable assets). -undertaking a scorched earth policy (to sell off assets or take out loans that would make the co less financially attractive). -applying shark repellent, which means amending the articles of incorp/bylaws to make a takeover more difficult (like req a large no of SHs to approve the merger). Termination of a corp, dissoution (*D*AMS), is a fundamental change, reqing director and SH approval. Dissolution can also be pursuant to a ct order. After dissolution, the corp continues in existence for the purpose of winding up. Liquidation involves the process of collecting the corp assets, paying the exps involved, satisfying creditors' claims, and distributing the net assets of the corp.
Corporate Distributions; Stock Redemption
Stock redemptions occur when a corp buys back stock from its SHs. If the stock redemption qualifies for sale/exchange treatmt, G/L is recog'd by the SH. If not, the redemption is treated as a div to the extent of the corp's E&P. The corp can recog gain (but not loss) on any appreciated prop distr'd as though it had sold the prop for FMV. -Proportional stock redemptions: taxable div inc (to SH - ord inc). Gen, the corp either redeems or cancels the stock pro rata for all SHs. -Disproportional stock redemptions (substantially disproportionate): sale by SH subj to taxable cap G/L to SH. Disprop means there has been a meaningful reduction in the SH's oship int. The % oship after the redemption must be <50% *AND* must be <80% of the % oship before the redemption. % oship incl what's owned by certain fam members (spouse, kids, grandkids, parents). Regardless of fam oship, a complete 100% term of a SH's int is considered disprop. -Partial liquidation of corp (stock held by noncorp SH): treated as an exchange of stock, not a div. -Complete buyout of stock: SHs entire int is redeemed, and the trans is treated as an exchange of stock. -Redemption not essentially equivalent to a div: treated as an exchange of stock. -Redemption to pay estate taxes or exps: treated as an exchange when the corp redeems stock that has been incl in the decedent's gross estate (subj to dollar and time limitations).
Workers' Compensation
Strict liab. State-run programs designed to enable employees to recover for injuries incurred while on the job. In most states, coverage is compulsory. Employers are strictly liable regardless of fault. Only rqmt is that the employee's injury occurred while acting in the scope of employmt. Fault is the most frequently tested issue in workers' comp. Remember that an employee can collect even if the employee was negligent, grossly negligent, or assumed the risk. Employee can't recover for injuries resulting from intoxication, fighting, or self-inflicted wounds. The purpose of workers' comp is to enable employees to recover from work-related injuries, regardless of negligence. Most employers must participate in workers' comp program. There are exceptions for agricultural workers, domestic workers, casual workers (like temp office workers), public employees, and indep contractors. Some states also exempt employers who have up to only 3 or 4 employees. The employer pays for workers' comp by purchasing ins from the state or a private carrier. Some states also allow employers to be self-insuring if they can prove they are financially responsible. In most states, coverage is compulsory. In states in which coverage isn't mandatory, an employer who elects not to participate in workers' comp gives up the common-law defenses of contributory negligence, assumption of risk, and the fellow servant doctrine. Also, damage awards aren't limited to what W/B recovered under workers' comp. Workers' comp ins premiums are ord bus exps deductible by the employer. Bc employees don't pay, no deduction for the worker. Workers' comp provides benefits for any injury/disease (incl aggravations of existing diseases) resulting from employmt. Benefits incl money for loss of inc, disability, loss of limbs, prosthetic devices, medical services, burial costs, and survivors' benefits. The program works like other ins, benefits are *NOT* limited to what was paid in on the employee's behalf. GR: can't sue employer but can sue 3rd parties.
Taxation of Foreign Entities; Anti-deferral Rules
Subpart F inc: The subpart F rules of the IRC are designed to prevent US SHs of a controlled foreign corp (CFC) from deferring inc recog and US tax until earnings are distr'd. The rules trigger immediate recog of CFC subpart F inc (gen incl certain types of passive inc), included on a pro rata basis on the SHs' TRs and treated as a deemed div taxed at ord rates (this is reported on sch C of Form 1120, or sch K of the 1120S or 1065). Relief through the FTC is still available, however, and the inc is not taxed again when actually distr'd. A foreign corp is considered a CFC if 50%+ of its stock is owned by US SHs on any day of the yr. A US SH is a person owning 10%+ of the CFC (constructive rules apply in this determination). If a co meets the oship rqmt as a CFC SH, it will also need to file Form 5471, info return of US persons w/ respect to certain foreign corps. Passive Foreign Investmt Co (PFIC): The PFIC anti-deferral rules apply to US residents who invest in a foreign corp, if at least 75% of the gross inc of such corp is passive inc OR at least 50% of the avg assets held by such corp are the type that produce passive inc. Passive inc here incl divs, int, royalties, rents, annuities, net gains on prop that gives rise to these items, etc. Usually the same inc that's passive under the subpart F rules. Direct/indirect US SHs of a PFIC are all subj to PFIC rules and are taxed in 1 of these methods: qualifying electing fund (QEF), mark-to-mkt rules, or excess distr rules. Info regarding the co's investmt in the PFIC is reported on Form 8621, info return by a SH of a PFIC or QEF. When both the PFIC and subpart F anti-deferral rules apply, the subpart F rules supersede the PFIC rules. Book ex for overlap btw PFIC rules and subpart F rules: Co A (US co) is a 12% owner in a foreign corp, D, whose primary source of inc (80% gross inc) is investmts. The other SHs of D are 60% US residents (split btw 6 US SHs) and 28% foreign residents. Determine the tax treatmt of A's investmt in D. -D qualifies as a CFC (owned 72% by 10% US SHs) and a PFIC (80% passive gross inc, >75%). -since the subpart F rules supersede the PFIC rules, A's inc from D will be subj to subpart F rules, resulting in immediate inc recog of D's subpart F inc.
Dividends-Received Deduction Continued
Summary of corp TI limitations: 1. gross inc (incl div inc). 2. LESS: deductions. Special deductions not included: -charity deduction -DRD -domestic production activities deduction -NOL CB -CL CB =3. A subtotal. 4. LESS: charity: -not gifts ($25 for bus gifts) -not political (none) -max allowed is 10% of A subtotal -5-yr CF -accrued amts are deductible if paid w/in 3.5 mos of YE. =5. B subtotal. 6. LESS: DRD. Rqmts are that (1) 1st corp is taxed and (2) owned 45 days before or after. Div inc: -100% if own 80-100% (consol) -80% if own 20 - <80% (large investmt) -70% if own <20% (small investmt). "Unrelated." -limited to % of B. -exception: if DRD creates/adds to corp NOL, DRD isn't limited to % of TI. =7. TI or loss. -NOL (hindsight is 2 x 20). The chart indicates that the corp char deduction is limited to 10% of A, which is defined as [gross inc - deductions] w/ 2 special deductions not included. The 70% and 80% deductions op exactly the same except for the % diffs. If you're polite take smaller piece of 70/80% of div or 70/80% of B. Losers (NOL) aren't polite and take the large piece.
Circular 230; Duties and Restrictions Continued Further
Tax advisors should provide clients the highest quality rep by adhering to best practices in providing tax prep advice/assistance in a submission to the IRS. These incl: -communicating w/ the client abt the terms of the engagemt to determine the client's purpose/use for the advice. -establishing the facts and arriving at a conclusion supported by the law and facts (not probability of being caught/audited). -advising the client abt the importance of the conclusions reached (like whether the client will be able to avoid penalties). -acting fairly and w/ integrity in practice before the IRS. -taking reasonable steps to ensure that *all members*, associates, and employees of the firm follow procs consistent w/ the above items. These best practices are super important! A practitioner may *NOT* endorse/otherwise negotiate any check issued to a client by the govt in respect of a fed tax liab (incl directing/accepting pmt by any means, electronic or otherwise, into an acct owned/controlled by the practitioner or any other firm w/ whom the practitioner is assoc'd). A practitioner can't notarize any signature of any person w/ respect to any matter in which the practitioner has an int (gen by repping a taxpayer before the IRS).
Gains (Excluded or Deferred); Homeowner's Exclusion Continued Further
Taxpayers may be eligible for a partial exclusion (not a reduced amt of gain eligible for the exclusion) if the sale is due to a change in place of employmt, health, or unforeseen circumstances, and the exclusion has been claimed w/in the previous 2 yrs or the taxpayer fails to meet the oship/use rqmts. This is the hardship provision. Under the hardship provision, the max exclusion is calc'd as [{the mos of qualifying oship/24 mos} x the max exclusion available to the taxpayer based on filing status]. The 24 mos is the min time pd the taxpayer must own/use the home to qualify for the exclusion. To meet the hardship provision for change in employmt, the taxpayer's new place of employmt must be at least 50 miles farther from the residence that's sold than was the distance btw the taxpayer's prev job and the home sold. Book ex for hardship provision: one yr after purchasing her home and living in it as her principal residence, a single taxpayer was diagnosed w/ nontreatable cancer. Sold her home to move in w/ her daughter, who would be caring for her. Sold the home for a gain of 150k. Determine the amt, if any, of the homeowner's exclusion available to the taxpayer. -not eligible for the max exclusion of 250k bc didn't meet the oship test. -exclusion available under the hardship provision = 125k. -[{12 mos/24 mos} x 250k] = 125k.
Temporary v Permanent Differences
Temp diffs are items of inc/exp that are recog'd in 1 pd for book but a diff pd for tax. These cause timing diffs btw the 2 incs, but there's no diff btw book and tax in the long run. Perm diffs are items of inc/exp that are recog'd for book but never for tax, or vice versa. Never reverse! For ex, depr is usually calc'd SL for books but accelerated (MACRS) for tax. Diff btw them will create an annual diff in depr exp, but ultimately will result in the same total deduction for book/tax, so temp diff. An ex of a perm diff is muni bond int inc, which is recog'd as inc for books, but always excluded for tax. This diff will never reverse. Book ex for temp v perm diffs: B corp recorded book inc of 560k for 20X6, which incl SL depr of 8k and muni bond int of 4k. MACRS depr is 12k (4k depr diff). Royalty inc of 17k was rec'd in advance of being earned (this is taxable) and approp not recorded for books. Reconcile book inc to TI. -temp diffs: 17k royalty inc for tax when rec'd, 0 for books until earned; 4k excess MACRS depr over SL. Net temp diffs are [17k - 4k] = 13k. -perm diffs: 0 muni bond int for tax, 4k for books. Subtract out for tax. -[560k book inc + 17k royalty inc for tax but not books - 4k muni inc for books but not tax - 4k depr deduction for tax but not books] = 569k TI. Exs of perm diffs (never reverse): -M&E -penalties -lobbying/political exps -state/muni bond inc Exs of temp diffs (timing diffs): -installmt sales -depr: MACRS v SL -char contrs (10% of letter A inc limit for tax) -start-up/org exps (look @ mos!) -bad debts (write-offs only for tax)
Federal Securities Regulation
The 2 major securities acts that you must know are the Securities Act of 1933 and the Securities Exchange Act of 1934. The 1933 act regulates OG issuance of secs (IPO), and the 1934 act regulates purchases/sales after initial issuance. A good rule of thumb for determining whether something is a sec is to ask whether the investor expects to take part in the mgmt of the bus. If the investor is passive (relies solely on the mgmt of others to make $$$), the investmt most likely is a security. Stocks, bonds, debentures (unsecured loan certificates issued by a co), oil well ints, stock ops, collateral trust certificates, warrants, and limited phsip ints are deemed secs and investmt contracts. CDs and gen pships ints are gen *NOT* deemed to be secs. In the case of gen partners, each partner is expected to participate in running the bus.
Audit Process
The FIT system is based on the self-assessmt of taxes. All persons w/ TIs exceeding certain amts are req'd to file annual inc TRs and timely remit taxes due. The audit process helps ensure this voluntary assessmt/pmt is actually occurring. A return may be examined/audited for a variety of reasons, and the exam may take place in several ways. After the audit, if there are any changes to the tax payable, the taxpayer either can agree w/ the changes and pay the additional tax or disagree and appeal the decision. Int on unpaid taxes may also be due. Selection of returns for audit (variety of ways): -statistical models: the IRS utilizes these (a form of discriminant analysis called the discriminant inv function system (DIF)) to select TRs most likely to contain errors and yield sig amts of additional tax rev upon audit. -random selection: in addition to statistical selection, a small no of additional returns are manually selected. -PY audit: if the taxpayer was audited in a PY and that prior audit led to assessmt of substantial deficiency, a subseq yr may be audited. -info return discrepancy: if info forms like W-2s and 1099s don't match the amts reported on a return, or if info is rec'd from other sources on potential noncompliance, an audit may be triggered. -deductions that exceed established norms: if an indiv's itemized deductions are in excess of norms established for certain inc levels, the return may be selected for audit. Most indiv returns are audited w/in 2 yrs from the date of filing the return. However, returns may be audited at any point prior to the expiration of the statute of lims. Even then, the taxpayer may consent to extend this statute upon IRS request. Large corps are subj to annual audits.
Taxpayer Penalties
The IRC contains many sections setting forth penalties, both civil and criminal, which the IRS can seek to impose on the taxpayer. 1. EIC penalty: more a statutory restriction on claiming the credit, rather than a penalty. Taxpayers who negligently claim the EIC may not claim it for 2 subseq yrs or for up to 10 yrs if the claim was fraudulent. 2. Penalty for failure to make sufficient estimated IT pmts: taxpayers (incl corps, estates, and trusts) who don't have sufficient amts of withholding and don't make timely pmts of estimated IT (incl SE tax) must pay this penalty, which accrues from the date the estimated IT must be paid until the TR due date w/o extensions. Penalty exceptions incl withholding and timely estimated pmts that are: -< or equal to 1k of CY tax. -at least 90% of the CY's tax. -at least 100% of the PY's tax (110% of PY's tax if PY's AGI exceeded 150k). -equal to estimated CY tax based upon the annualization of inc method. 3. Failure to file penalty: 5% per mo. 5% of the amt of tax due for each mo (or part of) the return is late, up to a max of 25%. Other key aspects of this penalty: -if the return is > 60 days late, the min penalty incrs to the lesser of $210 or 100% of the tax due. -if no tax is due, there's no failure to file penalty. -if both the failure to file penalty and failure to pay penalty are due, the failure to file penalty is reduced by the amt of the failure to pay penalty. -the penalty for failure to file a pship TR is $200/mo (or part therof, up to a max of 12 mos) the return is late (or req'd info is missing) x the no of people who are partners in the pship at any time during the yr. So [200/mo x total partners] for up to 12 mos. 4. Failure to pay penalty: 1/2 of 1% per mo (or any part of) up to a max of 25% of the unpaid tax. There's no penalty if at least 90% of the tax is paid in by the unextended due date and the bal is paid in by the extended due date. 5. Negligence penalty w/ respect to an understmt of tax (accuracy-related penalty when understmt isn't substantial): *NOT* fraud. This is an accuracy-based penalty for negligence or disregard of tax rules/regs. The penalty is 20% of the understmt of tax. -negligence means any failure to make a reasonable attempt to comply w/ the provisions of the IRC. -disregard means careless, reckless, or intentional disregard. -if the IRS imposes this penalty, the IRS can't impose either the penalty for substantial underpmt of tax or the penalty for a substantial valuation misstmt.
Affiliated Groups and Transfer Pricing; Arm's-Length Standard
The IRS adjustmts necessary to determine true TI (as opposed to the TI the taxpayer reported on their TR) apply to controlled transactions/transfers. The purpose of these adjustmts is to assume that reported prices (as adj per the auth given to the IRS) that one affiliate (controlled taxpayer) charges to another affiliate yield results consistent w/ the results that would have been realized if uncontrolled taxpayers had engaged in the same trans under the same circumstances (arms-length std). This applies to related party trans. A controlled transaction/transfer meets the arm's-length std if the results of the trans/transfer are consistent w/ the results that would have been realized if uncontrolled taxpayers had engaged in the same trans or transfer under the same circumstances. Related party trans = co customer trans results. Bc identical trans can rarely be located, whether a trans produces an arms-length result gen will be determined by reference to the results of comparable trans. Various stds of comparability (applicable pricing methodologies) are allowable and set forth in US treasury regs. Most common pricing methods: -comparable uncontrolled price (CUP): only for tangible prop (sales, purchases, and leases). Based upon ref to published mkt data. -comparable uncontrolled trans (CUT): only for intangible prop (regarding royalty pmts). -resale price: tangible prop only. -cost plus: tangible prop only. -comparable profits method: based upon op margin, gross margin, return on assets (ROA), or return on cap.
Capitalize or Expense
The IRS has issued regs specifying whether/when a taxpayer must capitalize costs incurred in acquiring, maintaining, or improving tangible prop. If the regs don't req capitalization, the costs are considered repairs and expensed. The GR is that all tangible prop that's not inventory must be capitalized, unless there's an exception. Materials and supplies are expensed. Gen, an item that costs 200 or less and has an economic life of 12 mos or less qualifies as materials/supplies. If the tangible prop qualifies as materials/supplies, it can be deducted in the yr of consumption if non-incidental, or the yr paid if incidental. Amts paid to acq/produce tangible/intangible prop are capitalized. Improvemts are capitalized. Improvemts to a single unit of prop must be capitalized if they result in a betterment to the prop, adapt the prop to a new/diff use, or result in a restoration of the prop. Indirect costs, like otherwise deductible repair/removal costs, that directly benefit or are incurred by reason of an improvemt, must be capitalized. A single unit of prop (UOP) is defined as all components that are functionally interdependent. A component is functionally interdependent if the placing in service of 1 component is dependent on the placing in service of other components. -a bldg structure is a single UOP to the extent of the bldg and its structural components other than those designated as bldg systems (HVAC, plumbing, electrical, etc.). -designated bldg systems considered sep from the bldg structure incl heating/ventilation/AC, plumbing, electrical, escalators, elevators, alarm/fire protection, security, and gas distr systems. -any amts paid/incurred to improve designated bldg systems are considered sep from the bldg structure and subj to the improvemt rules. Intangible prop is capitalized. Amts paid/incurred for acqing/creating/enhancing intangible prop must be capitalized. If an asset is req'd to be capitalized, its HP starts as of the date the asset is completed. There's some ambiguity as to when the constructed asset is considered completed, so detailed records S/B kept as to when expenditures have been capitalized.
Tax Return Preparer Continued
The IRS reqs all TR preparers to register w/ the IRS and obtain a PTIN. The signing TR preparer is the indiv TR preparer w/ the primary responsibility for the overall substantive accuracy of the prep of such return/claim for refund. The nonsigning TR preparer is any TR preparer who isn't signing a TR but who prepares all/a substantial portion of a return/claim for refund or offers advice (written/oral) to the taxpayer (or another TR preparer) when that advice leads to a position/entry that constitutes a subst portion of the return. Not primary. Assist, not merely mechanical. Factors to consider in determining whether a schedule/entry/portion of return or claim for refund is a substantial portion incl but aren't limited to the size/complexity of the item relative to the taxpayer's gross inc and the size of the understmt attributable to the item compared to the taxpayer's reported tax liab. Book ex for nonsigning TR preparer: an attorney, who's a PTIN holder, provides a spreadsheet to a CPA that shows the calc of inc to be reported on the inc TR of an estate. The inc reps a substantial portion of the return yet the attorney doesn't prep any other portion of the TR and doesn't sign it. The attorney C/B regarded as a nonsigning preparer for the return for the purpose of assessing TR preparer penalties.
Schedules M-1 and M-3
The IRS reqs that a co reconcile book/tax diffs on either the M-1 or the M-3 (based on total assets of co). Sch M-1 doesn't distinguish btw temp/perm diffs. The M-3 breaks out items of book inc/exp in more detail, and distinguishes btw temp/perm diffs. If the total assets of the co are $10M +, the co is req'd to reconcile book and taxable inc/loss on sch M-3. Book ex for sch M-1: 1. NI/loss per books. 2. + fed IT (per books). 3. + excess CLs over gains. 4. + inc subj to tax not recorded on books this yr, + installmt sale inc, + rents rec'd in advance. 5. + exps recorded on books this yr not on tax return, + book depr + M&E in excess of 50% allowance, + AFDA (incr) + warranty accrual + GW impairmt per books, + pension exp accrued, + penalties. 6. Subtotal lines 1-5. 7. - inc recorded on books this yr not incl on TR, - TE int, - life ins proceeds. 8. - deductions on this return not charged against book inc for the yr, - tax depr, - contr carryover, - section 179 deduction, - direct BD write-offs, - actual warranty costs, - amort of org cost, - GW amort per return, - pensions paid. 9. Subtotal lines 7-8. 10. TI [line 6 - line 9]. This goes on line 28 P1 of Form 1120. TI per page 1 of the TR before the DRD and the NOL CF deduction. Sch M-1 incl: -reconciliation of inc/loss per books w/ inc per return. -has all items shown above. -adds on the left, subtracts on the right. Sch M-2 incl: -analysis of unapprop'd RE per books (must tie to sch L). -[BB + NI + other - distrs - other] = EB. Sch M-3 incl: -NI/loss reconciliation for corps w/ total assets of 10M+. -fin info and NI/loss reconciliation. Bunch of Qs and some consol info. -reconciliation of NI/loss per I/S of includable corps w/ TI per return. GAAP on left, temp/perm diffs in the middle, tax on right. Can add/subtract across for each line item. -incl inc/loss items and exp/deduction items.
Terminating the S Corporation Election
The S corp status will term as a result of any of these: -holders of a majority (51% +) of the corp's stock (any combo of voting/nonvoting C/S) consent to voluntary revocation. -the corp fails to meet any or all of the eligibility rqmts (qualifications) for S corp status. The most common are corp owner and foreign owner. ->25% of the corp's gross receipts come from passive investmt inc for 3 consecutive yrs and the corp had C corp E&P at the end of each yr. The S corp status is terminated as of the beginning of the 4th yr. W/ C corp E&P, 3 strikes and you're out! Book ex for S corp termination: Small corp is an S corp, which has maintained a valid S election since 2005. In the CY, small admits large corp, a C corp, as a 40% SH. Determine the impact on the S election. -bc large corp is a C corp, small would no longer meet the rqmts of an S corp, and its S election W/B terminated upon the admittance of large as a SH. Once an S corp election is terminated or revoked, a new election can't be made for 5 yrs, unless the IRS consents to an earlier election. So wait 5 yrs or ask IRS permission. If the termination occurs in midyr, the corp will have 2 short yrs, a short S yr and a short C yr. Earnings are prorated on a daily basis to each of the short yrs. A special election may be made to cut off net inc at the exact date of conversion.
Formation of C Corporations; Shareholder Tax Consequences
The SH contributing prop (not services) in exchange for corp C/S has no G/L if these 2 conditions of IRC section 351 have been met: 1. 80% control: immediately after the trans, those transferors/SHs (control group) own at least 80% of the voting stock and at least 80% of the nonvoting stock. 2. No receipt of boot: boot C/B cash withdrawn or excess debt put into corp. These items rep boot (taxable) and will trigger gain recog: -cash withdrawn (boot rec'd may generate gain to transferor) and -receipt of debt secs (like bonds) The amt of liabs assumed that exceeds the adjusted basis of the total assets transferred to the corp is not boot (per se), but does generate gain. [NBV assets - liabs] = excess liab, gain. The basis of C/S rec'd from the corp will be the total of: -cash: amt contr'd. -prop: adjusted basis (NBV). The adjusted basis of the prop is reduced by any debt on the prop assumed by the corp (COD). [Asset NBV - liab] = basis in stock. Gain recog'd by the SH (when the debt exceeds the asset's adjusted basis) is added to bring the stock basis to 0. -services: FMV (taxable). The SH receiving C/S for services rendered must recog the FMV as ord inc. A SH who contrs only services isn't counted as part of the control group for purposes of the 80% control. The GR for taxable events and basis applies to corps: -taxable = FMV inc and FMV basis. -nontaxable = no inc and NBV basis (NBV - liabs = basis). Detailed alternative calc of basis to SH: [Adjusted basis of transferred prop (incl cash) + FMV services rendered + gain recog'd by SH - cash rec'd - liabs assumed by the corp - FMV of nonmoney boot rec'd] =basis of C/S. This is the exception to the GR.
Taxation of a C Corporation; Graduated Tax Rates and Taxable Income
The TI of a corp is arrived at by taking gross inc (basically same items as incl in indivs gross inc) and deducting the same bus exps an indiv would deduct. A corp, however, receives no exemptions. A corp's TI is subj to this graduated tax schedule: TI on left, rates for amt over x inc on right, -TI 1-50k: 15% of amt over 0 -TI 50,001 - 75k: 7,500 + 25% of amt over 50k -TI 75,001 - 100k: 13,750: 34% of amt over 75k. -TI 100,001 - 335k: 22,250 + 39% of the amt over 100k. -TI 335,001 - 10M: 113,900 + 34% of the amt over 335k. -TI 10,000,001 - 15M: 3.4M + 35% of the amt over 10M. -TI 15,000,001 - 18,333,333: 5.15M + 38% of the amt over 15M. -TI 18,333,333+: 35% of the amt over 0. The rate brackets above 35% result from a phase-out of lower brackets such that corps w/ TI above 18,333,333 will have all inc taxed at a flat 35%. Personal service corps are subj to a flat 35% tax rate regardless of their inc. Taxes incl: 1. Regular tax 2. Accumulated earnings tax OR personal holding co tax 3. AMT Up to 3 taxes on C corp! Graduated tax schedule relates to regular tax (1 of 3).
Federal Judicial Process Continued
The US district cts (2 of 3) are the gen trial cts of the US fed ct system. Both civil and criminal cases (not just tax cases) are filed in the district cts. There's at least 1 district ct for each state and other district cts for territories. Typically, a taxpayer will request a hearing before the district ct that has jurisdiction over the location in which the taxpayer lives/conducts bus. The disadv of these is that the taxpayer must pay the disputed tax liab before taking their case to the US district ct to sue for a refund. Gen, a claim for a refund must be filed w/in 3 yrs from the date the OG return was filed or 2 yrs from the date the tax was paid, whichever is later. These cases are heard before 1 judge (not a panel), and the taxpayer can request a jury trial (potential advantage). The US ct of fed claims (3 of 3) is a nationwide ct that has jurisdiction over most claims for money damages against the US, one type of which is tax refunds. The ct has concurrent jurisdiction w/ US district cts when the claim is for < 10k, and there's a statute of lims of 6 yrs from the time the claim arose. The taxpayer must pay the disputed tax and sue the IRS/govt for a refund (disadv). The ct of fed claims doesn't allow jury trials on any matter (disadv). There are 16 judges. Summary of US trial ct system: -US tax ct: nationwide ct solely for tax cases. No pmt req'd and has small claims division to hear claims involving disputed liabs of 50k or less. Judges are tax experts, no jury trial. Decisions are regular or memorandum. -US district ct: located throughout the US, w/ each ct assigned a specific geographic area. Pay and sue for refund. Judges aren't tax experts, jury trial is an option. -US ct of fed claims: located in DC. Pay and sue for refund. Jury trial not available. Gen handles large tax claims for high-worth indivs and national/multinational cos. The US cts of appeals (circuit cts) are the 1st level of fed appellate cts. A ct of appeals hears appeals from the US district cts and US tax ct. The US circuit ct of appeals (ct of appeals for the fed circuit) hears appeals from the US ct of fed claims. The US supreme ct is the highest ct in the nation and the last level of appeal. There are 9 justices (judges) that hear all cases the sup ct agrees to consider (grants writ of certiorari) in DC. No jury. The sup ct seldom hears tax cases (rare!). In most cases where it does hear a tax case, it's where there's a conflict among the cts of appeals.
Elements of a Legally Enforceable Contract; Agreement: The Acceptance
The acceptance is the offeree's assent to enter into a contract. Like offers, acceptances need not be in writing. An acceptance doesn't even req words. A simple nod or fall of a gavel (auction) can constitute an acceptance. -who may accept: GR is only the person to whom the offer was made may accept. Offers aren't assignable. Option contracts are assignable. -method of acceptance: gen may be in any manner reasonable under the circumstances (a mailed offer can be accepted by letter, email, etc.). However, if the offeror specs the method of comm, that method must be used. A purported acceptance w/ another method is a counteroffer. -acceptance gen must be unequivocal: common law (*RISE*) contracts follow the mirror image rule, which reqs an acceptance to mirror the offer to be effective. An attempted acceptance that changes some terms or adds new ones is not a valid acceptance, but rather a counteroffer, which serves as a rejection. The UCC does allow some minor changes, but the common law doesn't! -gen effective upon dispatch (mailbox rule): unlike revocations, rejections, and counteroffers (all must be rec'd to be effective), acceptances are gen effective when dispatched (mailed, emailed, faxed, etc) if properly addressed. This is the mailbox rule. It's irrelevant if a properly addressed acceptance is lost/delayed. Book ex for mailbox rule: on 2/1, A sends B a letter offering to employ B at A's dealership. On 2/5, B sends A a letter accepting. On 2/6, A changes her mind and calls B to revoke. On 2/7, A recs B's acceptance. -a contract was formed on 2/5, when the acceptance was sent. A's revocation is ineffective bc it came too late (after aceptance sent). The date A rec'd the acceptance is irrelevant. -under the mailbox rule, a contract is formed on dispatch even if the acceptance letter is never rec'd by the offeror.
Requirements of Regulatory Agencies; The American Institute of CPAs (AICPA) and State CPA societies
The code of prof conduct applies to all AICPA members. Many state CPA societies and state boards have incorp'd all/parts of the code. The AICPA and 49 state societies have created the Joint Ethics Enforcemt Program (JEEP) for enforcemt of their codes of conduct by means of a single investigation/action. Investigative info is shared btw the AICPA and state societies. JEEP objs also incl the promotion of uniformity in the codes of conduct of the AICPA and state CPA societies and uniformity in enforcemt and implementation of the codes of conduct. The AICPA and state societies can sanction their members, but can't suspend/revoke a CPA's license. AICPA may suspend/term membership for failure to pay dues or comply w/ membership retention rqmts (practice-monitoring or CPE rqmts). Membership can be suspended/terminated w/o a hearing for (no $, license, or jail): -proof of conviction of a crime punishable by imprisonmt for > 1 yr. -proof of conviction for willful failure to file any inc TR. -proof of conviction for filing a false/fraudulent TR or aiding in the prep of a false/fraudulent TR of a client. -supension/revocation of a member's license to practice pub accting as a disciplinary measure by a govt auth.
Corporate Taxable Income; Gross Income and Accrual v Cash Basis
The concept of gross inc is sim for corps and indivs, the GR being that inc is recog'd when rec'd. For ex: 1. cash rec'd in advance of accrual GAAP inc is taxed (temp diffs), like: -int inc rec'd in advance -rental inc rec'd in advance (nonrefundable rent deposits and lease cancellation pmts are rental inc when rec'd). -royalty inc rec'd in advance. 2. some GAAP inc items aren't includable as TI (perm diffs), like: -int inc from muni/state obligations/bonds. -certain proceeds from life ins on the life of an officer (key person policy) where the corp is the beneficiary. For life ins contracts issued after 8/17/06, limitations exist regarding the amt of proceeds excluded from inc relating to company-owned life ins (COLI) contracts, unless certain rqmts are met. The GR is that the portion of the proceeds that equals the prev paid premiums and other nondeductible amts paid in is tax-free, and the bal is gen taxable. -fed inc taxes are *NOT* a deduction. 3. in contrast to indiv taxpayers, corp CGs are taxed at the same rate as ord corp inc (no special CG rates apply). While the cash basis is used for tax purposes by most indivs, qualified personal service corps (treated as indivs for the purposes of these rules), and taxpayers whose avg annual gross receipts don't exceed 5M, the accrual basis of accting for tax purposes is req'd (even if cash basis) for: -the accting for purchases and sales of inv (and inventories must be maintained). -tax shelters. -certain farming corps (other farming or tree-raising businesses may gen use the cash basis) and -C corps, trusts w/ unrelated trade/bus inc, and pships having a C corp as a partner, provided the bus has > 5M of avg annual gross receipts for the 3 yr pd ending w/ the tax yr. Form 1120 (C corp TR) incl: -inc. -deductions. -signature. -paid preparer info. -divs and special deductions (sch C). -tax computation and pmt (sch J); tax computation and pmts and refundable credits. -other info (sch K); a bunch of Qs. -B/S per books showing BOY and EOY amts (sch L). -sch M-1; reconciliation of inc/loss per books w/ inc per TR. Shows all temp/perm diffs. -sch M-2; analysis of unappropriated RE per books (should tie to sch L).
Affordable Care Act (ACA) Continued
The employer and employee must pay a fee for failure to comply w/ the ACA. Employee penalty: An indiv owes the fee for any month that the person, a spouse, or any tax dependents don't have health ins that qualifies as min essential coverage. The penalty is the higher of: 1. 2.5% of household inc, w/ a yearly max equal to the national avg price of a Bronze plan sold through the health ins mktplace. 2. $695/adult plus $347.50/child under 18, w/ a fam max of $2,085. The indiv pays the fee when filing a fed TR for the yr there's no ins coverage. If the indiv doesn't pay the fee, the IRS will hold back the amt of the fee from any future tax refunds. Normal liens, levies, or criminal penalties for failing to pay taxes don't apply for failure to pay the fee. The fee is indexed for inflation. Employer penalty: an ALE may be subj to 1 of 2 potential employer shared responsibility pmts (but *NOT* both). Employer is not obligated to calc its liab and should not make a pmt w/o 1st being contacted by the IRS. 1. Penalty type 1: an ALE will owe the 1st type of employer shared responsibility pmt if it doesn't offer min essential coverage to at least 95% of its full-time employees (and their dependents) AND at least 1 full-time employee receives the premium tax credit for purchasing coverage through the health ins mktplace. -on an annual basis, the pmt is equal to 2k (indexed for inflation in future yrs) for each full-time employee, w/ the 1st 30 employees excluded from the calc. OR (not both!) 2. Penalty type 2: even if an ALE member offers min essential coverage to at least 95% of its full-time employees (and their dependents), it may owe the 2nd type of employer shared responsibility pmt for each full-time employee who receives the premium tax credit for purchasing coverage through the mktplace. Gen, a full-time employee could receive the premium tax credit if: -the min essential coverage the employer offers the employee isn't affordable. -the min essential coverage the empoyer offers the employee doesn't provide min value or -the employee is not one of at least 95% of full-time employees offered min essential coverage. -on an annual basis, the pmt is equal to 3k (indexed for inflation in future yrs) for each full-time employee who receives the premium tax credit. The total pmt in this instance can't exceed the amt the employer would have owed had the employer offered min essential coverage to at least 95% of its full-time employees (and their dependents). None of the pmts req'd of the employer under the employer shared responsibility provisions are tax deductible for the employer.
Federal Insurance Contributions Act (FICA) Continued
The employer's contr is deductible as an ord bus exp. Employee's contr is *NOT* deductible by the employee. Bc a SE person pays both contrs, 1/2 of the SE tax is deductible in arriving at AGI. FICA provides a no of benefits, incl disability pay, retiremt pay, survivor's benefits, dependent's benefits, and medical benefits under medicare (*NOT* medicaid, which is a state-run program). Benefits are available to all covered employees regardless of whether they're receiving benefits from a private plan. Employees may not opt out of social sec, even if covered by a private plan. Most important things to remember abt social sec (FICA) for the exam: -the employer must pay the tax and collect the employee's portion of the tax. -all inc derived from labor is taxed, unearned inc isn't taxed. -all employees are subj to the tax up to a max dollar amt for the social sec w/ no limit on the Medicare. SE inc is subj to both employer/employee taxation for inc over $400.
The Estate Tax (Form 706); Gross Estate
The estate tax is a transfer tax rather than an inc tax. It's imposed on the value (FMV) of prop transferred by the decedent at death. An estate must file IRS Form 706 if the gross value of the estate + historical taxable gifts by the decedent exceed 5,490,000 in 2017. Form 706 must be filed w/in 9 mos after the decedent's death (unless an extension is requested). Due in 9 mos for birth and death! The gross estate incl the value at the date of death (or alternative valuation date, earlier of the date prop is distr'd to heirs or 6 mos after the date of death. If sold, basis = SP) of all of the decedent's worldwide prop, incl real prop, personal tangible prop, and intangible prop. 6 feet buried, 6 mos later for alternative valuation date. The gross estate also incl the FMV of the decedent's share of jointly held prop. -if prop is owned jointly (50/50) w/ a spouse, incl 50% of FMV of jointly owned prop in gross estate. -if prop is owned in an arrangemt other than 50/50, incl [100% less other owner's contr] in gross estate (gifts to kids). -ins proceeds (if the deceased/estate is the beneficiary or had incidence of oship at death) are incl in the gross estate, since decedent controlled at death. -incomplete gifts (joint accts): gift = drawn upon. Part of gross estate. -revocable transfers: no future int, trust in which children receive in the future. Part of gross estate. -all prop entitled to be rec'd (inc in respect of a decedent), incl salary, rental inc, and pension inc. If a person dies on 1/1, max date for alternative valuation in 7/1 (6 mos later, 6 feet down), and estate TR is due 10/1 (9 mos at birth and death).
The Estate Tax (Form 706); Estate Deductions
The gross estate is reduced by deductions, incl: 1. Medical exps: deduction on incr TR or liab on estate return. Medical exps (*NOT* funeral exps, bc they're not deductible for inc tax purposes) paid out of the estate may be deducted on the final inc TR of the decedent (Form 1040), subj to the 10% limitation. This option is available provided: -the exps are paid w/in 1 yr of death. -they aren't deducted on the decedent's Form 706. -the executor files an approp waiver. 2. Admin exps: deduction on inc TR or liab on estate return. An estate is allowed to deduct exps of administering and settling the estate on Form 706. Alternatively, as in those situations where there's no taxable estate, the executor of the estate may deduct those exps on the estate's Form 1041. These incl: -outstanding debts of decedent -claims against estate -funeral costs -certain taxes For 1 and 2, exp or liab (but not both!). 3. Unlimited charitable deduction: unlimited transfers to charitable, scientific, educational, and religious orgs that are termed discretionary deductions. 4. Unlimited marital deduction: unlimited transfers to the decedent's spouse. Sometimes referred to as the unlimited marital deduction. 3 and 4 are both discretionary deductions.
Priorities; Buyers in the Ordinary Course, Holders in Due Course, and Holders of Possessory Liens
The heart of UCC article 9 is its allocation of rights/priorities btw conflicting ints in collateral. Conflicts can arise, for ex, btw a secured creditor and a buyer of the collateral, btw creditors w/ a sec int in the same collateral, etc. Priorities are discussed in the coming cards from highest priority to lowest. Priority ranking (*memorize!!!*): 1. buyer in the ord course of bus of inv that serves as collateral for a security agreemt created by the seller; holders in due course of negotiable instruments; and holders of possessory liens. 2. the holder of a properly perfected PMSI in the collateral. 3. the holder of a perfected sec int in, or a judicial lien in that has attached to, the collateral (incl the lien of a trustee in bankruptcy). Non-PMSI. 4. the holder of an unperfected sec int in the collateral. Attach only. 5. the debtor. Surplus. For 1 of 5, buyers in the ord course, holders in due course, and holders of possessory liens: a buyer who buys goods from a merchant's inv (store) in the ord course of the seller's bus has the highest priority in collateral. Such buyer takes free of a perfected sec int in the inv, even if he knows of the sec int, unless he knows the sale is in violation of the security agreemt. The buyer need not be purchasing for consumer use. Book ex for buyer in the ord course: S, an appliance retailer, borrowed $$ from bank to purch a new line of refrigerators to sell in his store. To secure the loan, gave bank a sec int in his inv. If G buys a refrigerator from S' store, G takes free of the bank's sec int. If S fails to pay the bank, bank can't repo the fridge from G. Drafters of exam Qs often ask Qs abt buyers in the ord course of bus. Remember that a buyer in the ord course will always prevail over a perfected creditor, even if the buyer had knowledge of the sec int, unless the buyer knows the sale violates the creditor's sec int. Like a buyer in the ord course, a holder in due course (HDC) of a negotiable instrument, or a holder to whom a negotiable doc of title has been negotiated, takes priority over an earlier perfected sec int. Thus, the best way to perfect a sec int in such items is to take possession of them. Taking possession of negotiable instruments gen prevents other ppl from gaining status as a HDC or the like. In most states, a repairer who doesn't get paid for repairing goods can place a mechanic's lien on the goods (can keep possession of them to ensure pmt). The mechanic's lien is valid as long as the repairer keeps possession of the goods. Such possessory liens gen have priority over existing perfected sec ints.
State Income Tax Considerations; Allocation and Apportionment of Federal Taxable Income Continued
The portions of ln 28 inc that aren't allocated entirely to 1 state are apportioned to all the states in which the corp does bus. Gen, apportionable items of inc are bus inc. That is, the inc does relate to the primary bus activities of the corp w/in the state. The inc apportioned to a state is usually the product of: -the apportionmt factor (based on the corp's % of prop, payroll, and sales in the state) and -the portion of ln 28 inc which is apportionable, bus inc (ln 28 inc less allocated inc). Each state dictates exactly how the apportionmt factor S/B determined in that state, and the methods vary slightly from state to state. However, the std apportionmt factor formula used by many states is calc'd this way: [{(prop and rent exp located w/in the state/total prop) + (payroll paid to employees w/in the state/total payroll) + (sales from sources w/in the state/total sales)}/3]. Book ex for allocation and apportionmt: A corp has commercial domicile in Kansas and has a breakdown of prop, payroll, and sales in Kansas, Missouri, Oklahoma, and Nebraska provided. Total ln 28 inc is 110k. 10k of that is allocable divs/int inc (nonbus inc). The remaining 100k relates to bus inc and is apportionable. Determine the corp's TI in each state w/ nexus. Calc apportionmt factors to do so. I will just do it w/ one state here, since repetitive. Kansas: -prop factor = (400k Kansas prop/500k total prop) = 80%. -payroll factor = (40k Kansas payroll/100k total payroll) = 40%. -sales factor = (300k Kansas sales/1M total sales) = 30%. -total factor = [(80% + 40% + 30%)/3] = 50%. -income apportioned to Kansas = [100k apportionable inc x 50%] = 50k. -total inc taxable in Kansas = [10k nonbus inc allocated to home state of Kansas + 50k inc apportioned to Kansas] = 60k. -do this for all other states. Gen only home state gets allocation.
Requirements of Regulatory Agencies; The American Institute of CPAs (AICPA) and State CPA societies Continued
The prof ethics division of the AICPA investigates potential disciplinary matters and refers approp cases to the joint trial board, which may expel a member by a 2/3 vote or suspend a member for up to 2 yrs (or impose lesser sanctions) by majority vote. Grounds for joint trial board sanctions: -violation of the bylaws or any rule of the code of conduct. -declaration by a ct of having committed fraud. -determination by the joint trial board of guilt for any act discreditable to the profession, or conviction of a criminal offense that tends to discredit the profession. -declaration by a ct that the CPA is insane/incompetent. -suspension/revocation of a member's license to practice pub accting as a disciplinary measure by a govt auth. -failure to cooperate w/ any prof ethics division disciplinary investigation. -failure to comply w/ educational and remedial/corrective action determined necessary by the prof ethics exec committee w/in 30 days. Notice of disciplinary action is published in a membership periodical (CPA newsletter). Possible sanctions incl (no license, money, or jail): -expulsion from AICPA or state CPA society. -suspension of membership in AICPA or state CPA society. -rqmt that CPE courses be taken as a remedial measure.
Corporate Formation
The realized gain for SH is [FMV prop contr'd - SH's basis for that prop]. Gain is only recog'd for SH to the extent of boot rec'd. The SHs tax basis in the shs is gen the [SH's NBV of the prop before the contr + any cash contr'd - any liabs assumed by the corp]. So SHs basis = [NBV prop contr'd + gain recog'd (cash rec'd) - boot rec'd (cash or liabs)]. Remember, there's no taxable boot from the debt relief unless the liabs exceed the basis of the contr'd prop. GAAP *F*/S gen record the A/Ls at their *F*MVs. For tax purposes, there's gen no tax on the transfer of assets to a corp (*N*BV, *N*o tax), so corp's tax basis in an asset is gen equal to the [SH's tax basis + any cash the corp had to pay to complete the transfer of the asset (gain recog'd by SH)]. The rule allowing a corp to take a higher amt of liab assumed as the basis of an asset only applies if the SH recogs gain due to liabs being in excess of the basis of all prop contr'd.
Privileged Communications, Confidentiality, and Privacy Acts
The rules of evidence protect info exchanged in certain confidential relationships (like attorney-client, doctor-patient) by granting evidentiary privilege - info exchanged w/in the scope of the relationship may *NOT* be disclosed as evidence in ct w/o the consent of the privilege holder. Privileges available to CPAs can incl: -attorney-client privilege: potentially available when the CPA has been engaged by the attorney prior to aid the attorney in providing legal services bc the expertise of a CPA is needed. Attorney-client privilege in general must be btw client/attorney, made in confidence for the purpose of securing legal advice. -work product privilege: can protect tangible materials produced in prep for litigation as requested by an attorney, but *NOT* the comm btw the attorney/acctant abt the product. -tax practitioner-taxpayer privilege: applies to tax advice from a tax practitioner that would qualify under the attorney-client privilege (limited to tax advice, same scope/limits as attorney-client). Applies only to fed auth'd tax practitioners under IRC section 7525. State law may vary. The tax practitioner privilege applies to civil cases under the IRC. IRC section 7525 provides that some comm btw taxpayers and fed auth'd tax practitoners is regarded as privileged. Provides that the same common law protections of confidentiality that apply to a comm btw a taxpayer and an attorney apply to comm btw a taxpayer and a fed auth'd tax practitioner (to the extent the comm W/B considered privileged comm if it were btw a taxpayer/attorney). The tax practitioner privilege may only be asserted in any noncriminal tax matter before the IRS and noncriminal tax proceeding in fed ct brought by/against the US. The phrase "fed auth'd tax practitioner" means any indiv auth'd under fed law to practice before the IRS. It's a category that incl CPAs, enrolled agents, and enrolled actuaries. The tax practitioner privilege shall *NOT* apply to any written comm btw a fed auth'd tax practitioner and any: -person -director, officer, employee, agent, rep of the person -other person holding a capital or profits int in the person In connection w/ the promotion of the direct/indirect participation of the person in any tax shelter (tax avoidance/evasion.). Same for criminal cases.
Related Party Provisions Continued; Constructive Ownership
The section 267 attribution rules are: 1. Stock owned directly/indirectly by a corp/pship/estate/trust is treated as owned proportionately by its SHs, partners, or beneficiaries. -Book ex: K owns 80% of H co, which owns 30% of ABC co. K's oship % in ABC co is 24% (80% x 30%). Treated as owning it through her oship in H co. 2. An indiv shall be considered as owning stock owned by those fam members related in accordance w/ section 267. -Book ex: C owns 30% of W corp. His wife, K, owns 20%. His grandson owns 5%,. His nephew owns 15%. C is treated as owning 55% of W (30% oship of his own + 20% oship of his wife + 5% oship of his grandson). His nephew isn't a related party under section 267. 3. Stock constructively owned by a person under rule 1 (proportionate attribution) shall be treated as actually owned by that person for the purposes of applying either rule 1 or 2 in other situations. Rule 2 (fam members) can't be applied in this manner. -Book ex: in ex 1, K was treated as constructively owning 24% of ABC co (80% x 30%). K's husband (ex 2), C, would have to incl K's 24% of ABC w/ any stock in ABC he actually owns when testing C for loss disallowance, bc K's constructive holdings are treated as actual for these purposes. -Book ex for non-attribution to other fam members: in the ex for rule 2, C was treated as constructively owning his wife's 20% int in W. C's 20% oship in W corp couldn't also be attributed to C's sister, S, bc this would involve double attribution w/ fam members, from C's wife (K) to C's sister (S). -Book ex for related parties: A corp owns 40% of C corp and 30% of D corp. D corp owns 40% of C corp. Determine whether A and C are related parties. Under the constructive oship rules, A and C are related parties, since A owns 52% of C. [30% oship of D x 40% oship by D of C] = 12% constructively. [12% constructive oship + 40% direct oship] = 52%.
The Gift Tax (Form 709); Taxable Gifts
The tax is paid by the person *giving* the gift. The gift tax is a transfer tax payable by certain donors of gifts. Its main purpose is to make the donor liable for the tax that would have been payable as estate tax at the donor's death. This reflects the theory that had the gift not been made, the asset would have been incl in the donor's estate and been taxable. So an indiv subj to gift tax, usually only a donor who gives > 14k (28k if married and gift splitting is elected) to a single donee in a yr, must file a gift tax return Form 709, which incl keeping track of total lifetime taxable gifts to date. Gifts of future interests are also subj to gift tax, w/o exemption, and must file Form 709. The estate tax return is considered the final gift tax return for purposes of computing the tax. Every transfer of money/prop, whether real/personal, tangible/intangible, for less than adequate/full consideration in money is a gift. The annual, inflation-adjusted exclusion is per person, per yr (to anyone). In determining the amt of gifts made in a calendar yr, the donor may exclude the 1st 14k of gifts to each donee. This annual exclusion isn't available for a gift of a future int (that can only be enjoyed by the donee at some future date), even if the donee does receive a current oship int in the gift. A gift by either spouse may be treated as made 1/2 by each. This gift splitting creates a 28k exclusion per donee (doubles the amt).
The Gift Tax (Form 709); Calculating Taxable Gifts
The total amt of gifts equals the aggregate value of all gifts made during the calendar yr less the applicable annual 14k (28k if married and gift splitting) exclusion per donee. Book ex for calculating taxable gifts: btw 1/1/Y1 and 3/31/Y1, J made these gifts: -14k cash to A. -4k sculpture to B. -100 shs of C/S in Z corp, valued at $400/sh, to C. Calc J's total amt of taxable gifts for the quarter. -14k cash to A and 4k sculpture to B totally excluded. -26k of the value given to C is taxable (100 x 400 = 40k - 14k exclusion = 26k). -J would owe gift tax only if the amt of J's cumulative (all yrs) taxable gifts exceeds 5,490,000. -J must file a gift TR bc the value of at least 1 of his gifts exceeds the 14k per donee exclusion amt. -the exclusion could have been doubled if married (gift splitting). To apply the annual exclusion to a gift, the gift must be: -a present int. -complete. -under 14k/28k per donee (unless paid directly for medical exps and/or education exps and/or paid to charities or spouse). Calc for tax due on current gifts: [Gross gifts in calendar yr (at FMV) - exclusion of 14k per donee/yr - unlimited marital deduction of gift to donor's spouse - charitable gifts] = taxable gifts this yr. [Taxable gifts this yr + taxable gifts of PYs] = cumulative lifetime gifts. [Tax due on cumulative lifetime gifts (calc) - gift tax paid on prior gifts - applicable credit] = tax due on current gifts.
The Estate Tax (Form 706); Transfer Tax Rate and Other Credits
The transfer tax rate sch is applied to total transfers. Lifetime taxable gifts and transfers at death are taxed on a cumulative basis. The IRC provides for a unified estate and gift tax credit of 2,141,800 for 2017. This tax credit is equal to the tax, before credits, on a 5,490,000 tentative tax base at death. The IRC calls this 5,490,000 amt the applicable exclusion amt. This amt isn't subtracted in calcing tentative tax base at death. The estate calcs the estate tax on the tentative tax base at death and then reduces that tax by the 2,141,900 unified estate and gift tax credit. The net result is gen an estate tax due equal to [40% x (tentative tax base at death - 5,490,000)]. For a deceased spouse's unused exclusion, if the spouse who dies 1st doesn't use all of their unified credit, the surviving spouse can use it (add it to their credit). For decedents who die in 2017, the estate of a surviving spouse may be able to use, in addition to the 2,141,800 unified estate and gift tax credit, an additional credit based on the unused exclusion amt of the surviving spouse's predeceased spouse. The unused exclusion amt is gen the predeceased spouse's applicable exclusion amt minus the portion of that exclusion amt the predeceased spouse's estate used to offset estate tax otherwise due. Book ex for exclusion: L and P are married. L dies in 2017. Tentative tax base at death is 3M, so estate claims a unified estate and gift tax credit equal to the estate tax, before credits, on 3M. The executor of L's estate timely elects to allow the P estate (when P dies) to use the L estate's unused exclusion amt of 2,490,000. P, who has never made any lifetime gifts, dies a yr later w/ a tentative tax base at death of 9M. Determine the exclusion amt and estate tax on the P estate. -exclusion amt = [5,490,000 available to P's estate + 2,490,000 of L's unused exclusion amt] = 7,980,000. -estate and gift tax credit will be equal to the tax on 7,980,000 and the net estate tax due will be 408k [40% x (9M - 7,980,000)]. Other credits reduce the gross estate tax and incl: -foreign death taxes -prior transfer taxes (prior gift taxes paid): gift taxes paid on gifts made after 1976 are technically not a credit but are subtracted from the tentative estate tax to arrive at the gross estate tax. Form 706 (Estate (and generation-skipping transfer) tax return) incl: -decedent and executor info -tax calc, incl the items below -total gross estate less exclusion -allowable deductions -basic exclusion amt -deceased spousal unused exclusion (DSUE) amt -credit for foreign death taxes -credit for tax on prior transfers -[FMV assets - liabs] = net worth/adjusted gross estate.
Common Features of Chapter 7 and 11 Cases; Property of the Bankruptcy Estate Continued
The trustee also has the power to set aside fraudulent transfers made w/in 2 yrs of the filing date. A fraudulent transfer is any transfer made w/ the intent to hinder/delay/defraud creditors or any transfer in which the debtor rec'd less than equivalent value while the debtor was insolvent. Debtor is insolvent here. Book ex for fraudulent transfers: a few days before filing a voluntary petition in bankruptcy and while debtor was insolvent., debtor gave friend a 5k cash gift. This can be set aside/recovered from friend as a fraudulent transfer. The trustee has the power to set aside/disaffirm preferences (90 days/1 yr). When the pmt is set aside, the pmt is taken back from the creditor who rec'd it and becomes part of the bankruptcy estate. Debtor is insolvent here. A preferential pmt is: -a *transfer* made to/for the benefit of a creditor; -on acct of an *antecedent debt* (already existing) of the debtor.; -made w/in *90 days* prior to the filing of the petition (1 yr if the creditor is an insider, like an officer of the debtor org or a close relative to the debtor); -made while the debtor was *insolvent* and -results in the creditor *receiving more than they would have rec'd* under the bankruptcy code. Preferential pmt is a heavily tested issue. Memorize the definition and explanations. Definitions of key parts of preferential pmt definition: -transfer: incl not only the pmt of $ or the giving of prop, but also the giving of a security int. Book ex for transfer: D, a retailer, owed C money. A few days before D filed her bankruptcy petition, gave C a security int in all of D's inv, which C perfects. C's int can be set aside as a preference. -antecedent (preexisting) debt: rather than a contemporaneous exhange. Prepaying or accelerating pmt. A pmt is a preference only if it's for antecedent/preexisting debt. A contemporaneous exchange for new value isn't a preference. Book ex for contemporaneous exchange for value: a few days after D, a retailer, filed for bankruptcy, she rec'd from A, a supplier, 6 cases of goods to be put into her inv. Paid for the goods in full on their arrival. No preference, contemporaneous exchange for value. The exception on contemporaneous exchange for new value has often been tested on past exams.
Elements of a Legally Enforceable Contract; Agreement (Mutual Assent, Offer and Acceptance): The Offer
There are 3 rqmts of a legally enforceable contract: 1. an agreemt made up of an offer and acceptance. 2. an exchange of consideration (something of value). 3. a lack of defenses. If these rqmts are met, there's an enforceable contract and remedies are available if one party breaches (doesn't perform as promised). A writing is *NOT* a gen element of a contract. Certain contracts must be evidenced by a writing (under statute of frauds), but the GR is that a writing isn't req'd. Thus, if an answer choice says an offer/acceptance must be in writing, scrutinize the facts carefully. If the contract isn't w/in the statute of frauds, the choice is prob wrong. Agreemt is 1 of 3 elements of an enforceable contract. Mutual assent is often said to be agreeing to the same bargain at the same time - a meeting of the minds. Gen, one party will make a proposal (offer), and the other party will agree to it (acceptance). The offer can be express/implied. It's a stmt by an offeror that gives the recipient (offeree) the power to form a contract by accepting before the offer is term'd. To be valid, the offer must be sufficient for a reasonable person to assume that it was a serious offer to enter into a contract. The offeror's subjective intent (if he thought he was making an offer) is irrelevant. Contract law follows an objective theory (would a reasonable person believe the offer was serious). Stmts made in jest/frustration and understood as such by a reasonable person aren't offers.
Substantiation and Disclosure of Tax Positions
There are factors which S/B considered when tax positions are taken on TRs to avoid/reduce penalties. 1. Frivolous TR: patently improper, merely arguable, < 20%. No defense. These positions have no basis in law/other auth. Disclosure won't protect a taxpayer/preparer from penalties if a TR position is frivolous. 2. Reasonable basis std: > 20%. GR: avoid most penalties. This is a tax position that has at least a 20% chance of succeeding, one that's arguable but fairly unlikely to prevail in ct. This std isn't met if the taxpayer fails to make a reasonable attempt to determine the correctness of a position that seems too good to be true. -this std will avoid the negligence penalty w/ respect to an understmt of tax that isn't substantial and the penalty for disregard of rules/regs, even if the taxpayer doesn't disclose the TR position for which the taxpayer has a reasonable basis. -this basis will avoid the substantial underpmt penalty *only if* the taxpayer disclosed the TR position (except tax shelters) for which the taxpayer has a reasonable basis. Subst underpmt penalty is still 20%, but harder to avoid. 3. Substantial auth std: > 33 % but < 50%. Most undisclosed. The subst auth std is a position that has a > 1/3 but a < 1/2 chance of succeeding. -only analyses and reports issued by congress, IRS regs/rules/releases, and US ct case decisions constitute subst auth. Tax articles and treatises don't constitute subst auth. 4. More-likely-than-not std: > 50%. This is met when there's a > 50% likelihood of a tax position being upheld by the cts. This std is more stringent than the subst auth std. -Need this for tax shelters (tax avoidance on tax evasion).
Below-Market Loans and Imputed Interest Continued
There is a de minimis exception for (<10k): -gift loans btw indivs: in the case of any gift loan directly btw indivs, the imputed int rules shall not apply to any day on which the aggregate outstanding amt of loans btw indivs doesn't exceed 10k. -compensation-related and corp-SH loans: the imputed int rules shall not apply to any day on which the aggregate amt of outstanding loans btw the borrower/lender doesn't exceed 10k for loans that are comp-related or corp-SH loans. For gift loans btw indivs, if the outstanding loans btw the lender/borrower total 100k or less, the foregone int to be incl in inc by the lender and deducted by the borrower is limited to the amt of the borrower's net investmt inc for the yr. If the borrower's net investmt inc is 1k or less, the foregone int is treated as 0. Foregone int is calc'd by the amt of int that W/B payable for that pd if the loan's int accrued at the applicable fed rate (AFR) and was payable annually on 12/31, minus any int actually payable on the loan for the pd. Book ex for imputed int: M loans 200k to his sister (over 10k and over 100k), A, payable in 10 yrs at an annual int rate of 1%. The AFR issued by the IRS for LT loans is 2.24%. Determine whether M's loan to A qualifies as a below-mkt loan and, if so, calc the imputed int inc to M. -bc the loan appears to be a gift loan btw indivs bc int is charged at below-mkt rates, this is a loan to which section 7872 applies and imputed int will be charged. -imputed int req'd under AFR = [2.24% x 200k] = 4,480. -int payable under the loan = [1% x 200k] = 2,800. -imputed int = [4,480 req'd - 2,800 paid] = 2,480.
Gains (Excluded or Deferred); Homeowner's Exclusion Continued
There's no age rqmt to receive the exclusion. No rollover to another house is req'd. The exclusion is renewable (multiple houses). A taxpayer may use the homeowner exclusion as often as available over their lifetime provided they meet the rqmts, but the exclusion may not be used more than once every 2 yrs. There's a nonqualified use provision (prorate gain exclusion) that applies if a taxpayer has a nonqualified use of the home after 1/1/10. A nonqualified use is any use of the home for a reason other than use as a principal residence. If a taxpayer has a nonqualified use of the home, the exclusion amt is not adjusted, but the portion of the gain attributable to the nonqualified use is not eligible for the exclusion. The amt of the gain not eligible for the exclusion is the ratio of [{the pd of nonqualified use/the total pd of time the taxpayer owned the prop} x the gain on the sale of the residence]. Book ex for reduced homeowner's exclusion: single taxpayer purch'd a home and lived in it as her personal residence for 1 yr. After 1 yr, she moved away for work for 2 yrs, during which time she still owned the house, but rented it to a tenant. After 2 yrs, came back to live in the house for 1 yr before selling it for a gain of 50k. She meets both the oship/use tests bc she owned/use the home for 2+ yrs during the 5-yr pd before sale, and qualifies for the max 250k exclusion. Determine any amt of gain not eligible for the homeowner's exclusion. -2 lived in, 2 rent. So 2 qualify, 2 don't. -bc there was a pd of 2 yrs of nonqualified use when the home was rented and not used by the taxpayer as her principal residence, the gain eligible for exclusion will be reduced. -gain not eligible for exclusion = 25k. -[{2 yrs nonqualified use/4 yrs oship} x 50k gain] = 25k. -taxpayer can take an exclusion on the sale of her home for 25k (50k - 25k). The remaining 25k gain on sale will be recog'd as CG by the taxpayer. The pd of nonqualified use doesn't incl any portion of the 5 yr pd ending on the date of the sale that's after the last date the home was used as the principal residence. Allows taxpayer to sell the home w/o having to count the pd the home is empty as a nonqualified pd. Book ex for qualified use: taxpayer purch'd a home 7 yrs ago and lived in it for 4 yrs. Then moved to a new city and put the home up for sale. The home sold after being empty for 3 yrs. Determine if any of the gain on sale is excluded from the homeowner's exclusion based on nonqualified use. -this 3-yr pd won't be considered as nonqualified use, so the entire gain is eligible for exclusion.
Secured Transactions
These Qs gen involve credit trans. A debtor buys something from a creditor or secured party on credit. The creditor wants to be able to rely on something other than the debtor's promise to ensure pmt, like a security int in collateral. A security int is a limited right in specific personal prop (the collateral) of the debtor that allows the creditor to take the prop (repossess) if the debtor fails to fulfill the credit obligation. A security int is effective btw the parties as soon as certain steps are taken to attach the int (step 1). Once the int is attached, if the debtor defaults, the creditor has some right to take the collateral to satisfy the debt. Attachment doesn't provide the creditor w/ rights against 3rd parties who might also have an int in the collateral. To gain rights over 3rd parties, a creditor must take added steps to perfect the security int (step 2). Perfection serves as a form of notice that the creditor has a security int in the collateral, and bc of this notice, gives the creditor rights in the collateral superior to certain 3rd parties. Book ex for a typical secured trans scenario: -creditor lends debtor $$ to buy office furniture and has them sign a security agreemt describing the furniture to be purch'd as the collateral. -debtor buys the furniture and the security int attaches. The parties agreed to create a security int as evidenced by the security agreemt, creditor gave value (loan), and debtor had an int (oship) in the collateral. -if debtor defaults, creditor can take the collateral and sell it, but prob not if 3rd parties have rights in the same collateral. -on the other hand, creditor can perfect the security int by filing a financing stmt. If debtor defaults, creditor will have rights to the collateral against both the debtor and most 3rd parties. Article 9 of the UCC, w/ certain exceptions, applies to most contractual security ints in personal prop or fixtures (personal prop attached to real prop to become part of the real prop) and outright sales of AR. Article 9 doesn't apply to security ints in land (mortgages), wage claims, and statutory liens, like mechanics liens. There's a special type of security int, a purchase money security int (PMSI), that has priority over all other types of security ints in the same collateral, if the PMSI is prop perfected. A PMSI arises when: 1. a creditor sells the collateral to the debtor on credit, retaining a security int for the purch price OR 2. the creditor advances funds used by the debtor to purch the collateral. The creditor may, but need not, be the seller of the collateral.
Effect of S Corporation Election on Shareholders; Fringe Benefits
These are deductible for non-SH employees and those employee SHs owning 2% or less of the S corp. The cost of fringe benefits for SHs owning >2% is *NOT* deductible to the S corp, unless the corp incl the benefits in the employee/SH's W-2 inc. Incl in that SH's inc on K-1. Sim a pship, SHs in an S corp must incl on their personal inc TR their distributive share of each sep pass-through item. SHs are taxed on these, regardless of whether or not they've been distr'd/withdrawn to them during the yr. Taxed like a bank acct (when earned).
Calculation of AMT; Adjusted Current Earnings (ACE)
This adjustmt is incl to ensure that corps don't report a profit for F/S purposes but pay little/no inc taxes. Bc the ACE adjustmt is intended to reflect the economic position of the co and capture sources of economic inc that may not be reflected in the AMTI base, the calc of the adjustmt is sim the calc of E&P of a corp. Step 1 is to determine ACE, step 2 is the calc of the actual ACE adjustmt. 1. ACE is equal to unadj AMTI adjusted by these primary items (Form 4626 has full list): *MOLDD* -*M*uni bond int is added back -*O*rganization exp deductions are added back to AMTI -*L*ife ins proceeds on key employees are added back -*D*epr diffs btw AMT and ACE depr may need to be added back/subtracted from AMTI depending on which is the larger amt (if AMT is higher than ACE, diff is added back) -*D*RD (70%) amt is added back 2. The ACE adjustmt is [75% x (ACE - AMTI before this adjustmt and the alternative tax NOL deduction)]. Book ex for ACE adjustmt calc: M corp reported unadjusted AMTI (after adjustmts and preferences) of 50k. M had rec'd 2k of muni bond int (M) during the yr that was exempt for regular tax purposes. M also had taken a 70% DRD deduction of 3k (D) and 1,500 of amort related to org expenditures (O). Calc M's ACE adjustmt. 1. [50k unadjusted AMTI + 2k muni bond int + 3k 70% DRD + 1.5k org exp amort] = 56,500 ACE. 2. [75% x (56,500 ACE - 50k unadjusted AMTI)] = 4,875 ACE adjustmt (positive). The ACE adj can be negative, but the amt of the negative adjustmt in a particular tax yr can't be > the cumulative net positive ACE adjustmts (prior positive ACE adjusts - prior negative) in prev tax yrs. Book ex for negative ACE adjustmt: L corp began the tax yr w/ a cumulative net pos ACE adjustmt of 60k. For the CY, calc'd a neg ACE adjustmt of 8k. -Not limited bc L has cumulative net pos adjustmt > the CY neg adjustmt. -If instead L had a cumulative net pos adjustmt of only 2k at the BOY, L's negative ACE adjustmt W/B limited to 2k, the cumulative net positive ACE adjustmt at the BOY. There's no carryover of unused neg amts, so the additional 6k neg adjustmt W/B lost. Book ex for ACE adjustmt calc: Unadj AMTI is 100k and ACE is 200k. Calc AMTI. -ACE adjustmt = [75% x (200k - 100k)] = 75k. -AMTI = [100K unadj AMTI + 75k ACE adjustmt] = 175k.
Elements of a Legally Enforceable Contract; Agreement: Termination of Offer
This can occur through revocation, rejection, or by law. To create a contract, an offer must be accepted before it's terminated. It can be term'd through the act of either party (offeror = revocation, offeree = rejection) or by op of law (like by death of a party). 1. Revocation by offeror: GR is offeror can revoke an offer any time before acceptance by communicating the revocation to the offeree. This is true even where the offeror promises to keep the offer open. -Book ex for revocation: M sent S an email offering to sell him 1 acre of commercial prop (*R*ISE) for 8k. M said S had 3 days to consider the offer and it would be irrevocable in the meantime. The next day, M got a better offer from someone else and called S to tell him he was revoking the offer. This was an effective revocation. Offeree should have purch'd an option. -the revocation can be direct (phone call to offeree withdrawing offer) or indirect, where the offeree gets correct info that the offeror no longer wants to make the offer (through conduct, like selling to someone else). -book ex for indirect revocation: A offers to sell his car to B for $500. B says he wants to think abt it. The next day, C, a friend of B, drives to B's house to show B the car she just bought from A. The offer to B is revoked. -the revocation is gen effective when rec'd by the offeree. Where revocation is by publication, it's effective when published. -while the GR is that all offers can be revoked, there's an exception which appears often on the exam, where consideration is paid to keep the offer open (option contract). An option is a distinct contract where the promisor promises to keep an offer open for consideration from the promisee. Buy time. The examiners often use irrevocability as a wrong answer choice. Will talk about parties' negotiations and ask you to pick a true stmt. 1 answer choice is that the offer is irrevocable or couldn't be revoked bc it's an option. Scrutinize the facts carefully. Key point is that if consideration wasn't given to keep the offer open, it's not an option.
Priorities; Properly Perfected PMSI
This is 2 of 5 in the priority ranking. Almost always wins. The person w/ the next highest priority in collateral is a holder of a prop perfected PMSI. Proper perfection depends on the nature of the collateral. A PMSI in consumer goods is auto perfected (don't have to file, but you should!). Exception to this is secondhand consumer purchaser w/o notice. PMSI loses. If a buyer of consumer goods resells them to another consumer buyer, the secondhand buyer will take free of an auto perfected PMSI in consumer goods as long as the secondhand consumer buyer had no notice of the sec int. This is the garage sale rule. Note that if the secured party filed to perfect, the secondhand buyer is subj to the sec int. Filing would give the secondhand buyer notice of the sec int (this is why you should still file despite auto perfection). Book ex for secondhand consumer purch: B buys a stereo for home use on credit from S (creditor-PMSI) and gives S a sec int in the stereo. S doesn't file a financing stmt, but still has a perfected PMSI in the stereo bc auto perfection. B sells the stereo to her neighbor, C, for use in her home. B stops making pmts to S. -S can't repo the stereo from C. -if S had filed a financing stmt, could repo the stereo from C. -even if S hadn't filed and C was using the stereo in her office, S could repo. Only consumer purchasers take free of auto perfected PMSIs. Examiners know you know the garage sale rule - a secondhand customer purchaser usually will take free of an auto perfected sec int in the collateral. So when they ask abt this topic they'll try to trick you by saying the secured party filed a financing stmt. Remember that if the secured party filed, the secondhand purchaser is subj to the sec int. The secured party can repo from the secondhand purchaser bc they had notice. For a PMSI in inv, file. Prior perfection and notice (filing) req'd for priority, no auto perfection. A PMSI in inv has priority over a prior perfected sec int in the same inv only if: -the PMSI is perfected when the debtor gets possession of the collateral (filing must occur before the inv is delivered to the debtor) and -any secured party who has filed a sec int in the same collateral is given notice of the PMSI before the debtor receives the inv. Book ex for PMSI in inv: on 3/1, bank loans A $$ and takes a sec int in A's inv. Bank files a financing stmt in the proper place. On 4/1, second bank promises to loan A 10k to purch food. For second bank to have priority over 1st bank, must file a financing stmt and notify 1st bank before A gets the food.
Filing a Consolidated Tax Return
This is a privilege afforded to affiliated groups of corps, and it can only be filed if all of the affiliated corps consent to it. Not all corps are allowed the privilege of filing a consol return. Exs of those denied privilege: S corps, foreign corps, most real estate investmt trusts (REITs), some ins cos, and most exempt orgs. To be entitled to file a consol return, all the corps in the group must meet these rqmts: 1. Be members of an affiliated group at some time during the tax yr and 2. Each member of the group must file a consent on Form 1122 (consent of sub corp to be incl in a consol inc TR). The act of filing a consol TR by all the affiliated corps will satisfy the consent rqmt. The election to consol (incl filing the consol TR and attaching Form 1122) must be made no later than the extended due date of the parent corp's TR for the yr. An affiliated group means a common parent directly owns: -80% + of the voting power of all outstanding stock AND -80% + of the value (FMV) of all outstanding stock of each corp. Corps in which an indiv (not a corp) owns 80%+ of the stock of 2+ corps are brother-sister corps and may not file consol'd returns. Illustration for consol'd return: C/S of parent who has 80% investmt in C/S of sub. Illustration for brother/sister corps (not consol'd): C/S of 1 corp is sep from that of another, SH same, but corps aren't the ones investing. Note that for GAAP consol if own over 50%, for tax consol if own over 80%.
Agent's Power to Contractually Bind the Principal; Ratification
This is if agent had apparent auth but not actual auth. Ratification allows a principal to choose to become bound by a prev unauth'd act of his agent. Rqmts: 1. agent must have indicated they were acting on behalf of the principal (if 3rd party didn't believe the agent was acting for a principal, no ratification). Agent must have apparent auth. 2. *ALL* material facts must be disclosed to the principal. 3. principal must ratify *ENTIRE* trans - no partial ratification. 4. ratification doesn't req consideration, and the principal need not notify the 3rd party of the ratification (bc 3rd party already thinks he has a contract w/ the principal). The principal may ratify expressly (say yes) or impliedly (by accepting the benefits of the contract when there's an opp to reject them). Gen, an act may be ratified unless performance W/B illegal, the 3rd party withdraws prior to ratification, or there has been a material change of circumstance so it wouldn't be fair to hold the 3rd party liable. Only the purported principal may ratify. Agent can't take over the contract for himself. Only a disclosed principal may ratify, undisclosed principal can't.
Taxation of a C Corporation; Accumulated Earnings Tax
This is tax 2 of 3 on C corps. When you don't give out enough divs. The accumulated earnings tax (AET) is a penalty tax imposed on regular C corps whose accumulated earnings (RE) are > 250k if improperly retained instead of being distr'd as divs to (high tax bracket) SHs. The AET is only paid when the IRS assesses the tax bc, during an audit, it concluded that insufficient divs were paid out compared to the amt of inc accumulated. Regular corps are entitled to 250k of lifetime accum'd earnings. Personal service corps are entitled to 150k only. The AET isn't imposed on personal holding cos (PHCs), TE corps, or passive foreign investmt corps. The additional TR for accum'd earnings is a flat 20%. Tax rate is the highest on div inc to indivs. To avoid unreasonable accumulation of earnings, there must be: -a demonstrated specific, definite, and feasible plan for the use of accumulation (reasonable needs) OR -a need to redeem the corp stock incl in a deceased SH's gross estate. Just bc the stock is widely held doesn't exempt it from the AET. The AET is not self-assessed by the corp, it's IRS assessed as a result of an audit. A div paid by the due date or hypothetical consent div may reduce/elim the tax. Calc: 1. Bus need: [beg E&P (RE) - corp needs] = beg excess. 2. Lifetime credit: [250k for regular corp OR 150k for personal service corp - beg excess] = remaining credit. 3. AET: [TI - all charity - all CLs - fed taxes - divs paid] = accumulated TI. [Accum'd TI - remaining credit] = current accumulated TI. [Current accum'd TI x 20%] = AET. -TI is before DRD, NOL, charity deduction, or CL carryover. -all the subtractions to get to accumulated TI are "valid excuses" to accumulate RE.
Corporate AMT
This is tax 3 of 3 on corps. Corps are subj to AMT of 20% of AMTI, less an exemption amt. The objective of corp AMT, like indiv AMT, is to ensure that every corp w/ substantial economic inc pays at least some min amt of tax despite the use of exclusions, deductions, and credits. Certain smaller C corps are exempt from AMT. The exemption applies if the annual avg gross receipts from the previous 3 pds are 7.5M or less. This amt is 5M for a C corp's 1st 3 yrs of existence. In addition, the corp must have been treated as a small corp exempt from AMT for all prior tax yrs (after 1997). Once the corp loses its small corp status, it can't qualify for any subseq tax yr. A C corp is exempt from AMT in its 1st yr of existence. The CPA exam has focused the majority of its Qs abt corp AMT on these 4 areas: 1. Distinguishing adjustmts, preferences, and ACE. 2. The exemption formula. 3. Credits available to reduce the minimum tax. 4. The min tax credit CF, to reduce future regular tax. AMT calc summary: Regular TI +/- adjustmt items to inc: *A LIE* *A*djustmts for G/L *L*T contracts *I*nstallmt sales (dealers) *E*xcess depr + *P*references to incr inc: *P*ercentage depletion *P*rivate activity (issued post 1986) TE int inc *P*re-1987 ACRS excess depr =Unadjusted AMTI +/- adjusted current earnings (ACE) incr/decr (negative adj is limited to past positive): this will *MOLDD* the TR *M*uni int inc *O*rganization exp amort *L*ife ins proceeds on key employees *D*iff btw AMT and ACE depr *D*RD (under 20% oship. Unrelated 70% DRD) - AMT NOL deduction =AMTI - AMTI exemption ([40k - 25% of MTI over 150k], so phase-out) =AMT base x 20% =gross AMT - AMT FTC (this calc is foreign to me, since the FTC is the only credit) =TMT -regular tax liab =AMT If a corp's TMT exceeds the regular tax liab, the excess is the AMT, payable in addition to regular tax.
Elements of a Legally Enforceable Contract; Consideration
This is the 2nd of 3 elements of a legally enforceable contract. Consideration is the price of contracting. Both sides must be supported by legally sufficient consideration. The law will *NOT* enforce gratuitious (free) promises. Something must be given in exchange for a promise to make it enforceable. There are 2 elements of consideration; something of legal value given by each party and a bargained for exchange. 1. Element of legal value: something is of legal value if it constitutes either a detriment to the promisee or benefit to the promisor. The promisor's promise is supported by consideration only if the promisee agrees to do something he isn't already obligated to do (a detriment) OR the promisor will obtain some benefit. Possible items of consideration incl promises to perform acts/refrain from performing (give up a legal right), promises to pay money, and promises to give land/goods/stock, etc. Book ex for consideration: P (promisor) agrees to sell L (promisee) his TV set for $200. P's promise (to sell) is upported by L's detriment (giving up $200). Consideration must be present on both sides, so L's promise (to give $200) is supported by P's detriment (giving the TV). Consideration need not have monetary value. As long as the promisee is promising to do something he isn't already obligated to do or promising to refrain from doing something he legally could do, there's consideration. Book ex for nonmonetary consideration: -F promises D he will give D $500 if she names her first-born son after him. D does so. Naming the son after F is valid consideration. -J promises K she will refrain from suing K for 60 days on a valid claim if K promises to give J an option to purch his prop for a spec'd price during the 60-day pd. Both promises constitute consideration (J's promise is called forbearance to sue). Consideration need not flow to one of the parties; it's sufficient to promise to do something for/give something to a 3rd party. Book ex for consideration flowing to 3rd party: A promises B he will pay her $10 if she promises to wash C's car. A's promise is sufficient consideration to support B's promise, even though C will receive the benefit. As long as the consideration isn't a sham, cts will not inquire into the adequacy of it (won't compare the relative value of the consideration exchanged). There's no rqmt that the consideration exchanged be of nearly equal value. GR: fairness isn't req'd. The only rqmt is that consideration be legally sufficient, meaning of legal value.
Eligibility and Electing S Corporation Status
To qualify as an S corp, these rqmts must be met: 1. Qualified corp: the corp must be a domestic corp. An S corp may own any int in a C corp (even 100%), but the S corp may not file a consol'd TR w/ the C corp. An S corp may also create a qualified S sub in which the S corp owns 100% of the stock. The 2 S corps would file as 1 entity for tax purposes. 2. Eligible SHs: -must be an indiv (USA), estate, or certain types of trusts. -may not be a nonresident alien. -qualified retiremt plans, trusts, and 501(c)(3) char orgs may be SHs. -neither corps nor pships are eligible SHs. -grantor and voting trusts are permissible SHs. 3. SH limit: there may not be >100 SHs. Fam members may elect to be treated as 1 SH. These incl common ancestors, lineal descendants of common ancestors, and their current/former spouses. Husband/wife = 1 SH. 100 US people and only C/S. 4. One class of stock: there may not be > 1 class of stock outstanding. However, diffs in C/S voting rights are allowed. P/S isn't permitted. All SHs (voting and nonvoting) must consent to a valid election on Form 2553, which the co files w/ the IRS. If the election is made at any time during the entire preceding yr or on/before the 15th day of the 3rd mo of the election yr, the election W/B effective the 1st day of the tax yr (1/1 for a calendar yr corp). If you're a new corp, get 75 days to elect. After the election is made, the consent of a new SH isn't req'd. The S corp status continues unless a SH(s) who own >50% of the stock affirmatively acts to term the election.
Circular 230
Treasury dptmt circular 230 is the IRS pub entitled "Regs governing practice before the IRS." It addresses the practice before the IRS w/ regard to: -rules governing the auth to practice before the IRS. -the duties/restrictions relating to practice before the IRS. -the sanctions for violation of the regs and -the rules applicable to disciplinary proceedings. 3 things are: 1- tax practitioners, 2- preparer (fee), and 3- taxpayer. The pub is divided into subparts addressing such practice: -A: rules governing auth to practice. -B: duties/restrictions in practice before the IRS. -C: sanctions for violating the regs. -D: rules applicable to disciplinary proceedings. -E: gen provisions. Most states (except CA) don't regulate either tax preparers (who prep TRs) or tax practitioners. Authority to practice = license. The rules governing practice before the IRS apply to: -attorneys. -CPAs. -enrolled agents. -enrolled actuaries. -enrolled retiremt plan agents. -indivs providing appraisals used in connection w/ tax matters (char contrs, estate and gift taxes, FMV for sales gain, etc). -unlicensed indivs who rep taxpayers before the examination, customer service, and the taxpayer advocate service in connection w/ returns they prepped and signed. -indivs rendering written advice w/ respect to an entity plan/arrangemt that has a potential for tax avoidance or evasion.
Liquidation of an S Corporation
Treated the same as liquidation of a C corp. Corp consequences: A corp will recog G/L on the distr of prop as if the prop was sold at FMV. [FMV - basis in assets] = taxable G/L. The taxable G/L is reported on the K-1 to SHs and incrs their basis. Distrs to related parties don't qualify for loss recog. SH consequences: -distrs from an S corp in complete liquidation of the S corp are treated as pmts in exchange for stock. -the SH's adjusted basis in the stock is subtracted from the cash and FMV of prop rec'd from the corp. -if the SH assumes corp liabs or receives prop subj to a liab, the amt realized is reduced by the amt of liab assumed. [cash + FMV prop - liabs assumed - stock basis] = taxable G/L. The stock basis here is adjusted for the taxable G/L of the corp above. -the SH's stock basis in this calc is determined after all of the other activity of the S corp for the yr has been taken into acct (share of taxable inc, etc). -the char of the G/L recog'd to the SH will depend on the SH's holding pd in the S corp stock and whether the stock is a cap asset to the SH. Book ex for liquidation of S corp: X corp (treated as an S corp for tax purposes) makes a distr in complete liquidation of a bldg w/ FMV of 100k and a basis to X of 60k to its only SH, W. X also had NI for the yr of 10k. W has a basis in it's X stock of 30k at BOY. Determine the tax consequences of the liquidating distr to X corp and W. Consequences to X: -recog'd gain of 40k (100k FMV - 60k basis). Consequences to W: -first calc basis in X stock immediately before the distr: Basis in X stock = [30k beginning basis + 10k NI + 40k recog'd gain on bldg distr (above)] = 80k. -W's gain on the distr is 20k (100k FMV bldg - 80k stock basis).
Separate Entities
Trusts and estates are sep entities, often called fiduciaries. Each has been created under a fiduciary relationship in which assets (principal/corpus) have been transferred to the entity so that a person w/ fiduciary responsibility for the entity can hold legal title to the prop for the benefit of named beneficiaries. Estates and trusts are sep IT paying entities, and distrs made by these entities are deductible by the entity but taxable to the recipient. Bc amts aren't taxed at both the estate and recipient level, double taxation is avoided. In this way, estates/trusts are conduits (flow-throughs). A fiduciary is a person in a position of special trust and confidence toward another who does one or both of these things: -holds prop for which another person has beneficial title or int and/or -receives and controls inc of another. Exs of a fiduciary are the trustee of a trust or the executor of an estate. Estates are subj to 2 sep taxes: -inc tax: due annually based on inc earned during the yr while the estate is in existence. -estate tax: one-time-only transfer tax based on the value of the decedent's estate (taxed to the estate before the prop is transferred).
Income Taxation Rules for Estates and Trusts; Annual Trust Income Tax Return (Form 1041)
Trusts are subj only to inc tax and are considered sep tax-paying entities. They're classified as either simple or complex. All trusts, except TE trusts, must use a calendar yr. Easy way to remember the filing rqmts for trust and estate IT yrs: -trusts: I "trust" you will remember 12/31 is YE. -estates: the govt lets you die "anytime." A trust may deduct amts distr'd to beneficiaries up to DNI (less adjusted TE int). This table lists deductions that may be taken to arrive at DNI that are exclusive to trusts (not estates). Charges (trusts only): 1. Exps: -current mgmt of principal and application of inc: inc. -incurred in connection w/ principal: principal. -investing and reinvesting principal: principal. -ord, in the admin, mgmt, or preservation of trust prop (real estate taxes): inc. -prep of prop for sale/rental: principal. 2. Extraordinary repairs: an allowance for depr may be established: principal. Simple trusts: -only make distrs out of current inc, can't make distrs from the trust corpus. -req'd to distr all of its inc currently. -can't take a deduction for a char contr. -entitled to a $300 exemption in arriving at its TI. Book ex for calcing trust TI: R trust, a simple trust, is req'd to make distrs only out of inc. For Y6, the trust has taxable int inc of 1k and made a 1k distr to L, the sole beneficiary of the trust. -the trust will have no TI. [1k int inc - 1k distr deduction] = 0 TI before exemption.
Unrelated Business Income (UBI); Definition and Ownership Limitation
UBI = taxable. UBI is the gross inc from any unrelated trade/bus regularly carried on, minus bus deductions directly connected therewith. UBI is: -derived from an activity that constitutes a trade/bus. -regularly carried on and -not substantially related to the org's TE purposes. This W/B something like conducting bus retreats. The CPA exam will attempt to confuse the candidate by asking Qs abt unrelated activities. Be aware unrelated bus doesn't incl any activity where all of the work is performed by unpaid workers (volunteers). Thus, the fact that the org uses unpaid workers makes the bus/activity related and not taxable. Furthermore, articles made by disabled persons as part of their rehab are deemed related and aren't taxable. These are exceptions not taxed. Statutory restrictions on UBI oship limit to 20% the combined oship of a bus enterprise by a private foundation and all disqualified persons. Furthermore, any excess holdings that aren't divested are taxed. If 3rd parties (those who aren't disqualified persons) have effective control of the bus enterprise, the foundation (together w/ the disqualified persons) may own up to 35%.
Defenses: Unilateral Mistake and Illegality
Unilateral Mistake: voidable in some cases. This is a mistake by 1 party. Gen is *NOT* a defense to a contract. One major exception is a unilateral mistake as to a material fact is a defense if the other party knew/should have known of the mistake. Bids. Book exs for unilateral mistake: -A enters into a contract w/ B to sell B a parcel of land. A knows the land can't support a bldg taller than 5 stories, but most of the bldgs in the area are only 3 stories. Unbeknownst to A, B intends to build a 20-story bldg on the land. B's unilateral mistake (abt the suitability of the land) is not a defense. However, if B showed A the plans to the bldg before the sale and A remained silent, the defense of unilateral mistake W/B available. -P is selecting bids from contractors for construction of a garage. 1 bid is subst lower than the others (bid 1- 6k, bid 2- 5.6k, bid 3-3.2k) so it's obv there's a mistake in the bid. The mistake will be a defense. Note that the bidder's negligence is irrelevant. Illegality: contract gen *void*. If the consideration or subj matter of a contract is illegal, the contract is gen void. Exs of illegality are arrangemts to commit a crime/tort (like steal and sell trade secrets), agreemts in restraint of trade (unnecessary/unreasonable covenant not to compete), gambling contracts, usurious contracts, etc. Book ex for illegality: J enters into a contact w/ K to murder L for 10 kilos of cocaine. Contract is *void* both bc the subj matter (murder) and the consideration (cocaine) are illegal. If a contract is illegal bc a party doesn't have a req'd license, enforcability depends on the reason for the license. -failure to have a license req'd to protect the public (CPAs, attorneys, drs, realtors, etc.) makes a contract *void*. Even if the unlicensed party performs the contract, the party can't collect. -if the license is req'd merely to raise rev (like vendors at a fair pay a license fee), the contract is enforceable.
Limited Liability Company (LLC) Continued
Unless the articles or an op agreemt provides otherwise, all members have the right to participate in mgmt decisions of the LLC. -member-managed LLC: if the members are managing the LLC, each member is an agent of the LLC and has the power to bind the LLC by acts apparently carrying on the bus of the LLC. -manager-managed LLC: if mgmt is by managers, each manager is an agent of the LLC and has the power to bind the LLC. In this case, the members are not agents of the LLC and do not have the power to bind it. Voting strength is proportional to contrs (like a corp). Ex: a member who contr'd 5% of the LLC's current cap is entitled to 5% of the total vote. Unless the articles or an op agreemt provide otherwise, P/Ls of an LLC are allocated on the basis of the members' contrs in most states (like a corp). Under the ULLCA, followed by only a few states but sometimes specifically tested on the exam, profits are shared equally, regardless of cap contrs. Most statutes provide that, unless the op agreemt provides otherwise, a member of an LLC may *NOT* transfer all of his int in the LLC w/o the consent of all other members (like a pship). A member is free to assign his int in distrs (like of profits or on dissolution), but is not free to assign his rights to manage the LLC. Transferability of oship is sim a pship. Each member of an LLC is entitled to inspect/copy the books/records of the LLC during reg bus hrs (like a pship). A LLC has a limited life (like a pship). Will dissolve upon: -expiration of the pd of duration stated in the articles. -the consent of all members. -the death, retiremt, resignation, bankruptcy, incompetence, etc. of a member (unless the remaining members vote to continue the bus). *These events dissociate the member*. -a judicial decree or administrative order dissolving the LLC for violation of law.
The Gift Tax (Form 709); Taxable Gifts Continued
Unlimited exclusions exist for: -pmts made directly to an educational institution: amts paid on behalf of a donee for tuition paid directly to an educational org are allowed as an unlimited exclusion from gift tax. -pmts made directly to a health care provider for medical care: fees paid directly to a health care provider for medical care of the donee are allowed an unlimited exclusion from gift tax. For these top 2 pay directly, don't give money to the person (donee)! -charitable gifts. -marital deduction: to qualify for this, there may not be a terminable int in the prop unless the prop qualifies as qualified terminable int prop (QTIP). To qualify as QTIP prop: (a) the donee spouse must be entitled to all inc from the prop for his/her lifetime. (b) no one another than the donee spouse may rec any distrs of inc/principal from the prop for his/her lifetime. (c) the donee spouse must have the right to req that the subj prop be made productive and (d) the prop must be subj to pmt of its pro rata share of estate taxes upon the death of the surviving spouse. To remember the bottom 2: god and marriage are the 2 that ruled your life. Book ex for marital deduction: When J and N became engaged, J gave N a ring w/ a 50k FMV. After their wedding, J gave N 75k cash so N could have her own bank acct. Both are US citizens. What was the amt of J's Y1 marital deduction? -75k. Transfers btw husband/wife (interspousal transfers) are not subj to taxation for gift/inc tax purposes. The 75k transfer was after the date of marriage and W/B subj to the marital deduction. -the 50k transfer prior to marriage wasn't subj to the marital deduction. W/B subj to the annual gift tax exclusion (14k).
Priorities; Unperfected Security Interest and Debtor
Unperfected sec int is unprotected. This is 4 of 5 on the priority ranking. Means you attach only. Unperfected sec ints have priority only over the debtor. If there are 2 unperfected sec ints in the same collateral, the 1st to attach has priority. The debtor is 5 of 5 on the priority ranking. After default, the debtor has the lowest priority in the collateral. The examiners often ask what party will have the highest priority in the collateral. Order of priority: -buyer in the ord course of bus, HDC, and the like. -a properly perfected PMSI holder, except in the case of a secondhand consumer purchaser of consumer goods subj to an auto perfected PMSI (that's why you should still file if auto perfected!). -perfected sec int holders and judicial lien holders once the lien has attached. -unperfected sec ints (attach only). -debtor. Although UCC article 9 provides rules for priority, parties entitled to priority under article 9 may contractually subordinate their right to those of other parties. So, if a client wishes to lend money to a debtor but all of the debtor's assets are subj to a sec int that W/B superior to the client's sec int, all is not lost. The client can negotiate w/ the other secured creditors for a subordination agreemt.
Corporation; Shareholders: Rights, Duties, Obligations, and Authority Continued
Upon 5 days' written notice stating a proper purpose (one related to the SHs rights in the corp) a SH may inspect/copy the corp's records. SH may send his attorney, acctant, or other agent to inspect. This right can't be abolished by the articles/bylaws. The examiners often ask abt SHs' inspection rights. Key is that the SHs (or their agent, attorneys, acctants, etc.) can inspect for any proper purpose (to start a derivative suit, to solicit SHs to vote for certain directors, etc.), but SHs can be denied inspection for improper purposes (like to get names for a retail mailing list). When a corp proposes to issue additional shs of stock, the current SHs often want to purch shares to maintain their proportional voting strength. The common law granted SHs such a right, the preemptive right. Under the RMBCA, preemptive rights do *NOT* exist unless the articles of incorp provide for them. When a corp has a legal cause of action against someone but refuses to bring the action, the SHs may have a right to bring a SH derivative action to enforce the corp's rights (SHs rep the best ints of the corp, so $ goes to corp). Such an action may be brought against directors of the corp or outsiders. *Derivative* actions may be brought only to vindicate wrongs against the corp. If a SH seeks to vindicate the SH's own rights against the corp, a *direct* action by the SH against the corp is approp, rather than a derivative action.
Character of Gain/Loss
When a taxpayer disposes of prop, the G/L recog'd is classified as either cap or ord. The char of the G/L is determined by the nature of the asset disposed of. Cap items aren't the same for GAAP and tax (section 1231). Cap assets incl prop (real/personal) held by the taxpayer, like: -personal auto of indiv taxpayer. -furniture and fixtures in the home of indiv taxpayer. -stocks/secs of all types (except those held by dealers). -personal prop of a taxpayer not used in a trade/bus. -real prop not used in a trade/bus -int in a pship. -goodwill of a corp. -copyrights, literary, musical, or artistic compositions that have been purch'd. -other assets held for investmt. Form 8949 was created to accumulate detailed info abt each sale of various investmts for taxpayers, sim to what was reported on sch D in the past. Totals from Form 8949 are transferred to sch D, which summarizes info. Noncapital assets (or treatmt except where noted) incl: -prop norm incl in inv or held for sale to customers in the ord course of bus. -depreciable personal prop and real estate used in a trade/bus (section 1231, 1245, and 1250 prop). Bus used PP&E. May be cap or ord. Remember 12/31 is the last day of the yr, section 1231 is the last section he will ask me to know! -accts and notes rec arising from sales/services in the taxpayer's bus. -copyrights, literary, musical, or artistic compositions held by the OG artist. Inventory. Compare to above, these are cap when purch'd. Exception is sales of musical compositions held by the OG artist receive CG treatmt. -treasury stock (not an ord asset and not subj to CG treatmt). Form 8949 incl: -sales and dispositions of cap assets. Part 1: ST -ST trans reported on Form 1099-B showing basis was reported to IRS. -ST trans reported on Form 1099-B showing basis wasn't reported to IRS. -ST trans not reported to you on Form 1099-B. -descr of prop, date acq'd, date sold, proceeds, cost/basis, adjustmt (if any) to G/L, and G/L. Part 2: LT -all the same things but for LT. Sch D incl (Form 1040, for indivs) incl: -cap G/Ls. -ST cap G/Ls (assets held 1 yr or less). Proceeds, cost, adjustmts to G/L, G/L. -LT cap G/Ls (assets held > 1 yr). Same stuff as ST. -summary section -sch D summarizes the info on Form 8949.
Gains (Excluded or Deferred); Involuntary Conversions Continued
When gain is recog'd bc the amt rec'd exceeds the cost of replacemt, the basis of the replacemt prop is its cost less the gain not recog'd. Boot = loot you kept. Book ex for basis calc'd when gain is deferred: C owned a bldg w/ an adjusted basis of 400k. State condemned it and awarded him 450k. C bought a new bldg for 440k. Determine the gain realized/recog'd and the basis of the new bldg. -[450k amt realized - 400k adjusted basis] = 50k realized gain. -[450k amt realized - 440k replacemt cost] = 10k recog'd gain. Boot/loot kept. -gain not recog'd = 40k (50k - 10k). -[440k cost of new bldg - 40k gain not recog'd] = 400k basis of new bldg. Nontaxable = NBV. When the gain exceeds 100k, prop acq'd from related parties and certain close relatives doesn't qualify as replacemt prop. Involuntary conversion rules apply to GAINS ONLY. Losses W/B recog'd. When the loss is recog'd, the basis of the new prop is its replacemt cost. Book ex for loss recog: R has a factory w/ a cost basis of 340k that was destroyed by a fire. His ins co paid him 330k. R used the $$ to buy a new plant for 500k. Determine any loss recog'd on the involuntary conversion and the basis of the new prop. -[340k basis - 330k rec'd] = 10k loss, recog'd (involuntary conversion rules only apply to gains). -basis of new factory = 500k cost.
Agent's Power to Contractually Bind the Principal; Contractual Liability
When is the P liable to 3rd parties? The principal will be bound by the agent's acts if the agent acted w/ actual auth or apparent auth, or if the principal ratified the trans. The principal's liab doesn't depend on whether the principal's existence or ID was disclosed. Summary chart; Will the agent's acts bind the principal? 1. Was there express/implied actual auth (Auth the agent reasonably believes he possesses based on his dealings w/ principal)? -if yes, principal will be bound. -if no, next step. 2. Was there apparent auth (auth the 3rd party reasonably believes the agent has based on the 3rd party's dealings w/ principal)? -if yes, principal will be bound. -if no, next step. 3. Did the disclosed principal ratify the contract after the agent entered into it on the principal's behalf and before the 3rd party withdrew? -if yes, principal will be bound. -if no, the principal won't be bound at all.
Reporting Partnership Losses (Limited to Basis)
[Cap acct + % liabs] = basis. Gen, a partner's distr share of the pship loss is allowed as an adjustmt to the basis of such partner's int in the pship at the end of the pship's tax yr. A partner's loss in excess of basis will be a CF indefinitely (and remain suspended until basis is reestablished). Book ex for reporting pship losses: on 1/1/Y1, B and C formed a pship. B contr'd prop w/ a 30k basis and FMV, C contr'd prop w/ a 6k basis and 30k FMV. Nontaxable = NBV. The partners have agreed to share P/Ls equally. During Y1, each partner withdrew 3k, and for the yr ended 12/31/Y1, the pship's op loss was 8k. Determine how much of the op loss each partner may deduct in Y1. -B's Y1 loss = [30k OG contrs - 3k withdrawal] = 27k basis at end of tax yr before pass-through. [27k - 4k share of op loss] = 23k. loss not limited due to basis. -C's Y1 loss = [6k OG contrs - 3k withdrawal] = 3k basis at end of tax yr before pass-through. Loss is limited to basis of 3k at end of tax yr. Gets 1k CF indefinitely until it can be utilized against future incrs in basis.
Business Gifts
A misc itemized deduction subj to the 2% limitation. Regardless, can only deduct up to $25/yr per recipient for them, and the remainder isn't deductible at all.
Fungible Goods
Able to be replaced by another identical item - mutually interchangeable. No specific performance, not unique.
Annualized v Prior Year Method; Safe Harbor
In calcing the amt of estimated tax pmts due, an indiv taxpayer may choose btw these methods: -annualized method: 90% of CY tax. -PY method: 100% of PY's tax, unless taxpayer's AGI is >150k, then 110% of PY's tax. The lesser of these provides a safe harbor to the taxpayer. W/ either method, pmts S/B made in 4 equal installmts.
Accounting Income of a Trust
Incl divs, int, and TE int. Items allocated to corpus aren't incl. A trust's exemption isn't taken into acct in determining its DNI.
Statute of Limitations for Fraud Claims for Contracts that Occurred a Long Time Ago
The statute of lims will begin to run when the party reasonably could have discovered the fraud. The lims pd gen is 4-6 yrs.
Adjustments to AMTI
"Unfavorable" = incr AMTI. "Favorable" = decr AMTI.
Elements of a Legally Enforceable Contract; Agreement: The Acceptance Continued
-method of comm spec'd: if the offeror req'd the acceptance be sent by a specific method, an acceptance sent by that method is effective when sent. -no method of comm spec'd: if the offer didn't state how acceptances were to be sent, an acceptance sent by any reasonable means is effective upon dispatch (letter, email, fax, etc.). If for any reason the attempted acceptance is invalid, it's a counteroffer! -offeror may opt out (exception to the mailbox rule): the offeror can opt out of the mailbox rule by stating in the offer that acceptances must be rec'd to be effective. In such cases, the acceptance must be rec'd before the offer terminates. Book ex for mailbox rule violated: on 11/1, D sent S an email offering to sell S a vase. The offer provided that an acceptance was be rec'd by 5 PM on 11/2. At 3 PM on 11/1, S sent D an acceptance by overnight mail, but it didn't reach D until 11/3. -there's no enforceable contract bc the acceptance came too late. The offer provided the acceptance had to be rec'd by 5 PM on 11/2, so the mailbox rule doesn't apply. -this is an invalid acceptance bc it's late, so a counteroffer. Prob will be a mailbox rule question on exam! Often, it's coupled w/ a revocability issue. Approach such Qs in 3 steps: 1. Was the offer revocable? Chances are yes, unless the offeree paid consideration to keep it open (option). 2. Determine whether the mailbox rule applies (acceptance is effective on dispatch rather than receipt, unless the offer stated an acceptance had to be rec'd to be effective). 3. Compare any effective revocation date w/ the effective acceptance date. If a revocation was effective first, the offer was term'd and there's no contract. If the acceptance was effective first, there's a contract and the revocation was ineffective. Remember that the mailbox rule only makes *acceptances* effective on dispatch. Revocations, rejections, and counteroffers are effective only upon receipt.
Tax Credits; Earned Income Credit Continued
2017 earned inc credit table: 1. If no children: -max earned inc credit: $510 -earned inc req'd to get max credit: $6,670 -credit rate %: 7.65% -phase-out %: 7.65% -credit phase-out for AGI or earned inc (if greater) over this amt (all taxpayers but MFJ): $8,340 -credit phase-out for AGI or earned inc (if greater) over this amt (MFJ): $13,930 2. One child: -max earned inc credit: $3,400 -earned inc req'd to get max credit: $10k -credit rate %: 34% -phase-out %: 15.98% -credit phase-out for AGI or earned inc (if greater) over this amt (all taxpayers but MFJ): $18,340 -credit phase-out for AGI or earned inc (if greater) over this amt (MFJ): $23,930 3. Two children: -max earned inc credit: $5,616 -earned inc req'd to get max credit: $14,040 -credit rate %: 40% -phase-out %: 21.06% -credit phase-out for AGI or earned inc (if greater) over this amt (all taxpayers but MFJ): $18,340 -credit phase-out for AGI or earned inc (if greater) over this amt (MFJ): $23,930 4. 3+ children: -max earned inc credit: $6,318 -earned inc req'd to get max credit: $14,040 -credit rate %: 45% -phase-out %: 21.06% -credit phase-out for AGI or earned inc (if greater) over this amt (all taxpayers but MFJ): $18,340 -credit phase-out for AGI or earned inc (if greater) over this amt (MFJ): $23,930 Book ex for earned inc credit: K is 26 YO. Reported 2017 AGI of 12k. Single, no dependents. Calc the amt of earned inc she can take in the CY. -[6,670 max earned inc eligible for credit x 7.65% credit rate %] = $510 max credit. -[12k earned inc - 8,340 phase-out threshold] = 3,660. [3,660 x 7.65% phase-out %] = 280 phase-out. -[510 max credit - 280 phase-out] = 230. -can take a $230 earned inc credit after phase-out. An indiv can't claim the credit if they have disqualified inc exceeding 3,450 (2017). Disqualified inc incl taxable/nontaxable int, divs, net rental and royalty inc, net CG inc, and net passive inc other than SE inc. To incr the prevention of improper claims, the PATH act expands the paid-preparer due diligence rqmts w/ regard to the earned inc tax credit.
Liquidation of a Partnership; Retirement or Death of Partner
3 of 3. Pmts to a retiring partner or to the interest successor of a deceased partner in liquidation of his entire pship int are allocated btw pmt for an int in the pship assets and other pmts. Pmts for the int in pship assets result in CG/L. If the pmts are measured by pship inc, they're treated as pship inc regardless of the pd over which they're paid. Thus, such pmts are taxable as ord inc to the retired partner as if he/she continued to be a partner. When a partner sells his/her int to a new partner in the middle of the tax yr, the selling partner's share of pship inc/losses must be allocated pro rata (based on the date of sale) btw the selling and purchasing partners. Per day, per %. Book ex for proration of pship inc: assume partner A, a 20% partner, sells to new partner X on 3/31. The pship reported 80k of pship inc for the entire tax yr. Determine A and X's shares of pship inc for the yr. -bc A sold after 1/4 of the yr, A will only report as his pro rata share 5% (20%/4) of the pship annual inc (4k = 80k x 5%), and x will report 15% (12k = 80k x 15%). -for A could also do [25% of the yr x 80k = 20k. 20k x 20%] = 4k, his share of the inc.
US Withholding on Dividends to Foreign Countries
30% withholding rate.
Taxation of Foreign Entities; Sourcing Foreign Income Continued
6. Sale or exchange of inventory prop: gains, profits, and inc derived from the purch of inv prop outside the US (other than w/in a possession of the US) and its sale/exchange w/in the US. 7. Underwriting inc: amts rec'd as underwriting inc (as defined in section 832(b)(3)) derived from the issuing (or reinsuring) any ins or annuity contract. 8. Social sec benefits. 9. Guarantees: amts rec'd, directly/indirectly, from: -a noncorp res or domestic corp for the provision of a guarantee of any indebtedness of such resident/corp. -any foreign person for the provision of a guarantee of any indebtedness of such person, if such amt is connected w/ inc which is effectively connected (or treated as such) w/ the conduct of a trade/bus in the US. After the determination of the source of the inc (US/foreign) a taxpayer may be req'd to allocate/apportion allowable deductions to determine US TI and foreign source TI. The foreign source TI will be used to calc the FTC limitation. Basically if the source was the US, US inc. For purposes of calcing the FTC, foreign inc must be sourced into these sep categories: -passive category inc (incl divs, int, rents, royalties, annuities, gain on sale of prop producing passive inc, etc.). -gen category inc (anything not in the other categories). -section 901(j) inc (earned from activities in sanctioned countries). -certain inc resourced by treaty. -foreign source lump-sum distr from a pension plan.
Small Business Stock
A noncorp SH, who holds qualified small bus stock for > 5 yrs, may gen exclude 100% of the gain on the sale/exchange of the stock. Max exclusion and limited to 100% of the GREATER OF: -10x the taxpayer's basis in the stock OR -10M, 5M if MFS (SH by SH basis). Qualified corporation and must have: -stock issued after 8/10/1993 -acq'd at the OG issuance -C corp only (not S corp) -< 50M of cap as of the date of stock issuance -80%+ of the value of the corp's assets used in the active conduct of 1 or more qualified trades or businesses. The includable portion of the gain is taxed at regular tax rates. The includable portion is the amt of gain that exceeds 10M (unless 10x basis is higher).
Credit Against Federal Unemployment Tax Rate
An employer may take a credit against the fed unemploymt tax in an equal amt to the state unemploymt rate (when employer's unemploymt rate is < the state's). 5.4%.
Obscure MCQ
Both PSCs and PHCs must incl in gross inc 100% of divs rec'd from unrelated taxable domestic corps in computing regular TI.
Comparison of Corporation to Other Business Entities
Bus entities are gen classified as corp, LCC, LP, pship, or sole prop. -corp: 1+ owners. Formed through the filing of articles of incorp w/ a state and recog'd as a legal entity sep from its owners (SHs). -LLC: 1+ owners. Formed through the filing of articles of org w/ a state and recog'd as a legal entity sep from its owners (members). A LCC can be taxed as a corp, pship, or sole prop. 1 owner = disregarded entity. -limited pship (LP): 2+ owners. Often org'd by a written agreemt and must file a certificate of limited pship to be recog'd by the state. -pship: 2+ owners. Often formed by a written agreemt known as a pship agreemt btw 2+ partners, or may be formed by oral agreemt. There's no rqmt to formally org under state law as compared w/ a corp. -sole prop: 1 owner. Not treated as a legal entity sep from its owner (unincorp'd), and owner isn't req'd to formally org the bus in the state. Unlike corps, indiv owners of a sole prop are ultimately responsible for the liabs of the bus. Comparison chart: 1. Corp: -limited liab: yes -entity taxation: on earnings -owner taxation: on divs -suitable for IPO: yes 2. LLC: -limited liab: yes -entity taxation: dependent on classification -owner taxation: dependent on classification -suitable for IPO: no 3. Pship: -limited liab: only for limited partners -entity taxation: none -owner taxation: on earnings -suitable for IPO: no 4. S corp: -limited liab: yes -entity taxation: not generally -owner taxation: on earnings, not gen distrs -suitable for IPO: no 5. Sole prop: -limited liab: no -entity taxation: none -owner taxation: on earnings -suitable for IPO: no
Section 1231, 1245, and 1250 Assets
Bus used assets (PP&E). 1. Section 1231: These assets are composed principally of depreciable personal and real prop used in the taxpayer's trade/bus and held for over 12 mos. Trade/bus prop and cap assets (held over 12 mos) that have been involuntarily converted (fire, etc.) are also incl in this section. -section 1231 gives a special benefit by allowing LT CGs treatmt (tax rates of 0, 15, and 20%) on net section 1231 gains from sales/exchanges/involuntary conversions of certain "noncap" assets, subj to section 1245 and 1250 provisions bc certain gains for section 1231 assets fall under sections 1245 or 1250. These lower CG rates don't apply to C corps. All CGs of a C corp are taxed at ord IT rates. Best of both worlds for section 1231, get CG treatmt for gains (lower TRs for indivs, trusts, and estates) and ord loss treatmt for losses (deduct against anything!). -net section 1231 losses (in excess of section 1231 gains) are treated as ord. Fully deductible against ord inc. This is when you didn't take enough depr. There are no section 1245 or 1250 losses. The advantages of an ord loss over a CL incl: (a) CLs in excess of CGs can't be deducted (except for 3k (1.5k if MFS) per yr for indivs, estates, and trusts). (b) a section 1231 net loss is deducted in full w/o consideration of CGs. 2. Section 1245: Machinery and equip. Gains only. These assets are gen personal prop used in a trade/bus for > 12 mos (autos). Upon the sale of a section 1245 asset (gen depreciable personal prop): -the lesser of gain recog'd or all A/D is recaptured as ord inc under section 1245 and -any remaining gain is section 1231 gain. 3. Section 1250: Real prop. Gains only. These assets are real props used in a trade/bus for over 12 mos. Section 1250 recapture for corps: section 1250 rules differ slightly from section 1245 in that gen, section 1250 recaptures only that portion of depr taken on real prop that's in excess of SL. -gen, section 1250 only applies to assets placed into service under the pre-1987 accelerated methods of depr for real prop. The current law reqs real prop to be depr'd under the SL method, so section 1250 rules no longer apply to real prop. -section 291 recapture now primarily applies to corps. -for corps, in addition to section 1250 recapture if applicable, the total amt of the taxable recapture on real prop as ord inc under section 291 is equal to 20% of the lesser of the recog'd gain or the accumulated SL depr. Any gain in excess of the amt recog'd as ord inc is allowed CG treatmt under section 1231. Ord inc treatmt will apply to 10% of the gain from section 1250 prop that hasn't been treated as ord inc under the 1250 recapture rules. For a corp the only benefit of getting CGs is that they're used to offset CLs. Book ex for application of section 1231: L inc, a corp, owned a bldg used in its bus w/ an OG cost basis of 100k and SL accum'd depr of 15k. L sold it for 95k. Calc the amt/char of the recog'd gain on sale. -recog'd gain on sale = [95k SP - tax basis of 85k (100-15)] = 10k. -of the 10k gain, the amt recog'd as ord inc is 20% of the lesser of 10k (gain recog'd) or 15k (A/D). -ord inc = [20% x 10k] = 2. Section 291 recapture. -remaining 8k gain (10k - 2k) will be recog'd as section 1231 gain.
Judicial Liens and Garnishment
Creditors w/o a security int or mortgage in the debtor's prop can gain rights in the debtor's prop through imposition of a judicial lien on prop in the debtor's hands or garnishmt of prop in the hands of a 3rd party. Prejudgment attachmt: before final judgmt in a suit on a debt is rendered, if the creditor has reason to believe the debtor will not pay, the creditor can ask the ct to provisionally attach a piece of the debtor's prop. 1. The ct then issues a writ of attachmt (to the local sheriff) and the prop is then seized so that if the creditor prevails, he will be assured of recovering on the judgmt through sale of the prop. 2. Gen, a hearing must be held before prop can be attached by the ct, and most cts req the creditor to post a bond for any damages that result if the creditor doesn't ultimately prevail in the suit. Judicial lien: 1. If a debtor is adjudged to owe a creditor money and the judgmt has gone unsatisfied, the creditor can request the ct to impose a lien on specific prop owned and possessed by the debtor. 2. After the ct imposes the lien, it will issue a writ (like writ of attachmt), usually to the local sheriff, to seize prop belonging to the debtor, sell it, and turn over the proceeds to the creditor. 3. Most states protect certain prop of the debtor to ensure the debtor doesn't become destitute. -many states provide a homestead exemption that excl items of a person's household, up to a certain amt, from the liens of most creditors (the exclusion doesn't apply to persons w/ purch money security ints (PMSIs) in personal prop or purch money mortgages against real prop. -when a taxpayer fails to pay fed taxes, the IRS can file a lien on all of the taxpayer's prop, incl prop exempt from levy under state law. Garnishmt: where a debtor is adjudged to owe a creditor money and the debtor has prop in the hands of a 3rd party (like money the debtor is owed by his employer, money in a bank acct, debts owed to a debtor), a writ of garnishmt may be sought. 1. The writ orders the person holding the prop to turn it over to the creditor or be held personally liable for the value of the prop not turned over. 2. Fed law provides that social sec pmts are *NOT* subj to garnishmt, execution, levy, or attachmt. 3. States often limit the amt of an employee's wages that may be garnished (like no more than 1/4 of an employee's weekly salary) to prevent the debtor from becoming destitute.
Book Income v Taxable Income
Differences between NI per a co's F/S and TI reported on a TR exist bc of the diff btw GAAP and tax law. Chart illustrating book inc v TI: -F/S: [Inc - exp] = NIBT (inc from continuing ops before taxes). [NIBT - tax] = NIAT. [NIAT + NIAT for disco ops] = NI (this is an accting adjustmt, net of tax to RE) -TR: [Gross inc - deductions] = A subtotal. [A - charity] = B subtotal. [B - DRD] = TI. -Diffs btw NI and TI are temp/perm diffs reconciled on the M-1/M-3. M-1 doesn't distinguish btw temp/perm diffs, but part III of M-3 does.
Failure to File and Failure to Pay Penalties
Failure to file: 5% per mo/fraction of a mo (up to max 25%). Failure to pay: 1/2% per mo/fraction of mo. Both are based on the amt *DUE* on the return. Failure to file penalty is reduced by the failure to pay penalty *FOR THE SAME PERIOD* (even if failure to pay penalty was for a longer pd than failure to file, so may need to reduce failure to pay penalty amt accordingly).
Priorities; Properly Perfected PMSI Continued
For noninv PMSI (equip), file. Prority if filing w/in a 20-day grace pd. A PMSI in noninv collateral (equip) has priority over conflicting sec ints in the same collateral as long as the PMSI is perfected w/in 20 days after the debtor recs possession of the collateral. -if perfected w/in the 20 day grace pd, perfection relates back to the day the debtor obtained possession (means the PMSI is superior to sec ints created during the 20-day grace pd). -there's no rqmt that the secured party notify other secured parties as must be done w/ an inv PMSI. Book exs for noninv PMSI (PMSI v non-PMSI): 1- as of 1/2, bank holds a perfected sec int in all of debtor's equip and after acq'd equip. Non-PMSI. On 7/16, dealer sells/delivers to debtor a new piece of equip, retaining a sec int in it (PMSI). On 7/25, dealer files a financing stmt perfecting a sec int in the equip. Even though dealer knew of bank's after-acq'd prop sec int, dealer has priority as to the new piece of equip bc filed w/in the 20-day grace pd. 2- on 7/16, dealer sells/delivers to debtor a new piece of equip, retaining a sec int in it (PMSI). On 7/20, bank loans debtor 10k, taking a sec int in all of debtor's equip, and files a financing stmt covering the equip (non-PMSI). On 7/25, dealer files a financing stmt perfecting a sec int in the new piece of equip. Dealer has priority in the equip it sold, bc dealer filed w/in the statutory 20-day grace pd. Use 7/16 for priority date since filed w/in 20 days. GR is perfected PMSI almost always wins. The examiners like to ask abt PMSI. Key points to remember: -a PMSI in consumer goods is auto perfected. Perfection of a sec int in other goods collateral reqs filing. -a PMSI in equip has priority over other perfected sec ints if filed anytime w/in 20 days of the debtor getting possession of the collateral. The perfection relates back to the date of possession. -there's no 20-day grace pd for PMSI in inv. To have priority, must be perfected before the debtor gets possession and notice must be given to other perfected parties in the same collateral (also before debtor gets possession).
Page 2 of Form 1040 Used for Reporting Tax Credits and Tax Liability
Incl: -tax and credits (incl AMT) -other taxes -pmts -refund -amt owed -3rd party designee info to talk to IRS -signature -paid preparer info
Deduction for Property Donated to Charity
LT appreciated prop. Limited to the LESSER of 30% of AGI or [50% of AGI - cash donated].
Mechanic's v Artisan's Lien
Mechanic's lien: arises from improvemts made on real prop. Artisan's lien: arises from improvemts made to personal prop. Either way, must give notice to the owner of prop of legal action before selling the debtor's prop to satisfy the debt (in most states).
Liquidation of a Subsidiary by a Parent
No G/L recog'd, parent takes sub's basis (carryover basis) in all assets and all tax attributes of the sub (unused NOL and CL carryovers, char contr carryovers, etc.).
Partner Basis Calculation Nuance
Nondeductible exps like life ins premiums where the pship is the beneficiary and penalties on late pmt of payroll taxes still reduce each partner's basis.
Tax Return Preparer Trick Question
Prepping returns for VITA for free doesn't make you a preparer, since not performing services for comp.
Tax Credits; Adoption Credit
Nonrefundable (reduces tax liab but no refund). A credit for qualifying exps of adopting a child is available. Max adoption tax credits: -per child or special needs child: 13,750 The adoption credit is nonrefundable, but any credit in excess of your tax liab may be CF for up to 5 years The credit is phased out in 2017 for mod AGI over 203,540 and <= 243,540. Eligible exps incl: -all reasonable and necessary exps, costs, and fees (legal agency). -the credit is *NOT* available for adopting the child of a spouse or for a surrogate parenting arrangemt. -med exps do *NOT* qualify as eligible exps. -for 2017, a taxpayer can exclude up to 13,570 of qualified adoption exps paid by an employer (exclusion is phased out w/ mod AGI of 203,540 - 243,540). The credit is claimed for yrs after the pmt is made until the adoption is final, at which point exps paid in the yr it becomes final are claimed in that yr. For foreign children adopted, no credit can be claimed until the yr it becomes final. In either case, exps paid in later yrs can be claimed in the yr paid.
Loss on Sale/Disposal of a Personal Use Asset
Not deductible! Incl loss on abandonmt of principal residence.
Interest Paid to the IRS for the Late Filing of a Return
Not deductible. Considered a fine/penalty, but also personal in nature.
Material Participation in a Business
One test for this is if the indiv participates in the activity for > 500 hrs during the yr. This means the inc from the bus W/B considered nonpassive.
Confirmation of a Reorganization Plan Under Chapter 11
Only the ct can confirm. Creditors and sec ints vote whether to accept the plan. Unimpaired parties, like secured creditors, are presumed to have affirmed, so their vote isn't necessary. A plan need not be affirmed by 2/3 of SHs (EQ sec holders), but rather by 2/3 of ints (2/3 of outstanding shares, which may be held by < 2/3 of SHs). A class of impaired claims is deemed accepted if it's accepted by creditors holding at least 2/3 in amt and > 1/2 in no of the allowed claims. Through the cram down provision of the bankruptcy code, a plan may be confirmed by a ct even if only 1 impaired class voted to affirm it.
Tax Credits; Retirement Savings Contribution Credit
Personal tax credit (reduce tax liab but no refund). For 2017, a nonrefundable tax credit that may offset both regular tax and AMT is available for contrs to a traditional/roth IRA. Other eligible retiremt plans are beyond the scope of the CPA exam. Eligible taxpayers: -at least 18 YO -not a full-time student -not a dependent For the yr 2017, the credit is limited to the excess of the regular tax liab and AMT liab of the taxpayer, minus the taxpayer's nonrefundable personal credits (except the retiremt savings contr credit, adoption credit, FTC, and some energy credits). No carryover is allowed. -50% credit rate: for MFJ w/ inc from 0 - 37k and single w/ inc 0 - 18.5k. Max eligible contr is 2k, max credit is 1k. -20% credit rate: for MFJ w/ inc from 37k - 40k and single w/ inc fro 18.5k - 20k. Max eligible contr is 2k, max credit is 1k. Should this be 400? -10% credit rate: for MFJ w/ inc from 40k - 62k and single w/ inc from 20k - 31k. Max eligible contr is 2k, max credit is 200. -0% credit rate: for MFJ w/ inc over 62k and single w/ inc over 31k. Max contr is 2k, max credit is 0. As inc goes up, credit goes down. For 2017, full phase-out applies to AGI for MFJ over 62k, to HOH over 46.5k, and to single and MFS over 31k.
Features of a Chapter 7 Liquidation; Reaffirmation of Discharged Debts and Revocation of Discharge
Reaffirmation of discharged debts: sometimes a debtor doesn't want a particular debt discharged in bankruptcy (like to maintain good relations w/ a creditor). The debtor may reaffirm such debts only if the agreemt to reaffirm the debt was made before the granting of the discharge. Revocation of discharge: bad faith, dishonest. A creditor or trustee may request a discharge be revoked if: -the debtor obtained the discharge fraudulently and the party seeking the revocation didn't discover the fraud until after the discharge was granted. -the debtor acq'd prop that would constitute prop of the estate and knowingly and fraudulently failed to disclose this fact. -the debtor failed to obey a ct order or answer material Qs or -the debtor hasn't given a satisfactory explanation for a failure to make docs available in connection w/ an audit that may be ordered by the US trustee or a mat misstmt in such docs.
The Securities Exchange Act of 1934; Antifraud Provisions: Rule 10b-5
Rule 10b-5, promulgated by the SEC under section 10(b) of the 34 act, prohibits fraud in collection w/ the purch/sale of any sec. Applies whether or not the secs are of a registered co. *Anyone* who sells/buys secs using fraud can be liable. A violation of rule 10b-5 can result in civil damages, an SEC injunction, or criminal fines/penalties. To recover damages for a violation of Rule 10b-5, plaintiff must prove all 5 elements of *MAIDS* (plus interstate commerce so fed law applies), unlike 11 where you don't need to prove reliance or scienter. -*M*aterial *M*isrep or *M*aterial omission of fact: plaintiff must prove the defendant made a mat misrep or mat omission of fact in connection w/ the sale. Book ex for fraud in purch/sale of shares: D calls P and tells him she holds B stock w. a mkt value of $50, but she will sell it to him for $25/sh. In fact, the stock's mkt value is $15. P buys D's stock. The fraud here was in connection w/ a purch/sale. Book ex for fraud not in connection w/ purch/sale: P is B's largest SH. To keep P from selling B stock, D, the president of B, tells P she is abt to announce that B had large profits during the past yr. In fact, B incurred huge losses. P holds onto his stock, and the value plummets after D announces the loss. The fraud was not in connection w/ a purch/sale of stock since P didn't buy/sell shs. -*A*ctual reliance: the plaintiff must have relied on the defendant's misrep. -*I*nduced; plaintiff bought/sold secs: rule 10b-5 applies only if the plaintiff bought/sold secs. -*D*amages; plaintiff suffered a loss: the plaintiff must prove he suffered a loss as a result of the fraud. -*S*cienter: intent to deceive or reckless disregard for the truth. The plaintiff must show scienter (the defendant intended to deceive or made false stmts w/ reckless disregard for the truth). Negligence on the part of the defendant isn't sufficient to satisfy this element. The intent req'd for a rule 10b-5 violation has been the focus of a no of past exam Qs. Sim intent isn't req'd to prove a violation of rule 11 under the 33 act. This diff has been important in Qs. -interstate commerce: the plaintiff must show that a means of interstate commerce was involved. Any use of the mail/phones or a national securities exchange is sufficient to satisfy this element. So fed law applies.
Effect of S Corporation Election on Shareholders; Pass-Through of Income and/or Losses (to Shareholder K-1) Continued
Sep stated items are on the K-1 to each SH. These S corp items flow through to the SH in a manner sim a pship (see sch K-1 for complete list): -ord inc (not subj to FICA), incl recapture inc and unearned rev not related to rental activities and mark-to-mkt inc. -rental inc/loss, incl recapture inc and unearned rev related to rental activities. -portfolio inc (incl int, divs, royalties, and all CG/Ls). -TE int. -% depletion. -foreign inc tax -section 1231 G/Ls. -char contrs. -exp deduction for recovery prop (Section 179). -unrecaptured section 1250 inc. -G/L from sale of collectibles. SH taxed when earned, *NOT* when distr'd/rec'd. Book ex for ord inc calc and sep stated items: G corp, an S corp, had these items of inc/deduction for the yr. Gives a list. Sep stated items incl int inc (sch B), section 1231 gain (sch D) and char contrs (sch A). Calc G corp's ord inc and sep stated items for the yr. -ord inc = [150k gross inc - 70k COGS - 40k salary exp - 10k depr exp] = 30k. -sep stated items = 10k int inc, 5k 1231 gain, and 5k char contrs.
Taxation of Foreign Entities; Sourcing Foreign Income
Sourcing rules determine whether inc/deductions are generated from sources w/in or outside the US. For non-US persons, the sourcing rules help to provide limitations on the inc subj to US taxation. For US persons, the sourcing rules help to determine the inc that's incl in the numerator as foreign TI. The IRC IDs 9 items of inc that S/B treated as sources of inc from w/in the US (US inc): 1. int: int from the US or DC and int on bonds/notes/other int-bearing obligations of noncorp residents or domestic corps. 2. Divs: the source of divs is gen determined by the residence of the corp paying the div. 3. Personal services: comp for labor or personal services performed in the US. There's a special exception for indivs temp performing services in the US. They must meet these rqmts: -the labor/services are performed by a nonres alien indiv temp present in the US for a pd/pds not exceeding a total of 90 days during the taxable yr. -such comp doesn't exceed 3k in the aggregate and -the comp is for labor/services performed as an employee of or under a contract w/: (a) a nonres alien, foreign pship, or foreign corp, not engaged in trade/bus w/in the US OR (b) an indiv who's a citizen/resident of the US, a domestic pship, or domestic corp, if such labor/services are performed for an office or place of bus maintained in a foreign country or possession of the US by such indiv/pship/corp. 4. Rents and royalties: rentals/royalties from prop located in the US or from any int in such prop, incl rentals/royalties for the use of or for the privilege of using in the US patents, copyrights, secret processes/formulas, GW, TMs, trade brands, franchises, and other like prop. 5. Disposition of US real prop int: gains, profits, and inc from the disposition of a US real prop int.
General Partnership/Joint Venture; Distribution of Assets - Final Accounting
Terminate ops. When a solvent pship is dissolved an its assets are reduced to cash, the cash must be used to pay the pship's liabs in this order (1): -Creditors: creditors, incl partners who are creditors, must be paid before the non-creditor partners receive any pmts. -Partners: after obligations to creditors are satisfied, each partner is entitled to pmt, 1st to return their contrs and then on acct of profits. (2) To determine the amts due/owed, deduct from the assets left upon dissolution any amts owed to creditors (incl partners who are creditors) and then deduct the amts needed to return the partners' contrs (if not already repaid). (3) if money still remains, it's a profit that must be divided among the partners. If the assets at dissolution are < what's needed to pay the creditors and return contrs, there's a loss that must be divided among the partners. Either way, remember that unless the pship agreemt provides otherwise, profits are divided equally among partners and losses are divided the same way as profits. Book ex for dissolution of pship: A, B, and C contr'd 30k, 15k, and 5k (50k total), respectively, to the ABC pship. Upon dissolution, after paying all creditors, 20k remains. The pship has suffered a 30k loss bc 50k was contr'd to cap and only 20k remains. The pship agreemt is silent as to how loses are to be divided, but says profits are 40% to A, 25% to B, and 35% to C. Bc the pship agreemt is silent as to loss allocation, they'll be allocated in the same proportions as profits. 40% to A (12k), 25% to B (7,500), and 35% to C (10,500). -A is entitled to receive 18k (30k cap contr - 12k share of loss). -B is entitled to recieve 7,500 (15k cap contr - 7,500 share of loss). -C owes 5,500 (5k cap contr - 10,500 share of loss). Book ex for when partner refuses to pay: if there's a loss and some partners refuse to contr, aren't subj to process (aren't w/in a cts jurisdiction), or are insolvent, the remaining partners must share the extra loss proportionally. So if in the above ex C refused to pay anything else, A and B would have to share the 5,500 loss on a 4 to 2.5 basis (A would have to deduct an extra 3,385 from his cap and B would have to deduct an extra 2,115 from her cap). Of course, if C is solvent, A and B can seek to recover the 5,500 from C in an action for indemnification.
Limited Partnerships
The limited pship was designed to allow limited partners to invest in the bus but not have the drawbacks of personal liab. A limited pship is like a gen pship, but has both gen and limited partners. They key diffs related to liab for gen and limited partners incl: -gen partners have unlimited liab for debts/obligations of the pship. -limited partners' liab is limited to the total amt of their investmt in the pship.
MCQ - S Corporation Stock Basis
The order in which stock basis is incr'd/decr'd is important, bc both the taxabity of a distr and the deductibility of a loss are dependent on stock basis. There's an ordering rule for computing stock basis. Stock basis is adj annually, as of the last day of the S corp year, in this order: 1. Incr'd for inc items and excess depletion. Also incr'd for additional SH investmt in corp stock. 2. Decr'd for distrs. 3. Decr'd for non-deductible, non-cap exps and depletion and 4. Decr'd for items of loss and deduction. When determining the taxability of a non-div distr, the SH looks solely to their stock basis (debt basis isn't considered).
Effect of S Corporation Election on Shareholders; Computing Shareholder Basis in S Corporation Stock
The rules for determining SH's basis in S corp stock are gen the same as for pships. *B*eginning: initial basis *A*dd: inc items (sep and non-sep stated). Incl tax-free inc. Also add additional SH investmts in corp stock. *S*ubtract: distr to SHs and loss or exp items. =*E*nding basis. S corp debt does *NOT* incr SH's basis (at-risk). An S corp SH is permitted to deduct (on personal inc TR) the pro rata share of the S corp losses subj to this limitation: Loss limitation = [basis + direct SH loans - distrs]. Book ex for at-risk amt calc: G is a SH in an S corp. He contr'd 12k in cash and land w/ a basis of 25k and a FMV of 100k. Also loaned the S corp 15k (nonrecourse). G has 10k as his pro rata share of S corp inc not distr'd. -at-risk amt = [12k cash contr + 25k basis in land contr'd + 10k undistr'd share of inc] = 47k. -at-risk amt wouldn't incl nonrecourse loans. -at-risk amt would incl the basis of the prop transferred, rather than FMV. -once his pro rata share of inc is distr'd, his basis, as well as at-risk amt, would be reduced.
Code Section 1244 Stock
This is small bus stock. When it's sold or becomes worthless, an *OG* SH can be treated as having an ord loss (fully deductible) up to 50k (100k if MFJ). Losses in excess of this amt are CLs (only deductible against CGs). Don't forget abt 3k CL deduction against ord inc for indivs.
Affiliated Groups and Transfer Pricing; Definitions and IRS Distribution/Apportionment/ Allocation
US fed tax definitions: -controlled taxpayer: any one of 2+ taxpayers owned/controlled directly/indirectly by the same interests. The def incl a taxpayer that owns/controls the other taxpayers. Sub. This is whether legally enforceable or not. -uncontrolled taxpayer: any 1 of 2+ taxpayers not owned/controlled directly/indirectly by the same interests. -controlled: incl any kind of control, direct/indirect, whether legally enforceable or not, and however exercisable/exercised, incl control resulting from the actions of 2+ taxpayers acting in concert w/ a common goal/purpose. A presumption of control arises if inc/deductions have been arbitrarily shifted. -taxpayer: for purposes of the IRS' authority to make these adjustmts w/ respect to controlled trans, this is any person, org, or bus, whether or not subj to any tax imposed by the IRC. -controlled transaction/transfer: any trans/transfer btw 2+ members of the same group of controlled taxpayers. Parent <--> sub, sub <--> sub. -uncontrolled trans: any trans btw 2+ taxpayers that are not members of the same group of controlled taxpayers. co <--> customer. -uncontrolled comparable: uncontrolled trans or uncontrolled taxpayer that is compared, under any applicable pricing methodology, w/ a controlled trans or controlled taxpayer (ex: under the comparable profits method, an uncontrolled comparable is any uncontrolled taxpayer from which data are used to establish a comparable op profit). IRS distr/apportionmt/allocation: To prevent the evasion of taxes or clearly reflect the inc of 2+ orgs, trades, or businesses that are directly/indirectly owned by the same interests, the IRC auths the IRS to adj (distr/apportion/allocate) upward/downward the gross inc, deductions, credits, and allowances btw or among such orgs, trades, or businesses. The orgs/trades/businesses don't need to be incorp'd, org'd in the US, or affiliated. The IRS' auth to make these adjustmts also extends to members of an affiliated group that file a consolidated US inc TR.
Related Party Provisions Continued; Capital Gains and Related Parties
W*R*aP. Applies to disallowed losses, gains are taxed. GR: CG taxes are imposed on all sales of non-depreciable prop (like land) btw all related parties. Exception: sales btw these related parties don't get CG treatmt: -husband/wife (basis is merely transferred). -an indiv and a 50% + controlled corp/pship (where the gain is taxed as ord inc). For both of these, you're pretty much selling it to yourself. Losses are disallowed on most related party sales trans, even if they were made at an arms-length FMV price (W*R*aP up losses and throw them away!). The basis and related G/L of the 2nd buying relative depends on whether the 2nd relative's resale price is higher/lower/btw the 1st relative's basis and the lower SP to the 2nd relative. Same as gift-tax basis rules. Can also calc G/L on sale by 2nd related party as [SP - purch price - unrecog'd loss from 1st related party]. Give same result as gift tax rules. Gain is recog'd only to the extent that the future sales price exceeds the prev relative's cost basis. Book ex for basis in related party trans: N bought stock for 20k that he sold to his bro, R, for 16k. The 4k loss (20k - 16k) is disallowed. R then sells the stock to B, an unrelated party, for 21k. Determine R's basis in the stock and his recog'd G/L on the sale to B. -recog'd gain = [21k SP - 16k R's basis - 4k disallowed loss] = 1k gain. -same as w/ gift tax, write down cost (20k) and relative paid (FMV, 16k) in order of amt, then put down the SP. The one the SP is closer to (20k) will be the amt subtracted to calc the G/L. Loss is recog'd only to the extent that the SP to the unrelated party is lower than the acquiring relative's OG purch price in the asset (FMV). No G/L is recog'd when the SP to the unrelated party is btw the OG cost basis and the related party purch price. The HP starts w/ the new owner's pd of oship. The purchasing relative's basis rules are same as the gift tax rules: -sell higher than relative's basis = use relative's basis to determine gain. -sell btw relative's basis and lower purch price by relative = SP is basis, no G/L. -sell lower than lower purch price by relative = use purch price to determine loss.
Related Party Provisions
W*R*aP. The provisions of section 267 prevent taxpayers from shifting oship of stock or prop to a related person/entity in an effort to take advantage of beneficial provisions of the IRC when essentially still controlling their OG int through their related party. To accomplish this, section 267 lays out "constructive oship" rules, in which stock held by certain parties related to the taxpayer is treated as through it's actually held by the taxpayer. Any trans btw a personal services corp and an employee owner are auto classified as related parties (regardless of the oship % of the employee owner). Section 267 defines related parties as: -bros/sisters. -husband/wife. -ancestors and lineal descendants (son, father, grandfather). -entities that are >50% owned, directly/indirectly, by indivs, corps, trusts, and/or pships. Constructive oship rules apply. -controlled groups (any 2 corps, pships, S corps, or a combo of those, both >50% owned by the same party). -various relationships btw trusts, grantors, fiduciaries, executors, and beneficiaries. -TE orgs (w/in definition of section 501) and person controlling, directly/indirectly, such orgs. In-laws and step-relationships are *NOT* related parties. May become out-laws.
The Securities Exchange Act of 1934; Registration Requirements
While the secs act of 1933 is concerned w/ the initial issuance of secs, the 1934 securities exchange act is concerned w/ exchanges (sales, purchases, etc.) of secs *after* they're issued. The act has registration and reporting provisions that apply only to certain cos and antifraud provisions that apply to all purchasers/sellers, regardless of registration. So key parts are (1) sales/purchases of secs after they're issued, (2) reporting provisions applicable to certain cos, and (3) antifraud provisions applicable to all purchasers/sellers. The SEC can seek suspension or revocation of a co's registered secs for violation of the 34 act's registration or reporting rqmts. Note that prosecution for criminal violations of the 34 act are undertaken by the dptmt of justice and not the SEC (which investigates). The 1934 act reqs the following to register w/ the SEC (*memorize*!): -any cos whose shares are traded on a national exchange. -cos that have > 10M in assets and at least 2k SHs in any outstanding class (large private cos). -cos that have > 10M in assets and at least 500 SHs who are not accredited, in any outstanding class (large private cos). -national stock exchanges, brokers, and dealers. On past exams, conditions that subject a corp to the reporting rqmts of the 34 act have been a key issue, so memorize. The registration stmt must incl the co's fin structure; nature of its bus and outstanding secs; the names/remuneration (money paid for a work/service) of directors, officers, underwriters, and 10%+ SHs; outstanding options; and mat contracts. The registration stmt must also incl F/S audited by a pub accting firm registered w/ the PCAOB. Securities of investmt cos, savings and loans, and charitable orgs are exempt. Examiners often ask abt reporting cos, those req'd to register under the 34 act. Remember that registration is req'd if the shares are sold on a national exchange. Registration is equally req'd if the co has (i) at least 2k SHs or at least 500 unaccredited SHs and (ii) > 10M in assets.
Elements of a Legally Enforceable Contract; Agreement: The Offer Continued
Widely distr'd stmts like ads are *NOT* offers bc they aren't addressed to anyone in particular. They're usually considered only to be invitations seeking offers. *EXCEPTION* is an ad that limits the scope of the ppl who can accept (1st 5 customers get x discount, or offer for a reward), which will be considered an offer. Book ex for ads: S places an ad in the paper announcing that his store is opening and quoting the price of some items. This isn't an offer but an invitation seeking offers. An offer must be definite and certain in its terms. What's essential depends on the type of contract involved. An offer for the sale of goods gen need only incl the quantity term (I offer to sell x widgets). This is under the UCC, don't need to spec price (or anything else but quantity). A valid offer to create a contract under common law (like one involving services or real prop, *RISE*) must incl: *ALL* of these! -identity of offeree and subj matter. -price to be paid. -time of performance. -quantity involved. -nature of work to be performed. Book ex for definite terms: A asks B to repair a broken window at A's store w/in 3 days, at a price to be agreed upon later. Offer here will fail for indefiniteness of the price term.
Basis; Basis of Contributing Partner's Interest
[NBV assets - other partners' % of liabs assumed] = net basis. The partner's OG basis for a pship int acq'd by a contr is: 1. Initial basis. Shall be: -cash: amt contr'd. -prop: adj basis (NBV). -liabs (we put in): incoming partner's liabs assumed by other partners is a *reduction* in basis (not 100%). -services: FMV (and taxable to incoming partner if issued in exchange for a cap int). -liabs (we take on): other partner's liabs assumed by the incoming partner (incl other incoming partners' liabs being transferred in), loans guaranteed by the partner, or loans made by the partner to the pship (incr basis). 2. Prop subj to an excess liab: When prop subj to a liab is contr'd to a pship and the subseq decr in the partner's indiv liab exceeds his/her pship basis, the excess amt is treated like taxable boot, so taxable gain to partner. [NBV - other partners' % of liabs assumed] = negative net basis = taxable boot/loot (brings basis back up to 0). In a pship, it's important to remember to subtract only the labs assumed by the other partners and not the entire liab (<100%). Diff from corp tax, where reduce basis by 100% of liab put in. Book ex for contr'd prop w/ excess liab: B and P admit T to their pship as a 1/3 partner. T contrs a bldg worth 500k w/ a basis of 100k. There's a mortgage of 225k on the bldg, assumed by the pship. -[100k rollover cost basis - 150k liabs assumed by others (225k x (2/3))] = -50k net basis to T. Since this is <0, it's gain/boot that's taxable to T. -T's basis in his pship int is 0. The -50k is incr'd for the 50k taxable gain. -the other partners incr their basis by the 150k liabs they assumed (75k each). A partner's cap acct in a pship can never begin w/ a negative bal (when liabs assumed by pship are > the adjusted basis (NBV) of assets contr'd). The excess liab is treated as taxable boot, and the recog'd gain incrs the cap acct to a 0 starting point.
Automatic Perfection on Assignment of Accounts Receivable
A sec int in A/R can be auto perfected upon attachmt, but only if the A/R assigned don't make up a sig part of the assignor's A/R (so not auto perfected if assign all A/R!). Must be "small scale."
Generation-Skipping Transfer Tax (GSTT)
Designed to prevent an indiv from escaping an entire generation of gift/estate tax. This is a sep tax imposed in addition to fed estate and gift tax. The tax applies when indivs transfer prop to a person who is 2+ generations younger than the donor/transferor. Either the trustee or transferor pays the GSTT. The IRC provides that for 2017 transfers, the GSTT rate is equal to the highest estate and gift tax rate in effect. For 2017, the exemption amt is 5,490,000. Married couples can split the GSTT and obtain a max total exemption of 10,980,000 for 2017. Form 709 (gift and generation-skipping transfer) TR incl: -gen info. -tax computation. -computation of taxable gifts, incl gifts subj to only to gift tax, w/ gifts made by spouse if splitting gifts. Also incl direct and indirect skips for the GSTT and taxable gift reconciliation. -gifts from prior pds. -deceased spousal unused exclusion (DSUE). -computation of GSTT, incl generation-skipping transfers, GST exemption reconciliation, and tax computation.
Limited Partnership
LP incl at least 1 GP and 1 LP. A limited pship is made up of 1+ gen partners (personal liab for all pship debts) and 1+ limited partners (liab for pship debts gen is limited to their investmt). Examiners sometimes ask whether a LP can be formed w/ limited liab for all partners. The answer is no! You need at least 1 GP who has unlimited personal liab for all pship obligations. A limited pship does not have a perpetual life, unless the pship agreemt provides otherwise. Limited partners are much like SHs (sim corp). They contr cap in exchange for a pship int, but they don't participate in day to day mgmt. A limited pship can be formed only pursuant to a state statute and only by filing a certificate of limited pship. w/ the state (sim corp). In a limited pship, mgmt is the responsibility of the gen partners, like in a gen pship. A gen partner (agent) is personally liable for all pship debts. If there's a loss, only the gen partner can be held personally liable. A gen partner may also be a limited partner at the same time (but still has unlimited personal liab). A gen partner may be a secured/unsecured creditor of the pship. A limited partner's liab is limited to his investmt and unpaid cap commitmts. Has no right to take part in the mgmt of the bus. Passive, like a SH (it's a security). A limited partner is *NOT* an agent of the bus and gen can't bind the bus in contract. Nevertheless, a limited partner has a right to review the fin info and TRs of the limited pship. Under the revised uniform limited pship act of 1976 (RULPA), a limited partner who participates in control of the bus is liable to any creditor who reasonably believes he is a gen partner. Under the uniform limited pship act of 2001 (ULPA), partners can't be held personally liable for participating in mgmt. Exam Qs should spec which act applies. Under both RUPA (1976) and ULPA (2001), a limited partner may vote on extraordinary matters w/o incurring liab (like admission/removal of a gen partner, dissolution, amending the certificate of LP, sale of substantially all assets, etc.). Under RULPA (1976), limited partner's names can't be ID'd w/ the bus, or they might be considered gen partners and lose their limited liab status. This is not true under ULPA (2001).
Partnership Operations: Partner Basis Formula
Like a bank acct. *B*eginning cap acct: incl cash, FMV services (taxable), and NBV assets - liabs assumed by others. + *A*dd all inc: ord, cap, and *tax-free*. - *S*ubtract all losses: partner may take a pship loss as a tax deduction up to their basis. Up to 0ing out basis. - *S*ubtract withdrawals: for prop distr, reduce cap acct by the adj basis (NBV) of the distr'd prop, can't go past 0 in the cap acct. Like a bank acct, withdrawal = nontaxable = NBV. = *E*nding cap acct + % liabs (recourse and nonrecourse): your share of liabs incrs your basis. Diff from S corp. S corp's liabs don't incr SH basis (at risk). = YE basis. Cap acct and pship basis (outside basis) aren't the same thing. Basis = [cap acct + partner's share of liabs].
Remedies
The last contracts issue is what to do when a party fails to perform something he/she is contractually obligated to do (what to do when there's a breach). This is where remedies come in. At common law, if there has been a mat/substantial breach, the non-breaching party can be discharged from the contract. If the breach is only minor, the non-breaching party isn't discharged, but is entitled to damages. Damages incl cash or performance. Once there's a breach, the next step is to determine the damages to which the non-breaching party is entitled. Numerous damage measures are shown below, but the key to each is that they're intended to put the non-breaching party in *as good a position as he would have been had there been no breach*. Even if you can't remember a specific remedy, remember the goal of remedies and it'll be easier to pick the right choice. Types of remedies: 1. Compensatory damages: benefit of the bargain. The std measure of damages for personal service contracts awards the non-breaching party enough money to obtain substitute performance (the diff btw the cost of substitute performance and the contract price). Book ex for compensatory damages: B contracts to build a garage for A for 5k. B gets a more lucrative construction job and refuses to build A's garage. A hires J to build a garage for 6k. Can collect 1k from B. 2. Consequential damages: if foreseeable. In addition to the std measure of damages, a party may also collect all damages that are reasonably foreseeable as a result of the breach (like extra weathering of B's car from no garage or extra storage fees). 3. Specific performance: used w/ land or unique items, *NOT* services. This is essentially a ct order that the breaching party perform or face contempt charges. It's available if ints in land or unique personal prop (one-of-a-kind items, like a patent) are involved. In such cases, money W/B an inadequate remedy (a specific piece of prop or unique item of personal prop can't necessarily be purch'd w/ money). Specific performance can't be used to force a party to perform personal service contracts (cts consider this a form of involuntary servitude, prohibited by the 13th amendmt). If specific performance is available, a party can receive either specific performance OR compensatory damages, but NOT both.
Voluntary Dissolution and Termination of a Corporation
Voluntary dissolution of a corp reqs the filing of articles of dissolution w/ the state.
Privileged Communications, Confidentiality, and Privacy Acts Continued
WPs belong to the acctant (or their firm) that preps them, not the client. The acctant is prohibited from showing the WPs to anyone w/o the client's permission, except in these situations: -in response to a subpoena relevant to a ct case. -to a prospective purchaser of the CPA's practice, as long and the prospective purchaser doesn't disclose the confidential info. -to a state CPA society voluntary QC review panel, when requested. -in defense of a lawsuit brought by a client. -to be used in defense of an official investigation by the AICPA/state trial board. -when GAAP reqs disclosure of such info in the F/S. Although a CPA may allow a prospective purchaser to review confidential WPs, the CPA may not turn over the WPs to a purchaser w/o the client's permission. From Q explanation: turn over WPs for things like valid ct subpoena, peer review, GAAP/GAAS, AICPA/state trial board, defend lawsuit. GR for WPs is that CPA owns, but duty of confidentiality unless exception applies.
Loss Limitations (Business Type Activity); Passive Activity Losses
3. Passive activity losses (PALs): A taxpayer may have sufficient tax basis and at risk amts, but still not be able to deduct a loss against ord inc. A passive activity is one in which the taxpayer doesn't materially participate. Incl rental activities, ints in limited pships, S-corps, and most tax shelters. A passive activity loss may not be deducted against wages/salaries/other active inc or against portfolio (int/divs) or CG inc. Exps related to passive activities can only be deducted to the extent of inc from all passive activities. Allocate passive losses (from multiple PALs) to any passive inc on a pro-rata basis. If several losses and some inc, pro rate losses to inc, CF remainder. CF w/o any time limit unused PALs held in suspension. Suspended losses are used to offset passive inc in future yrs. -if still unused, suspended losses become fully tax deductible in the yr the prop is disposed of/sold. -if the taxpayer becomes a material participant in the passive activity (active now instead of passive), unused passive losses from the activity can be used to offset the taxpayer's inc in the same activity. No "net rental loss" allowed. CF, offset future passive inc, deduct in yr prop sold. Taxpayers subj to PAL rules incl indivs, estates, trusts, personal service corps, and closely held C corps.
Itemized Deductions; Charitable Contributions Continued Further
A char deduction may be taken for the exp incurred when the taxpayer takes into the home a full-time student (like an exchange student). This student may not be beyond the 12th grade. The total deduction is up to $50/mo for each full mo (15+ days) the student is in the home and attending school. Regardless of the amt of the cash contr, taxpayers must keep records that substantiate their deductions. Either a bank record (cancelled check or itemization on a bank stmt w/ the charity's name) or a written acknowledgemt from the charity is req'd. The acknowledgemt must be obtained by the earlier of the filing date or the due date of the return. For contrs of > $500 of noncash prop (large noncash contrs) the taxpayer must file Form 8283, giving certain info. In addition, taxpayers claiming > 5k for any 1 item or group of sim items, like a stamp collection, need a written appraisal for each such item/group donated, except no appraisal is needed for publicly traded services. These are additional substantiation rqmts for large noncash contrs. All char contr carryovers are applied on a FIFO basis, after CY contrs are deducted, subj to the % of inc limitations. Can CF 5 yrs. Misc notes: char contrs to foreign charities are *NOT* deductible as char contrs! Also, to be deductible, all char contrs must be substantiated (by a cancelled check, reciept, etc.). A contr that isn't substantiated isn't deductible!
Loss Limitations (Business Type Activity)
A taxpayer's loss from rental or bus activity is limited by 3 factors. True whether taxpayer directly owns the rental prop or bus or owns a % of the rental/bus activity through a flow-through entity (pship/LLC/S-corp). A loss may be deducted if it's > the 3 limitations: 1. Tax basis. 2. At-risk basis. 3. Passive loss limitations. 1. Tax basis: essentially the taxpayer's investmt in the asset adj for items like inc/debt. Any losses not deductible in the CY bc of tax basis limitation are CF until the taxpayer generates more tax basis to absorb the loss. Suspended losses remaining bc of insufficient basis when a partner sells their int are lost. 2. At-risk basis: if a taxpayer has sufficient tax basis to cover a loss, the loss then must not be > than the taxpayer's "at-risk" amt. The amt a taxpayer is considered "at-risk" reps the taxpayer's economic risk in the activity. Losses w/ sufficient tax basis but not "at-risk" basis are CF until the taxpayer generates more at-risk basis or the activity is sold. If the activity is sold, and there are any unused suspended at-risk losses, the taxpayer can offset the gain from the sale of the activity by the unused at-risk losses. See next card for passive activity losses.
Rule for Charitable Contributions as Itemized Deductions
Contrs of LT prop are gen deductible at FMV at the date of the gift. Could elect to deduct the cost instead of the appreciated amt, but the deduction W/B limited to 50% of AGI and further limited by the cost basis of the donated item, so prob would give a smaller deduction than if FMV were used. Contrs of ST prop are gen deductible at the lower of cost or FMV. Donations of ST CG prop are deductible to the donor to the extent of their adjusted basis.
Educator Expenses (Permanently Extended by the PATH Act of 2015)
Eligible educators can deduct up to $250 of qualified exps paid. If spouses are filing jointly and both are eligible educators, max deduction is $500. Neither spouse can deduct > $250 of their qualified exps. An eligible educator is a K-12 teacher/instructor/counselor/principal/aide in a school for at least 900 hrs (part time) during the school yr. Qualified exps incl ord and necessary exps paid in connection w/ books, supplies, equip (incl comp equip, software, and services), and other materials used in the classroom. -deductible exps also incl the costs of prof developmt. -an ord exp is one that's common and accepted in one's educational field. -a necessary exp is one that's helpful and approp for one's profession as an educator (doesn't have to be req'd). Qualified exps don't incl exps for homeschooling or for nonathletic supplies for courses in health/PE. Qualified exps must be reduced by these amts: -excludable US series EE and I Savings Bond int from Form 8815. -nontaxable qualified state tuition program earnings. -nontaxable earnings from Coverdell education savings accts. -any reimbursemts rec'd for these exps that weren't reported in box 1 of Form W-2.
Employee Stock Options; Nonqualified Options Continued
Employee taxation: 1. If there's a readily ascertainable value (taxable when granted): the employee recogs ord inc in that amt in the yr granted. If there's a cost to the employee, the ord inc is the [value of the option - the cost]. -there's no taxation on the exercise date. The basis of the stock is [the exercise price + any amt prev taxed on the grant date]. Any future sale of the stock could result in a cap G/L. -the holding pd beings w/ the exercise date. -if the employee allows the options to lapse (not exercised), there's a cap loss based on the value of the options previously taxed. 2. If there's no readily ascertainable value (taxed at exercise): the taxable event is the exercise date, not grant date. -on the exercise date, the employee recogs ord inc based on [the FMV of the stock purch'd less amts paid (if any) for the option]. The basis of the stock is [the actual exercise price + any ord inc recog'd]. Any future sale of the stock could result in a cap G/L. -the holding pd begins w/ the exercise date. -if the options lapse, no tax consequences! Employer taxation: Gen, an employer may deduct the value of the stock option as a bus exp in the same yr the employee is req'd to recog the option as ord inc. Book ex for nonqualified stock option: on 7/1/Y10, B was granted a nonqualified stock option to purch 200 shs of his employer's stock for $12/sh. The option was selling for $4/sh on an established exchange (readily ascertainable value). B exercised the options on 8/7/Y11. The stock was selling for $18/sh on the exercise date. On 11/1/Y12, B sold all the shares for $20/sh. Employee: -B must report ord inc of $800 [200 x $4] on the date of the grant bc readily ascertainable value. -B's adjusted basis in the stock is 3,200 [2,400 exercise price (200 x $12) + 800 recog'd ord inc]. -B has a LT CG in Y12 of $800 [4k SP (200 x 20) - 3,200 adjusted basis]. Employer: B's employer can take a tax deduction of $800 in Y10 (at grant date), the amt of ord inc recog'd by B.
Employee Stock Options; Qualified Options - Incentive Stock Options Continued
Employee taxation: not taxable inc as comp (when granted or exercised) and cap G/L when sold (SP - purch price). -gen, no taxation of the option as comp. Basis of the stock is the exercise price + any amt paid for the option (if any). -gen, any G/L on a subseq sale of the stock is cap. If the holding pd rqmts aren't satisfied, any gain is ord, up to the amt that the stock's FMV on the exercise date exceeded the option price. -gen, if the options lapse, no deduction is available as the option wasn't taxed in the 1st place. There might be a loss if any amt was paid for the option itself. -an employee may exercise up to 100k of ISOs a yr. Any amt exercised that exceeds this will be treated as a nonqualifying option. -the excess of [the FMV of the stock on the exercise date - the purch price] is a preference item for AMT. Employer taxation: no tax deduction. Gen, an employer doesn't get a tax deduction for an ISO bc it's not considered comp inc to the employee. Book ex for ISO: On 7/1/Y10, M got an ISO to purch 200 shs of her employer's stock for $120/sh. The FMV of the stock on the grant date was $120/sh (meets rqmt for exercise price not to be < FMV at grant date). M exercised the options on 8/7/Y11. The stock was selling for $150/sh on that date. On 11/1/Y12, M sold all of the shs for $200/sh. Employee: -M doesn't recog any ord inc at the grant date bc this qualified as an ISO. 0 inc. -M's adjusted basis in the stock is the exercise price of 24k (200 shs x $120). -M has a LT CG in Y12 of 16k. This is [40k SP (200 shs x $200) - adjusted basis of 24k]. The holding pd rqmts have been met so cap. -M also has an AMT preference item in Y11 for 6k [200 shs x (150-120)]. Employer: M's employer gets no deduction for the granting of the option.
Exemptions; Personal Exemptions
Exemptions go on exemption section of 1040. You, spouse, dependents. Q w/ personal exemptions is how many? Gen, an indiv is entitled to a personal exemption indexed annually for inflation. For 2016/17, this amt is $4,050. Exam tests more on qualifications for personal exemptions, bc dollar amts change. Dollar amts rarely tested. Persons eligible to be claimed as dependents on another's TR won't be allowed a personal exemption on their own returns. Folks use it, you lose it. For married taxpayers: -each married taxpayer gets their own personal exemption on the joint/sep return. The exemption for a spouse is always considered a personal exemption (not dependency), even if spouse doesn't work. -usually a married taxpayer filing sep is entitled to claim only their own personal and dependency exemption. However, a married filing sep taxpayer may claim their spouse's personal exemption if: (1) spouse has no gross inc. (2) spouse wasn't claimed as a dependent of another taxpayer. If a person is born/dies during the yr, they're entitled to either a personal or dependency (as approp) exemption for the entire yr. Get full exemption. Exemptions aren't prorated. There's a phase-out of personal exemptions (robinhood rule) that reduces them by 2% for every 2,500 or portion thereof (1,250 for married filing sep) by which gross inc exceeds: -joint/surviving spouse: 313,800 -HOH: 287,650 -single: 261,500 -married filing sep: 156,900 Basically exemptions are phased out when inc gets high, usually don't test on dollar amts. Book ex for calc of phase-out: married filing jointly couple has AGI of 323,300 in 2017. Would only get 92% of the exemptions to which they would otherwise be entitled. Calc of 92%: -[323,300 - 313,800] = 9,500/2,500 = 3.8 (*always round up*), so 4. -[4 x 2%] = 8%. [100% - 8%] = 92%.
Flow-Through Business Entities
For tax purposes, bus entities are either sep taxpaying entities or flow-throughs. A bus entity that's a sep taxpaying entity pays tax on the inc earned by the bus. A flow-through entity reports inc on a TR filed for informational purposes only. The inc flows through to the owners/SH of the entity's personal TRs, so the tax is paid at the owner/SH level only. There are lots of types of legal entities, but the US tax system recogs 4 categories: 1. Pship: flow-through entity that reports inc on Form 1065. K-1 to partners. Can also be a LLC w/ multiple owners. 2. S corp: flow-through entity that reports inc on Form 1120S. K-1 to SHs. 3. Sole prop: flow-through that reports inc on Form 1040, sch C. Can also be a LLC w/ just 1 owner. 4. C corp: sep taxpaying entity that reports inc on Form 1120. Focus here is on flow-throughs that give owners/SHs a K-1 w/ the inc info to be reported on Form 1040.
Itemized Deductions; Interest Expense
I'm interested in a *HIPPE*. *H*ome mortgage int *I*nvestmt int exp *P*ersonal/consumer int *P*repaid int *E*ducational loan int 1. *H*ome mortgage int: deductions are allowed to qualified residence int on a 1st or 2nd home (principal residence and 1 other). A home used for personal purposes for at least 14 days in a tax yr qualifies as a second home. Mortgage int allocated to part of the home that's used exclusively for bus may be deductible on sch C. There are 2 categories of qualified residence interest: 1- acquisition indebtedness (1M or 500k MFS maximum): int on up to 1M (500k MFS) of acq indebtedness is deductible as qualified residence int. Int on excess principal (over 1M or 500k MFS) is treated as personal int, so isn't deductible. Acq indebtedness is debt that's: -incurred by buying/constructing/substantially improving the taxpayer's principal and 2nd home. -secured by the home. -points related to acq indebtedness are deductible immediately. -refinancing points must be amortized over the pd of the loan. 2- home equity indebtedness (100k or 50k MFS maximum): used for anything. Debt that's secured by the taxpayer's principal or 2nd residence, but isn't acquisition indebtedness (not used to acq/build/improve the home) is classified as home EQ indebtedness. -the max amt that can be treated as home EQ indebtedness is the lesser of 100k (50k MFS) or the FMV of the prop reduced by the amt of outstanding acq indebtedness. -the proceeds of home EQ loans may be used for any purpose (vacation, medical exps, etc), but the int isn't deductible if the proceeds are used to buy secs or certificates that produce tax-free inc. -int on any excess amt is treated as personal int. -mortgage ins premiums paid in connection w/ qualified acq debt were deductible through 12/31/16 as qualified residence int. This provision hasn't been extended. So the total amt of debt you can have outstanding for the int to be deductible is 1.1M (550k MFS).
Form 1040; Individual Income Tax Return
Incl: -filing status (single, married filing jointly/sep, head of household (HOH), or qualifying widower w/ dependent child). -exemptions (you, spouse, dependents). -income (see items listed on prior card). -AGI section (incl adjustmts from prior card to get to AGI). -tax and credits section (has itemized deductions v std deduction, has exemptions, shows AMT, lists credits). -other taxes (SE tax, SS and medicare, IRA taxes, household employmt taxes, health care, other misc taxes). Total tax shown at the end of this. -pmts (fed IT withheld, estimated pmts, more credits). -refund (if pmts > total taxes, shows amt overpaid). -amt owed (total taxes - pmts). Also shows any penalties. -third party designee (person who can talk to IRS abt return... tax preparer). -signature. -paid preparer info (name, signature, date, PTIN, firm info, firm's EIN, phone no).
Filing Status
Incl w/ the exemption section of the 1040. Single, married filing joint/sep, HOH, and qualifying widower w/ dependent child. 1. Single: use EOY test. You're considered unmarried for the whole yr if, on the last day of your tax yr, you're either unmarried or legally separated. 2. Joint returns: use EOY test. To file a joint return, the parties must be married at the EOY, living together in a recog'd common law marriage, or married and living apart (but not legally separated or divorced). -if married during the yr, a joint return may be filed, provided the parties are married at YE. Incl same-sex couples legally married under state law (bc of the sup ct case Obergefell v Hodges, same-sex couples can be married in all states). -if divorced during the yr, a joint return can't be filed. -if one spouse dies during the yr, a joint return may be filed. For both single and joint returns, 12/31 decides your status! 3. Married filing sep (MFS): married taxpayers can file a sep return even if only 1 spouse has inc for the yr. In a sep property state, a husband/wife who elect to file using the married filing sep status must sep report their own inc, exemptions, credits, and deductions on their own indiv IT returns. In a community prop state, most of the inc, deductions, credits, etc. are split 50/50. 4. Qualifying widower w/ dependent child: qualifying widower may use the joint tax return std deduction and rates (but not the exemption for the deceased spouse) for each of 2 taxable yrs after the yr of death, unless they remarry. If remarried, surviving spouse will file a return (joint/sep) w/ new spouse. -the surviving spouse must pay > 1/2 the cost of maintaining a household where a dependent child lives for the *whole taxable yr*. The dependent child must be a child (incl adopted child but not a foster child) or stepchild of the surviving spouse. Surviving spouse must also be entitled to a dependency exemption for the child. -*W*idower, *W*hole yr.
Individual Retirement Accounts; Nondeductible IRA
Indivs not eligible to make deductible contrs to regular (deductible) and roth IRAs may contr to nondeductible IRAs. Nondeductible contr limitations up to the lesser of: -5,500 for 2017 -indiv's comp -limit not contr'd to other (regular/roth) IRAs Earnings on such contrs will accumulate tax-free (deferred) until withdrawn. Distrs from a nondeductible IRA will be taxed as follows: -taxable: prev accumulated untaxed earnings. -nontaxable: the principal contrs (not deducted when contr'd). This is the final option (fallback) to use when not eligible for deductible or roth IRAs.
Flow-Through Business Entities; Reporting Partnership Income and Losses
Info from a K-1 (sch E). A pship is not a taxpaying entity and files an info return, Form 1065. The Surface Transportation and Veterans Health Care Choice Improvemt Act of 2015 changed the filing deadline for pship returns to 3/15 (extension to 9/15 if necessary). List below shows which pship items will be reported sep on Form 1065 and which will pass through to each indiv partner's inc TR as sep line items to be treated by each indiv according to their own circumstances. The details of the pship's bus inc/exps are reported only on Form 1065. Pship inc/loss is gen allocated per the pship agreemt. [bus inc - bus exps - guaranteed pmts (pship deduction)] = net bus inc/loss. This calc is shown on the 1065. 1. Net bus inc/loss: 1065, sch K, and K-1. 2. Guaranteed pmts to partners (specific partner's inc): 1065, sch K, K-1. Sep reported items: 3. Net "active" real estate inc/loss: sch K and K-1. 4. Net "passive" real estate inc/loss: sch K and K-1. 5. Int inc: sch K and K-1. 6. Div inc: sch K and K-1. 7. Cap G/LSs: sch K and K-1. 8. Char contrs: sch K and K-1. 9. Section 179 (exp election): sch K and K-1. 10. Investmt int exp: sch K and K-1. 11. Partners' health ins premiums (reported as part of guaranteed pmts): 1065, sch K, and K-1 12. Retiremt plan conts (Keogh plan): 1065, sch K, and K-1 13. Tax credits (reported by pship but claimed by partners): sch K and K-1. Need to consider net bus loss limitations. Contrs made on behalf of employees to retiremt plans are deductible on Form 1065 and not reported on the schs K and K-1. Contrs for partners aren't deducted on Form 1065, but are reported on schs K and K-1. A partner must incl on his personal inc TR his distributive share of each sep "pass-through" item. Guaranteed pmts are distributive deductions to partners via the K-1 and also taxable inc to the partner receiving the pmts. Sch K-1 for partners incl: -info abt pship. -info abt partner. -partner's % share of P/L and capital. -partner's capital acct analysis. -partner's share of CY inc, deductions, credits, and other items; specifically (listing schedules these flow to on the 1040): (a) Sch E items: ord bus inc/loss, net rental real estate inc/loss, other rental inc/loss, and royalties. (b) Sch B items: int inc, ord divs, qualified divs. (c) Sch D items: net ST/LT cap G/L. (d) Sch SE: SE earnings/loss. -also comes w/ a whole page of info detailing which line items on the K-1 flow to where on the 1040, etc.
Standard Deduction
Itemized deductions are a team tested together. They're summed and compared to the std deduction and the larger of the two is used on the return as a below-the-line (AGI) deduction. 1040EZ means the std deduction was used. Std deduction is the freebie! Those who don't itemize receive a std deduction, w/ the amt determined based on filing status. -single: $6,350 -HOH: $9,350 -MFJ or surviving spouse: $12,700 -MFS $6,350. This is available only if the taxpayer and spouse don't itemize. No double dipping. The std deduction for a taxpayer who's >= 65 YO or blind is incr'd by an additional amt. For 1 qualified: -if single and 65 or blind: $1,550 -if married and 65 or blind: $1,250 -if single and both 65 and blind: $3,100 -if married and both 65 and blind: $2,500 For 2 qualified (both spouses): -if each 65 OR blind: $2,500 -if each 65 and blind $5,000 A taxpayer who uses the std deduction and is >= 65 YO and/or blind is entitled to an incr'd std deduction. The CPA exam has often given Qs that incorrectly suggest that being blind and/or 65 or older will entitle the taxpayer to an additional exemption (wrong! Std deduction incr'd!). Book exs for additional std deduction: -B and S (couple) are both 66 and file jointly. For tax yr 2017, the std deduction W/B 15,200 (12,700 + 2,500) bc each spouse is 65 or older. -for tax yr 2017, E, a blind, single taxpayer, may claim a std deduction of 7,900 if he's blind (6,350 std + 1,550) or 9,450 (6,350 + 3,100) if he's both blind and 65 or older. For the std deduction as a dependent of another (your kids get), the 2017 amt is the greater of $1,050 (or the higher amt adjusted for inflation) or earned inc + $350. So a dependent taxpayer w/ $1,300 earned inc could claim a std deduction of $1,650 (1,300 + 350). The dependent's std deduction remains limited by the regular std deduction for the yr. Dependent taxpayers may claim the same additional std deduction as other taxpayers for blindness and/or age 65+ status.
Exemptions; Dependency Exemptions Continued - Multiple Support Agreements
One "supporter" gets full exemption. When 2+ taxpayers together contr > 50% to the support of a person but none of them indiv contrs > 50%, the contributing taxpayers, all of whom must be qualifying relatives of (or lived the entire yr w/) the indiv, may agree among themselves which contributor may claim the dependency exemption. A contributor must have contr'd >10% of the person's support in addition to meeting the other dependency tests to be able to claim them as a dependent. The joint contributors are req'd to file a multiple support declaration, Form 2120. Book ex for multiple support agreemt: P, whose single and lives alone in Idaho, has no inc and is supported by T (48%, unrelated friend), A (43%, his sister), and M (9%, his son). -Under a multiple support agreemt, the dependency exemption can only be claimed by A, who meets all tests. -T doesn't meet R or T tests is *SUPORT*. -M doesn't meet the S test or any others.
Exemptions; Dependency Exemptions Continued - Qualifying Child
Option 1, *CARES*. If the parents of a child are able to claim the child but don't, no one else may claim the child unless that taxpayer's AGI is higher than the AGI of the highest parent. In gen, a child is a qualifying child of the taxpayer if they meet these conditions: 1. *C*lose relative: under this test, to be a qualifying child of a taxpayer, child must be their son/daughter/stepchild/brother/sister/step-sibling, or a descendant of one of these. An indiv legally adopted by the taxpayer, or one lawfully placed w/ the taxpayer for legal adoption, is treated as their child. A foster child placed w/ the taxpayer by an auth'd placemt agency or by judgmt, decree, or other order of any ct of competent jurisdiction also is treated as their child. 2. *A*ge limit: 19 or 24 + college. Age limit test varies depending on the benefit. Gen, child must be younger than the taxpayer, and under age 19 (or 24 if full-time student) to be a qualifying child. No age limit for indivs who are totally and perm disabled at any time during the tax yr. A full-time student is one who attends an educational institution for at least part of each of 5 mos during the taxable yr. An educational institution is 1 that maintains full-time faculty and a daytime program. School attendance only at night doesn't qualify. 3. *R*esidency and filing rqmts: under these, child must have the same principal residence as taxpayer for > 1/2 of the tax yr. Child can't file a joint return for the yr (unless filed only for a refund claim). 4. *E*lim gross inc test (but exemption is req'd): gross inc test (per *SUPORT*) doesn't apply to a qualifying child. However, child is only qualifying if taxpayer can/does claim an exemption for them. 5. *S*upport test changes: the support test has been mod to determine whether the child didn't contr > 1/2 their own support. The rqmt that the taxpayer/parent provides > 1/2 of the child's support is elim'd.
Specific Items of Income and Exclusions; Payments Pursuant to a Divorce
Pmts for the support of a spouse (alimony) are inc to the spouse receiving the pmts and deductible to arrive at AGI (adjustmt) by the contributing spouse. To be deemed alimony under the tax law: -pmts must be legally req'd pursuant to a written divorce (or separation) agreemt. -pmts must be in cash (or its equivalent). Could pay credit card bills or college fees. -pmts can't extend beyond the death of the payee-spouse. -pmts can't be made to members of the same household. -pmts must not be designated as anything other than alimony and -the spouses may not file a joint return. If any portion of the pmts is fixed by the agreemt as being for the support of minor children (child support), or is contingent on the child's status, like reaching a certain age, such portion isn't deductible by the spouse making pmt and isn't includable by the spouse receiving pmt. This would mean it's nontaxable to the spouse receiving the $$. If the decree/agreemt specs that pmts are for both alimony and child support, but the pmts subseq made fall short of fulfilling these obligations, the pmts will be allocated 1st to child support (until the entire child support obligation is met) and then to alimony. If a divorce settlemt provides for a lump-sum pmt or prop settlemt by a spouse, that spouse gets no deduction for the pmts made, and the pmts aren't includable in the gross inc of the spouse receiving the pmt. HI*D*E IT.
Estates and Trusts Continued
Principal v inc rules chart: Gen, the rules of GAAP apply to the determination of receipts as principal (corpus) and inc. 1. Annuities: apportion (btw principal and inc). 2. Bonds: principal. 3. Bus (sole prop or pship): profit is inc, loss is principal. 4. Change in form of principal: principal. 5. Condemnation proceeding: principal. 6. Corp distributions: -call for shares: principal. -cash div (regular and extraordinary): inc. -liquidation (total or partial): principal. -merger/consol/reorg: principal. -proceeds of rights of prop distr: inc. -rights to subscribe to shares/secs: inc. -rights to subscribe to shs of secs of distributing corp: principal. -sales of rights of distributing corp: principal. -stock div: principal. -stock in another corp: inc. -stock split: principal. 7. Depreciation allowance: principal. 8. Depr and depletion exp: inc. 9. Discount on t-bills and certificates: inc. 10. Eminent domain proceedings: principal. 11. Employee pmts (last salary, post-death bonus, death benefits): principal. 12. Int (apportion bond amort to principal, rest is inc): apportion btw principal and inc. 13. Ins proceeds from damages to prop: principal. 14. Prepmt penalties (except bond call premium): inc. 15. Profit from change in form of principal (like sale of bldg or stock for cash profit): principal. 16. Regulated investmt co: ord inc distr is inc, other distrs are principal. 17. Rental inc (real and personal prop): in arrears or prepaid/advance are both inc. 18. Sale or transfer of principal: principal. 19. S corp inc: principal and inc. 20. T-bill and certificate discount: inc. 21. Street assessmts: principal. Chart shows some unusual treatmts by trusts/estates.
State and Local Business Tax Deduction on Schedule C v State and Local Income Tax
SAL bus taxes are fully deductible on sch C, but SAL inc taxes (even if it says for the bus) are not deductible on sch C, but always a personal exp that can be deducted on sch A as an itemized deduction.
Business Income or Loss; Long-Term Contracts
Special rules are req'd for most taxpayers who op under LT contracts (exceptions exist). A LT contract is gen defined as a contract that's incomplete at the end of the tax yr in which it was started (doesn't start/finish w/in same tax yr) and relates to the manufacture, installation, building, or construction of real or personal prop. % of completion method is req'd for income recognition for nonexempt LT contracts. Unless an exemption exists for a taxpayer/contract, LT contracts must be accted for using the % of completion method to determine TI for a particular contract. A taxpayer may use other methods for contracts if an exemption exists, so contracts are eval'd on a contract-by-contract basis. Certain contracts are exempt from the rqmts of LT contract inc recognition for tax purposes and may use other methods (like completed contract method) to calc their TI under the contract for regular IT purposes. These incl: -small contractors: projects that are expected to last no > 2 yrs and performed by a taxpayer who has avg annual gross receipts not exceeding 10M for the 3 yrs that precede the tax yr in question. -home construction contractors: at least 80% of the total contract costs are related to the construction/rehabilitation of certain dwelling units, which don't incl hotels, etc., where the majority of the use is on a transient basis. Unless an exemption exists for a taxpayer/contract, those involved in LT contracts must use cost allocation rules to acct for their LT projects. In addition to all the direct costs assoc'd w/ the project, other costs that relate to the activities of the LT contract (like storage, production pd int, pension plan contrs, etc.) must be allocated to the cost of the LT project. Essentially, the uniform capitalization rules apply to LT contracts. Costs assoc'd w/ mkting, advertising, selling, and R&D aren't subj to such cost allocation (capitalization). Small contractor and home construction contractors aren't req'd to employ the cost allocation rules. However, (1) they're req'd to allocate production pd int related to the contract to the costs of the project, and (2) home construction projects that aren't also small constructions projects must use the uniform capitalization rules. Also, int for the production pd need not be capitalized if the total cost of the project is <= 1M and the project is est to take < 12 mos to complete.
Itemized Deductions
Team tested together. These are referred to as "from AGI" deductions and are reported on Sch A (taken out of AGI, not deducted to get to AGI like adjustmts). A taxpayer itemizes deductions when from AGI deductions are > the std deduction. Taxpayers who are MFS must both take the std deduction or itemize, can't have 1 spouse take the std deduction and 1 itemize (no double dipping). Sch A (itemized deductions) incl: -medical and dental exps: 10% AGI -taxes paid -int paid -gifts to charity: up to 50% AGI -casualty and theft losses: 10% AGI -misc deductons: 2% AGI -other misc deductions Sch A is personal, sch C is bus, sch E is rental. The itemized deduction phase-out starts when AGI exceeds $313,800 for MFJ and surviving spouses, $287,650 for HOH, $261,500 for single taxpayers, and $156,900 for MFS. The total of all a taxpayer's itemized deductions are reduced by the smaller of 80% of itemized deductions affected by the limit or 3% of the amt by which the taxpayer's AGI exceeds the prev mentioned amts. These deductions are subj to the overall limit on itemized deductions: -taxes paid -int paid -gifts to charity -job exps and certain misc deductions -other misc deductions These deductions aren't subj to the overall limitation on itemized deductions: *GIMC* to remember -*G*ambling losses -*I*nvestmt int exp -*M*edical and dental exps -*C*asualty and theft losses (non bus)
Specific Items of Income and Exclusions; State and Local Tax Refunds
The receipt of a SAL IT refund in a subseq yr isn't taxable if the taxes paid didn't result in a tax benefit in the prior yr. -If itemized in the prior yr: SALT refund is taxable (unless a competing tax law, like AMT, caused the initial taxes paid to be nondeductible). Taxable bc deducted last yr, so add back in to inc. -If std deduction used in PY (1040 EZ): nontaxable SALT refund. Int inc on late refund is taxable. Book ex for nontaxable and taxable SAL refund: C, a single indiv, used the std deduction in Y10. In Y11, got 150 state IT refund. Not includable in his Y11 inc bc he didn't itemize in Y10, so didn't get a tax benefit from the state IT paid. -If he had benefitted from deducting the state taxes when paid in Y10, a Y11 (or later) refund of those taxes W/B taxable inc for fed purposes when rec'd, regardless of whether or not the taxpayer itemized deductions in the yr the refund was rec'd.
Individual Income Tax Calculation and Limitations
The tax rates for indivs are 10, 15, 25, 28, 33, 35, and 39.6%. Schedule of brackets: 1. Single (highest) -10%: 0 - 9,325 -15%: 9,325 - 37,950 -25%: 37,950 - 91,900 -28%: 91,900 - 191,650 -33%: 191,650 - 416,700 -35%: 416,700 - 418,400 -39.6%: over 418,400 2. HOH: -10%: 0 - 13,350 -15%: 13,350 - 50,800 -25%: 50,800 - 131,200 -28%: 131,200 - 212,500 -33%: 212,500 - 416,700 -35%: 416,700 - 444,500 -39.6%: over 444,500 3. MFJ (lowest): -10%: 0 - 18,650 -15%: 18,650 - 75,900 -25%: 75,900 - 153,100 -28%: 153,100 - 233,350 -33%: 233,350 - 416,700 -35%: 416,700 - 470,700 -39.6%: over 470,700 4. MFS (1/2 of MFJ): -10%: 0 - 9,325 -15%: 9,325 - 37,950 -25%: 37,950 - 76,550 -28%: 76,550 - 116,675 -33%: 116,675 - 208,350 -35%: 208,350 - 235,350 -39.6%: over 235,350 For 2017, a reduced tax rate of 20% (if a taxpayer is in the 39.6% tax bracket), 15% (for most taxpayers), and 0% (if a taxpayer is in the 15% and/or 10% tax bracket) is provided for qualified divs and LT CGs.
Itemized Deductions; Charitable Contributions Continued
The taxpayer may only deduct the excess contribution over the consideration rec'd (only deduct excess paid for item). Charitable orgs that obtain contrs of > $75 in exchange for services or prop must provide the donor w/ a written stmt that estimates the value of the deductible portion of the pmt. Book ex for deductible contr: -raffle tickets bought at a charity bazaar that have a chance of winning a prize don't give rise to a charitable deduction. -V buys a ticket to a charity ball for $200. The actual value of attending the ball was $50. V may take a charitable deduction of $150 (excess). Taxpayers who don't itemize deductions may not deduct charitable contrs. A deduction is allowed only for the tax yr in which the contr is made (same rules as medical): -cash/check: actually paid. -credit card: when charged, a contr made by a bank credit card is deductible in the yr the charge is made, even if pmt to the bank for the charge occurs the following yr. A taxpayer may deduct out-of-pocket exps incurred as a result of giving services to a charity. This incl the cost of driving to/from volunteer work. The taxpayer may take 14 cents/mile or the actual cost of gas/oil. W/ either method, the taxpayer may also incl parking and tolls. An act of congress is req'd to change the std mileage rate for char contrs. Cannot deduct the value of free services! Just out of pocket exps.
Exemptions; Dependency Exemptions
These are part of personal exemptions. People, *NOT* pets. Taxpayer is entitled to an exemption for each qualifying child/relative. There are rqmts for each category. For qualifying child: *CARES* -*C*lose relative -*A*ge limit -*R*esidency and filing rqmts -*E*liminate gross inc test -*S*upport test changes For qualifying relative: *SUPORT* -*S*upport (>50%) test -*U*nder a specific amt of taxable gross inc test -*P*recludes dependent filing a joint return test -*O*nly citizens (residents of US/Canada/Mex) test -*R*elative test OR -*T*axpayer lives w/ indiv for whole yr test R and T are OR. The amt of the dependency exemption is 4,050 for 2016. Taxpayers must get a social sec no for any dependent who has attained the age of 1 as of the close of the tax yr. A taxpayer will be entitled to a full dependency exemption for anyone they *CARES* for or *SUPORT*, even if the dependent was born/died during the yr.
Specific Items of Income and Exclusions; Dividend Income Continued
These items are exempt from gross inc (tax-free distributions): 1. ROC: exists when a co distrs funds but has no E&P. Taxpayer will simply reduce (but not below 0) their basis in the C/S held. 2. Stock split: when this occurs, the SH will allocate the OG basis over the total no of shares held after the split. 3. Stock div (unless cash or other prop option/taxable FMV): unless the SH has the option to receive cash or other prop (which would then be taxable at the FMV of the div), the basis of the shs after distr depends on the type of stock rec'd. -same stock: OG basis divided by total shs. -diff stock: OG basis is allocated based on the relative FMV of the diff stock. 4. Life ins divs: divs caused by oship of ins w/ a mutual co (premium return). CG distribution: distrs by a corp that has no E&P and for which the SH has recovered their entire basis are treated as taxable gross inc. So: -1st: divs to the extent of E&P (taxable). -2nd: divs when there's no more E&P are a ROC and reduce the basis of the SH. Tax-free. -3rd: divs when there's no more E&P and SH's basis is 0 are CG distrs and taxable. Schedule B is used to report int and ordinary divs. B= banks, bond int, divs. Part 1 shows int, part 2 shows ord divs, and part 3 shows foreign accts and trusts (latter is just a series of Qs more than a list of amts that are summed). Part 3 only must be completed if either int or divs are > $1,500 when summed (summed w/in their respective categories, so like total int OR total divs, not total int and divs summed).
Tax Planning
Understanding the implications of the timing of inc/deductions is an effective tool for maximizing the AT wealth of a taxpayer. Using the TVM principles, a taxpayer can eval the effect of the timing of a tax decision. 2 basic tax strategies, assuming the taxpayer's tax rate remains constant: 1. defer taxable inc 2. accelerate tax deductions Important tax factors may change btw yrs in a dynamic tax environmt. These changes may be a result of a change in tax law or a change in the taxpayer's personal situation, like retiremt or opening a new bus. Therefore, many other factors must be considered for tax planning. Incl: -type of inc -changing tax rates -type of entity -taxpayer's filing status 1. Book ex for timing of inc (w/ constant tax rates): postpone inc. J owns a small retail bus. J is a cash-based, calendar yr taxpayer. Reports her inc/exps for the bus on sch C. Has the opp to make an unusually large sale in the amt of 100k and is trying to determine the best tax strategy regarding the timing of the sale. Can finalize the sale/get pmt on 12/31 of the CY or 1/1 of next yr. J's marginal tax rate (MTR) is 30% in both yrs. For all of the exs in the tax planning topic, assume an AT rate of return on investmts of 10% for PV analysis. PV factor for 1 yr at 10% is .909. Advise J on whether it's optimal for the sale to made in the CY or next yr. -if J finalizes the sale/gets pmt on 12/31, has to report the 100k of inc on this yrs TR. [100k x 30%] = 30k. [30k x PV factor of 1] = 30k. [100k inc - 30k tax] = 70k AT inc. -if J finalizes sale/gets pmt on 1/1, will have inc 1 yr later on next yr's TR. [30k x .909 PV factor] = 27,270. [100k - 27,270] = 72,730 AT inc. -option to defer the inc to next yr results in 2,730 extra inc AT, considering the TVM, since the PV of tax paid 1 yr later is < than if the tax is paid in the CY.
Flow-Through Business Entities; Reporting S Corporation Income and Losses
Use K-1 (sch E). An S corp is also not a taxpaying entity. Files an info return, Form 1120S, by 3/15 (extension to 9/15 if necessary). The details of the S corp's bus inc/exps are reported only on the 1120S. Allocations to SHs are made on a per-share, per-day basis. These S corp items flow through to the SH sim to a pship (see K-1 for complete list): -ord inc (not subj to FICA), incl recapture inc and unearned rev not related to rental activities and mark-to-mkt inc. Sep reported items: -rental inc/loss, incl recapture inc and unearned rev related to rental activities. -portfolio inc, incl int, divs, royalties, and all cap G/Ls. -TE int -% depletion -foreign IT -section 1231 G/Ls -char contrs -exp deduction for recovery prop (section 179) -unrecaptured section 1250 inc -G/L from sale of collectibles Book ex for allocation on a per-share, per-day basis: D corp, an S corp, is owned equally by 3 SHs, R, T, and P. The corp is on a calendar-yr basis. On 2/1/Y5, P sold his 1/3 int in D corp to G. For the yr ended 12/31/Y5, the corp had non-sep stated ord inc of 120k (10k/mo). Y5 inc S/B allocated as follows: -R: [120k x (1/3)] = 40k. -T: [120k x (1/3)] = 40k. -P: [40k x (31/365)] = 3,397. ~ 1/12 of 1/3. -G: [40k x (334/365)] = 36,603. ~ 11/12 of 1/3. Sim a pship, the SHs in an S corp must incl on their personal inc TR their distributive share of each sep "pass-through" item. SHs are taxed on these items, regardless of whether or not the items have been distributed (withdrawn) to them during the yr. Sch K-1 for S corp SHs incl: -info abt corp -info abt SH -SHs % stock oship for the yr -SHs share of CY inc, deductions, credits, and other items; specifically (listing schs these flow to on the 1040): (a) Sch E: ord bus inc/loss, net rental real estate inc/loss, other rental inc/loss. (b) Sch B: int inc, ord divs, qualified divs. (c) Sch D: net ST/LT cap G/L. -incl lots of other specific pass-through items -has page identifying which line items on the K-1 go where on the 1040, etc. -no guaranteed pmts line item (like on pship K-1).
Specific Items of Income and Exclusions; IRA Income
Withdrawing money from an IRA. Gen, retiremt $$ can't be withdrawn until the indiv is 59.5 yrs old (except in certain situations) or the indiv elects to receive equal periodic distrs over his life expectancy. A taxpayer is req'd to start withdrawals by the age of 70.5 (req'd minimum distribution, RMD). Benefits aren't taxable until the taxpayer receives the distr. For traditional deductible IRA distributions, when a person retires, the funds will be taxed as ord inc when rec'd (regardless of what type of inc, like CG, was earned while the funds were invested). Put in before-tax (BT) dollars. For nondeductible IRAs: -roth IRA: all qualified benefits rec'd from a roth are nontaxable. Put in after-tax (AT) dollars. -traditional nondeductible IRA: benefits rec'd are partially taxable. ROC isn't taxable, so the amt rec'd must be prorated btw the contributed and noncontributory portions of the acct. Principal is nontaxable, accumulated earnings are taxable when withdrawn. Gen, a premature distribution (early withdrawal) is subj to a 10% penalty tax (on top of any incr in regular IT) if the indiv hasn't met an exception. There is no penalty tax (but still subj to ord IT) if the premature distr was used to pay: *HIM DEAD* -*H*ome buyer (1st time): 10k max exclusion applies if the distr is used toward the purch of a 1st home (w/in 120 days of distr). -*I*nsurance (medical): if unemployed w/ 12 consecutive weeks of unemploymt comp or self-employed (who are otherwise eligible for unemploymt comp). -*M*edical exps in excess of 10% of AGI. -*D*isability (perm or indefinite disability, but not temp disability). -*E*ducation: college tuition, books, fees, etc. -*A*nd -*D*eath. Excess contrs to the plan are subj to a cumulative 6% excise tax each yr until the excess is corrected. The amts invested in an IRA can be placed into a domestic trust or custodial acct or can be invested directly in indiv annuity contracts issued by an ins co. An indiv's interest in the plan must be nonforfeitable.
Itemized Deductions; Interest Expense Continued
*HIPPE*. 2. *I*nvestmt interest exp: like gambling loss rules. The investmt int deduction for indivs is limited to net (taxable) investmt inc. No negative amt allowed as a deduction, only offset positive amts. Items to incl as investmt (taxable) inc: -int/divs (portfolio inc) -divs (portfolio or investmt inc) -rents -royalties (in excess of exps) -net LT and ST cap gains (only if the taxpayer elects not to claim the reduced CG tax rate) Any div inc (from stock purch'd w/ borrowed funds) that the taxpayer treats as investmt inc for the purposes of the limitation on investmt exp is not a qualified div, available for the 15% tax rate. Int exp used to purch tax-free bonds is not deductible (exclude as investmt taxable inc) bc the int earned on the bonds isn't taxable. Easy way to remember this is to think of it like the limitations on gambling losses. Investmts (risk/gamble) have the limitation of not being permitted to deduct a net investmt exp. Investmt exps (like investmt advice fees, safe deposit box rentals, etc) other than int are deductible on sch A as part of misc itemized deductions (subj to 2% of AGI). Only those exps deductible on sch A (exceeding 2% of AGI) are used when calcing the amt of net investmt inc (which is the limit for the investmt int deduction). This is the investmt int exp limit. Exclude as an investmt exp any int exp taken into acct in determining the inc/loss from: -a passive activity (losses and credits can be CF indefinitely). -rental real estate (passive activity) in which the taxpayer doesn't actively participate (int exp when the taxpayer does actively participate is treated sep). The excess of investmt int paid over the allowed investmt int (deduction) can be CF indefinitely (CF the disallowed exp and apply in future pds).
Itemized Deductions; Interest Expense Continued Further
*HIPPE*. 3. *P*ersonal (consumer) int: isn't deductible. Personal int incl int on: -a personal note to a bank/person for borrowed funds. -life ins loans. -bank credit cards or other revolving charge accts. -a purch of personal prop like autos, TVs, clothes, etc. -int on fed, state, or local tax underpmts. Student loan int exp adjustmt (above-the-line) is a max of $2,500/yr. Excess is personal consumer int and isn't deductible. 4. *P*repaid int: allocate to proper pd. Deduct when both incurred and paid. Prepaid int must be allocated over the pd of the loan (for the taxpayer making the pmts), even for a cash basis taxpayer. Prepaid int rec'd is taxable as inc in the yr rec'd and isn't allocated (the hypocrisy!). 5. *E*ducational loan int: adjustmt, *NOT* itemized deduction. This is a deduction to arrive at AGI (above-the-line). Max is $2,500, excess isn't allowed.
Itemized Deductions; State, Local, and Foreign Taxes
*NOT* fed IT. For cash-method taxpayers, deductible taxes are gen deductible in the yr paid. For accrual-method taxpayers, taxes are gen deductible in the yr in which they accrue. Death and taxes are the 2 things that are guaranteed in life. Taxes = RIPS. *R*eal Estate *I*nc tax *P*rop tax *S*ales tax 1. *R*eal estate taxes (state, local, and foreign): the taxpayer must be legally obligated to pay in order to deduct the taxes. Prorate taxes in the yr of sale/purch. -taxes paid under protest are deductible. Subseq recovery incl in gross inc. -real estate taxes do *NOT* incl street, sewer, and sidewalk assessmt taxes (not special assessmt). -taxes paid through an escrow impound acct are deductible when paid to the taxing auth (bank/agent pays town). -foreign real estate taxes paid are only deductible for real estate held as an investmt. -real estate taxes on land held for appreciation may be capitalized or deducted at the option of the taxpayer. -real estate taxes allocated to part of the home that's used exclusively for bus may be deductible on sch C. 2. *I*ncome taxes (state, local, and foreign): estimated taxes paid during the yr are deductible. Withheld taxes from paychecks during the yr are deductible. Assessmts paid during the yr for the PY's tax are deductible. Refunds are an item of gross inc (if the tax was deducted in a PY) and shouldn't be netted against the itemized tax deduction. 3. *P*ersonal prop taxes (state and local): assessed by state/local govts on personal prop owned by the taxpayer, like vehicles and boats. To be deductible, the tax must be based on the value of the personal prop and paid during the tax yr. 4. *S*ales tax (perm extended by the PATH act of 2015): a taxpayer may elect to deduct either state and local inc taxes OR state and local gen sales taxes (not both). If the sales tax is chosen to be deductible, the amt is determined by either: -the total of actual gen sales taxes paid or -the relevant IRS table + any amt of sales tax paid for a motor vehicle, boat, or other IRS-approved items. A tax benefit rule applies to the impact of sales tax. If a taxpayer itemizes deductions in a yr and a takes a deduction for state inc taxes instead of a deduction for sales taxes in that yr, the tax benefit rule will calc the taxability of the state tax refund on the extra benefit rec'd from claiming the higher state inc tax deduction instead of what would have been allowed if the state sales tax had been deducted. Nondeductible taxes incl: *FIB* 1. *F*ederal taxes (incl social sec). 2. *I*nheritance taxes for states (also called federal estate pick-up tax). 3. *B*usiness (sch C) and rental prop taxes (sch E). Bus goes against bus. For federal purposes, cash basis taxpayers are entitled to a deduction in the yr an item is paid/charged, NOT in the yr applied to. There's no matching to the yr the tax is applicable.
Itemized Deductions; Charitable Contributions
-Charity: items given to orgs (tax deductible). -Gifts: items given to indivs (like a needy fam. Nondeductible). -Political contrs: items given to candidates (nondeductible). A gift must be in the form of cash or prop (FMV). The deduction for contr'd prop is usually measured by the lesser of the prop's basis or its FMV at the time the contr is made. The max allowable deduction for an indiv is: -cash: 50% of AGI. -FMV prop: 30% of AGI for gifts of LT CG prop to pub charities. Special rules apply to the deductibility of gifts of LT CG prop (appreciated prop): -deduct at FMV: appreciated prop (w/ value > its basis) is deductible at its FMV if it was held > 1 yr. -30%/50% AGI limit: a taxpayer may deduct the full value of LT CG prop (w/o paying CG tax on the appreciation), but the total value of such prop deducted may not exceed 30% of the taxpayer's AGI for gifts to a pub charity. No more than 20% may be deducted for gifts to a nonoperating private foundation (so either 20 or 30% out of 50% total contrs in general is the max). -combination rules: always remember that, in addition to the above, the total deduction for ALL gifts (to incl LT CG prop, cash, and other prop) may not exceed 50% of AGI. The CPA exam has typically tested these rules w/ regard to charitable contrs limitation: -overall limit = 50% AGI. -cash: may be all 50% -general prop: lesser of basis or FMV -LT appreciated prop: limited to the lessor of: (a) 30% AGI. (b) the remaining amt to reach 50% after cash contrs.
Specific Items of Income and Exclusions; Annuities and Rental Income
1. Annuities: treat investmt (paid) as depreciation. The investmt amt is divided by a factor repping the no of mos over which the investmt will be recovered. This factor is based on the age of the annuitant at the start of the payout pd. Factors range from 360 for starting ages under 56 to 160 for starting ages over 70. Book ex for annuity: GRs; if the investmt in the contract is 60k and the annuitant is 64 YO (factor of 260 mos per IRS table) at the start of the payout pd: -[60k/260 mos] = $230.77 excludable from each of the 1st 260 pmts (not taxable). Amts of each pmt in excess of $230.77 are taxable. -if the annuitant lives longer than actuarial payout pd (260 mos), then further pmts are fully taxable. -if the annuitant dies before the 260 pmts are collected (death before full recovery), the unrecovered portion of the 60k is a misc itemized deduction on the annuitant's final IT return not subj to the 2% of AGI floor. 2. Rental inc: passive activity. Schedule *E* --> real *E*state. Net rental inc/loss is calc'd on sch E and reported as a single line item on the 1040 (rental real estate, royalties, ...).
Attorney Fees Paid in Discrimination Cases and Domestic Production Activities
1. Attorney fees paid in discrim cases: In certain cases, an adjustmt is allowed for attorney fees paid in connection w/ age/sex/racial discrim and whistle-blower cases. The adjustmt amt is limited to the amt claimed as inc from the judgmt. This assists some taxpayers in avoiding the AMT related to the deduction, which was prev reported as a misc itemized deduction (disallowed for AMT purposes). 2. Domestic production activities: There's an adjustmt for domestic production activities (code section 199). Taxpayers will receive an adjustmt for 9% of qualified production activities inc or the taxpayer's TI w/o considering the deduction (whichever is less). The deduction is for businesses of architectural and engineering, construction, film production, and the sale/rental/lease of the co's manufactured equip. A Form 8903 will be filed.
Specific Items of Income and Exclusions; Business Income or Loss, Farm Income, and Gains and Losses on Disposition of Property
1. Bus inc/loss: net bus inc/loss from a sole prop is calc'd on schedule C or C-EZ and reported on Form 1040 as a single item (the specific line item is bus inc/loss). 2. *F*arm inc: P/L from farming is calc'd on Schedule *F* and reported on Form 1040 as a single line item (farm inc/loss). 3. G/Ls on disposition of prop: Schedule *D*--> *D*ealings in G/Ls. G/L on the disposition of prop is measured by the diff btw the amt realized and the adjusted basis. G/Ls are given tax effect (recog'd) only when the asset is sold/disposed of by other means. Whether on a cash or accrual method, taxpayers who sell stock or securities on an established securities mkt must recog G/Ls as of the trade date, not the settlemt date. Basic formula in determining G/L: [amt realized - adjusted basis of assets sold] = G/L realized.
Specific Items of Income and Exclusions; Nontaxable Miscellaneous Items
1. Life ins proceeds (nontaxable): the proceeds of a life ins policy paid bc of the death of the insured are excluded from gross inc of the beneficiary. -the int inc element on deferred payout arrangemts is fully taxable. Int rec'd on installmt payout is taxable. -if the proceeds are used to pay for LT care, accelerated death benefits rec'd by an insured who is terminally ill (provided there's certification that the insured is expected to die w/in 24 mos), is chronically ill, or reqs assisted living aren't taxable. 2. Gifts and inheritances (nontaxable): gross inc doesn't incl prop rec'd from a gift/inheritance. However, any inc rec'd from such prop (like int inc, rental inc, etc.) after the prop is in the hands of the recipient is taxable. 3. Medicare benefits (nontaxable): exclude from gross inc basic medicare benefits rec'd under the social sec act. 4. Workers' comp (nontaxable): exclude from gross inc comp rec'd under a workers' comp act for personal injury/sickness. Compare to unemploymt comp (taxable). 5. Personal (physical) injury/illness award (nontaxable): exclude from gross inc damages rec'd as comp for personal (physical) injury/illness. 6. Accident ins; premiums paid by taxpayer (nontaxable): exclude from gross inc all pmts rec'd (even w/ multiple recoveries) if the indiv paid all premiums for the ins. 7. Foreign-earned inc exclusion: taxpayers working abroad may excl from gross inc up to $102,100 (2017) of their foreign-earned inc. To qualify for the exclusion, taxpayer must satisfy 1 of these 2 tests: 1- bona fide residence test: taxpayer must have been a bona fide resident of a foreign country for the entire taxable yr. 2- physical presence test: the taxpayer must have been present in the foreign country for 330 full days out of any 12-consecutive-mo pd (which may begin on any day). The exclusion can't exceed the taxpayer's foreign earned inc reduced by the taxpayer's foreign housing exclusion (max of $16,336 in 2017, 16% of foreign-earned inc exclusion). Also, the amt of excluded inc and housing is used to determine the IT rate (and AMT tax rate) for the taxpayer for the yr (although it isn't taxed, the excluded inc could cause other inc to be taxed at higher rates, as if the excluded inc were taxable).
Specific Items of Income and Exclusions; Nontaxable Fringe Benefits
1. Life ins proceeds: the proceeds of a life ins policy paid bc of the death of the insured are gen excluded from the gross inc of the beneficiary. -the int inc on deferred payout arrangemts is fully taxable. -accelerated death benefits rec'd by a terminally ill insured (certified that they're expected to die w/in 24 mos) are not taxable, or a chronically ill insured (or reqing assisted living), if the proceeds are used to pay for LT care. -for policies issued after 8/17/06, if the policy is company-owned (COLI), the employer beneficiary may excl from gross inc benefits rec'd (no more than the total amt of premiums and other amts paid by the policyholder). Any excess rec'd beyond the amt of premiums/other amts paid by the policyholder W/B taxable. The gross inc inclusion rqmt for the COLI is N/A if proper notice and consent rqmts are met and any of these situations apply: (a) the insured was a qualified highly compensated officer, director, or employee and a US citizen or resident. (b) proceeds were paid to a member of the insured's family. (c) the beneficiary is a fam member or another indiv (not the policyholder). (d) the beneficiary is a trust for the benefit of the insured's family (or the estate of the insured). 2. Accident, medical, and health ins (employer-paid): premium pmts are excludable from the employee's inc when the employer paid the ins premiums, but amts paid to the employee under the policy are includable in inc, unless such amts are: 1- reimbursemt for medical expenses actually incurred by the employee or 2- comp for the perm loss or loss of use of a member/function of the body. 3. De minimis fringe benefits: so minimal they're impractical to acct for and may be excluded from inc. Things like employee's personal use of a co computer. 4. Meals and lodging: the gross inc of an employee doesn't incl the value of meals/lodging furnished to them in kind by an employer *for the convenience of the employer* on the employer's premises. Also, in order to be nontaxable, the lodging must be req'd as a condition of employmt. 5. Employer pmt of employee's education expenses: B/S and MBA. Up to $5,250 may be excluded from gross inc of pmts made by the employer on behalf of an employee's educational expenses. The exclusion applies to both undergraduate and graduate-level education.
Flow-Through Business Entities; S Corporation and Partnership Self-Employment Tax Difference
1. Pmt for services: -Partners in a pship (incl members of a LLC) are considered to be SE, not employees, when performing services for the pship. Guaranteed pmts are reasonable comp paid to a partner for services rendered or use of cap w/o regard to his ratio of inc. They're allowable tax deductions to the pship and treated as SE inc to the partner. -When performing services for an S corp, SHs are treated as employees for tax purposes. IRS rules req that S corps pay SHs who are also employees a reasonable comp that is subj to payroll taxes. The S corp pays the employer portion of payroll taxes in connection w/ the comp, and the SH pays the employee portion of payroll taxes on the comp, as w/ any other employer/employee relationship. 2. Distributive share of inc/loss: -For a gen partner of a pship, net earnings from SE incl the partner's distributive share of the inc/loss from that trade/bus. Limited partners don't pay SE tax on their distributive share of pship inc, only pay SE tax on guaranteed pmts. -The allocated inc from an S corp is not subj to SE tax but is only subj to the SH's personal IT. Being able to avoid SE taxes is viewed as a big advantage of operating as an S corp in comparison to operating as a pship.
Tax on Self-Employment, Self-Employed Health Insurance, and Keogh (Profit-Sharing) Plans
1. Tax on SE (social sec 50%): SE taxpayers w/ bus NI are subj to 2 taxes: inc tax and social sec/medicare tax. 50% of the SE social sec/medicare tax is deducted to arrive at AGI. You pay both halves of social sec, boss and employee, deduct boss half as an adjustmt. Not deducted on sch C. 2. SE health ins (100% deductible): SE indivs may deduct all of the medical ins premiums paid for the taxpayer, spouse, and dependents (fam) provided that the plan is set up in the name of the SE indiv or their bus. Not deducted on sch C. 3. Keogh (profit-sharing) plans: SE retiremt plan. Not deducted on sch C. A SE taxpayer subj to SE tax is gen allowed to set up a keogh plan. The max annual deductible amt is limited to the lesser of: -54k (2017. Indexed for inflation) or -25% net keogh/SE earnings The max annual addition (contr) may exceed the deductible amt for the yr. Limited to the lesser of: -54k or -100% net earnings (only if comp is < 54k). Net earnings from SE (after the keogh deduction and 1/2 of the SE tax) are calc'd as: Keogh net earnings = [bus inc - bus exps] = net bus inc. [net bus inc - 1/2 SE tax - keogh deduction] = keogh net earnings (multipled by 25% to get keogh deduction). 25% of the SE inc after the keogh deduction is the mathematical equivalent of 20% (25%/125%) of SE inc before the keogh deduction. Book ex for calcing max allowable deduction for keogh plan: P has SE NI (after 1/2 of SE tax but before any keogh deduction) of 100k. Calc P's max allowable deduction to his keogh plan for 2017. -[100k gross SE inc x 20% shortcut] = 20k max allowable deduction. -Check: [100k gross - 20k keogh deduction] = 80k. [80k x 25%] = 20k.
IRA Contribution and Withdrawal Summary
1. Traditional deductible IRA: -tax adjustmt: yes -max contr in 2017: 5,500 -accumulate tax-free/deferred: yes -withdrawals: (a) principal: taxable (b) earnings: taxable 2. Catch-up IRA: -tax adjustmt: yes -max contr in 2017: 1k -accumulate tax-free/deferred: yes -withdrawals: (a) principal: taxable (b) earnings: taxable 3. Roth IRA: -tax adjustmt: no -max contr in 2017: 5,500 -accumulate tax-free/deferred: yes -withdrawals: (a) principal: nontaxable (b) earnings: nontaxable 4. Nondeductible IRA: no phase-out, last option. -tax adjustmt: no -max contr in 2017: 5,500 -accumulate tax-free/deferred: yes -withdrawals: (a) principal: nontaxable (b) earnings: taxable 5. Coverdell education IRA: not combined w/ the others. -tax adjustmt: no -max contr in 2017: 2k -accumulate tax-free/deferred: yes -withdrawals: (a) principal: nontaxable (b) earnings: nontaxable
Specific Items of Income and Exclusions; Unemployment Compensation and Social Security Income
1. Unemploymt comp: a taxpayer must incl in gross inc the full amt rec'd for unemploymt comp. Workers' comp is tax free. 2. Social security inc: social sec benefits rec'd might be incl in inc. Taxpayers are classified into 5 categories depending on the level of provisional inc, which is [AGI + TE int + 50% of social sec benefits]. Taxpayers must incl in inc the lesser of 50% (or 85%, depending on the inc) of social sec rec'd or 50% (or 85%, depending on inc) of the excess provisional inc over the threshold. -low inc: no social sec benefits are taxable (inc <= 25k for single filers or <= 32k for MFJ). -lower middle inc: < 50% of social sec benefits are taxable. -middle inc: 50% of social sec benefits are taxable (inc over 25k for single or 32k for MFJ). -upper middle inc: btw 50% and 85% of social sec benefits are taxable. -upper inc: 85% of social sec benefits are taxable (inc over 34k for single, 44k for MFJ). Modified AGI (provisional inc), incl these items: -any inc excluded bc of the foreign earned inc exclusion. -any exclusion/deduction claimed for foreign housing. -any int inc from series EE bonds that was able to be excluded bc of qualified higher education exps. -any deduction claimed for student loan int or qualified tuition and related exps. -any employer-paid adoption exp that was excluded. -any deduction claimed for an annual (non-rollover) contr to a regular IRA. Basically, these items aren't taken into acct in determining AGI v mod AGI.
Itemized Deductions; Casualty and Theft Losses
10% AGI test. Casualty and theft losses of nonbus prop are deductible to the extent that each indiv loss exceeds $100 and the aggregate of these excess losses (excess over $100) exceeds 10% of AGI. The $100 floor applies to each sep casualty event. *REMEMBER* the 100k reduction applies to each sep casualty loss, the 10% of AGI reduction applies to all of the casualty losses in the aggregate. The amt regarded as casualty loss is the diff btw the mkt value of the prop immediately before the casualty and its mkt value immediately afterward. However, the loss may not exceed the adjusted basis of the prop. Whichever amt is used must be reduced by the amt of any ins recovery. Calc: [Smaller loss - ins recovery] = taxpayer's loss. [Taxpayer's loss - 100] = eligible loss. [Eligible loss - 10% AGI] = deductible loss. Smaller loss refers to (1) lost cost/adjusted basis or (2) decr'd FMV. *GR for last ditch rushing* (works like 60-70% of the time): Smallest loss is the correct answer. A casualty loss must be sudden/unexpected. The IRS has held that termite damage is not a deductible casualty loss bc the damage occurs over a long pd of time (some cts have disagreed). Sim, damage caused to trees by disease isn't deductible. A casualty loss for nonbus prop can't de deducted unless: -an ins claim was filed OR -the losses aren't covered by ins. No casualty loss can be deducted if fail to notify insurer. No casualty loss deduction is allowed for lost, misplaced, or broken prop.
Itemized Deductions; Miscellaneous Itemized Deductions Continued Further
10. Activities not engaged in for profit (hobbies): not deductible. There's a statutory presumption that an activity is engaged in for profit if it shows a profit for 3+ taxable yrs during a pd of 5 consecutive taxable yrs ending w/ the yr in question. In the case of businesses engaged in the breeding/training/showing/racing of horses, this presumption will apply if a profit is made in 2 of 7 consecutive taxable yrs. Book ex for determining whether an activity is for profit: R raises/sells guinea pigs as pets. Shows a profit in Y7, Y4, Y3, and loss in Y6. For Y7, the bus is considered engaged in for profit (3 of 5 yrs test met). The test includes the CY in question. Taxpayers must incl inc generated from a hobby in gross inc. Exps from a hobby can only be deducted to the extent of gross inc from the hobby and are taken as itemized deductions in this order: -exps attributable to mortgage int and prop taxes deductible 1st. -all other hobby exps w/ the exception of depr exp are deductible next as misc itemized deductions. -depr exp is deducted last as a misc itemized deduction. Misc itemized deductions are only deductible to the extent they exceed 2% of AGI! Book ex for hobby: H is a single doctor in texas. He owns/ops a cattle ranch, which has been profitable only 1 of the last 10 yrs. W/o regard to his hobby, H's AGI is 225k. His only other itemized deductions are 4k of prop taxes on his residence and $3,500 of char contrs. Gives a list of revs/exps from the ranch in 2017. Has net loss from hobby. Determine TI/loss after inclusion of the hobby inc/exps. -Step 1; limitation to the extent of hobby inc: [31k hobby inc to incl in gross inc - 7,500 prop taxes on barn/land - 23,500 misc deductions subj to 2% floor (plug)] = 0. Misc deductions are a plug since can't go below 0. -Step 2; calc of TI: [225k AGI before hobby inc + 31k hobby inc] = 256k AGI after hobby inc. [256k AGI after hobby inc - 7,500 prop taxes on barn/land - 18,380 total misc itemized deductions after 2% AGI floor reduction - 4k prop taxes on residence - 3,500 of charitable contrs - 4,050 2017 personal exemption] = 218,570 TI. -18,380 total misc itemized deductions after 2% AGI floor reduction = [-23,500 other exps of hobby + 5,120 reduction by 2% of AGI (.02 X 256k)] -main takeaways from the TI calc are to reduce other hobby exps deducted by 2% of AGI and to remember to also deduct the personal exemption.
Filing Requirements for Individuals
1st consideration is who must file a return. Gen, taxpayer must file a return if their inc is >= the sum of: 1. the personal exemption + 2. the regular std deduction (except for married filing sep) + 3. the additional std deduction amt for taxpayers > 65 YO or blind (except for married filing sep). Certain indivs must file IT returns even if their inc is < the GR rqmt. Incl: -indivs whose net earnings from SE are $400 +. -indivs who can be claimed as dependents on another taxpayer's return w/ (1) unearned inc of > 1,050 for 2017 or 2016, (2) earned inc of > 6,350 for 2017 (6,300 for 2016), or (3) total inc that exceeds the larger of 1,050 or earned inc (up to 6k for 2017, 5,950 for 2016) + 350. Indiv taxpayers must file on/before the 15th day of the 4th mo following the close of the taxpayer's taxable yr (4/15). An automatic 6-mo extension (until 10/15) is available for taxpayers unable to file on 4/15. *Not an extension for pmt of any taxes owed*. Granted automatically, but must be requested by the taxpayer filing form 4868 by 4/15. *Even w/ an extension, the due date for pmt of taxes remains 4/15*.
Itemized Deductions; Miscellaneous Itemized Deductions
2% AGI test. A deduction is allowed only to the extent that these misc deductions combined exceed 2% of AGI and weren't taken as part of an allowable adjustmt. 1. Unreimbursed bus exps (employee): only employee moving exps are adjustmts. While an employee is considered to be in a trade/bus, he's allowed only certain limited deductions in determining his AGI. Before considering these items, must distinguish btw reimbursed and unreimbursed exps. An employee may always deduct reimbursed exps incurred on behalf of his employer. The reimbursemts may be incl in his gross inc. The unreimbursed items that may be deducted are: 1- travel, meals, and lodging (overnight bus travel): all exps incurred for meals/lodging while away from home overnight may be deducted. SE would deduct on sch C. The IRS insists that "away from home" means away overnight. Sup ct has upheld this position. Book ex for overnight rule: exec from Chicago flies to NY on bus. leaves at 5 AM, returns at 11 PM on same day. No deduction for meals while in NY. When an employee goes away on a bus trip for a short time, he/she is entitled to deduct travel exps. No deduction is allowed for the travel exps of a spouse/dependent/companion unless that person is an employee of the taxpayer and has a bona fide bus purpose in traveling. If an employee stays away for many mos, IRS may argue they've shifted their tax "home" and are no longer "away from home" w/in the meaning of the IRC. 2- transportation exps (100% deductible): all transportation exps incurred in furtherance of the employee's bus are deductible except ord commuting exps. This incl both out-of-town and local travel and automobile exps. The std mileage allowance for 2017 is 52.5 cents/mile. -btw home and temp work site: deductible if not your reg job site. -btw home and regular office: not deductible. -btw home and second job: not deductible. -btw home and out-of-town bus: deductible. -btw regular office and temp work site: deductible. -btw regular office and 2nd job: deductible. -btw regular office and out-of-town bus: deductible. Book ex for deductible transportation exps: -employee flies from Chicago to NY on bus: airfare deductible. -employee takes a cab from his office to client: cab fare deductible. -employee takes cab from home to office: exp isn't deductible, commuting exp. -employee takes a cab from day to evening job: exp is deductible. 3- meals and entertainment exps (50% deductible): to be deductible, entertainment exps must gen be either "directly related to" or "assoc'd w/" the active conduct of a trade/bus. Only 50% of the cost of entertainmt is deductible. No deduction allowed for club dues. Random note: common misc itemized deduction of an employee is union dues.
Tax Planning Continued
2. Book ex for timing of inc (w/ increasing tax rates): same facts as prior ex, but tax rate is 31% in Y2. Advise J on whether it's optimal for the sale to be made in the CY or next yr. -option to report in CY still yields 70k AT inc. -option to report next yr: [100k x 31%] = 31k. [31k x .909 PV factor] = 28,179. [100k - 28,179] = 71,821. -option to report next yr is still more attractive, but by less; incr in AT inc is only 1,821. -taxpayer must eval specific facts/circumstances in their situation to effectively understand the timing effects of taxable inc. -still more beneficial to wait here bc TVM. 3. Book ex for timing of deductions (w/ constant tax rates): accelerate tax deduction. J is planning to purch new equip for her retail bus costing 20k. Considering whether to purch the equip this yr and deduct the cost of the equip on the CY TR, or purch the equip next yr and deduct it on that TR. MTR is 30%. Determine which yr J should purch the equip to provide the lowest AT cost. -if purch equip in CY: [20k deduction x 30%] = 6k tax savings. [6k x PV factor of 1] = 6k. [20k BT cost - 6k PV of tax savings] = 14k AT cost. -if purch equip next yr: [6k x .909 PV factor] = 5,454 discounted tax savings. [20k - 5,454] = 14,546 AT cost. -purch equip in CY to get the lowest AT cost! 4. Book ex for timing of deductions (w/ increasing tax rates): accelerate tax deduction. Same facts as prior ex, but assume bus inc will rise w/ the use of the new equip, so MTR will incr from 30% in CY to 35% next yr. Determine which yr J should purch the equip to provide the lowest AT cost. -if purch equip in CY: 14k AT cost as shown above. -if purch next yr: [20k x 35%] = 7k tax savings. [7k x .909 PV factor] = 6,363. [20k - 6,363] = 13,637 AT cost. -w/ a rising TR next yr, purchasing the equip next yr gives lowest AT cost. -now cheaper to wait to take deduction! Many factors must be considered in determining the timing of inc/deductions for a taxpayer. In a changing tax environmt, the facts/circumstances unique to the taxpayer must be eval'd. These exs illustrate the effect of properly timing inc/deductions to incr the AT wealth of the taxpayer.
Filing Status Continued
5. Head of household: dependent. HOH status entitles certain taxpayers to pay lower taxes due to a larger std deduction and wider tax brackets. Conditions to qualify: 1- indiv isn't married, is legally separated, or is married and has lived apart from his/her spouse for the last 6 mos of the yr as of the close of the taxable yr. 2- the indiv isn't a qualifying widower. 3- the indiv isn't a nonresident alien. 4- the indiv maintains as their home a household that, for *> 1/2 of the taxable yr*, is the principal residence of a qualifying person (dependent child/parent, etc.). -*H*ead, *H*alf yr. -Qualifying child incl: --child, stepchild, legally adopted child, foster child, brother/sister, or descendant of one of these who you claim as a dependent under the qualifying children rules. --divorced parents: assuming all other rqmts are met, custodial parent is entitled to the HOH status even if they've waived their right to the dependency exemption w/ Form 8332. -A dependent parent isn't req'd to live w/ the taxpayer, provided the taxpayer maintains a home that was the principal residence of the parent for the entire yr (nursing home). Maintaining a home means contributing over 1/2 the cost of upkeep. Rent, mortgage, int, prop taxes, ins, utility charges, repairs, and food. -Dependent relatives (like grandparents, brothers, sisters, aunts, uncles, nephews, nieces, stepparents, and parents/brothers/sisters in-law) other than a father/mother must live w/ the taxpayer. Cousins, foster parents, and unrelated dependents don't qualify. Not freeloading friend! --kissing cousins and foster beer don't change your filing status! -Summary of who meets qualifying person rqmt: --child/descendant: qualifying dependent, must live w/ taxpayer (for > *H*alf of yr). --parents: qualifying dependent, don't need to live w/ taxpayer. --relative: qualifying dependent, must live w/ taxpayer. To avoid confusing time pd rqmts for diff filing statuses: -*W*idower, principal residence for dependent child for *W*hole yr. -*H*OH, principal residence for qualifying person for > *H*alf a yr.
Itemized Deductions; Miscellaneous Itemized Deductions Continued
2. Education exps (those not deducted above AGI): don't confuse w/ "educational int" allowed as an adjustmt (2,500) and tuition and fees deduction allowed as an adjustmt (4k). An indiv may deduct education exps if they either: -maintain/improve skills needed by the indiv in their trade/bus OR -meet the express rqmts of the indiv's employer for retention of this job. Must be job related! An indiv may *NOT* deduct educational exps if they were to meet min job rqmts or if they qualified him for a new trade/bus. Book ex for deductible education exp: B, an attorney, takes a 1 day course (not at a qualified higher education institution) in estate planning. Can deduct the cost of the course as a misc itemized deduction if it helps maintain/improve her legal skills. 3. Uniforms: the purch/cleaning/repair of uniforms qualify as deductible exps. The uniforms must not be of a type normally worn as street clothes when off the job. 4. Bus gifts: max is $25/person per yr. 5. Employmt agency fees (job hunting exps): an indiv may deduct employmt agency fees for a new job in the same profession. These fees aren't deductible for a 1st job or entirely new profession. 6. Exps of investors (safe deposit box and investmt advice): rental exps for safe deposit boxes used to store investmts are deductible, along w/ investmt advice and newsletters. 7. Subscriptions to professional journals: deductible. 8. Tax prep fee: a deduction is allowed for the legal/accting fees incurred in the prep of the taxpayer's return. No deduction is allowed for legal/accting fees incident to divorce unless, for ex, they're related to tax planning aspects or spent pursuing TI. 9. Debit card convenience fees incurred to pay IT: Convenience fees charged by the card processor for the use of the debit card to pay fed IT (incl estimated taxes) are deductible in the yr the fee was incurred.
Loss Limitations (Business Type Activity); Passive Activity Losses Continued Further
3. PALs continued again: Examples. 1- Book ex for classification of inc: M has a 30k tax basis in a limited pship int. At-risk amt is 25k. M is a 10% investmt partner only and has no mgmt responsibilities in the pship. Doesn't materially participate in the pship. This yr the pship had a 400k loss, so 40k for M's share. M's other sources of inc for the yr incl 75k in wages, 6k inc from a 5% investmt in a diff pship in which he doesn't materially participate, 3k in LTCG, and 12k in div inc. Classify M's inc into the 4 categories of inc. -ordinary: 75k wages. -portfolio: 12k div inc. -capital: 3k LT CG. -passive: 6k inc from other pship. 2- Book ex for tax basis, at-risk basis, and PAL limitation: Same facts as above. How much of M's 40k loss is deductible in the CY? Consider the 3 factors limiting losses. -tax basis: M has 30k tax basis in limited pship int, so can only get 30k loss deduction bc of his tax basis. 10k CF. -at-risk: at-risk basis is 25k, so can only deduct 25k of the 30k loss available after considering tax basis. Disallowed 5k loss CF. -PAL limitation: bc M doesn't actively participatein the pship, the investmt is a passive activity. PALs can only be used to offset passive inc. His investmt in the other pship is also passive (6k inc from that). So, of the 25k available for deduction after considering tax/at-risk bases, can deduct 6k. The disallowed 19k loss due to PAL will be CF. -6k deductible in CY. -total CF = [10k tax basis CF + 5k at-risk CF + 19k PAL CF] = 34k. 3- Book ex for use of losses when investmt is sold: Assume M sells his int in the pship in the following yr for a 20k gain. Determine how the suspended losses are treated. -the 10k suspended loss due to tax basis is lost. -the 5k at-risk CF can be deducted against the 20k gain on sale of the pship int. -the 19k passive loss is fully deductible against non-passive inc in the yr of disposal. -[5k + 19k] = 24k. [24k total losses - 20k gain] = 4k loss.
Loss Limitations (Business Type Activity); Passive Activity Losses Continued
3. PALs continued: An indiv may deduct rental activity losses (although deduction may be limited) if either of these 2 conditions are met: 1. Mom and pop exception: taxpayers may deduct up to 25k/yr of net PALs attributable to rental real estate annually if the indivs are actively participating/managing (although not participating to the extent needed to avoid passive activity classification) and own at least 10% of the rental activity. Any excess W/B CF indefinitely as an unused PAL. An estate can qualify for the 2 yrs following the decedent's death if the decedent actively participated in the operation. The 25k allowance is reduced by 50% of the excess of the taxpayer's AGI (w/o consideration of this loss deduction) over 100k. The allowance is elim'd completely when AGI exceeds 150k. 2. Real estate professional (not passive activity): if these conditions are met and the taxpayer is deemed to have material participation in the activity, the rental activities aren't considered passive and the taxpayer (often referred to on CPA exam as "real estate person") can fully deduct losses from the rental activities against other inc: - > 50% of the taxpayer's personal services during the yr are performed in real prop businesses AND - the taxpayer performs > 750 hrs of services in real prop businesses during the yr. This is gen rental real estate activity that's considered to be passive (even if the taxpayer materially participates in the activity) unless 1 of the 2 exceptions applies. So exception to PAL incl RE agent that's active. These 2 exceptions allow for the deduction of the "net loss" from passive activities.
Individual Retirement Accounts; Deductible IRAs
4 diff types of IRAs and 1 other type of retiremt plan called a Keogh plan that have been tested on the CPA exam. The 4 IRA accts are: 1. deductible IRA 2. nondeductible IRA 3. roth IRA 4. coverdell education savings accts (IRA) Starting with deductible IRAs here (1 of 4). Note that all the ones listed aren't deductible, just showing all options. Contrs to regular (deductible) IRAs may/may not be deductible. The regular IRA is deductible from gross inc to arrive at AGI. The adjustmt is allowed for a yr only if the contr is made by the due date of the return for indivs (4/15). Filing extensions aren't considered, so if extension, *DON'T* get extension on time to put $$$ into IRA. Earnings on deductible IRAs accumulate tax-free (deferred). Withdrawals are taxable as ord inc and may be subj to applicable penalties. No IRA deduction if (1) rich *AND* (2) in a retiremt plan. A taxpayer (gen) won't be permitted to deduct a contr to an IRA when these conditions are both present: 1. Excessive AGI: Rich. When AGI of the taxpayer is >= certain higher amts, 1 of the 2 conditions that disqualify deduction of the contr is met. Both conditions must be present! -higher amt if single is 62k - 72k. -higher amt if joint is 99k - 119k. 2. Active participation in another qualified plan: In a retiremt plan. When a taxpayer or spouse actively participates in another qualified plan, the 2nd condition that disqualifies deduction of a contr is met, although there's an exception (and related phase-out exception). Both conditions must be met before deduction is disallowed. -exception: indiv isn't considered an active participant in an employer-sponsored retiremt plan just bc their spouse is. -phase-out: the max deductible IRA contr for an indiv who's not an active participant, but whose spouse is, is phased out for taxpayers w/ mod AGI > 186k but <196k (2017). Super rich! -husband/wife tested sep, unless super rich, then tested together. Book ex for phase-out of IRA deduction: K, a single taxpayer, is an active participant in her employer's pension plan. K's AGI is 64k. Calc max IRA deduction. -[64k AGI - 62k amt for excessive AGI] = 2k excess. -[2k/10k (phase-out range btw 62k and 72k)] = 20%. -[20% x 5,500 max IRA deduction] = 1,100 amt of IRA phased out. -[5,500 max deduction - 1,100 phase-out] = 4,400 CY max IRA deduction for K.
Specific Items of Income and Exclusions; Nontaxable Fringe Benefits Continued
6. Qualified tuition reduction: employees of education institutions studying at the undergrad level who receive tuition reductions may excl the tuition reduction from inc. Grad students may excl tuition reduction only if they're engaged in teaching/research activities and only if the tuition reduction is in addition to the pay for the teaching/research. To be excludable, tuition reductions must be offered on a nondiscriminatory basis. 7. Qualified employee discounts: employee discounts on employer-provided merch and service are excludable as follows: -merch discounts: the excludable discount is limited to the employer's GP %. Any excess must be reported as inc. -service discounts: the excludable discount is limited to 20% of the FMV of the services. Any excess must be reported as inc. -employer-provided parking: the value of this up to $255 (for 2017) per mo may be excluded. The exclusion is available even if the parking benefit is taken by the employee in place of taxable cash compensation. -transit passes: the value of employer-provided transit passes up to $255 (for 2017) per mo may be excluded. 8. Qualified pension, profit sharing, and stock bonus plans: -pmts made by employer (nontaxable): put into trust acct. Gen, pmts made by an employer to a qualified pension, profit-sharing, or stock bonus plan aren't inc to the employee at the time of contr. -benefits rec'd (taxable): you withdraw/get $$. The amt that is exempt from tax (plus any inc earned on such amt) is taxable to the employee in the yr in which the amt is distr'd or made available to the employee. 9. Flexible spending arrangemts (FSA): a FSA stems from section 125 of employee flexible benefit plan and is a plan that allows employees to receive a pre-tax reimbursemt of certain (spec'd) incurred expenses. -pretax deposits into employee's acct: employees have the ability to elect to have part of their salary (gen up to 2,600 for 2017) deposited into a flexible spending acct designated for them. These deposits must be done via salary reduction directly by the employer, and the employee is not taxed on that inc. The employee has the option to use the deposited funds to pay for qualified health care and/or qualified dependent care costs, and submits claims to the plan admin for reimbursemt. -forfeit funds not used w/in 2.5 mos after YE: use it or lose it. Funds not used w/in 2.5 mos after YE or not claimed w/in a pd of time (usually 6 mos) are forfeited. However, this grace pd only applies if the employer amended the plan accordingly.
Individual Retirement Accounts; Coverdell Education Savings Accounts (Education IRAs)
A sep education savings acct (trust or custodial acct, w/ limits indep of those for other IRAs) is available. Not limited by any amts contr'd to other types of IRAs. Set up to pay the qualified education exps of a designated beneficiary. Contrs are nondeductible. Max contr *per beneficiary* is 2k/yr (good for lots of grandkids!). Earnings accumulate tax-free while in an education savings acct. Distrs of both principal/int are also tax-free to the extent they're used for qualified education exps of the designated beneficiary. May also be used for qualified elementary and secondary school exps. Qualified education exps (through high school) incl tuition, fees, tutoring, books, room/board, supplies, and equip. Any amts remaining when the beneficiary reaches 30 YO must be distr'd (unless special needs beneficiary). Time limitation. Distr may take 2 forms: 1. distributed to beneficiary: distributed amt is taxable to beneficiary and assessed a 10% penalty. 2. rollover to another fam member: the bal can be rolled over tax-free to another fam member of the taxpayer. This is permitted, and no 10% penalty is assessed. So you don't lose it. A taxpayer can claim the american opportunity or lifetime learning credit for a tax yr and also excl from gross inc amts distr'd from a coverdell education savings acct (educational IRA). Contr rqmts: -designated beneficiary must be a child under 18. No limit on the no of beneficiaries (each 1 has a sep acct). -the contr limit is 2k per beneficiary (in 2017). -the contr amt is phased-out for taxpayers w/ mod AGI btw: (a) 95k - 110k for single. (b) 190k - 220k for married. -the phase-out limits are the same regardless of whether the taxpayers are active plan participants.
Alimony
Alimony pmts to a former spouse are adjustmts deductible to arrive at AGI. Pmts for support of a spouse are inc to the spouse receiving the pmts and are deductible to arrive at AGI (adjustmt) by the contributing spouse. These conditions must exist for alimony to be deductible: -pmts must be legally req'd under a written divorce/separation decree/agreemt. -pmts must be in cash (or its equivalent). Equivalent W/B to pay credit card bills or college tuition bills. -pmts can't extend beyond the death of the payee-spouse. -pmts can't be made to members of the same household. -pmts must not be designated as anything other than alimony and -the spouses may not file a joint TR. If any portion of the pmt is fixed by the decree/agreemt as being for the support of minor children (or is contingent on the child's status, like them reaching a certain age), such portion (child support) is not deductible by the spouse making pmts and not includable in inc by the spouse receiving the pmt. Nontaxable to payee, nondeductible to payor. If the decree/agreemt specs that pmts are to be made both for alimony and child support, but the pmts subeq made fall short of fulfilling these obligations (deadbeat dad), the pmts will be allocated 1st to child support (until entire child-support obligation for the yr is met), then to alimony. If the divorce settlemt provides for a lump-sum pmt or prop settlemt by a spouse, that spouse gets no deduction for pmts made, and pmts are not includable in the gross inc of the spouse receiving the pmt. Nontaxable, nondeductible. HI*D*E IT.
Characterizations of Income
All inc can be characterized and put into 1 of 4 baskets of inc. Understanding the baskets is helpful in calcing the limitations on tax liab or deductibility of various items, like passive activity losses, cap G/L, and the investmt int deduction. 1. Ordinary: incl salaries/wages, SAL refunds, alimony, IRA and pension inc, SE (sch C) inc, unemploymt comp, social sec, prizes, the taxable portion of scholarships/fellowships, gambling inc, and anything not falling into the other baskets. 2. Portfolio: incl inc a taxpayer would earn on their portfolio of assets, like int and divs. 3. Passive: gen means an activity in which a taxpayer didn't actively participate (active incl working in a bus, etc.). Only passive losses may offset passive inc, and a net passive loss isn't deductible on the TR (suspended and CF until passive inc exists to offset it), unless an exception exists and the rqmt for passive treatmt is removed. -rental inc/royalties: rental inc rec'd on a prop that a taxpayer owns and rents (as opposed to a cap G/L that may exist when the prop is sold) is gen passive, unless exceptions exist. Exceptions incl a limited exception for real estate prop and certain real estate professionals. -beneficiaries of trusts and investmts in pships/LLCs/S-corps: indivs/cos w/ investmts in pships/LLCs/S-corps and beneficiary interests in trusts/estates will rec a K-1 from the entity each yr. This is the investor's share of the earnings/deductions of each co. A sch K is filed for each co (entity), and the sch K-1s are attached for all of the investors (beneficiaries). The sum of the K-1s (issued to each indiv investor) by line item equals the reported sch K nos (total for entire entity). K-1s can report inc from any basket. If an investmt in a co is deemed limited (as opposed to general) for the investor, the inc from the bus activities will be deemed passive for tax purposes, and the passive activity loss rules will apply. Even gen partners can get passive inc on their K-1s (like if pship had a rental activity). This will be sep from regular bus activities and on a diff line item on the K-1 as rental. 4. Capital: sales of cap assets create cap G/Ls. A cap asset is gen any prop (personal or bus), but there are some exceptions.
Employee Stock Options; Qualified Options - Employee Stock Purchase Plans
An ESPP may grant options to employees to purch stock in the corp. Rqmts: -the plan must be written and approved by the SHs. -an ESPP can't grant options to any employee who has > 5% combined voting power of the corp, parent, or sub. -gen, the plan must incl all full-time employees other than highly compensated employees and those w/ < 2 yrs employmt. -the option exercise price may not be < the LESSER OF 85% of the FMV of the stock when granted or exercised. -the option can't be exercised > 27 mos after the grant date. -no employee can acq the right to purch > $25k of stock/yr. -once exercised, the stock must be held at least 2 yrs after the grant date and at least 1 yr after the exercise date. -the employee must remain an employee of the corp from the grant date until 3 mos before the option is exercised. Employee taxation: not taxable inc as comp (when granted or exercised), cap G/L when sold. -gen, no taxation of the option as comp. The basis of the stock is [the exercise price + any amt paid for the option (if any)]. -gen, any G/L on a subseq sale of the stock is cap. If the holding pd rqmts aren't satisfied, any gain is ord up to the amt that the stock's FMV on the exercise date exceeded the option price. -gen, if the options lapse, no deduction is available, as the option wasn't taxed in the first place. There might be a loss if any amt was paid for the option itself. -if the option price is < FMV of the stock on the grant date, then ord inc is recog'd as the LESSER OF the diff btw the FMV of the stock when sold and the exercise price OR the diff btw the exercise price and the FMV on the grant date (exception to cap G/L when sold GR). Most likely scenario here is ord inc = [FMV - 85%]. Employer taxation: no tax deduction. Gen, employer doesn't get a tax deduction for an ESPP bc it's not considered comp inc to the employee.
Farming Income Continued
Book ex for farming GP calc: E has a farming bus, and is req'd to use the accrual method (so inv). During Y3, had net sales of $75k. Inv at the BOY was $15,600 incl livestock held for resale. Inv at the EOY was $14,200. Inv purchases during the yr, incl livestock, were $60k. Determine E's farming GP. -[14,200 EI + 75k net sales - 15,600 BI - 60k inv purchases] = 13,600. -alternative calc: *B*B inv 15,600 +*A*dd purchases 60k -*S*ubtract EB inv 14,200 =*E*B, COGS. 61,400. [75k - 61,400] = 13,600 GP. Taxpayers w/ a qualifying farming bus may be able to avg some/all of the CY's farm inc by spreading it out over the past 3 yrs. Farm inc averaging provides farmers the opp to lower their tax liab during a yr in which they earn a sig higher inc than in the previous 3 yrs. An indiv isn't req'd to have been engaged in a farming bus in any of the base yrs in order to make a farm inc averaging election. Sch J is used for averaging farm inc. Book ex for farm inc averaging: In the CY, a farmer had a bountiful crop, and the inc from his farming bus incr'd sig in Y2 compared to Y1. The incr'd farming inc resulted in the farmer being taxed at a higher rate than in the past 3 yrs. The farmer can elect to avg some/all of the CY's inc over the past 3 yrs. Schedule F (P/L from farming) incl: -farm inc -farm exps -net farm P/L
Rental Income or Loss Continued
Book ex for vacation home rental: J rents her vacation home for 2 mos and lives there for 1 mo (during the other 11 mos, lives in the city). So, of the 3-mo pd the vacation home is used, 1/3 personal, 2/3 rental. Assume J's gross rental inc is 6k, her real estate taxes are 2,400, int is 3,600, utilities are 4,800, and related depr is 7,200. Ways these amts are deductible: -gross rental inc all goes to sch E. -[total taxes and int x (2/12)] deducted on sch E. Allocated based on [rental pd/total annual pd]. -[gross rental inc - int and taxes] goes to personal, sch A. -[utilities and depr x (2/3)] deducted on sch E. Allocated based on [rental pd/total annual usage]. -so 1/3 of each goes to sch A as not deductible. -for depr, limited to < 2/3 of the expense bc can't make rental inc < 0 w/ deductions, so diff [4,800 deductible for 2/3 - 1,800 remainder before 0] is carried over to next yr and applied against future inc from this prop. Sch E (rental) incl: -inc -exps -total rental real estate and royalty inc/loss -inc/loss from pships and S-corps (comes from K-1s) -inc/loss from estates and trusts (comes from K-1s) -inc/loss from real estate mortgage investmt conduits -summary (incl farm rental inc, reconciliation of farming/fishing inc, and reconciliation for real estate profs)
Individual Income Tax Calculation and Limitations Continued
Book exs for calcing indiv IT liab: super specific nos, but the point is that you apply the rate applicable to the filing status of the indiv to the amts w/in each bracket. So for lowest bracket it's the amt from 0 - the limit x the lowest bracket tax rate. The next tax rate would be multiplied by the income from the top of the lowest bracket's range until the top of its own range. Eventually, all of the products are summed to arrive at the total tax liab. The indiv IT rate structure is a progressive tax rate structure. W/ a progressive tax rate structure, the marginal TR (MTR) incrs as TI incrs. The MTR is the tax rate applied to the next amt of incremental TI or deductions (the TR applied to the next dollar of inc). It's calc'd as the [change in tax/change in TI]. Book ex for increasing MTR: M (files MFJ) has discovered that he will receive an additional consulting check in dec 2017 that he didn't expect until next yr. Before the additional inc, his TI is 70k. After the receipt of the additional inc, his TI is 85k. Determine M's MTR on the additional TI -shows tax calc for the 70k using the rate schedule for MFJ. Total tax is 9,567.50. -shows tax calc for the 85k using the rate schedule for MFJ. Total tax is 12,727.50. -MTR = [change in tax/change in TI] = [(12,727.50 - 9,567.50)/(85k - 70k)] = [3,160 change in tax/15k change in TI] = 21%.
Business Income or Loss; Long-Term Contracts Continued Further
Certain items S/B noted w/ regard to the effects from LT contracts on AMT: -the % of completion method is req'd to be used for AMT, regardless of the method used for regular tax (except for home construction contracts). -even if the % of completion method is used for regular tax purposes, there are likely to be diffs in the calc of TI bc the calc of AMTI must take into acct not only the method of inc recognition, but also other AMT rules (like depr methods). Misc effects of LT contracts: -change in accting method: IRS permission req'd. The method used by a taxpayer for the inc recognition on a contract is deemed a method of accting by the IRS and can't be changed for the contract w/o consent of the IRS. Also, if the taxpayer desires to sever a contract into various contracts or aggregates several contracts into 1 larger contract, IRS approval is gen req'd, and a stmt explaining the changes must be attached to the OG TR for the yr. -unique rules for personal prop contracts: for the manufacture of personal prop to qualify as a LT contract, not only must the contract not be completed w/in the yr it was started, but it also must be for the manufacture of a unique item (one made specifically for a customer that couldn't be sold to others, is not gen part of a taxpayer's normal inv, and reqs sig preproduction costs). -related parties: a taxpayer who performs an activity that would normally not be considered a LT contract activity (like engineering or design services) must report inc using the % of completion method if it's incidental to or necessary to a related party's LT contract that must be reported using the % of completion method.
Individual Retirement Accounts; Roth IRA
Contrs to a roth aren't deductible when made. Earnings accumulate tax-free while in a Roth. Distrs of both principal/int are tax-free provided they're qualified distrs. The overall limit for regular deductible and roth IRA contrs in a yr (annual aggregate contrs to all IRA accts except the Coverdell education acct) remains at 5,500 for single taxpayers and 11k for married. The amt that can be contr'd to a roth is the amt remaining after subtracting any contr made to a regular IRA. These limits are the same regardless of whether the taxpayers are active plan participants, incl those who are active in IRA-based pension plans like SEP (Simplified Employee Pension) and SIMPLE (Saving Incentive Match Plans for Employees) plans. Bc the roth phase-out inc levels are higher, many taxpayers will qualify for roth IRAs but not regular. Roth IRAs are subj to the min distribution rules of deductible IRAs, which apply once an indiv turns 70.5 YO. Phase-out inc limits (mod AGI): -single taxpayers w/ mod AGI >= 118k but < 133k (2017). -joint filers w/ mod AGI >= 186k but < 196k. -MFS w/ mod AGI from 0 to <10k.
Employee Stock Options; Nonqualified Options
Corps may grant their employees the option to purch stock in the corp. There are 2 types of employee stock options; nonqualified and qualified. If the option doesn't meet certain conditions for qualified stock options, it will be treated as nonqualified. A nonqualified option is taxed when granted if the option has a readily ascertainable value at the time of the grant. Bc nonqualified options often don't have an ascertainable value, the option is gen taxed when exercised. If the option is traded on an established mkt, it will have a readily ascertainable value (taxable when granted). Otherwise, it will only have a readily ascertainable value if *ALL* of these conditions are met: -the option is transferable. -the option is exercisable immediately in full when it's granted. -there are no conditions or restrictions that would have a sig effect on the value. -the FV of the option privilege is readily ascertainable. For qualified v nonqualified, overall taxable gain is the same, just the timing differs.
Individual Retirement Accounts; Roth IRA Continued
Cumulative distrs from Roth IRAs are 1st considered to be a tax-free return of cumulative contrs. Subseq distrs are distrs of earnings and will be taxable unless those distrs are qualified nontaxable distrs. Qualified nontaxable distrs are those made at least 5 yrs after the 1st day of the yr of the taxpayer's 1st contr to a Roth IRA and made: -after the taxpayer reaches 59.5 -to a beneficiary after the taxpayer's death -bc the taxpayer is disabled or -for use by a "first-time" homebuyer (taxpayer not owning a principal residence in the 2-yr pd before buying this residence) to acq a principal residence. There's a lifetime 10k limit on qualified distrs for this purpose. Transfers (rollovers) can be made from regular IRAs to roths. There are currently no AGI limitations that affect these transfers. Any transferred amts that were prev deducted (and any earnings) are includable in inc, but there's no penalty. Withdrawals allocable to the transferred amts can't be made until amts have been in the Roth for at least 5 yrs. Eigible taxpayers may also be entitled to a tax credit (max 1k) for contrs to either a traditional or roth IRA, subj to certain inc limitations (retiremt savings contributions credit).
Gross Income
Determining this is the 1st step in determining tax liab. Gen, gross inc means all inc from whatever source derived, unless specifically excluded. So if you find $ in your house and can't find the owner, it's still inc even though you didn't earn it. Except in cases of gain derived from dealings in prop, inc is determined by the amt of cash, prop (FMV), or services obtained. For noncash inc, the amt of the inc is the *FMV* of the prop/services rec'd. If something is taxable, inc is FMV, basis is FMV. If something is nontaxable, no inc, basis is NBV. Book ex for noncash inc: a taxpayer performs services and gets a car w/ a FMV of 3k as comp. The amt of inc for the taxpayer is 3k. To be taxable, a gain must be both realized and recog'd. -realization: real world. Reqs the accrual or receipt of cash/prop/services, or a change in the form/nature of the investmt (a sale or exchange). -recognition: record. Means the realized gain must be incl on the TR (there's no provision that permits exclusion/deferral under the IRC). Book ex for recognition concept: a taxpayer owns stock for which he paid 100, and it goes up in value to 150. There's no realized gain even though there has been an incr in the taxpayer's wealth. Gain is realized when the shares are sold for 150 or exchanged for prop worth 150. If the gain is taxable, it would also be recog'd on the TR. For the timing of rev recog, several methods: -accrual method: recog occurs according the the rules of GAAP (w/ some exceptions), so rev is taxable when earned. -cash method: recog occurs in the pd the rev is actually or constructively rec'd in cash. The inc section of the 1040 provides a list of inc items to fill in, as well as an other inc line item w/ a space to explain.
Penalty on Early Withdrawal of Savings (Interest Income): Interest Forfeited
Do not net against int inc! An ex of forfeited int is the int penalty on early withdrawal of savings when funds in a CD are withdrawn before maturity.
Health Savings Accounts
Enable workers w/ high-deductible health ins to make pretax contrs of up to 3,400 in 2017 (6,750 for fams) to cover their health care costs. These amts are incr'd by 1k for those who reach age 55 w/in the tax yr. No contrs are allowed once a taxpayer becomes covered by Medicare parts A or B. Any amt paid/distributed out of a HSA that's used exclusively to pay the qualified medical exp of any acct beneficiary isn't includable in gross inc. Distrs for qualified drugs incl only those prescribed by a physician. An exception is that distrs not used to pay qualified medical exps are includable in gross inc and subj to a 10% penalty. For 2017, a high-deductible health plan is one that has at least a $1,300 annual deductible for self-only coverage and a $2,600 deductible for fam coverage. These amts are indexed for inflation. Annual out-of-pocket exps paid under the plan must be limited to $6,550 for indivs and $13,100 for fams. These exps incl deductibles, co-pmts, and other amts (other than premiums) that must be paid for plan benefits. No new Archer Medical Savings Accounts (MSAs) C/B established after 2007. However, any accts established prior to 2008 are allowed to continue. Archer MSAs are sim IRAs but used for health care. Typically only used if the HSA is unavailable, since HSAs are gen more flexible. -qualified participants are SE indivs or employees of small businesses (<50 employees). -these accts were designed to be and must be used in conjunction w/ a high-deductible ($3,350 single/$6,750 fam) health ins plan. -the max out-of-pocket exps limit for 2017 is $4,500 single/$8,250 fam.
Tuition and Fees Deduction
Expired 12/31/16. Doesn't need to be work-related. The qualified higher-education exps above-the-line deduction (adjustmt) applies regardless of whether the education is work-related. Exps above the max are only deductible as education exps (itemized deductions subj to 2% of AGI limitation). This deduction expired in 2016 and hasn't been extended rn. The max deduction is 4k (2016). This is allowed for taxpayers w/ AGI <= 65k (130k for MFJ). The max adjustmt is 2k for taxpayers w/ AGI > 65k (130k for MFJ) but <= 80k (160k for MFJ). No adjustmt exists for taxpayers w/ AGI > 80k (160k for MFJ). Just be aware of robinhood rule, not worth memorizing most phase-outs. A taxpayer isn't eligible to claim the deduction if the expenses were applied to either: -the american opportunity credit and/or lifetime learning credit -nontaxable education savings acct distrs For tax yrs beginning after 6/29/2015, taxpayers claiming the tuition and fees deduction must receive form 1098-T, which reports the qualified tuition and related exps billed to the taxpayer during the calendar yr.
Business Income or Loss; Long-Term Contracts Continued
For cash basis taxpayers, the starting date of production (production pd) is gen the date on which the contractor incurs costs (other than start-up engineering, design, etc., costs that are excluded from cost allocation) under the contract. For accrual basis taxpayers, the starting date is the later of the date for cash basis or the date the taxpayer has incurred at least 5% of the total costs initially estimated under the contract. The end date of the production pd is gen the date on which the work under the contract is complete (per contract provisions) or on the date the taxpayer has incurred at least 95% of the total costs expected under the contract. The amt of gross inc under the contract that is recog'd on the tax return is the portion of the inc that relates to the % of the contract that has been completed during the yr. -the % is calc'd under the cost-to-cost method, which is the ratio of the total cumulative costs incurred to date at the end of the tax yr divided by the total expected costs to be incurred under the contract. Provides a total % complete amt for the contract as of the end of the tax yr. -to calc the amt of inc that will be recog'd under the contract for a given tax yr, multiply the ratio determined w/ the cost-to-cost method by the total contract price and subtract the amt of inc that was recog'd in PYs for the contract. [costs incurred/total expected cost] = [work done/total work] = % earned. [(% earned x total contract price) - inc recog'd in PYs] = inc recog'd on CY TR.
Business Income or Loss; Uniform Capitalization Rules
For inventory. These apply to all bus enterprises that meet the criteria for implementation (incl sole props, pships, and corps) and provide guidelines w/ respect to capitalizing/expensing certain costs (like taxes paid in connection w/ the acq of prop are capitalized as part of the prop's cost). In the 1st yr of implementation, they gen cause an incr in the carrying cost of EI and a decr in op exp. This results in an incr to TI. Uniform cap rules apply to these prop types: -produced for use: real or tangible personal prop produced by the taxpayer for use in their trade/bus (like machine tools for use in the production line of a machine tool manufacturer). -produced for sale: real/tangible personal prop produced by the taxpayer for sale to their customers (manufacturer's inv). -acq'd for resale: real/tangible personal prop acq'd by the taxpayer for resale (retailer's inventory). However, the uniform capitalization rules *don't* apply to (inv) prop acq'd for resale if the taxpayer's avg gross receipts for the preceding 3 yrs don't exceed 10M annually. Costs req'd to be capitalized incl DM, DL (comp, vacation pay, payroll taxes), and applicable indirect costs (those to which allocation must be applied, like factory OH). Exs of applicable indirect costs (capitalizable exps) incl utilities, warehousing costs, repairs, maintenance, indirect labor (supervisory), rents, storage, depr/amort, ins, pension contrs, engineering and design, repackaging, spoilage/scrap, and admin supplies. DM, DL, and OH capitalized, expensed when sold (inv). Costs not req'd to be capitalized incl selling, advertising, and mkting exps, certain G&A exps, research, and officer comp not attributed to production services. Pd exps.
Children of Divorced Parents
GR (custodial parents): gen, the parent who has custody of the kid for the greater part of the yr takes the exemption (determined by a time test, not the divorce decree). Doesn't matter whether that parent actually provided > 1/2 of the child's support. If the parents have equal custody during the yr, the parent w/ the higher AGI will claim the exemption. Exception (custodial parent waives right): a noncustodial parent isn't allowed a dependency exemption based solely upon language written in a divorce agreemt. Noncustodial divorced/separated parent may claim the exemption for their child if the custodial parent waives the right to the exemption. This is done by the custodial parent's signing of a written declaration attached to the noncustodial parent's return. Form 8332 is used as the req'd written declaration. The custodial parent may revoke the release of claim using the Form 8332 provided that: -notice is given to the noncustodial parent at least 1 tax yr in advance (so if give notice in 2017, revocation not effective until 2018). -a copy of Form 8332 claiming the revocation is attached to the custodial parent's TR. Remember this rule and don't let the CPA exam trick you: There's an increased std deduction (*NOT* an additional exemption) for being age 65 or older or blind.
Individual Retirement Accounts; Deductible IRAs Continued
GR is that a taxpayer gen may deduct from inc the amt of a regular IRA contr. The max deduction is limited to the lesser of $5,500 or the indiv's comp. The max contr for married taxpayers (MFJ) is 11k (5,500 per spouse), provided their *combined* earnings total is at least that much. His + hers = theirs for IRA! Comp incl salary, wages, commissions, bonuses, and alimony (she earned it...). Comp doesn't incl int, divs, annuity inc, and pensions. Rules summary chart for a traditional IRA w/ married indivs: 1. If both have earned inc, both have no pension, and 2017 mod AGI is unlimited: both can deduct the IRA contr. 2. If he has earned inc, she doesnt, neither have a pension, and 2017 mod AGI is unlimited: both can deduct the IRA contr. 3. If he has earned inc, she doesn't, he as a pension (obv she doesn't since no job), and 2017 mod AGI is <= 99k: both can deduct the IRA contr. 4. If he has earned inc, she doesn't, he has a pension, and mod AGI is btw 119k and 186k (rich): he can't deduct the IRA contr but she can. 5. If he has earned inc, she doesn't, he has a pension, and 2017 mod AGI is >= 196k (super rich): neither can deduct the IRA contr. For mod AGI > 99k but < 119k, the IRA deduction for the working spouse phases out. For mod AGI > 186k but < 196k, the IRA deduction for the nonworking spouse phases out. At mod AGI of 196k+, both spouses can't contr to a traditional IRA. The CPA exam likes to refer to the nonworking spouse as a "full-time parent." Indivs who are > 50 YO are allowed an additional contr (adjustmt) of 1k (in 2017). This is extra, called the catch-up contr. Eligible taxpayers also may be entitled to a tax credit (max 1k) for contrs to either a traditional or roth IRA, subj to certain inc limitations. This is the retiremt plan contr credit.
Specific Items of Income and Exclusions; Interest Income
GR: all int inc is taxable, unless it's specifically excluded. Taxable int inc incl: -int from fed bonds. -int from industrial developmt bonds. -int from corp bonds. -part of the proceeds from an installmt sale is taxable as int. -int paid by the fed/state govt for late pmt of a tax refund. -for certain taxpayers and certain bonds, the amort of a bond premium is an offset (reduction) to the int rec'd and a reduction to the bond's basis, and the amort of a bond discount is an addition to the int rec'd and an addition to the bond's basis. -gift rec'd to open a bank acct (FMV). These items are TE int inc (reportable but not taxable), and must be shown on the return but aren't taxable: 1. State and local govt bonds/obligations: int on state/local bonds/obligations is TE. Mutual fund divs for funds invested in tax-free bonds are also TE. This and the int paid by a state govt for a late tax refund are diff types of state int inc. 2. Bonds of a US possession: int on the obligation of a possession of the US, like Guam or Puerto Rico, is TE. 3. Series EE (US savings bonds): int on Series EE (*E*ducational *E*xpenses) Savings Bonds issued after 1989 is TE when: -it's used to pay for higher education (reduced by tax-free scholarships) of the taxpayer, spouse, or dependents. -the taxpayer is over age 24 when the bond is issued. -a married taxpayer files a joint return and -the taxpayer meets certain inc rqmts. Phase-out starts when modified AGI exceeds an indexed amt. For 2017, phase-out begins at $78,150 for single and HOH and at $117,250 for married filing jointly. When a taxpayer uses bonds for a child's education, the bonds must be registered in the taxpayer's name and/or spouse's name. The child can be listed as a beneficiary on the bond, but not as a co-owner. 4. Veterans administration insurance: int on insurance divs left on deposit w/ the VA insurance is TE. Forfeited int is a penalty for early withdrawal of savings (gen on a time deposit, like a CD at the bank). The bank credits the int to the taxpayer's acct and then, in a sep trans, removes certain int as a penalty for withdrawing the funds before maturity. The int rec'd is taxable on the taxpayer's IT return, but the amt forfeited is also deductible as an adjustmt in the yr the penalty is incurred. Thus, the taxpayer only pays tax on the amt of int actually rec'd. Note that the amt of forfeited int is deducted sep and not netted w/ int inc on the TR.
Specific Items of Income and Exclusions; Salaries and Wages
Gross inc incl many forms of comp for services. -money: all money rec'd, credited, or available (constructive receipt). -prop: the FMV of all prop is incl as gross inc. -cancellation of debt (COD): all debts cancelled are incl in gross inc (except for certain cancellations of mortgage debt on principal residences, which have detailed guidelines for excluded amts and debts canceled when insolvency exists). Book ex for COD inc: M owes bank 80k on unsecured note. Satisfies it in full w/ a pmt of 30k, bank forgives the remaining 50k. Mary has COD inc of 50k. -bargain purchases: if an employer sells prop to an employee for < its FMV, the diff is inc to the employee. -guaranteed pmts to a partner: these are reasonable comp paid to a partner for services rendered (or use of capital) w/o regard to the partner's ratio of inc. This earned comp is also subj to SE tax. -taxable fringe benefits (non-statutory): the FMV of a fringe benefit not specifically excluded by law is includable in inc. Ex: an employees personal use of a co car is incl as wages in an employee's inc. Also, the amt included is subj to employmt taxes and withholding. -portion of life ins premiums: premiums paid by an employer on a group term life ins policy covering his employees are not inc to the employees up to the cost on the first 50k of coverage per employee. Premiums above the 1st 50k of coverage are TI to the recipient and normally included in W-2 wages (this amt is calc'd from an IRS table, and isn't the entire amt of the premium in excess of the 50k coverage).
Loss Limitations: Capital Losses
Net CL deduction and loss carryover rules: -3k max deduction: indiv taxpayers realizing a net LT/ST CL may only recog (deduct) a max of 3k of the amt realized from other types of gross inc (ord, passive, portfolio). A joint return is treated as 1 person. If MFS, the loss deduction is limited to half (1,500). -limitation: CLs are also limited to taxable inc before personal exemptions. -excess net CL: CF an unlimited time until exhausted. It maintains its char as LT/ST in future yrs. -a personal (nonbus) bad debt: personal (nonbus) bad debt loss is treated as a ST CL in the yr debt becomes totally worthless. -worthless stock/securities: the cost (or other basis) of worthless stock/secs is treated as a CL, as if they were sold on the last day of the taxable yr in which they became totally worthless. A CL can haunt you forever (CF indefinitely). Can't change the past, so no CB!
Business Income or Loss; Net Business Income or Loss
Net bus inc is taxable. 2 taxes on NI: 1. Inc tax. 2. Federal SE tax: You're the employee and employer, so pay tax for both. -an adjustmt to inc is allowed for 1/2 (7.65% of up to $127,200 of SE inc in 2017 + 1.45% of SE inc thereafter, if applicable) of SE tax (medicare + social sec) paid. -this allows the sole prop the ability to deduct the employer portion of the SE tax as an adjustmt to gross TI (of which the net sch C amt is a part). -all SE inc is subj to the 2.9% medicare tax. -up to $127,200 in 2017 is subj to the 12.4% social sec tax (so total of 15.3% on SE earnings up to $127,200 in 2017). -the actual SE tax is calc'd on 92.35% of SE inc (100% - 7.65%). Book ex for calc of SE tax: T earns 20k from his consulting bus, which he runs as a sole prop. This was the only inc he had in the CY. Determine his SE tax. -[20k x 92.35%] = 18,470. -[18,470 x 15.3%] = 2,826 SE tax. Schedule SE (for SE/social security tax) incl: -flowchart to determine whether to use short or long schedule SE. -section A: short sch SE. Incl net farm profit from sch F, and net P/L from sch C. Also incl SE tax and deduction for 1/2 of it. -section B: long sch SE. Lots more Qs. -part 2: option methods to figure net earnings. A bus w/ a loss may deduct the loss against other sources of inc. When the loss exceeds these amts (net taxable loss), the excess NOL is permitted as a carryover (at taxpayer's election, it may be used as a CF only). -2 yr CB, 20 CF. -hindsight is 2 x 20!
Other Miscellaneous Deductions
No 2% AGI test. These itemized deductions are fully deductible, not subj to 2% of AGI deduction rule. 1. Gambling losses: remain fully deductible, but only to the extent of gambling winnings. 2. Fed estate tax paid on inc in respect of a decedent: This is estate tax paid by an indiv bc of inc rec'd by the indiv as a beneficiary of the estate. The indiv will incl the inc rec'd as part of gross inc on the Form 1040 (w/ the same nature of inc, like int inc, as it would have been in the hands of the decedent). Estate tax will apply bc the item of inc was considered part of the estate for its valuation (ex: accrual of a "loaded" installmt note receivable). The fed estate tax paid (on Form 706) that related to the value of this inc item is an allowable deduction for inc tax purposes. CPA exam hint: the exam will test you on items and ask if it's an adjustmt or itemized deduction.
Business Income or Loss; Nondeductible Expenses
On sch C. Incl: 1. Salaries paid to the sole proprietor (considered a draw). 2. Fed IT. 3. Personal portion of: -automobile, travel, and vacation exps. -personal M&E exps: 100% of country club dues are nondeductible. -int exp: may be reported as an itemized deduction if mortgage int or investmt int is paid. -state and local tax exp: report as an itemized deduction on sch A. -health ins of a sole proprietor: although this isn't reported on sch C as an exp, it is reported as an adjustmt to arrive at AGI. Allocate bus/personal, only incremental direct cost. 4. Bad debt exp of a cash basis taxpayer (who never reported the inc). 5. Char contrs: reported as an itemized deduction on sch A. Often the examiners list personal itemized deductions and try to trick you into deducting them for bus. Schedule C (1040) incl: -inc -exps -net P/L -COGS (must use accrual method for inventory) -info on your vehicle (depreciation) -other exps (blanks to list them on)
Exemptions; Dependency Exemptions Continued - Qualifying Relative
Option 2, *SUPORT*. Taxpayers can apply the *SUPORT* dependency exemption rules to claim a dependency exemption for a qualifying relative who doesn't satisfy the qualifying child rqmts. In gen, an indiv is a qualifying relative if they meet these criteria: 1. *S*upport test: taxpayer must have supplied *> 1/2* of the support of a person to claim them as a dependent (or multiple support). Support means the actual exps incurred by/on behalf of the dependent. Scholarships rec'd by a dependent student child/stepchild aren't incl in determining their total support. Social sec and welfare benefits are incl in their total support, but only to the extent such amts are actually expended for support purposes. 2. *U*nder exemption amt of taxable gross inc: a person may not be claimed as a dependent unless their gross inc is < the exemption amt (4,050 during 2016/17). Taxable inc is only inc that's taxable and included for the purpose of determining whether the dependent has earned < the exemption amt. Nontaxable inc is OK and incl: -social sec (at low inc levels) -tax-exempt (TE) int inc (state and muni int inc) -TE scholarships 3. *P*recludes dependent filing a joint return: taxpayer will lose the exemption for a married dependent who filed a joint return, unless there's no tax liab on the couple's joint return and there wouldn't have been any tax liab on either spouse's return if they had filed sep. 4. *O*nly citizens of the US or residents of the US/Canada/Mex: the dependent must either be a citizen of the US or resident of US/Canada/Mex. 5. *R*elative: children/grandchildren, parents/grandparents, brothers/sisters, aunts/uncles, nieces/nephews (and step-everything and in-laws) can be claimed as dependents. Children incl legally adopted children, foster children, and stepchildren. Foster parents and cousins must live w/ the taxpayer for the entire yr (kissing cousins, foster beer). A child born at any time during the yr may be claimed as a dependent (the exemption isn't prorated!). OR 6. *T*axpayer lives w/ the indiv (if non-relative) for the whole yr: non-relative member of a household (person living in the home for the entire yr) may be claimed as a dependent, provided the taxpayer's relationship w/ that person doesn't violate local law. Foster parents and cousins must live w/ the taxpayer the entire yr bc they're not regarded as relatives.
Itemized Deductions; Medical Expenses
Pmts on behalf of filing taxpayer, spouse, or dependent (who has rec'd > 1/2 of their support from the filing taxpayer) qualify. No pets! The definition of dependent for this purpose doesn't consider the dependent's gross inc or the joint return rqmt. No limit on the dependent's gross inc when it relates to medical/dental exps (all other dependency tests (except MFJ) still apply). -*S*upport over 50%: yes -*U*nder $ TI: no (inc not a factor here) -*P*recludes joint return: no -*O*nly citizens: yes -*R*elative: yes OR -*T*axpayer lives w/: yes Potentially deductible exps incl: -paid (cash/check) amts during the yr. -charged amts during the yr (regardless of when paid). -pmts made for a deceased spouse (deductible in yr paid, even if diff from the yr the spouse died). -amts repaid to the taxpayer (or anyone else for the taxpayer) by hospital, health, or accident ins must reduce otherwise allocable exp (before the 10% is applied). Indivs are typically cash basis, so gen, in order to be tax deductible, the item must have been incurred as an expense and paid/charged before YE (incurred and paid!). Qualified med exps, to the extent they exceed med ins reimbursemt and 10% of the taxpayer's AGI, are deductible (7.5% of AGI for taxpayers age 65 + was only through the 2016 tax yr). [Qualified med exps - ins reimbursemt] = qualified medical exp paid. [Qualified medical exp paid - 10% of AGI] = deductible medical exps. Types of deductible medical exps (allowed): -medicine/drugs (prescription), incl medicare part D premiums. -doctors. -medical and accident ins (incl qualified LT care premiums, although the deduction is limited based on the age of the taxpayer). -req'd surgery (even req'd cosmetic). -transportation to medical facility: actual cost or allowance (17 cents/mile for 2017). -physically disabled costs: expense full amt, do *NOT* depreciate. Exps incurred by the physically disabled for the removal of structural barriers in their residences to accommodate a disability are treated as medical exps.
Farming Income
Schedule *F*. A person/entity who engages in the mgmt/operation of a farm w/ the intent of earning a profit will report inc/exps (either cash or accrual basis) using a sch F (which carries to the face of Form 1040, like NI on a sch C carries over). Inc from farming activities is treated the same as inc from other bus activities. 1. Cash basis: Most farmers use this. -inventories of produce, livestock, etc. aren't considered. -gross inc incl cash and the value of all other items rec'd from the sale of produce, livestock, etc. that has been *raised* by the farmer. -for livestock or other items a farmer may have bought, profit is computed by subtracting the purch price (cost) from the sales price. Line 1b sch F. -ins pmts from crop damage are treated as inc. -int paid on a loan used for the farming bus is deductible. Expense inv under the cash basis! Book ex for farming deduction: B is a cash basis sole prop farmer. During Y2, spends 2,100 on feed for the livestock. B may deduct the entire 2,100 on his Y2 IT return, bc he isn't req'd to consider inv. 2. Accrual method: req'd for certain corp and pship farmers as well as for all farming tax shelters. Inventories must be used and maintained, and they must be taken at the start/end of the tax yr. These methods of inv valuation for farming are accepted by the IRS: -cost. -LCM. -farm-price method: inv is valued at the mkt price less the disposition costs and gen must be used for all items inventoried by the farming bus, except for any livestock valued using the unit-livestock-price method. -unit-livestock-price method: uses a value for each livestock class at a std unit price for animals w/in the class. For accrual must use inv! For accrual method, GP = [value of inventories at YE + the proceeds rec'd from the sales during the yr - the value of inventories at the BOY - the cost of inv purch'd during the yr].
Business Income or Loss; Gross Income and Expenses
Schedule C or C-EZ. NI from SE is computed on sch C. The NI from the sole prop is then transferred to Form 1040 as 1 amt. P/L = [gross bus inc - bus exps]. For SE. Items that would normally be rev in a trade/bus or other SE activity (like director or consulting fees) are incl as part of gross inc on Sch C. -cash: amt rec'd. -prop: FMV. -COD. Expenses incl items one would expect to find in a bus, like: -cost of goods (inv is expensed when sold). -salaries and commissions paid to others (*NOT* yourself. Your money = draw. You're taxed on net profit, not draw). -state and local bus taxes paid. -office exps (supplies, equip, rent). -actual automobile expenses (depr exp is limited to only that portion used for bus) or a std mileage rate (53.5 cents/mile for 2017). -bus M&E expenses at 50% (when all proceeds go to benefit a charity 100% may be deductible for char contrs). -depr of bus assets. -int exp on bus loans (int exp paid in advance by a cash basis taxpayer can't be deducted until the tax yr/pd to which the int relates). Must be both incurred and paid. -employee benefits. -legal/prof services. -bad debts actually written off for an accrual basis taxpayer only (the direct write-off method, not allowance method, is used for tax purposes). Cash basis taxpayer isn't allowed a bad debt deduction!
Rental Income or Loss
Schedule E, passive activity. Rental activity is reported on Sch E. Usually regarded as passive. Basic formula for the determination of net rental inc/loss: [gross rental inc + prepaid rental inc (nonrefundable deposit) + rent cancellation pmts + improvemt in-lieu of rent (at FMV) - rental exps] = net rental inc/loss. For the rental of a residence (home): -if rented < 15 days: treated as a personal residence. The rental inc is excluded from inc, and mortgage int (1st or 2nd home) and real estate taxes are allowed as itemized deductions. Depr, utilities, and repairs aren't deductible. -if rented 15+ days: if rented for 15+ days and used for personal purposes of the greater of: 1- > 14 days or 2- >10% of the rental days it's treated as a personal/rental residence. Exps must be prorated btw personal and rental use. However, a diff proration method is used for mortgage int and prop taxes than for other prop-related exps (utilities, ins, depr, etc). Rental use exps are deductible only to the extent of rental inc. *NO* rental loss allowed. -proration for mortgage int and prop taxes = [rental pd/total annual pd (12)]. -proration for other exps = [rental pd/total annual usage], so like [mos rented/total mos stayed in]. For the rental of a nonresidence (rental prop), the taxpayer incl inc rec'd from the prop in gross inc and deducts all exps allocated to the rental prop on sch E of the 1040. Rental losses are considered passive and will be deductible only to the extent of passive inc. An exception to this rule allows an active participant in rental activity to deduct up to 25k of rental losses against nonpassive inc.
Individual Income Tax Formula
Summary of calc of taxable inc (TI) and fed inc tax (IT) liab/refund for indivs. These items are reported on the indiv IT return (Form 1040). Gross inc -adjustmts =adjusted gross inc (AGI) -std deduction (everyone's entitled) *OR* -itemized deductions (use if > std) -exemptions =TI x TR =fed inc tax (types are regular and alternative minimum tax [AMT]) -tax credits +other taxes (like self-employmt [SE] tax) -pmts (withholding, estimated taxes, 1st yr overpaid, excess social security) =tax due OR refund. TI is the base for indiv IT. Breakout of calc of TI for indiv taxpayers: 1. Gross inc incl: -wages -int -divs -state tax refunds -alimony rec'd -bus inc -cap G/L -IRA inc -pension and annuity -rental inc/loss -K-1 inc/loss (passthrough) -unemploymt comp -social security benefits -other inc 2. Adjustmts (subtracted from gross inc): deduction to arrive at AGI. If qualify for *a*ny 1 of these *a*djustmts, *a*lways *a*llowed to take it. Incl: -educator expenses -IRA -student loan int exps -tuition and fee deduction -health savings acct (HSA) -moving exps -1/2 SE taxes -SE health ins -SE retiremt -int withdrawal penalty -alimony paid 1-2 = AGI 3. Itemized deductions incl: -medical (in excess of 10% of AGI) -taxes; state and local (SALT. Income/sales and prop) -int exp (home and investmt) -charity (up to 50% of AGI) -casualty/theft (in excess of 10% of AGI) -misc (in excess of 2% of AGI) -other misc Can do std deduction instead of itemized deductions! Only take itemized if the sum of them is > std deduction. So itemized deductions are tax deductible together or trashed. 4. Exemptions: the no changes annually. For 2017 exemption is $4,050. Multiply [exemption amt x no of allowable exemptions] to get amt to subtract. Allowed exemptions for: -taxpayer -spouse -dependents AGI - 3 and 4 = TI.
Specific Items of Income and Exclusions; Taxable Miscellaneous Income and Partially Taxable Miscellaneous Items
Taxable misc inc: 1. Prizes and awards: the FMV of these is taxable inc. An exclusion from inc for certain prizes/awards applies when the winner is selected for the award w/o entering into a contest (no action on their part) and assigns the award directly to a governmental unit or charitable org. 2. Gambling winnings/losses: -winnings: incl in gross inc. -losses: unless taxpayer is in the trade/bus of gambling (which follows other specific reporting rules), gambling losses may only be deducted to the extent of gambling winnings. The allowable amt of these gambling losses are deductible on sch A as an itemized deduction, but the amt isn't subj to the 2% of AGI limitation on misc itemized deductions. Don't itemize = don't get losses! 3. Bus recoveries: to decide whether a bus recovery is excludable, one must determine what the damages were paid "in lieu of." So if a damage award is comp for lost profit, it's inc. 4. Punitive damages: fully taxable as ord inc if rec'd in a bus context or for loss of personal rep. Punitive damages rec'd by an indiv in a personal injury case are also taxable, except in wrongful death cases where state law has limited wrongful death awards to punitive damages only. Partially taxable misc items: Scholarships and fellowships. 1. For a degree-seeking student: scholarships/fellowship grants are excludable only up to the amts spent on tuition, fees, books, and supplies (*NOT* room and board), provided: -the grant is made to a degree-seeking student. -no services are to be performed as a condition to receiving the grant and -the grant isn't made in consideration for past/present/future services of the grantee. So taxable if room and board or services req'd. 2. For non-degree-seeking student: scholarships/fellowships awarded to non-degree seeking students are fully taxable at FMV. 3. Tuition reductions: graduate TAs and RAs who receive tuition reductions are taxed on the reduction if it's their only comp, but not if the reduction is in addition to other taxable comp.
Student Loan Interest Expense
The adjustmt for education loan int exp is limited to 2,500. All int pmts qualify for the adjustmt. It's phased-out btw: -65k - 80k for single. -135k - 165k for married. Deduction is completely phased out at AGI >= 80k for single taxpayers and 165k for MFJ (all 2017 amts). A dependent may not claim the adjustmt. The taxpayer must be legally obligated to pay the loan (ex: int paid by a parent on a child's student loan won't qualify as an allowable adjustmt). Int is only deductible on loans incurred by a taxpayer solely to pay for qualified education exps (gen loans like a home equity line of credit wouldn't qualify). Any extra or disallowed is "personal interest" and not deductible. Disallowed itemized deduction.
Specific Items of Income and Exclusions; Dividend Income
The source of the distr dictates the char. These are the 4 sources: -earnings and profits (E&P. Basically RE)/current: distr by current YE. -E&P/accum'd: distribution date. -return of capital (ROC): no E&P. -cap gain (CG) distrs: no E&P/no basis. All divs that rep distrs of a corp's E&P (sim RE) are includable in gross inc. The taxable amt to the SH receiving is: -cash: the amt rec'd. -prop: FMV. Qualified divs are those paid by domestic or certain qualified foreign corps. They get a special (lower) tax rate. - to be qualified divs, the stock must be held for > 60 days during the 120-day pd that begins 60 days before the ex-dividend date (date on which a purch'd share is no longer entitled to an recently declared divs). -disqualified divs incl: (a) employer stock held by an ESOP. (b) amts taken into acct as investmt inc (for purposes of the limitation on investmt exps). (c) short sale positions. (d) certain foreign corps. (e) divs paid by credit unions, mutual savings banks, bldg and loan associations, mutual insurance cos, and farmer's cooperatives. -tax rates for qualified divs in 2017: (a) 15%: most taxpayers. (b) 0%: low-inc taxpayers (those in the 10% or 15% ord inc tax bracket). (c) 20%: high-inc taxpayers (those in the 39.6% ord inc tax bracket).
Employee Stock Options; Qualified Options - Incentive Stock Options
There are 2 types of qualified stock options, incentive stock options (ISOs) and employee stock purch plans (ESPP). An ISO is usually granted to a key employee and is a right to purch the stock at a discount. Rqmts: -the ISO must be granted under a plan, approved by the SHs, that sets out the total no of shs that may be issued and who may receive them. -the options must be granted w/in 10 yrs of the earlier of the date the plan was adopted or approved. The options must be exercisable w/in 10 yrs of the grant date. -the exercise price may not be < the FMV of the stock at the grant date. -the employee may not own >10% of the combined voting power of the corp, parent, or sub as of the grant date. -once exercised, the stock must be held at last 2 yrs after the grant date and at least 1 yr after the exercise date. -the employee must remain an employee of the corp from the date the option is granted until 3 mos (1 yr if due to permanent and total disability) before the option is exercised.
Adjustments
These are "above-the-line" (AGI) deductions to arrive at AGI. For *A*djustments, *A*ny one, *A*ny time, *A*ny amount, *A*utomatically *A*lways *A*llowed. Itemized deductions are below-the-line. Test as a team and compare to the std deduction. Note: only memorize phase-out amts in general if specifically told to. Otherwise, just be aware there's a phase-out. Adjustmts for AGI (above-the-line) incl: -educator exps (perm extended by the Protecting Americans from Tax Hikes (PATH) Act of 2015). -IRA deduction. -student loan int deduction. -tuition and fees deduction. -health savings acct (HSA) deduction. -moving exps. -deductible part of SE tax (boss' half. Not deducted on sch C, adjustmt). -SE health ins deduction (not deducted on sch C, adjustmt). -deduction for contrs to certain SE retiremt plans (not deducted on sch C, adjustmt). -penalty on early withdrawal of savings. -alimony paid. -attorney fees paid in certain discrimination and whistle-blower cases. -domestic production activities deduction. These are all listed on the 1040 under AGI. Reduce inc to AGI, which is reduced by other deductions to arrive at TI. The CPA exam often refers to adjustmts as "deductions to arrive at AGI."
Itemized Deductions; Medical Expenses Continued
Types of nondeductible medical exps (not allowed): -elective surgery, elective cosmetic ops, drugs that are illegal, travel, vitamins, the part of social sec tax paid for basic Medicare, funerals, cemetery lots, and ins against loss of earnings due to sickness or accident (note that cosmetic surgery req'd due to an accident or deformity can qualify). -life ins (financial ins). -capex (up to the incr in FMV of the prop bc of the expenditure) except those noted above. Amt paid above FMV incr = deductible. -health club membership recommended by a doctor for gen health care (would need to be more specific to be deductible). -personal hygiene and other ord personal exps (toothpaste, toiletries, over-the-counter medicines, bottled water, diaper service, maternity clothes, etc.). Amts repaid to the taxpayer (or anyone else for the taxpayer) by hospital, health, or accident ins must reduce otherwise allowable exp (before the 10% is applied). So subtract ins reimbursemt. -reimbursemt of exps by an employer (or by policies provided by an employer) that exceed the total of medical or dental exps paid by a taxpayer will be included as part of gross inc. -reimbursemt of any exp deducted in a PY will be included as part of gross inc in the yr rec'd. Medical exps to the extent they exceed 10% of the taxpayer's AGI are deductible. So subtract 10% of AGI test. 7.5% if over 65.
Nonaccountable Plan
Under a nonacctable plan (exps aren't reported to the employer), any amts rec'd by an employee from the employer must be reported by the employer as part of wages on the employee's W-2 for the yr and subj to IT withholding rqmts. The gross amt rec'd is reported as inc. Any exps taken against the gross amt rec'd in a nonacctable plan (like car mileage exps and reimbursemt to co) are considered misc itemized deductions subj to the 2% of AGI limitation. Practice Q tried to make this out to be an acctable pan by refunding excess funds to the employer. Ignore that! Q says the plan is nonacctable, so full amt is incl in inc.
Estates and Trusts
Use K-1 (sch E). Estates and trusts are sep IT paying entities. Distributions made by these are deductible by the entity but taxable to the recipient. Fiduciary tax accting is used in trusts/estates, and is centered on the classification of all receipts/disbursemts as either principal (corpus) or inc. The rules are gen the same as GAAP for principal and inc. The amts taxed to the fiduciary (trust/estate) and the beneficiaries are usually determined by the classification of the receipt/disbursemt as either principal or inc. Cap G/Ls (absent written provisions to the contrary) are classified as principal and must remain w/in the trust (allocated to corpus) to be taxed at the trust/estate (fiduciary) level. Inc distr'd to beneficiaries (and reported on sch K-1 and Form 1041) retains the same char (TE, portfolio, passive) as the inc had at the fiduciary level (which is the same as occurs in pship taxation. Distr'd inc is taxable up to distributable NI (DNI). DNI is the max amt taxable to the beneficiary, if distr'd to them. So amt actually distr'd is taxed, up to DNI amt. Sch K-1 (for form 1041) for beneficiaries of estates and trusts incl: -info abt estate/trust. -info abt beneficiary. -beneficiary's share of CY inc, deductions, credits and other items; specifically (listing schs these flow to on the 1040): (a) Sch B: int inc, ord divs, qualified divs. (b) Sch D: net ST/LT cap gain. (c) Sch E: ord bus inc, net rental real estate inc. -various other line items. -a stmt must be attached w/ the beneficiary's share of inc/directly apportioned deductions from each bus, rental real estate, and other rental activity. -has additional page identifying where the line items on the K-1 flow to on the 1040, etc.
Moving Expenses
Work-related. A taxpayer can deduct moving exps paid/incurred during the taxable yr in connection w/ the commencemt of work as an employee or as a SE indiv at a new principal place of work. No deduction is allowed unless the distance btw the employee's new place of bus and his old residence is at least 50 miles *greater* than his old residence was from his former principal place of work (50 mile incr in commute, not just 50 mile commute). If staying in the old house would incr the commute by at least 50 miles, the employee qualifies, assuming the employee moves. The distance btw the taxpayer's new residence and new place of work must gen be <= the distance from his old residence to the new place of work (unless the taxpayer can prove that a longer commute was req'd as a condition of his employmt or can prove that the actual commute time and exp are decr'd). If he had no former principal place of work, the new place of bus must be at least 50 miles from his former residence. The employee must work full-time in the new location at least 39 weeks during the 12-mo pd immediately following his arrival (39-week stay, 75% of next yr). SE persons must work full-time at least 78 weeks during the 24-mo pd after arrival to meet the test. If the time pd hasn't expired when the return is due, the employee may deduct the moving exp, but if he subseq moves before the time pd is up, he must incl the amt deducted as inc in the following yr. Only direct moving costs are allowable (fam and furniture), incl: -travel and lodging for the taxpayer and his fam. Transportation exps are deductible at actual out-of-pocket amts or 17 cents/mile for 2017. Tolls and parking fees, but not other amts, can be added to the mileage rate if it's used. -transporting household goods and personal effects to the new location. Employer reimbursemts are excludable from inc to the extent that the amts qualify as deductions. The CPA exam frequently incl these items in moving exp questions that are nondeductible: meals, pre-move house hunting, exp of breaking a lease, and temp living exps.
