R1- Individual Taxation
personal exemption amount for each individual
$3950
business expenses (schedule C-EZ) (items expected to find in business) (net income from self-employment)
- COGS, salaries, employee benefits, office expenses - state and local business taxes paid - actual automobile expenses - business and entertainment expense at 50% - depreciation on business assets - interest expense on business loan (important) - legal and professional services - bad debts actually written off (direct write-off method)
nonqualified option - employee taxation (without readily ascertain value)
- Yr granted: no tax - Yr exercised: ordinary income = FMV of stock purchased minus option cost - Yr of sale: cap gain/losses
nonqualified option - employee taxation (readily ascertain value)
- Yr granted: ordinary income = option value x # of options - Yr exercised: no tax. Basis = exercise price + amt taxed before - Yr of sale: Capital gain/loss = FMV - basis
flexible spending arrangment (FSAs)
- allows employee to receive a pre-tax reimbursement of certain (specified) incurred expenses - employee can have up to $2500/year of their salary deposited into a flexible spending account designated for them (via salary deduction, pay for qualified health care or qualified dependent care costs), and forfeit funds not used within 2 1/2 months after year-end
employee stock purchase plan (ESPP) characteristics
- approved by shareholders - employee can't own more than 5% voting power - include all full-time normal employees (not those < 2 years of work) - option exercise price cannot be lesser than the lesser of 85% of stock when granted/exercised - option cannot be exercised more than 27 months after grant date - can't purchase more than $25000 stock per year - remain employed for 3 months (same as ISO)
passive activity loss mom and pop exception (taxpayer has passive income but actively participates in rental activity)
- deduct up to $25000/year of net passive loss if actively participates (though not active enough) and owns more than 10% of rental activity - reduce by 50% of the excess of AGI over $100000. Allowance is eliminated completely if AGI over $150000
incentive stock option (ISO) characteristics
- granted upon a plan approved by shareholders - employees can't own more than 10% voting power - exercise price > FMV of stock @ grant date - must be exercised within 10 years (earlier of the date the plan was adopted/approved), stock must be held 2 years after grant date and 1 year after exercise date - employee must remain from the date option is granted until 3 months before option is exercised
head of household Half year
- larger standard deduction and wider tax bracket 1. not married, or married and live apart 2. not a "qualifying widower", not a non resident alien 3. household for more than 1/2 year be principle residence of dependent child (divorced mom), father/mother not required to live with taxpayer (nursing home) but provide half of the living cost, dependent relative
ISO employee/employer taxation
- no taxation to employee, not deductible to employer - G/L is capital; holding period not satisfied --> ordinary - may exercise up to $100k of ISOs in a year
child support
- nontaxable and nondeductible - if the payment is made for both alimony and child support but is not enough, then it's allocated to child support first (that portion is not taxable)
ESPP employee/employer taxation
- not taxable/deductible - G/L on sale is capital; holding period not satisfied then gain is ordinary up to the amount that the stock's FMV on the exercise date exceeded option price - option price < FMV of stock on the grant date, ordinary income is recognized as the lesser of the difference of FMV of stock when sold and the exercise price, or the difference between the exercise price and FMV of stock on the grant date
non deductible expense on schedule C
- salaries paid to sold proprietor - federal income taxes - personal expenses - charitable contributions
qualified employee discount deductible for employee 1) merchandise discount 2) service discount 3) employer-provided parking 4) transit passes
1) merchandise discount: limited to employer's gross profit percentage 2) service discount: limited to 20% of FMV of services 3) parking: $250 per month 4) transit passes: up to $130 per month
Traditional nondeductible IRA
1) principal nontaxable 2) accumulated earnings taxable when withdrawn
exemptions
1) small contractors (last no more than 2 years, performed by a taxpayer with annual gross receipts not exceeding $10 million) 2) home construction contractors 3) services provided by architects, engineers, designers, construction management advisors, software implementation personnel 4) under warranty agreement
children of divorce parents
1. Custodial parent takes the exemption 2. Exception: custodial parent waives right (signing a written declaration)
5 categories of taxpayers and their corresponding taxable social security benefits
1. Low income = nontaxable (income below: single $25000, MFJ $32000) 2. Lower middle income = less than 50% SSB taxable 3. Middle income = 50% SSB taxable (income over: single $25000, MFJ $32000) 4. Upper middle income = between 50% and 85% taxable 5. Upper income = 85% taxable (income over: single $34000, MFJ $44000)
payments to be classified as alimony (taxable income) include:
1. Payment must be in cash or its equivalent. 2. Payments must end a the recipient's death 3. Payments must be legally required pursuant to a written divorce (or separation) agreement. 4. Cannot be made to members of the same household. 5. Must not be designated as anything other than alimony. The spouses may not file a joint tax return. Note: The requirements for payments to be considered alimony (income) are the same as for payments to be alimony (deductions).
Spouse as personal exemption on a separate return A married tax payer filing separately may claim spouse's personal exemption if the following tests are met:
1. Spouse has no gross income; and 2. Spouse was not claimed as a dependent of another tax payer
qualifying relative test (SUPORT) if CARES is not met
1. Support more than 1/2 2. Under exemption amount of (taxable) gross income (taxable income of dependent must not > 3950) Taxable income doesn't include social security at low income level, tax exempt interest income. 3. Preclude dependent filing joint return 4. Only US citizen or resident of US, Mexico, Canada 5. Relative 6. Taxpayer lives with individual for the whole year
The requirements that enable a taxpayer to be classified as a "qualifying widow(er)" are:
1. The taxpayer's spouse died in one of the two previous years and the taxpayer did not remarry in the current tax year, 2. The taxpayer has a child who can be claimed as a dependent, 3. This child lived in the taxpayer's home for all of the current tax year, 4. The taxpayer paid over half the cost of keeping up a home for the child, 5. The taxpayer could have filed a joint return in the year the spouse died.
qualifying widower (surviving spouse) with dependent child - must Whole year
1. Two years after spouse's death: might use the joint tax return with standard deduction and rates (not exemption for the deceased spouse) for each of the two taxable year following the year of death, unless remarries. 2. Principal residence of the dependent child for the whole taxable year (blood or adoption)
qualifying child exemption (CARES test)
1. close relative (including lawful adoption) 2. age limit (under 19 or 24 if full-time college for at least 5 months) 3. residency (live in same house for more than 6 months) 4. eliminate gross income test (does not apply) 5. support test changes (provide more than 1/2 support) - eliminated
Accrual method used for farming income methods of inventory valuation
1. cost 2. lower of cost or market 3. farm price method 4. unit-live-stock method
uniform capitalization rule applies to retailers whose average gross receipts for the preceding three years exceed what amount?
10,000,000
when to file tax return?
April 15 due date
Which of the following conditions must be present in a post-1984 divorce agreement for a payment to qualify as deductible alimony? I. Payments must be in cash or its equivalent. II. The payments must end at the recipient's death. a. II only. b. Both I and II. c. I only. d. Neither I nor II.
B. Both I and II
Adjustment for SE tax paid
Below the line amount of 1/2 amount of SE tax paid is deductible
Parker, whose spouse died during the preceding year, has not remarried. Parker maintains a home for a dependent child. What is Parker's most advantageous filing status? a. Qualifying widow(er) with dependent child. b. Single. c. Married filing separately. d. Head of household.
Choice "a" is correct. A qualifying widow(er) is a taxpayer who may use the joint tax return standard deduction and rates (but not the exemption for the deceased spouse) for each of two taxable years following the year of death of his or her spouse, unless he or she remarries. The surviving spouse must maintain a household that, for the whole entire taxable year, was the principal place of a son... (whether by blood or adoption). The surviving spouse must also be entitled to a dependency exemption for such individual. Choice "d" is incorrect. Parker would not qualify as head of household for the first two years after the death of Parker's spouse because one of the requirements for Head of Household status is that the taxpayer is NOT a surviving spouse.
Nare, an accrual-basis taxpayer, owns a building which was rented to Mott under a ten-year lease expiring August 31, Year 8. On January 2, Year 2, Mott paid $30,000 as consideration for cancelling the lease. On November 1, Year 2, Nare leased the building to Pine under a five-year lease. Pine paid Nare $10,000 rent for the two months of November and December, and an additional $5,000 for the last month's rent. What amount of rental income should Nare report in its Year 2 income tax return? a. $45,000 b. $40,000 c. $10,000 d. $15,000
Choice "a" is correct. Prepaid rent is income when received even for an accrual-basis taxpayer. The $30,000 received as consideration for cancelling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month's rent is also rental income.
With regard to the inclusion of social security benefits in gross income, for the Year 8 tax year, which of the following statements is correct? a. Eighty-five percent of the social security benefits is the maximum amount of benefits to be included in gross income. b. The social security benefits in excess of the modified adjusted gross income over a threshold amount are included in gross income. c. The social security benefits in excess of one half the modified adjusted gross income are included in gross income. d. The social security benefits in excess of modified adjusted gross income are included in gross income.
Choice "a" is correct. The amount of social security benefits that is taxed is dependent on whether the combined income (AGI plus interest on tax-exempt bonds and 50% of the social security benefits) is greater than a threshold amount. If the combined income is less than the threshold, the amount taxed is the lesser of 1) 50% of the benefits or 2) 50% of the excess of the combined income over the threshold. If the combined income is greater than the threshold, the amount taxed is the lesser of 1) amount calculated above plus 85% of the excess of the combined income over the threshold or 2) 85% of the benefits. Thus, 85% of the benefits is the maximum amount of benefits that may be included in gross income.
For a cash basis taxpayer, gain or loss on a year-end sale of listed stock arises on the: a. Trade date. b. Date of delivery of stock certificate. c. Settlement date. d. Date of receipt of cash proceeds.
Choice "a" is correct. Trade date. Gain or loss on a year-end sale of listed stock arises on the trade date. Rule: Whether on the cash or accrual method of accounting taxpayers who sell stock or securities on an established securities market must recognize gains and losses on the trade date, rather than on the settlement date.
In Year 1, Smith, a divorced person, provided over one half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During Year 1, Ruth did not live with Smith. She received $9,000 in Social Security benefits. Clay, a 25-year-old full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return for Year 1, owing an additional $500 in taxes on his wife's income. How many exemptions was Smith entitled to claim on his Year 1 tax return? a. 1 b. 2 c. 3 d. 4
Choice "b" is correct. Smith is entitled to an exemption for himself. He is also entitled to an exemption for his mother Ruth (qualifying relative). Ruth has $9,000 in Social Security payments during Year 1, but because that is her only income, the Social Security is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent. Clay cannot be taken as a dependent because he filed a joint return with his wife. Because the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay. Smith is entitled to two exemptions.
Smith has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities. What amount of the rental losses may Smith deduct in determining taxable income? a. $40,000 b. $0 c. $15,000 d. $20,000
Choice "c" is correct. Generally, none of the passive losses from real estate are deductible against nonpassive income. However, Smith actively participates, which means that the "mom and pop" exception of up to $25,000 will apply. This exception is phased out over AGI of $100,000 through $150,000. That is 50 cents on the dollar. Smith's AGI is $120,000. That is $20,000 into the phaseout range. So $10,000 of the $25,000 is phased out and Smith may deduct $15,000 of the $40,000 passive loss.
Freeman, a single individual, reported the following income in the current year: Guaranteed payment from services rendered to a partnership $ 50,000 Ordinary income from an S corporation 20,000 What amount of Freeman's income is subject to self-employment tax? a. $0 b. $20,000 c. $50,000 d. $70,000
Choice "c" is correct. Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to self-employment tax. Payments not guaranteed are merely another way to distribute partnership profits. The ordinary income reported from an S corporation is taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).
A taxpayer's spouse dies in August of the current year. Which of the following is the taxpayer's filing status for the current year? a. Single. b. Qualified widow(er). c. Married filing jointly. d. Head of household.
Choice "c" is correct. The joint return rates apply for two years following the death of a spouse, if the surviving spouse does not remarry and maintains a household for a dependent child. There is nothing in this question that says whether or not the surviving spouse maintains a household for a dependent child. However, since the question is asking about the current year, the surviving spouse is considered to be married (and thus able to file as married filing jointly) for the entire current year even if the spouse dies earlier in the year (in this case in August).
On December 1 of the current taxable year, Krest, a self-employed cash basis taxpayer, borrowed $200,000 to use in her business. The loan was to be repaid on November 30 of the following year. Krest paid the entire interest amount of $24,000 on December 1 of the current year. What amount of interest was deductible on Krest's current year income tax return? a. $0 b. $24,000 c. $22,000 d. $2,000
Choice "d" is correct. Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on December 1, of the current year, only the interest relating to December of the current year can be deducted in the current year. The question does not give an interest rate, but because the loan is to be repaid in a lump sum at maturity, 1/12 of the interest, or $2,000 applies to each month.
A couple filed a joint return in prior tax years. During the current tax year, one spouse died. The couple has no dependent children. What is the filing status available to the surviving spouse for the first subsequent tax year? a. Married filing separately. b. Surviving spouse. c. Head of household. d. Single.
Choice "d" is correct. For the first subsequent tax year (and all other subsequent tax years) after the death of a spouse with no dependent children, filing status is single. Choice "b" is incorrect. Filing status is not "surviving spouse" because there are no dependent children. Choice "a" is incorrect. Filing status is not "married filing separately" in the first subsequent tax year after the death of a spouse since the couple is no longer married. Choice "c" is incorrect. Filing status is not "head of household" because there are no dependent children and no other qualifying dependents.
In the current year, a taxpayer reports the following items: Salary $ 50,000 Income partnership A (materially participates) 20,000 Passive activity loss from partnership B (40,000) During the year, the taxpayer disposed of the interest in partnership B, which had a suspended loss carryover of $10,000 from prior years. What is the taxpayer's adjusted gross income for the current year? a. $30,000 b. $70,000 c. $60,000 d. $20,000
Choice "d" is correct. The $50,000 salary and income from partnership activity of $20,000 are taxable. Typically, passive activity losses, whether in the current or prior years, may only be used to offset passive activity income. The exception to this is in the year the passive activity is disposed of (sold), if still unused, passive activity losses are fully deductible in the year of disposal:20000
net self-employment income
Deductions to arrive at net self-employed income include all necessary and ordinary expenses connected with the business. Estimated federal income tax payments are not an expense. Charitable contributions by an individual are only deductible as an itemized deduction on Schedule A.
exception to penalty tax (still subject to ordinary income tax)
H - home buyer I - insurance M - medical expense exceed 10% AGI D - disability (not temporary) E - education and D - death
exemption - birth or death during the year
If a person is born or die during the year, he or she is entitled to either a personal or a dependency exemption during the entire year
Self-employment tax calculation
Net earning from SE x 15.3% (12.4% SSC + 2.9% Medicare)
Kiddie tax rule
Net unearned income of a dependent child under 18 years of age (or from 18 to 24) and does not provide half of support and is a full-time student is taxed at parent's higher tax rate. Net unearned income = total unearned income - 1000 (child's standard deduction) - 1000 (taxed at child's rate)
Which one of the following will result in an accruable expense for an accrual-basis taxpayer? a. A signed contract for repair work to be done and the work is to be completed at a later date. b. An invoice dated prior to year end but the repair completed after year end. c. A repair completed prior to year end and paid upon completion. d. A repair completed prior to year end but not invoiced.
RULE: An accruable expense is one is which the services have been received/performed but have not been paid for by the end of the reporting period. Choice "d" is correct. The facts indicate that a repair was completed prior to year end but not yet invoiced. If it has not yet been invoiced, it is assumed that it has also not yet been paid for. Therefore, this is a situation in which the repair expense would be accrued at year end. Services have been performed, but they have not been paid for, as they have not even been invoiced yet.
Chris, age 5, has $3,000 of interest income and no earned income this year. Assume the current applicable standard deduction is $950, how much of Chris' income will be taxed at Chris' parents' maximum tax rate?
The amount of income for a child under 18 that is taxable at the parents' maximum tax rate is deemed the "kiddie tax." To calculate the amount that is taxed at the parents' highest rate, take the child's total interest income ($3,000 in this question) and reduce it by the child's standard deduction ($950 in this case). The next $950 is then taxed at the child's rate, and the balance of $1,100 ($3,000 - $950 - $950 = $1,100) is taxed at the parents' highest rate.
Net earning from self-employment calculation
Total amount of self-employment income x 92.35%
difference between IRA and Roth IRA Deductibility
Traditional IRA contributions are tax deductible on both state and federal tax returns for the year you make the contribution, while withdrawals in retirement are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings and withdrawals are generally tax-free.
taxable interest income
a. bonds except for municipal bonds b. premiums received for opening a savings account (prize and awards) included at FMV c. part of the proceeds from installment sales taxable as interest d. interest paid by federal or state government for late payment of tax refund (principal is not taxable) e. amortization of bond premium is an offset to interest received and deduction to the bond's basis
tax-exempt interest income (reportable but not taxable)
a. state/local gov bonds, bonds of US possession (GUAM or Puerto Rico) b. Series EE (us saving bonds) - educational expenses
Roth IRA taxable?
all qualified benefits received from Roth IRA are nontaxable
extension of tax return
automatic six-month extension (October 15), but still have to pay the estimated tax on April 15
passive activity losses treatment in case the business is sold
becomes fully tax deductible the property is sold (go against the passive loss rule)
business income or loss (Schedule C-EZ)
cash = amount received property at FMV cancellation of debt
farming income (Schedule F)
cash basis, expense inventories (inventories of produce, livestock... are not considered)
nonqualified option - employer taxation
deduct the value of stock option as a business expense in the same year that the employee is required to recognize the option as ordinary income
single test
end of the year test - Single at year-end or - Legally separated
joint return test
end of the year test - one spouse dies during the year, can still file joint return - must be married at year end, living together under common law marriage, or married an d living apart (not legally separated or divorced)
interest income portion on deferred payout arrangement on life insurance proceeds
fully taxable
basic formula to determine net rental income (taxable)
gross rental income + prepaid rental income (nonrefundable deposits) + rent cancellation payment + improvement in-lieu-of rent <rental expenses> = net rental income/loss
uniform capitalization rule
guides how to capitalize inventories capitalize: direct materials, direct labor, overhead do not capitalize: selling, advertising, general, R&D expense
treatment of rental income - rent more than 15 days
if residence is rented for 15 or more days, and is used for personal purposes for the greater of 1) more than 14 days or 2) more than 10% of rental days --> personal residence; expenses must be prorated between personal and rental use; a different proration method must be used for mortgage interest and property taxes; loss deducted to the extent of rental income
qualified options 2 types
incentive stock option employee stock purchase plan
interest expense on business loans
interest expense paid in advance by tax payer cannot be deducted until the tax year/period to which the interest relates (must be incurred and paid)
property settlement in divorce
nontaxable and not deductible
qualified pension, profit-sharing, stock bonus plans made by employer
nontaxable to employers, taxable to employees
partially taxable fringe benefit - portion of group life insurance premium - income to employee classification
not income up to $50000/employee (nondiscriminatory plan only); premium in excess is taxable income included in W-2 of employee
tax for long-term contracts
percentage of completion method for nonexempt long-term contracts
social security income
provision of income = AGI + tax exempt interest + 50% of social security benefits. Must include in income the lesser of 50% (or 85%) of SS received or excess provisional income over the threshold
tax-free distributions
return of capital, stock split, stock dividend, life insurance dividends
More on interest on EE saving bonds
tax exempt when: pay for higher ed (reduced by tax-free scholarship) of taxpayer, spouse, dependents; taxpayer or joint ownership; taxpayer over 24 when issued, bonds acquired after 1989; phased out
IRA income withdral
taxable regular rate + 10% penalty tax rate
Employee stock option - nonqualified options
taxed when granted if the option has value Condition: - Option is transferable - Exercisable immediately in full when granted - No restrictions with a significant effect on value - FV of the option privilege is certain
treatment of rental income - rent less than 15 days
treated as personal residence, rental income is excluded from income, expenses not deductible
employer payment of employee's educational expenses - taxable to employer?
up to $5250 maybe excluded from gross income of payments made by employers on behalf of employee's educational expenses (applies to both undergraduate and graduate level)
IRA ordinary income
when the person retires, the fund will be taxed as ordinary income when received
