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ARE - Individual Tax


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What is the all-inclusive concept?
All economic benefits received are taxable unless Congress says otherwise
Ex: gifts, inheritances, municipal bond interest are all exclusions
What is included in Gross Income?
Salaries and wages, interest and dividends, capital gains, net profits from a trade/business
What are the two methods of accounting?
Cash Basis and Accrual basis
What is Adjusted Gross Income (AGI)
Gross Income - "For AGI" Deductions - AGI

"the line"
What are examples of "For AGI" Deductions (above the line)?
-Trade or Business Expenses
-Certain IRA Contributions
-Keogh Plan Contributions
-Alimony Payments
-Half of S.E. Tax (deducted above the line)
-Moving expenses
-Student Loan Interest
-Penalties for early withdrawals from CDs
What is the standard deduction?
1. basic standard deduction -> depends on filing status (det. amt)
2. Additional standard deduction -> function of add'l factors (64+, blind) - fixed amount, added to basic
What are examples of Itemized Deductions?
-charitable contributions
-medical expenses
-casualty & theft losses
-certain taxes
-ceratin interest payments
If a person may be claimed as a dependent on another person's tax return, what is their personal exemption and standard deduction?
personal exemption = 0

standard deduction limited
How do you compute Taxable Income?
AGI - (the larger of standard or itemized deductions) - personal and dependent exemptions = taxable income
What is a tax credit?
Reductions to tax liability
How do corporations treat foreign income taxes paid?
May be claimed either as a deduction or as a credit, at the option of the corporation
What is the statute of limitations for an individual tax return?
3 years from return due date, not including extensions

6 years if >25% income omitted
What is the statute of limitations for filing for fraud, or failure to file?
No time limit
What is constructive receipt?
occurs when funds are set aside and made available to the taxpayer

-not subject to substantial limitation
What is the claim of right doctrine?
occurs when funds are received but set aside, and not available to the taxpayer

-attorney receives pmt but set in escrow, cant touch it yet
In the cash basis, deductions are only taken when cash is paid, except for what two circumstances?
1. Inventory - cant expense cost of inventories acquired - only when sold

2. Capital expenditures - not currently deductible, depreciated instead. Includes any benefits extending beyond current period (deductions for prepaid interest or prepaid rent are spread over period of benefit)
Is there are a Bad Debt Deduction for Trade Receivables if you are a cash basis taxpayer?

Cash basis means no income accrued. No income accrued means no basis in the receivables
Are bargain purchases includable in Gross Income?
Are incentive stock options included in gross income?
They are included when employee sells the stock, and may result in a tax deferral
Are nonqualified stock options included in Gross Income?
Price difference is included in income when employee exercises the option
Where is net profit from a trade or business reported?
Revenues and Expenses reported on Schedule C.

Net profit also subject to S.E. tax
What expenses are deductible?
Ordinary (customary and usual) and Necessary (beneficial to TP's business - reasonable amount)
What type of expenses are nondeductible?
-Personal Expenses

- Capital expenditures (deductible ratably, not currently)

- Pmts against Public Policy
What is the Self-Employment tax comprised of?
(equiv to ss taxes usually withheld)
OASDI and Health Insurance

-SE Individuals pay both the employer's (7.65%) and employee's (7.65%) share
How is the SE tax treated as a deduction?
- 1/2 of SE Tax is deducted above the line (For AGI)

-not deducted on Schedule C

-SE Tax is in addition to regular tax liability
How is Rental Income reported?
Cash payments, as well as lease cancellation payments, forfeited deposits, security deposits applied towards rent, tenant improvements made in lieu of rent
How are installment sales reported?
When TP's sell property on installment basis, part of each payment represents return on investment, and part represens profit.

-compute GP percentage --> (Profit on sale/Sales Price)

GP x Payments received = Taxable Income
What is the exclusion ratio for annuities?
(Investment / Expected Return)

Exclusion ratio x Pmts received = Excludable portion
How are gamblings winning treated in gross income?
Winnings are gross income - NOT NET winnings and losses. Losses are itemized deductions (below the line) limited to amt of winnings, but treated separately
When is contigent property recognized? (i.e. employer gives worker stock contingent on term of service - risk of forfeiture)
-defer recognition until risk of forgeiture passes

-taxpayer may elect earlier recognition but later forfeigure creates no deduction
Is municipal bond interest taxable?

(US state and local, not foreign)
-gain or loss on sale is taxable though
How and when are education savings bonds excludable income?
-income is excluded when bonds are redeemed for college tuition and fees

-exclusion only for original purchaser, spouse and dependents

-phased out for higher incomes, reduced for scholarships
Are life insurance proceeds excludable?
proceeds paid by reason if insured's death are excluded from income (treated same as inheritance)
What is the Accelerated Death Benefit?
policy pays off due to chronic or terminal illness

such death benefit is excluded from income
What are the 3 conditions that must be satisfied in order to exclude awards & prizes?
1. Did not actively enter contest
2. No obligations attached
3. Proceeds must go directly to a governmental unit or charity

(for religious, charitable, scientific, artistic, educational, etc)
Area gifts excludable from TI?
-based on intent of donor - must be "no strings attached"
Are inheritances excluded from taxable income?
How are insurance dividends excluded?
Insurance dividends are deemed to be returns of premiums, not gross income
How is child support and alimony reported in taxable income?
Child support is excluded by recipient, nondeductible by payor

Alimoney: included by recipient, deducted For AGI by payor
Are divorce transfers taxable income?
NO. Recipient retains original basis of property transferred
When are disability insurance payments taxable?
If employer paid premiums, then benefits are taxable

If employee paid premiums, then benefits are nontaxable
If an individual taxpayer's passive losses and credits relating to rental real estate activities cannot be used in the current year, then they may be carried when and for how long?
Forward indefinitely or until the property is disposed of in a taxable transaction
How much of unemployment compensation benefits should be included in gross income?
the entire amount of benefits received in gross income regardless of the level of a taxpayer's adjusted gross income.
What is the maximum amount of tax free life insurance coverage that can be provided by an employer?
up to $50,000
How are hobby revenues and expenses treated in relation to deduction for/from AGI?
Hobby related revenue above the line

Hobby related expense below the line
What are the 5 characteristics of alimony?
1. Cash
2. Divorce or separate maintenance instrument
3. Not to same household members
4. Pmts must terminate upon death of recipient (they are living expenses)
5. Pmt cannot be characterized as other than alimony in the decree or written agreement
What is the limit of capital loss deductions?
$3000 per year
How is interest forfeiture treated (on early withdrawal from a CD)?
-above the line deduction
-not offset against income
-all income goes into gross income
-forfeiture is deducted from GI separately in year of forfeiture
How does a Roth IRA work?
-contributions are nondeductible
-income accumulates tax free
-withdrawals are not taxed
What is a Keogh Plan
retirement plan for self employed individuals
How are meals & entertainment costs deducted?
exclude 50% meal and entertainment cost you pay
-must be away from home, or incur in an activity related to and associated to a business discussion
How are student loans interest deducted?
TP can deduct up to $2000 of interest on qualified educational loans (subject to AGI phase-outs)
What is the moving expense test?
(above the line deduction)

1. Job related

2. Time test: 39/52 weeks or 78/104 if self employed

3. Distance test: commute must increase by at least 50 miles
What moving expenses are deductible?
Direct expenses relating to moving the family
-household goods
-transportation and lodging
-not meals
What is the deduction for medical expenses limited to?
total qualified, un-reimbursed, paid medical expenses, reduced by 7.5% AGI
Who are medical dependents?
those that meet the relationship, support and citizenship test on.
Where are decedent's expenses from?
either final income tax return or estate tax return, but not both
What taxes are deductible?
-state local and foreign property tax (not a fee or assessment). must be ad valorem (based on value of property)

-state and local income taxes (amounts paid are includable as itemized deduction)
What are the nondeductible taxes?
- federal income taxes
- social security tax
- gift/inheritance taxes
- another's taxes
- gas/sales taxes
- water use/bridge use taxes
What are Above-the-line Interest deductions?
-borrow money for business activity
-borrow for rental activity
-borrow for education
What are the below the line interest deductions?
- Investment Interest Deduction, to the extent of net investment income (gross investment income - investment related expenses) -> ceiling on investment interest deduction
How is Home Equity Indebtedness treated?
-deducted below the line

-debt secured by equity on house, up to $100,000 of debt

-vacation, college, medical expenses
Are loan points deductible?
points paid to lenders are treated as prepaid interest - so deductible in full on acquisition indebtedness

- must be prorated if incurred during refinancing
What interest expense is nondeductible?
Interest paid on personal loans (auto loans, credit cards)
What is the current exemption amount?
How many personal exemptions does a TP get?
1 personal exemption for self
1 personal exemption for spouse
What are the dependency tests?
1. Support
2. Relationship
3. Gross Income
4. Joint return
5. Citizenship
What is the Support Test?
- must provide over 50% of support by taxpayer

-includes food, shelter, medical care, clothing and related matter
-includes all money received for and spent on dependent, even if money received was nontaxable
**if income is saved, it doesnt count as support - not counted
**scholarships are not included in support test
What is the Multiple Support Agreement?
allows exemption in cases where more than one TP contributes to support, but no one provides over 50%
Who gets the exemption in the case of children of divorced parents?
-parents having custody for the greater part of the year may claim the kids as dependents if the parents together provide more than 50% of the childs support

-custodial parent may grant dependency to other parent, but it has to be in writing
What is the relationship test?
must be a relative of the TP (blood or marriage ties EXCEPT COUSINS) or household (resides with TP all year)
What is the Gross Income Test?
Gross income means only income subject to tax, ignores nontaxable SS benefits...not gifts, not nontaxable scholarships, includes taxable scholarships

** dep's income must be less than the $$amt of the exemption ($3050)
When does the limit of $3050 not apply to the Gross Income test?
-if dependent is under 19
-if full time student under 24 years old
What is the Joint Return test? Exception?
a joint return filer may not be claimed by another taxpayer as a dependent on another's return

Exception: joint return was only to get a refund of withheld taxes, neither MFJ filer was required to file a return, neither MFJ filer would have a tax liability if they had filed separately
What is the Citizenship test?
Must be a citizen or resident of US, Canada, or Mexico
What are the 5 Filing Statuses?
1. Single

2. Married Filing Jointly (MFJ)

3. Married Filing Separate (MFS)

4. Surviving Spouse

5. Head of Household (HH)
What does Single mean?
-unmarried or legally separated
-abandoned spouses can use HH rates
-marital status determined as the last day of the taxable year, except for SS
What does Married Filing Separetly entail?
-rarely results in tax savings
-both or neiher itemize, no EIC, no child care credit
What does Surviving Spouse status entail (or qualified widower)?
allows taxpayer to use MFJ tax rates for 2 years following spouse's death if:

-widow must maintain residence for dep. child/stepchild
-not remarried

in year of death, still file MFJ
What is the standard deduction for a single person?
What is the Head of Household status?
-single, unmarried
-abandoned spouse -> married but havent lived with spouse for last half of tax year and have a dependent
What is the standard deduction for MFJ? MFS? HH?
MFJ = $7950

MFS = $3975

HH = $7000
HH rule in relation to relative? 3 Exceptions?
TP must provide half the cost of home for a relative (dependent)

Exception - if relative is an unmarried child (includes grandchild, stepchild or adopted) dont have to be the TP's dep.

Exception - TP may maintain a sep. home for the TP's parent(s) as long as at least one of them qualifies as TP's dep

Exception - death of dep during the year does not change the HH status for that year
What is the Kiddie Tax?w
when a child under 14 has unearned income over $1500, the excess is taxed at the parent's highest tax rate
What does the itemized deduction cutback not apply to?
medical expenses

investmenet interest

wagering losses

casualty and theft losses
What is a credit?
direct reduction of tax liability
What are the 2 types of tax credits?
1. Nonrefundable

2. Refundable (negative tax)
What is the maximum allowable child credit amount for 1 amount? 2 or more?
$2400, $4800
Is foreign earned income taxable?
yes, but there is a Foreign Tax Credit
What does the Foreign Tax Credit give you the choice of doing?
Either claiming a credit or deducting foreign taxes as itemized deductions.

can exclude some income earned in foreign income
What is the Hope Scholarship Credit?
available only for expenses for the first two years of college
What is the Lifetime Learning Credit?
20% credit for up to $5000 per year in qualified expenses, may be claimed for unlimited years, available to TPs and dependents
What is the Earned Income Credit?
-must have earnings from salaries, wages or self employment

-higher credit for TPs with qualifying children

-reduced credit for TPs without children

-amt determined by modified AGI
To avoid the Underpayment Penalty, how much of the total tax due must the TP have paid by year end?
at least 90% of the total tax due
How much time do you have to claim a refund on an outstanding tax return?
3 years from date return filed


2 years from payment of tax
What is the statute of limitation for assessments?
3 years from later of filing or due date
On the sale or exchange of a personal residence, how much can be excluded from income?
up to $250,000 ($500,000 on joint return) of gain realized if indiv ownded and occupied as personal residence at least 2 of 5 years preceding the sale or exchange
What happens to the gain in excess of the allowable exclusion?
must be included in income regardless of whether sales proceeds are reinvested in a new house
What type of property qualifies for like-kind exchanges? What types are not eligible?
-must be an exchange of business or investment property for like-kind business or investment property

-inventory, stocks, bonds, notes and Pship interests are not eligible
What does "like-kind" refer to?
class of property

real must be exchanged for real, personal for personal
What is boot?
an equalizing asset in an exchange of assets with different values

Ex: cash and liabilities (anything exchanged other than the like-kind property)
What direction is the liability flow in like-kind exchanges?
Liabilities given up -> boot received

Liabilities assumed -> boot given
What is the gain recognized in a like-kind transaction?
lesser of:

net boot received or realized gain
How do you determine an involuntary conversion realized gain/loss?
Proceeds - basis
How are gains recognized in an involuntary conversion?
lower of realized gain and un-reinvested proceeds

realized loss is always recognzied in full
What is the replacement period for an involuntary conversion?
end of second tax year following gain realization (receipt of proceeds)

condemnaion of real property allows unil end of 3rd tax year
How do you determine the Net Capital Position?
- Combine all ST capital gains and losses

- Combine all LT capital gains and losses
Can you gain a net ST gain and a net LT gain?
no they have different tax treatments
How are net ST and LT gains taxed differently?
Net ST gain taxed at ordinary rates, but Net LT gain subject to reduced tax rates (favorable treatment)
What is the max total annual deduction for capital losses?

use ST first, then LT if possible
How long is the Capital Loss Carryover for individuals?

-Carryover losses combine with current year capital gains or losses

-No capital loss carrybacks for individuals
What is Section 1244 stock?
when stock was acquired, the paid-in-capital and capital stock did not exceed $1million
How are losses from the sale of 1244 stock treated?
In year of loss, ordinary loss up to $50,000 per taxpayer

- any balance remaining is short term capital loss in carryover years
An individual who actively participates in rental activity can deduct how much in losses annually? (Rental loss exception)
How is the Alternative Minimum Tax computed?
Taxable Income +/- AMT Adjustements + Tax Preferences - Allowable Exemption = Alternative Minimum Taxable Income

AMTI x Rate - Reg tax liability = AMT
What is the AMT tax rate?
26% for AMT to $175k, and 28% in excess
The AMT is paying the higher of what?
Tentative AMT or regular tax

if reg tax lower - add AMT
if reg tax higher - no AMT
How does the AMT carry forward?
AMT paid carries forward indefinitely as a credit against future regular tax liability.
What are the AMT adjustments?
- Misc itemized deductions

- Deductible taxes

- Medical expenses allowed only in excess of 10% of AGI

-Home second mortgage interest

- Standard deduction

-Personal exemptions

-subtract state tax refunds
What are AMT preferences?
Additions to AMTI base:
-percentage depletion in excess of basis
-intangible drilling and development costs
-tax exempt interest on private activity bonds issued after 8/7/1986
Are educational expeneses deductible?
Not if they either qualify the taxpayer for a new trade or business, or are required to satisfy minimum educational requirements for qualification in the employment, trade or business of the taxpayer
What is the appropriate tax treatment for a loss sustained from a nonbusiness bad debt?
Deductible in Schedule D--Capital Gains or Losses.

A nonbusiness bad debt is treated as a short-term capital loss, subject to the limitations for deductibility under Code §§1211 and 1212. Capital gains and losses are entered on Schedule D--Capital Gains or Losses.
What is the appropriate tax treatment for qualifying medical expenses not reimbursed by insurance?
in Schedule A—Itemized Deductions (deductibility subject to threshold of 7.5% of adjusted gross income).
What is the appropriate tax treatment for personal life insurance premiums paid by an individual?
Not deductible
If services are paid for in property, how are they reported?
if services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation
The 2002 deduction by an individual taxpayer for interest on investment indebtedness is limited to what?
the taxpayer's net investment income earned in 2002
What is the general business credit?
the sum of 11 credits listed therein
Are disability benefits included in gross income?
Are life insurance proceeds included in gross income?
Is jury duty pay included in gross income?

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