Income tax
Why should a taxpayer be interested in the character of income received?
A taxpayer should be interested in the character of income received because the character of the income determines how the income is treated for tax purposes (including the rate at which the income is taxed). For example, ordinary income is taxed at the rates provided in the tax rate schedule. Qualified dividend income and long-term capital gains (after a netting process) are taxed at either a 0%, 15%, or 20% rate depending on the taxpayer's taxable income level.
Assume Francine spends more time living with Darren than Donna after the separation. Who may claim Francine as a dependent?
Darren. When a child is a qualifying child of both parents, the parent with whom the child resides for the longest period of time during the year is entitled to claim Francine as a dependent. In this case, because Francine lived with Darren longer than she lived with Donna, Darren is entitled to claim Francine as a dependent. However, Darren could agree to allow Donna to claim Francine as a dependent under the divorce agreement. Darren would sign a Form 8332 allowing Donna to claim Francine as a dependent and Donna would attach it to her tax return
Emily and Tony are recently married college students. Can Emily qualify as her parents' dependent? Explain.
Depending on the circumstances, Emily may qualify as a dependent of her parents. A taxpayer who files a joint return with his or her spouse may not qualify as a dependent of another, unless there is no tax liability on the couple's joint return and there would not have been any tax liability on either spouse's tax return if they had filed separately. As long as Emily and Tony meet these criteria, then Emily will qualify as a dependent of her parents assuming she also meets the tests to be her parents' qualifying child or qualifying relative.
Assume Francine spends an equal number of days with her mother and her father and that Donna has AGI of $52,000 and Darren has AGI of $50,000. Who may Francine as a dependent?
Donna. Because Francine lived with Donna and Darren an equal amount of time during the year, the tiebreaker on who may claim Francine as a dependent is based on each taxpayer's AGI. In this case Donna's AGI is higher than Darren's so she is entitled to claim Francine as a dependent. However, Donna could agree to allow Darren claim Francine as a dependent through the divorce agreement. Donna would sign a Form 8332 allowing Darren to claim Francine as a dependent and Darren would attach it to his tax return.
Explain what it means to say that a married couple filing a joint tax return has joint and several liability for the taxes associated with the return?
Each spouse is liable for the full amount of taxes owed on a joint return, regardless of which spouse earned the associated income.
Distinguish earned income from unearned income, and provide an example of each.
Earned income is income derived from services and includes compensation and other forms of business income received by a taxpayer even if the taxpayer's business is selling inventory. In contrast, unearned income is income derived from property. Salary is a good example of earned income whereas interest is an example of unearned income.
Suppose Emily receives a competing job offer of $120,000 in cash compensation and nontaxable (excluded) benefits worth $5,000. What is the amount of Emily's after-tax compensation for the competing offer? Which job should she take if taxes are the only concern?
Emily's after-tax compensation is $105,191,
Dewey is a lawyer who uses the cash method of accounting. Last year Dewey provided a client with legal services worth $55,000, but the client could not pay the fee. This year Dewey requested that in lieu of paying Dewey $55,000 for the services, the client could make a $45,000 gift to Dewey's daughter. Dewey's daughter received the check for $45,000 and deposited it in her bank account. How much of this income is taxed, if any, to Dewey? Explain.
A cash method taxpayer recognizes income on the value of property received, so $45,000 of income will be recognized in this year. The assignment of income doctrine holds that earned income is taxed to the taxpayer providing the goods or services. Hence, Dewey and not his daughter is taxed on the entire amount of service income. Because the money went to Dewey's daughter, his daughter will be treated as though she received a gift from Dewey.
What is the difference between a tax deduction and a tax credit? Is one more beneficial than the other? Explain.
A deduction generally reduces taxable income dollar-for-dollar (although from AGI deductions may not reduce taxable income dollar-for-dollar). This translates into a tax savings in the amount of the deduction times the marginal tax rate. In contrast, credits reduce a taxpayer's taxes payable dollar-for-dollar. Thus, generally speaking, credits are more valuable than deductions.
f taxpayers are not allowed to claim deductions for dependency exemptions, is it necessary to determine who qualifies as a taxpayer's dependents? Briefly explain.
Even though taxpayers don't take deductions for dependency exemptions, it is still important to determine who qualifies as a taxpayer's dependents because taxpayers with dependents qualify for certain tax benefits that taxpayers without dependents do not. For example, taxpayers must have dependents to file as head of household instead of single. Also, taxpayers with dependents are allowed to claim credits such as the child tax credit, the American opportunity credit, the earned income credit, and other credits.
he cash method of accounting means that taxpayers don't recognize income unless they receive cash or cash equivalents. True or false? Explain.
False - under the cash method, taxpayers recognize income in the period they receive it (in the form of cash, property, or services).
True or False. For purposes of determining head of household filing status, the taxpayer's mother or father is considered to be a qualifying person of the taxpayer (even if the mother or father does not qualify as the taxpayer's dependent) as long as the taxpayer pays more than half the costs of maintaining the household of the mother or father. Explain.
False. The taxpayer must be able to claim his or her father or mother as a dependent in order for the father or mother to be a qualifying person for purposes of determining head of household filing status.
name three factors that determine whether a taxpayer is required to file a tax return.
Filing status (e.g., single, married filing joint, etc.), age, and the taxpayer's gross income.
Explain why taxpayers are allowed to exclude gifts and inheritances from gross income even though these payments are realized and clearly provide taxpayers with the wherewithal to pay.
Gifts and inheritances are taxed by a separate tax system (the unified Federal gift and estate tax). Taxing gifts and inheritances as income to the recipient would subject these payments to double taxation.
What is the difference between gross income and adjusted gross income, and what is the difference between adjusted gross income and taxable income?
Gross income is more inclusive than is adjusted gross income (AGI). Gross income is all income from whatever source derived that is not excluded or deferred from income. AGI is gross income minus "for AGI" deductions. Therefore, the primary difference between gross income and AGI is the amount of for AGI deductions. Adjusted gross income is more inclusive than taxable income. AGI is gross income minus for AGI deductions. Taxable income is AGI minus "from AGI" deductions. Consequently, the difference between AGI and taxable income is the amount of from AGI deductions. From AGI deductions include the qualified business income deduction and either itemized deductions or the standard deduction.
Assume the same facts as part (b), except that Abbi and her husband report a $0 tax liability on their joint tax return. Also, if the couple had filed separately, Abbi would not have had a tax liability on her return, but her husband would have had a $250 tax liability on his separate return. Can Jamel and Jennifer claim Abbi as a dependent on their tax return? Why or why not?
No. Jamel and Jennifer may not claim Abbi as a dependent even though she is their qualifying child because she fails the joint return test. Even though the couple had no tax liability on their joint return and Abbi would not have had a tax liability on a separate return, because Abbi's husband would have reported a tax liability on his separate return, Jamel and Jennifer may not claim her as a dependent.d.
The goal of tax planning is to minimize taxes." Explain why this statement is not true.
In general terms, the goal of tax planning is to maximize the taxpayer's after-tax wealth while simultaneously achieving the taxpayer's nontax goals. Maximizing after-tax wealth is not necessarily the same as tax minimization. Specifically, maximizing after-tax wealth requires one to consider both the tax and nontax costs and benefits of alternative transactions, whereas tax minimization focuses solely on a single cost (i.e., taxes).
are taxpayers allowed to deduct net capital losses (capital losses in excess of capital gains)? Explain
In general, a taxpayer is allowed to deduct, as a "for AGI deduction," up to $3,000 of net capital loss against ordinary income. If the net capital loss exceeds $3,000, the taxpayer is allowed to carry the loss over indefinitely to deduct in subsequent years (subject to the $3,000 annual deduction limitation). If, however, a capital loss arises from the sale of a personal use asset (such as a personal automobile or a personal residence), the loss is not deductible.
how do parents determine who claims the child as a dependent if the child is a qualifying child of both parents when the parents are divorced or file separate tax returns?
In the case of divorced parents or parents filing separately, the parent with whom the child has resided with the longest during the year (the custodial parent) has priority for claiming the child as a dependent. However, the custodial parent can allow the noncustodial parent to claim the child as a dependent through Form 8332. The noncustodial parent attaches the form to his or her tax return. If the child resides an equal time with each parent (as would likely be the case if the married couple was filing separately), the parent with the higher AGI has priority
Assume that in addition to the original facts, Jeremy has a long-term capital gain of $4,000. What is Jeremy's tax refund or tax due including the tax on the capital gain?
Jeremy has tax due of $156,
Assume the original facts except that Jeremy had only $7,000 in itemized deductions. What is Jeremy's tax refund or tax due?
Jeremy has tax due of $425
eremy earned $100,000 in salary and $6,000 in interest income during the year. Jeremy's employer withheld $10,000 of federal income taxes from Jeremy's paychecks during the year. Jeremy has one qualifying dependent child (age 14) who lives with him. Jeremey qualifies to file as head of household and has $23,000 in itemized deductions, including $2,000 of charitable contributions to his church.a. Determine Jeremy's tax refund or taxes due.
Jeremy will receive a refund of $444
Jorge and Anita, married taxpayers, earn $150,000 in taxable income and $40,000 in interest from an investment in City of Heflin bonds. Using the U.S. tax rate schedule for married filing jointly (see Example 1-3), how much federal tax will they owe? What is their average tax rate? What is their effective tax rate? What is their current marginal tax rate?
Jorge and Anita will owe $24,497 in federal income tax this year computed as follows: $24,497 = $9,328 + 22% ($150,000 - $81,050). Jorge and Anita's average tax rate is 16.33 percent. Average Tax Rate = TotalTax/Taxable Income = $24,497/$150,000 = 16.33%Jorge and Anita's effective tax rate is 12.89 percent. Effective tax rate = Total Tax/Total Income = $24,497/($150,000 + $40,000) = 12.89%Jorge and Anita are currently in the 22 percent tax rate bracket. Their marginal tax rate on increases of income up to $22,750 and deductions up to $68,950 is 22 percent.
For tax purposes, why is the married filing jointly tax status generally preferable to the married filing separately filing status? Why might a married taxpayer prefer not to file a joint return with the taxpayer's spouse?
Married couples filing joint returns combine their income and deductions and agree to share joint and several liability for the resulting tax. Filing a joint return generally results in a lower tax liability than does filing separately due to more favorable tax rate schedules and higher phase-out thresholds for various tax benefits. However, a couple may prefer to file separate returns in certain circumstances for nontax reasons. For example, when a married couple is separated but the couple does not want to have anything to do with each other or when one spouse does not want to be liable for the tax liability of both parties, the couple may choose to file separately.
Assume the original facts except that Abbi is married. She and her husband live with Jamel and Jennifer while attending school and they file a joint return. Abbi and her husband reported a $1,000 tax liability on their tax return. If all parties are willing, can Jamel and Jennifer claim Abbi as a dependent on their tax return? Why or why not?
No, Jamel and Jennifer may not claim Abbi as a dependent because she filed a joint return with her husband, and they reported a tax liability on their joint return. c.
Would Aishwarya be allowed to claim Jasmine as a dependent for Jasmine for 2021 if Aishwarya provided more than half of Jasmine's support in 2021, Jasmine lived in Aishwarya's home from July 15 through December 31 of 2021, and Jasmine reported gross income of $5,000 for the year?
No. Jasmine would fail the qualifying child test because she did not have the same principal residence as Aishwarya for more than half the year. Jasmine would fail the qualifying relative test because her gross income is not less than $4,300.
Are taxpayers required to include all realized income in gross income? Explain.
No. Taxpayers are allowed to permanently exclude certain types of income from gross income or defer certain types of income from taxation (gross income) until a subsequent tax year. Consequently, taxpayers are not required to include all realized income in gross income.
Assume the original facts except that Tim earned $10,000 and used all the funds for his own support. Are the Smiths able to claim Tim as a dependent?
No. The Smiths may not claim Tim as a dependent because he is not a qualifying relative as analyzed below.
Assume the original facts except that Tim is a friend of the family and not John's uncle.
No. The Smiths may not claim Tim as a dependent because he is not a qualifying relative as analyzed below.
im was injured in an accident and his surgeon botched the medical procedure. Jim recovered $5,000 from the doctor for pain and suffering and $2,000 for emotional distress. Determine the taxability of these payments and briefly explain to Jim the apparent rationale for including or excluding these payments from gross income.
Payments to compensate taxpayers for personal injuries are excluded from gross income. Payments for emotional distress are included in gross income, unless they are associated with medical expenses or related to physical injuries. In this case, all $7,000 is excluded from gross income because Jim's emotional distress is associated with a physical injury.
If a person meets the qualifying relative tests for a taxpayer, is that person automatically considered to be a dependent of the taxpayer? Explain
No, taxpayers may claim a qualifying relative as a dependent only if the qualifying relative is a citizen of the United States or a resident of the United States, Canada, or Mexico. Further, the qualifying relative must meet the joint tax return test if the person is married (no joint return with spouse unless there is no tax liability (positive taxable income) on the joint return and there would have been no tax liability on either separate tax return if the spouses had filed separately).
Assume the original facts except that Jason earned $5,500 while working part-time and used this amount for his support. Can the Samsons claim Jason as their dependent? Why or why not?
No, the Samsons may not claim Jason as their dependent. He is neither their qualifying child nor their qualifying relative. S
Assume the original facts except substitute Jason's grandparents for his parents. Determine whether Jason's grandparents can claim Jason as a dependent.
No, the grandparents may not claim Jason as a dependent. He is neither a qualifying child nor a qualifying relative.
is a qualifying relative always a qualifying person for purposes of determining head of household filing status?
No. A qualifying relative who meets the relationship test only because the individual lived as a member of the taxpayer's household for the entire year (no qualifying family relationship) is not a qualifying person for head of household filing status purposes.
Are all capital gains (gains on the sale or disposition of capital assets) taxed at the same rate? Explain.
No. If a taxpayer holds a capital asset for a year or less the gain is taxed at ordinary tax rates. If the taxpayer holds the asset for more than a year before selling, the gain is taxed at either a 0%, 15%, or 20% rate depending on the taxpayer's taxable income level. If the taxpayer sells more than one capital asset during the year and recognizes both capital gains and capital losses, the gains and losses are netted together before determining the applicable tax rate.
Compare and contrast realization of income with recognition of income.
Realization is a judicial concept that determines the period in which income is generated, whereas recognition is a statutory concept that determines whether realized income is going to be included in gross income during the period. Realization is a prerequisite to recognition and absent an exclusion or deferral provision, recognition is automatic.
how are realized income, gross income, and taxable income similar, and how are they different?
Realized income is more broadly defined than gross income which is more broadly defined than taxable income. Gross income includes all realized income that taxpayers are not allowed to exclude from gross income or are not permitted to defer to a later year. Consequently, gross income is the income that taxpayers actually report on their tax returns and pay taxes on. In the tax formula, taxable income is gross income minus allowable deductions for and from AGI. Taxable income is the base used to compute the tax due before applicable credits. However, any income included in gross income can be considered "taxable" income
Which is a more appropriate tax rate to use to compare taxpayers' tax burdens - the average or the effective tax rate? Why?
Relative to the average tax rate, the effective tax rate provides a better depiction of a taxpayer's tax burden because it depicts the taxpayer's total tax paid as a ratio of the sum of both taxable and nontaxable income earned.
xplain how state and local governments benefit from the provisions that allow taxpayers to exclude interest on state and local bonds from their gross income.
State and local governments benefit because it allows them to pay a lower interest rate on the debt because investors are willing to accept the lower rate since they are not taxed on the interest income.
hrough November, Cameron has received gross income of $120,000. For December, Cameron is considering whether to accept one more work engagement for the year. Engagement 1 will generate $7,000 of revenue at a cost to Cameron of $3,000, which is deductible for AGI. In contrast, engagement 2 will generate $5,000 of qualified business income (QBI), which is eligible for the 20 percent QBI deduction. Cameron files as a single taxpayer, and he did not contribute to charity during the year. a. Calculate Cameron's taxable income assuming he chooses engagement 1 and assuming he chooses engagement 2. Assume he has no itemized deductions.
Taxable income $111,450
how do taxpayers determine whether they should deduct their itemized deductions or utilize the standard deduction?
Taxpayers generally deduct the greater of (1) the applicable standard deduction or (2) their total itemized deductions, after limitations. However, taxpayers that do not want to bother with tracking itemized deductions may choose to deduct the standard deduction, even when itemized deductions may exceed the standard deduction.
What are the basic requirements to exclude the gain on the sale of a personal residence?
Taxpayers meeting certain home ownership and use requirements can permanently exclude up to $250,000 ($500,000 if married filing jointly) of realized gain on the sale of their principal residence. Gain in excess of the excludable amount generally qualifies as long-term capital gain subject to tax at preferential rates. To satisfy the ownership test, the taxpayer must have owned the residence (house, condominium, trailer, or houseboat) for a total of two or more years during the five-year period ending on the date of the sale. To satisfy the use test, the taxpayer must have used the property as her principal residence for a total of two or more years (noncontiguous use is permissible) during the five-year period ending on the date of the sale. The tax law limits each taxpayer to one exclusion every two years. Married couples filing joint returns are eligible for the full $500,000 exclusion if either spouse meets the ownership test and both spouses meet the principal-use test. However, if either spouse is ineligible for the exclusion because he or she personally used the $250,000 exclusion on another home sale during the two years before the date of the current sale, the couple's available exclusion is reduced to $250,000.
What requirements do an abandoned spouse and qualifying widow or widower have in common?
Taxpayers qualifying as an abandoned spouse are treated as not married at the end of the year and may therefore qualify for the head of household filing status. The requirements for both abandoned spouse and qualifying widow or widower require that the taxpayer no longer be living with his or her spouse at year end, whether through death (for qualifying widow or widower) or by separation (for at least 6 months for abandoned spouse). Further, both require that the taxpayer has a dependent child who resides with the taxpayer. The qualifying widow status requires that the dependent child live with the taxpayer for the entire year. The abandoned spouse status requires that the dependent child live with the taxpayer for more than half the year. Furthermore, for qualifying widow status, the dependent child must be a child or stepchild (including an adopted child but not a foster child) for whom the taxpayer can claim a dependency exemption. For abandoned spouse/head of household purposes, the dependent child must be a child, stepchild (including an adopted child), or a foster child.
All else being equal, should taxpayers prefer to exclude income or defer it? Why?
Taxpayers should prefer to exclude income rather than defer income. When they exclude income, they are never taxed on the income. When they defer income, they are still taxed on the income but they are taxed in a subsequent tax year.
Why are some deductions called "above the line" deductions and others called "below the line" deductions? What is the "line"?
The "line" is adjusted gross income (AGI) [line 11 of page 1 of the 2020 Form 1040]. AGI is considered the line because of the significance it plays in the amount of deductions allowed from AGI. For AGI deductions are called above-the-line deductions because they are deducted in determining AGI. "From AGI" deductions are called below-the-line deductions because they are deducted after AGI has been determined. They are deducted from AGI to arrive at taxable income. Below the line deductions may be subject to limitations based on the taxpayer's AGI.
anet is a cash-method, calendar-year taxpayer. She received a check for services provided in the mail during the last week of December. However, rather than cash the check, Janet decided to wait until the following January because she believes that her delay will cause the income to be realized and recognized next year. What would you tell her? Would it matter if she didn't open the envelope? Would it matter if she refused to check her mail during the last week of December? Explain.
The constructive receipt doctrine states that a taxpayer realizes and recognizes income when it is actually or constructively received. Constructive receipt is deemed to occur when the income has been credited to the taxpayer's account or when the income is unconditionally available to the taxpayer, the taxpayer is aware of the income's availability, and there are no restrictions on the taxpayer's control over the income. This doctrine prevents Janet, a cash basis taxpayer, from arbitrarily shifting income to a later period by postponing the delivery or acceptance of a payment. It does not matter if she refuses to open the envelope or check her mail, because the income is unconditionally available to her, she is aware of the income's availability, and there are no restrictions on her control over the income.
What is an "implicit tax," and how does it affect a taxpayer's decision to purchase municipal bonds?
The price of tax-advantaged assets like municipal bonds is bid up in competitive markets relative to the price of similar assets, like corporate bonds, without tax advantages. The higher price paid for tax-advantaged assets reduces the rate of return on these assets relative to other similar assets without tax advantages. This difference in rates of return represents an "implicit tax" on tax-advantaged assets.A taxpayer would have to calculate whether her implicit tax rate is greater than or less than her individual marginal tax rate (explicit rate) before deciding to purchase municipal bonds. If her explicit tax rate exceeds her implicit tax rate on municipal bonds, she will prefer municipal bonds over taxable bonds all else being equal.
Aishwarya's husband passed away in 2020. She needs to determine whether Jasmine, her 17-year-old stepdaughter who is single, qualifies as her dependent in 2021. Jasmine is a resident but not a citizen of the United States. She lived in Aishwarya's home from June 15 through December 31, 2021. Aishwarya provided more than half of Jasmine's support for 2021. a. Is Aishwarya allowed to claim Jasmine as a dependent for 2021?
Yes, Aishwarya may claim a Jasmine as a dependent in 2021. Jasmine meets the citizenship/residency test because she is a resident of the United States, and she meets the requirements to be considered Aishwarya's qualifying child
Would Aishwarya be allowed to claim Jasmine as a dependent for 2021 if Aishwarya provided more than half of Jasmine's support in 2021, Jasmine lived in Aishwarya's home from July 15 through December 31 of 2021, and Jasmine reported gross income of $2,500 for the year?
Yes, Jasmine would qualify as Aishwarya's qualifying relative
Average tax
represents the taxpayer's average level of taxation on each dollar of taxable income. Specifically, tax bill / taxable income
effective tax
represents the taxpayer's average rate of taxation on each dollar of total income (i.e., taxable and nontaxable income). total tax/total income
Marginal tax rate
tax rate that applies to the taxpayer's additional taxable income or deductions that the taxpayer is evaluating in a decision. Specifically, Tax/taxable income.
Francine's mother Donna and her father Darren separated and divorced in September of this year. Francine lived with both parents until the separation. Francine does not provide more than half of her own support. Francine is 15 years old at the end of the year. a. Is Francine a qualifying child to Donna?
yes
ased on the definition of gross income in §61 and related regulations, what is the general presumption regarding the taxability of income realized?
§61(a) defines gross income as all income from whatever source derived. Reg. §1.61-(a) provides further insight into the definition of gross income as follows: Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. Thus, the general presumption regarding any income realized is that it is taxable, unless otherwise excluded by law.
How are state-sponsored 529 educational savings plans taxed if investment returns are used for educational purposes? Are the returns taxed differently if they are not ultimately used to pay for education costs?
"qualified higher education expenses" for college students (no annual limit) or for tuition expenses for students at public, private or religious elementary or secondary schools (subject to a $10,000 limit per beneficiary per year). Qualified higher education expenses include tuition, books, supplies, required equipment and supplies, computer equipment and software, and reasonable room and board costs of attending a higher education institution. If distributed investment returns are used for any other purpose, or exceed the $10,000 limit for tuition expenses attributable to public, private or religious elementary or secondary schools, the distributee will pay tax on the investment returns in the year received at ordinary rates. In many instances, the distributee will also be required to pay an additional 10% penalty tax in addition to the normal tax on the investment returns
Bob's Lottery, Inc., has decided to offer winners a choice of $100,000 in ten years or some amount currently. Assume that Bob's Lottery Inc. earns a 10 percent after-tax rate of return. What amount should Bob's offer lottery winners currently in order for him to be indifferent between the two choices?
$100,000 in ten years is worth $38,600 today to Bob ($100,000 × .386 (Discount Factor, 10 Year, 10 percent)). Thus, Bob should offer lottery winners $38,600 today for him to be indifferent between the two choices.
chuck, a single taxpayer, earns $75,000 in taxable income and $10,000 in interest from an investment in City of Heflin bonds. Using the U.S. tax rate schedule, how much federal tax will he owe? What is his average tax rate? What is his effective tax rate? What is his current marginal tax rate?
$12,249 = $4,664 + 22% ($75,000 - $40,525)—rounded up to the nearest dollar. Chuck's average tax rate is 16.33 percent. Average Tax Rate = Total Tax/Taxable Income = $12,249/$75,000 = 16.33%Chuck's effective tax rate is 14.41 percent. Effective tax rate = Total Tax/Total Income = $12,249/($75,000 + $10,000) = 14.41%Chuck is currently in the 22 percent tax rate bracket. His marginal tax rate on increases in income up to $11,375 and deductions from income up to $34,475 is 22 percent.
What is a "wash sale"? What is the purpose of the wash sale tax rules?
A wash sale is a tax term that applies to transactions in which a taxpayer purchases the same stock or "substantially identical" stock to the stock they sold at a loss within a 61-day period centered on the date of the sale. A wash sale occurs when an investor sells or trades stock or securities at a loss and within 30 days either before or after the day of sale buys substantially identical stocks or securities. Because the day of sale is included, the 30 days before and after period creates a 61-day window during which the wash sale provisions may apply.The purpose of the wash sale tax rules is to prevent taxpayers from accelerating losses on securities that have declined in value without actually changing their investment in the securities. The 61-day period ensures that taxpayers cannot deduct losses from stock sales while essentially continuing their investment in the stock.
Compare and contrast for and from AGI deductions. Why are for AGI deductions likely more valuable to taxpayers than from AGI deductions?
All deductions are classified as either "for AGI" or "from AGI" deductions. Gross income minus for AGI deductions equals AGI. AGI minus from AGI deductions equals taxable income. For AGI deductions are often referred to as deductions above the line, while deductions from AGI are referred to as deductions below the line. The line is AGI (2020 Form 1040, line 11).
Jamel and Jennifer have been married 30 years and have filed a joint return every year of their marriage. Their three daughters, Jade, Lindsay, and Abbi are ages 12, 17, and 22 respectively, and all live at home. None of the daughters provides more than half of her own support. Abbi is a full-time student at a local university and does not have any gross income. a. Which, if any, of the daughters qualify as dependents of Jamel and Jennifer?
All three daughters qualify as their dependents as qualifying children a
Describe the concept of realization for tax purposes.
As indicated in Reg. §1.61-(a), the tax definition of income adopts the realization principle. Under this principle, income is realized when (1) a taxpayer engages in a transaction with another party, and (2) the transaction results in a measurable change in property rights. In other words, assets or services are exchanged for cash, claims to cash, or other assets with determinable value. The concept of realization for tax purposes closely parallels the concept of realization for financial accounting purposes. Requiring a transaction to trigger realization reduces the uncertainty associated with determining the amount of income because a change in rights can typically be traced to a specific moment in time and is generally accompanied by legal documentation.
he concept of the time value of money suggests that $1 today is not equal to $1 in the future. Explain why this is true.
Assuming an investor can earn a positive return (e.g., 5 percent), $1 invested today should be worth $1.05 ($1 × (1+.05)1) in one year. Hence, $1 today is equivalent to $1.05 in one year.
Tim is a plumber who joined a barter club. This year Tim exchanges plumbing services for a new roof. The roof is properly valued at $2,500, but Tim would have billed only $2,200 for the plumbing services. What amount of income should Tim recognize on the exchange of his services for a roof? Would your answer change if Tim would have normally billed $3,000 for his services?
Assuming the roof is properly valued, the taxpayer should recognize the value of the property received or $2,500 regardless of the amount he would have billed. The value of the plumbing services, however, would help determine the value of the roof.
Rank the following three single taxpayers in order of the magnitude of taxable income (from lowest to highest) and explain your results. Assume none of the taxpayers contributed to charity this yea
Baker has the highest taxable income, followed by Chin and then Ahmed. Baker's taxable income is highest because he had a small amount of for AGI deductions, his itemized deductions were less than the standard deduction amount so he didn't get any tax benefit from his itemized deductions. Baker also had a small amount of QBI deduction. This was not enough to make up for his lack of other deductions. Chin was next. Chin didn't have any for AGI deductions but he had enough itemized deductions to exceed the standard deduction by $1,600. Chin's biggest deduction was the deduction for QBI. This is a from AGI deduction that is not an itemized deduction. Ahmed has the lowest because he had the most for AGI deductions. See the following analysis:
Based on the definition of gross income in §61, related regulations, and judicial rulings, what are the three criteria for recognizing taxable income?
Based on §61(a), Reg. §1.61-(a), and various judicial rulings, taxpayers recognize gross income when (1) they receive an economic benefit, (2) they realize the income, and (3) no tax provision allows them to exclude or defer the income from gross income for that year.
Tomiko is a 50 percent owner (partner) in the Tanaka partnership. During the year, the partnership reported $1,000 of interest income and $2,000 of dividends. How much of this income must Tomiko include in her gross income?
Because Tanaka is a partnership (a flow-through entity), Tomiko must include her share of the partnership's income in her gross income. In this case, Tomiko's ownership interest is 50%, so she will include $500 of interest income and $1,000 of dividends in her gross income and report it on her tax return just as if she had received these amounts directly.
sabella provides 30 percent of the support for her father Hastings, who lives in an apartment by himself and has no gross income. Is it possible for Isabella to claim her father as a dependent? Explain.
Because her father meets the relationship and gross income test for a qualifying relative, the support test is the only obstacle for Isabella to claim her father as a dependent. The basic support test requires that Isabella must have provided more than half of the support for her father in order to claim him as a dependent. Because Isabella provides only 30% of her father's support, she does not meet the basic test. However, Isabella could potentially qualify to claim her father as a dependent under a multiple support agreement. For Isabella to qualify to claim her father as a dependent under a multiple support agreement, the following requirements must be met:
escribe the kinds of insurance premiums an employer can pay on behalf of an employee without triggering includible compensation to the employee.
Health insurance premiums and a portion of life insurance premiums. The exclusion for health insurance premiums is limited to qualified plans that reimburse medical costs for the employee, spouse, and dependents. The cost of medical coverage paid by an employer and offered through a health insurance exchange is not an excludable benefit unless the employer is a small employer that elects to make all of its full-time employees eligible for plans offered through an exchange. For this purpose, a small employer is an employer that employed an average of at least one but 100 or fewer employees during business days in the prior year, and employs at least one employee on the first day of the plan year. The scope of the exclusion for life insurance premiums is limited to qualified group term policies up to a face amount of $50,000.
What is the difference between horizontal and vertical equity? How do tax preferences affect people's view of horizontal equity?
Horizontal equity means that two taxpayers in similar situations pay the same tax. Vertical equity is achieved when taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax. One can view vertical equity in terms of tax dollars paid or in terms of tax rates. Governmental units provide tax preferences for a variety of reasons - e.g., encourage investment, social objectives, etc. Whether one views these tax preferences as appropriate or not, greatly influences whether one considers a tax system to be fair in general and specifically, horizontally equitable. Specifically, if one views a tax preference as being inappropriate, this would adversely affect one's view of horizontal equity.
George purchased a life annuity to provide him monthly payments for as long as he lives. Based on IRS tables, George's life expectancy is 100 months. Is George able to recover his cost of the annuity if he dies before he receives 100 monthly payments? Explain. What happens for tax purposes if George receives more than 100 payments?
If George dies before receiving the expected number of payments, the amount of unrecovered investment (the initial investment less the amounts received treated as a nontaxable capital recovery) may be deducted on his final income tax return (as an itemized deduction). Conversely, if George lives longer than his estimated life expectancy, he will receive more than the expected number of payments. The entire amount of these "extra" payments is included in his gross income, because he would have completely recovered his investment in the annuity when he receives the payment in month #100.
Strictly considering tax factors, should Nitai work or repair his car if the $400 he must pay to have his car fixed is deductible for AGI?
If Nitai works, he will receive $500, and he will be allowed to deduct the $400 repair expense, leaving him with taxable income of $100 ($500 - $400) on which he will pay $12 in taxes. So, if he works, he will receive $500, pay $400 to have his car fixed, and pay $12 in taxes, leaving him with $88. If he doesn't work, he won't have any income, he won't pay any taxes, and he won't be out of pocket because he will do his own repair work (assuming the repair only requires labor). So, he's $88 better off by working and having his car repaired by Autofix (considering only tax factors).
itai, who is single and has no dependents, was planning on spending the weekend repairing his car. On Friday, Nitai's employer called and offered him $500 in overtime pay if he would agree to work over the weekend. Nitai could get his car repaired over the weekend at Autofix for $400. If Nitai works over the weekend, he will have to paythe $400 to have his car repaired, but he will earn $500. Assume Nitai's marginal tax rate is 12 percent rate. a. Strictly considering tax factors, should Nitai work or repair his car if the $400 he must pay to have his car fixed is not deductible?
If Nitai works, he will receive $500, but he will have to pay $60 in taxes ($500 × 12%), netting him $440. He then must pay $400 for his car to be repaired, which means he will gain $40 ($440 - 400) by working. If he doesn't work, he won't have any income, he won't pay any taxes, and he won't have to pay to have his car repaired. Overall, he would be $40 better off by working.Note that taxes may not be the only concern here. Nitai would also need to factor in how much he enjoys repairing his car and how much he enjoys working. He could also consider whether he will do a better job repairing his car or whether Autofix could do a better job.
Describe the circumstances under which distributions from defined contribution plan are penalized. What are the penalties?
If an employee receives a distribution too early or too late the employee is penalized. A distribution is considered to be received too early if it is received before the individual reaches 59 ½ years of age or 55 if retired from service. The penalty on an early distribution is 10% of the entire distribution amount. A distribution is subject to penalty if it is received too late or is insufficient in amount. A minimum distribution penalty applies when taxpayers don't receive the required minimum distribution for a particular year. The required minimum distribution is based on the age of the taxpayer and tables provided by the IRS. The minimum distributions must be received by later of April 1st of the year after the year in which the employee turns 72 ½ or when the employee actually retires. When an employee fails to receive the minimum distribution, the employee is penalized at 50% on the difference between the required distribution and the amount actually distributed.
What federal income-related taxes are (or might) taxpayers (be) required to pay? In general terms, what is the tax base for each of these other taxes on income?
In addition to the individual income tax (federal taxable income is the base), individuals may also be required to pay other income-related taxes such as the alternative minimum tax (AMT, self-employment tax, the net investment income tax, and the additional Medicare tax. These taxes are imposed on a tax base other than the individual's taxable income. The AMT tax base is alternative minimum taxable income, which is the taxpayer's taxable income adjusted for certain items to more closely reflect the taxpayer's economic income than does taxable income. The tax base for self-employment taxes is the net earnings derived from self-employment activities. The tax base for the net investment income tax is the taxpayer's net investment (unearned) income (subject to certain thresholds), and the additional Medicare tax base is earned income (in excess of a threshold).
How do two taxpayers determine who has priority to claim a person as a dependent if the person is a qualifying child of both taxpayers when neither taxpayer is a parent of the child (assume the child does not qualify as a qualifying child for either parent)?
The priority in claiming a qualifying child as a dependent is as follows:(1) The parent of the child.(2) If the child is a qualifying child to both parents, then the parent with whom the child has resided with the longest during the year.(3) If the child resides with the parents equally or the child resides with taxpayers who are not parents (the child is not a qualifying child of a parent but the child is a qualifying child of more than one non parent), then the taxpayer with the highest AGI.Consequently, the taxpayer with the higher AGI could claim the person as a dependent.In the case of divorced parents or parents filing separately, the parent with whom the child has resided with the longest during the year (the custodial parent) has priority for claiming the child as a dependent. However, the custodial parent can allow the noncustodial parent to claim the child as a dependent through Form 8332. The noncustodial parent attaches the form to his or her tax return. If the child resides an equal time with each parent (as would likely be the case if the married couple was filing separately), the parent with the higher AGI has priority.
compare and contrast the relationship test requirements for a qualifying child with the relationship requirements for a qualifying relative.
The relationship test for a qualifying child includes the taxpayer's child or descendant of a child (child or grandchild) while the relationship test for qualifying relatives includes both descendants and ancestors of the taxpayer (child, grandchild, parents, or grandparent). The relationship test for qualifying child includes siblings of the taxpayer or descendants of siblings of the taxpayer while the qualifying relative test also includes siblings of the taxpayer and sons or daughters of the taxpayer's siblings. The relationship test for qualifying relative also includes the taxpayer's in laws, aunt, uncle, and any person (even if there is no qualifying family relationship as described above) who has the same principal place of abode as the taxpayer for the entire year. Thus, the relationship test for qualifying relative is much broader in scope than the relationship test for qualifying child.
In general terms, what are the differences in the rules for determining who is a qualifying child and who qualifies as a dependent as a qualifying relative? Is it possible for someone to be a qualifying child and a qualifying relative of the same taxpayer? Why or why not?
The rules for determining who qualifies as a dependent as a qualifying child and who qualifies as a dependent as a qualifying relative overlap to some extent. The primary differences between the two are: (1) the relationship requirement is more inclusive for qualifying relatives than qualifying children, (2) qualifying children are subject to age restrictions while qualifying relatives are not, (3) qualifying relatives are subject to a gross income restriction while qualifying children are not.(4) taxpayers need not provide more than half a qualifying child's support, though the child cannot provide more than half of his/her own support, but, absent a multiple support agreement, taxpayers must provide more than half the support of a qualifying relative, and(5) qualifying children are subject to a residence test (they must live with the taxpayer for more than half the year) while qualifying relatives are not.An individual may not be a qualifying child and a qualifying relative of the same taxpayer. By definition, a qualifying relative must be someone who is not a qualifying child. Consequently, the qualifying relative tests apply only when the individual does not pass the qualifying child tests.
Brad purchased land for $45,000 this year. At year-end Brad sold the land for $51,700 and paid a sales commission of $450. What effect does this transaction have on Brad's gross income? Explain.
The sale increases Brad's gross income by $6,250. The selling expenses reduce the amount realized on the sale from $51,700 to $51,250 and the $45,000 cost of the land is a return of capital. The excess of the amount realized over the cost is included in his gross income ($51,700 - $450 - $45,000 = $6,250).
What is the deciding factor in determining whether a capital gain is a short-term or long-term capital gain? What tax rates apply to short-term gains versus long-term capital gains?
When a capital asset that has been held for more than one year is sold, it generates a long-term capital gain. Long-term capital gains are taxed at preferential rates. When it has been held for one year or less, it generates a short-term capital gain when sold. Short-term capital gains are taxed as ordinary income.
Which engagement maximizes Cameron's after-tax cash flow?
While both engagements generate the same taxable income (and tax liability) engagement 2 produces $1,000 more net cash flow than engagement 1. Engagement 1 provides $7,000 of revenue but costs $3,000 (net of $4,000 excluding taxes which are constant between both engagements). Engagement 2 provides $5,000 of income at a cost of $0 (ignoring taxes which are the same between engagements). Cameron should choose the $5,000 engagement over the $4,000 engagement. Note that Cameron is entitled to a $1,000 QBI deduction but he does not incur a cost to get the QBI deduction. It is simply the product of the QBI and 20%. Further, note that the QBI is a from AGI deduction but it is not an itemized deduction so Cameron can deduct it even though he doesn't have any itemized deductions.
he Samsons are trying to determine whether they can claim their 22-year-old adopted son, Jason, as a dependent. Jason is currently a full-time student at an out-of-state university. Jason lived in his parents' home for three months of the year, and he was away at school for the rest of the year. He received $9,500 in scholarships this year for his outstanding academic performance and earned $4,800 of income working a part-time job during the year. The Samsons paid a total of $5,000 to support Jason while he was away at college. Jason used the scholarship, the earnings from the part-time job, and the money from the Samsons as his only sources of support.a. Can the Samsons claim Jason as their dependent?
Yes, the Samsons may claim Jason as their dependen
Assume the original facts except that Jason's grandparents, not the Samsons, provided Jason with the $5,000 worth of support. Can the Samsons (Jason's parents) claim Jason as their dependent? Why or why not?
Yes, the Samsons may claim Jason as their dependent. Jason is their qualifying child. See the following analysis.
Assume the original facts except that Abbi is married. Abbi files a separate tax return. Abbi's husband files a separate tax return and reports a $250 tax liability. Can Jamel and Jennifer claim Abbi as a dependent?
Yes. Because Abbi files a separate return, and she meets all other dependency requirements [see answer to part (a)]. Jamel and Jennifer may claim Abbi as a dependent.
John and Tara Smith are married and have lived in the same home for over 20 years. John's uncle Tim, who is 64 years old, has lived with the Smiths since March of this year. Tim is searching for employment but has been unable to find any—his gross income for the year is $2,000. Tim used all $2,000 toward his own support. The Smiths provided the rest of Tim's support by providing him with lodging valued at $5,000 and food valued at $2,200. a. Are the Smiths able to claim Tim as a dependent?
Yes. The Smiths may claim Tim as a dependent as a qualifying relative as analyzed below.
Assume the original facts except that Tim is a friend of the family and not John's uncle and Tim lived with the Smiths for the entire year.
Yes. The Smiths may claim Tim as a dependent because he is a qualifying relative as analyzed below.