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3Q USA Tax 

College of Administration and Finance Sciences


Assignment (3)

Deadline: Saturday 27/11/2021 @ 23:59

Course Name: Tax and Zakat Accounting

Student’s Name:

Course Code: ACCT 422

Student’s ID Number:

Semester: 1st

CRN:

Academic Year: 1443 H

For Instructor’s Use only

Instructor’s Name: Dr. Ashfaque Ahmed

Students’ Grade: /5

Level of Marks: High/Middle/Low

Instructions – PLEASE READ THEM CAREFULLY

· The Assignment must be submitted on Blackboard (WORD format only) via allocated folder.

· Assignments submitted through email will not be accepted.

· Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page.

· Students must mention question number clearly in their answer.

· Late submission will NOT be accepted.

· Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions.

· All answers must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism.

· Submissions without this cover page will NOT be accepted.

Assignment 3

Q-1- To make income taxable, income must be realized and recognized. Explain in your own words the difference between income realization and income recognition, and then provide a short numerical example to indicate the difference (Do not copy the same numerical example from other students). (1.5 mark)

Answer

Q.2- Mr. X and Mrs. Y are married and have two dependent children. P & Q They also fully support Mrs. Y’s mother who lives with them and has no income. Their 2014 tax and other related information is as follows: (2 marks)

Particulars

Amount in $

Total salaries

320,000

Bank account interest income

7,000

Municipal bond interest income

3,000

Value of employer provided medical insurance

11,000

Value of premiums for $ 100000 of group term life insurance provided by employer

1,000

Gift from X’S parents

30,000

Gain from the sale of qualified small business stock acquired in 2008

30,000

Total itemized deductions

32,000

Dividend income—from ABC stock,

4,000

Loan from X’S parents

10,000

Required: Compute Mr. X and Mrs. Taxable income. (Show all calculations in proper /good form.)

Q.3- Ahmed’s medical expenses include the following: (1.5 mark)

Particulars

Amount in $

Food for personal use (expenses)

2,000

Travel allowances

5,000

Visitors fees

1,000

Prescription drugs

1,200

Eyeglasses

700

General purpose vitamins

200

Medical premiums

21,700

Doctors’ fees

4,000

Hospital fees

6,700

Ahmed’s AGI for the year is $66,000. He is single and age 59. Insurance company reimburses none of the medical costs and other related items. After considering the AGI floor,

Required – What will be Ahmed’s medical expense deduction?

Taxable Activity and Tax Exempt Incomes; Deductions and Losses

Article 8: Income subject to Tax

Taxable income is the gross income including all revenues, profits, and gains of any type and of any form of payment resulted from carrying out an activity minus exempted income

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

The gain or loss from the disposal of an asset is the difference between the compensation received and its cost base

No gain or loss on disposal of a depreciable asset is taken into account other than what is stated in Article 17 of this Law.

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

(c) In determining taxable income, a natural person may not take into account gain or loss on disposal of an asset that is not for use in the activity

(d) The cost base of an asset purchased, produced, manufactured, or constructed by the taxpayer is the amount paid or incurred by the taxpayer in cash or in kind in the process of acquiring the asset.

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

(e) Where a taxpayer disposes of part of an asset, the cost base is apportioned between the part retained and the part disposed of in accordance with their market value at the time of purchase

(f) Expenses incurred to alter or improve a non-depreciable asset are added to the cost base of the asset.

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

(g) The compensation value for disposal of an asset against assets in kind is based on the market value of those assets in kind, including exemption from debt on the asset

(h) Where a taxpayer disposes of an asset by gift or inheritance, the disposer is treated as having received compensation equal to the market value at the time of disposal (unless paragraph (i) applies.

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

(i) If an asset disposed of is encumbered by debt exceeding its market value, the taxpayer disposing of the asset is treated as having received compensation equal to the value of the debt

(j) In determining tax base, no gain or loss is taken into account on an involuntary disposal of an asset, to the extent that the compensation value is used to purchase of the same kind of asset within one year of the disposal.

Income Tax Law Articles 8 to 19

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Article 9: Gains and losses on disposal of assets.

(k) The cost base of a replacement asset described in (j) is determined with reference to the cost base of the replaced asset

(l) Where an asset owned by a taxpayer is converted to personal use or ceases to be used in the generation of income, the taxpayer is deemed to have disposed of the asset for its market value, with the recognition of the gain but not the loss.

Income Tax Law Articles 8 to 19

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Article 10: Exempt Income

The following types of income are exempt from income tax;

Capital gains realized from the disposal of securities traded in the Stock Market in the Kingdom in accordance with restrictions specified in the regulations

Gains resulting from disposal of property other than assets used in the activity.

Income Tax Law Articles 8 to 19

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Article 11: Donations

In determining the tax base of each taxpayer, a deduction is allowed for donations paid during the taxable year to public agencies or philanthropic societies licensed in the Kingdom which are non profit organizations and are allowed to receive these donations.

Income Tax Law Articles 8 to 19

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Article 12: Expenses related to earning income

All regular and necessary expenses of earning taxable income, paid or accrued, incurred by the taxpayer during the taxable year are deductible in determining the tax base, with the exception of outlays of a capital nature and expenses according to Article 13 of this law.

Income Tax Law Articles 8 to 19

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Article 13: Non Deductible Expenses

No deduction is allowed for the following;

Expenses not connected with the earning of taxable income

Any amounts paid to a shareholder, partner or any of their relatives, which constitute salaries, wages, awards or the like, or which do not satisfy the conditions for transactions among independent parties

Income Tax Law Articles 8 to 19

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Article 13: Non Deductible Expenses

No deduction is allowed for the following;

Recreation expenses

Expenses of a natural person for personal consumption

Income tax paid in the Kingdom or another country

Fines and financial penalties paid or payable to any party in the Kingdom

Bribes or similar amounts considered a criminal offense.

Income Tax Law Articles 8 to 19

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Article 14: Bad Debts

A taxpayer my deduct bad debts arising from the sales of goods or services that have bee previously declared as taxable income of the taxpayer

A bad debt may be deducted when stricken off the taxpayer’s books, when there is suitable evidence proving the impossibility of collecting it as specified in the regulations

Income Tax Law Articles 8 to 19

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Article 15: Reserves and Allocations

No reserves or allocations may be deducted except allocations of doubtful debts for banks

The regulations shall determine the rules and restrictions specifying such allocations

Income Tax Law Articles 8 to 19

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Article 16: Research and Development Expenses

Research and development expenses connected with the earning of taxable income my be deducted

Expenses for the purchase of land or equipment used for research and development may not be deducted

Such equipment shall be subject to depreciation under Article 17 of this Law

Income Tax Law Articles 8 to 19

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Article 17: Depreciation

Depreciation is explained in Article 17 paragraphs (a) through (l)

Terms and classifications are detailed in the Article to provide extensive guidance

Income Tax Law Articles 8 to 19

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Article 18: Expenses of Asset Repair and Improvement

Expenses incurred by the taxpayer for the repair or improvement of depreciable assets in each group may be deducted

The amount of expenses deductible in accordance with paragraph (a) for each year shall not exceed 4% of the balance of the value of the group at the end of that year

The amount exceeding the limit in paragraph (b) will be added to the balance of the value of the group

Income Tax Law Articles 8 to 19

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Article 19: Expenses for Geological Surveying and Preliminary Work for the Extraction of Natural Resources

Expenses of this Article are deducted in the form of amortization at the depreciation rates determined in paragraph (b) of Article 17

This Article also applies to expenses of intangible assets incurred by the taxpayer

Income Tax Law Articles 8 to 19

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Determination
of Tax

Chapter 2

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DETERMINATION OF TAX
(1 of 2)

Formula for individual income tax

Deductions from adjusted gross income

Determining the amount of tax

Business income and business entities

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Treatment of capital gains and losses

Tax planning considerations

Provisions applicable to higher-income taxpayers

Compliance and procedural considerations

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DETERMINATION OF TAX
(2 of 2)

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Formula for Individual
Income Tax (1 of 2)

Gross income

See Table 3 for items listed in §61(a)

– Exclusions (see Table 2)

Gross Income

– Deductions for AGI (see Table 4)

Adjusted Gross Income (AGI)

Tax rate schedules, std. deduction, personal exemptions, & other amounts are adjusted for inflation.

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Formula for Individual
Income Tax (2 of 2)

Adjusted Gross Income (AGI)

– Deductions from AGI:

Greater of itemized deductions or std ded.

Personal and dependency exemptions

Taxable Income

X Tax rate or rates (tax table or schedule)

Gross tax

– Credits and prepayments (see Table 5)

Net tax payable or refund due

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Deductions from
Adjusted Gross Income

Itemized deductions

Standard deduction

Personal exemptions

Dependency exemptions

Child credit

Making work pay credit and social security tax reduction

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Itemized Deductions
(1 of 2)

See Table 6 for partial list

Medical expenses

Taxes

Investment and residential interest

Charitable contributions

Personal casualty and theft losses

Miscellaneous deductions

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Itemized Deductions
(2 of 2)

Only claim itemized deductions if total greater than std. deduction

Some items limited by varying percentages of adjusted gross inc.

Medical expenses

Casualty losses

Miscellaneous itemized deductions

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Standard Deduction

Varies based on:

Filing status, age, and vision

$6,100 – $12,200 in 2013

Increase over 2012 to adjust for inflation

Increase std. ded. if elderly &/or blind

Used when std. ded. > itemized ded.

Limited std. ded. in certain situations

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Personal Exemptions

Generally, each taxpayer allowed one

Unless claimed as dependent on another return

$3,900 in 2012

Additional allowed for spouse on joint return

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Dependency Exemptions
Requirements for All Dependents

Have a qualifying identification number

Meet a citizenship test

Meet a separate return test

Not themselves claim another person as a dependent

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Dependency Exemptions
Additional Requirements for Qualifying Children

Relationship test

Age test

< 19 or full-time student < 24

Abode test

Live w/taxpayer > ½ of year

Support Test

Dependent provides < ½ own support

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Dependency Exemptions
Additional Requirements for Other Relatives

Relationship test

Related to or live w/taxpayer whole yr

Gross income test

Dependent’s gross inc. < exemption amt.

Support test

Taxpayer provides > ½ support

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Child Credit

$1K per qualifying child

Under 17 and a “qualifying” child

Credit reduced if MAGI exceeds

MFJ $110k; Single $75k; MFS $55k

Child credit refundable to extent of 15% of taxpayer’s earned income in excess of $3K

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Determining the Amount of Tax

Filing status

Joint return

Surviving spouse

Head of household

Single taxpayer

Married filing a separate return

Abandoned spouse

Dependents with unearned income

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Filing Status
(1 of 3)

Married filing jointly

Marital status on last day of tax year

Common law marriages recognized

Spouses must be U.S. citizens or residents

Federal Defense of Marriage Act of 1996 defines marriage as between a man and a woman

Same-sex couples cannot file a joint federal return, but may file joint state return in some states

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Filing Status
(2 of 3)

Surviving spouse

Files as married filing jointly

Head of household

Unmarried and maintains home in which dependent lives > ½ yr

Married filing separately

Single – taxpayers not in other categories

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Filing Status
(3 of 3)

Relative tax liability by filing status from lowest to highest

Married filing jointly

Surviving spouse

Head of household

Includes abandoned spouse

Single

Married filing separately

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Children with
Unearned Income
Personal Exemption & Standard Deduction

No personal exemption on own return

Standard deduction reduced to greater of

Earned income OR

$1K OR

Dependent’s earned income plus $350

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Children with
Unearned Income
Kiddie Tax (1 of 2)

All kids < 18 yrs old

Tax rate on child’s net unearned inc. in excess of $2K same as parents’ rate if higher than child’s rate

Certain kids age 18-23

If 18, applies if earned income < ½ support AND unearned income > $1K

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Children with
Unearned Income
Kiddie Tax (2 of 2)

Certain kids 18 – 23 (cont’d)

If 19-23, same rules as for age 18 ONLY if also a full-time student

Parents of child subject to kiddie tax may elect to include child’s dividend &interest income on their own return

If child’s total gross income ≤ $10K &

All child’s income from div. & interest

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Business Income & Bus Entities C Corporation Formula

Gross Income

– Exclusions

Gross Income

– Deductions

Taxable Income

X Tax Rates

Gross Tax

– Credits and prepayments

Net tax payable or refund due

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First $50K 15 % of Taxable Inc
> $50K But Not > $75K $7,500 + 25% of Taxable Inc
> $75K But Not > $100K 13,750 + 34% of Taxable Inc > $75K
> $100K But Not > $335K $22,250 + 39% of Taxable Inc > $100K
> $335K 34% of Taxable Inc
> $10M But Not > $15M 3.4M + 35% of Taxable Inc > $10M
> $15M But Not > $18,333,333 $5.150M + 38% > $15M
> $18,333,333 35% of Taxable Inc

Business Income & Bus Entities C Corporation Tax Rates

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Business Income & Bus Entities Flowthrough vs. Non Flowthrough

Flow-through entities do not pay tax at the entity level

C corporations pay tax at the entity level and the owners pay tax on corporate earnings (dividends) when received

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Capital Gains & Losses
Capital Asset Definition

Capital asset defined in §1221

Assets other than inventory, trade receivables, certain self-created works, depreciable business property, business land, and certain government publications

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Capital Gains & Losses
Classification of Capital Gains and Losses

Capital gains and losses are divided into 2 categories

Long-term is held for over 12 months

Short-term is held less than 12 months

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Capital Gains & Losses
Tax Rates on Net Capital Gains

Net long-term gain

Taxed at maximum of 15%

0% if in the 10% or 15% tax

Rate scheduled to increase in 2013 to lesser of 20% or regular tax rate

Net short-term gain

Taxed at the same rate as other income

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Capital Gains & Losses
Tax Treatment of Net Capital Losses

Individuals can deduct only up to $3K of net capital losses from their other income

Unused losses are carried over indefinitely to offset gains in future years

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Provisions Applicable to Higher-Income Taxpayers
(1 of 3)

Top tax brackets increased

Income tax – 39.6%

Tax rate on dividends – 20%

Payroll tax increase

0.9% on earnings >$200K ($250K MFJ)

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Investment tax

3.8% on lesser of investment income or AGI in excess of $200K ($250K MFJ)

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Provisions Applicable to Higher-Income Taxpayers
(2 of 3)

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Personal and dependency exemptions phased out

Reduced by 2% for each $2.5K ($1.25K MFS), or fraction thereof, above $200K ($250K MFJ)

Itemized deductions reduced by up to 80%

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Provisions Applicable to Higher-Income Taxpayers
(3 of 3)

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Tax Planning Considerations

Shifting income between family members

Splitting income

Maximizing itemized deductions

Filing joint or separate returns

Innocent spouse provision

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Compliance & Procedural Considerations

Who must file

See Chart on page 35

Due dates for filing return

Individuals and Partnerships

15th day of 4th month after year end

Forms 1040, 1040EZ, and 1040A

Corporations

15th day of 3rd month after year end

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Chapter 2

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Gross Income:
Inclusions

Chapter 3

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GROSS INCOME: INCLUSIONS

Economic and acct concepts of inc.

To whom is income taxable?

When is income taxable?

Items of gross income

Tax planning considerations

Compliance & procedural considerations

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Concepts of Income

Economic concepts of income

Accounting concepts

Tax concept of income

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Economic Concepts of Income

Wealth that flows to individuals

Changes in value in individuals’ wealth

Unrealized gains

Gifts & inheritances considered income

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Accounting Concepts of Income

Values are measured by a transaction approach

Income realized as result of completed transactions

Use historical cost

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Tax Concept of Income

Conditions to make income taxable

Administrative convenience

Wherewithal to pay

Gross income defined

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Conditions to Make
Income Taxable

Economic benefit to taxpayer

Income must be realized

Earnings process complete

Income must be recognized

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Administrative Convenience

Economic concept is considered too subjective

Objectivity achieved at price of equity

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Wherewithal to Pay

A tax should be collected when the taxpayer can most easily pay

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Gross Income Defined
(1 of 2)

Section 61(a) defines gross income

“all income from whatever source derived,” including (but not limited to) the following items:

Compensation, income derived from business, gains from dealings in property, interest, rents, royalties, dividends, alimony, annuities, life insurance, pensions

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Form of receipt

Gross income not limited to cash

§1.61-1a, income may be “realized in any form, whether in money, property, and services”

Indirect economic benefit

Items indirectly benefiting taxpayers excluded from gross income

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Gross Income Defined
(2 of 2)

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To whom Is Income Taxable?

Assignment of income

Allocating income between married people

Income of minor children

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Assignment of Income

Supreme Court in Lucas v. Earl (1930)

Ruled that individual taxed the earnings from his personal services

Helvering v. Horst (1940)

Ruled that assignment of income doctrine applies to property

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Allocating Income between
Married People (1 of 2)

Common law property system

Used in 42 states

Income taxed to person who earns it or who owns the income-producing property

Joint income comes from jointly owned property

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Community property states

All income deemed to be earned equally by spouses except income from separate property

Separate property of each spouse

Property owned prior to marriage

May be community income or separate income, depending on state of residence

Allocating Income between
Married People (2 of 2)

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Income of Minor Children

Taxed to child regardless of state’s property law system

Unearned income of minor under 24 may be taxed at parent’s higher rate

See Chapter 2

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When Is Income Taxable?

Cash method

Accrual method

Hybrid method

See Topic Review 1

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Cash Method
(1 of 3)

Cash receipts and disbursements

Used by most individuals, and most non-corp. bus. with no inventory

Constructive receipt

Report inc. in year actually received

Check received after banking hours

Bond interest coupons that have matured but not redeemed

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Cash Method
(2 of 3)

No constructive receipt if

It is subject to substantial limitations

Payor does not have funds necessary to make payment

Amount is unavailable to taxpayer

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Cash Method
(3 of 3)

Exceptions to basic cash method

Interest on Series E or EE Savings Bonds

Special rules apply to farmers and ranchers

Small taxpayer exception for inventories

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Accrual Method

Report income in year income earned

Right to income

Amount can be determined with reasonable accuracy

Prepaid income

Generally taxable when received

Exceptions in Rev. Proc. 2004-34

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Hybrid Method

Accrual method for purchases and sales

Cash method in computing all other income and expenses

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Items of Gross Income
(1 of 2)

Compensation

Business income

Gains from dealings in property

Interest

Series EE bond interest exception

Rents and royalties

Dividends

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Items of Gross Income
(2 of 2)

Alimony and separate maint. pmts.

Pensions and annuities

Income from life insurance and endowment contracts

Inc. from discharge of indebtedness

Income passed through to taxpayer

Other items of gross income

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Dividends
(1 of 3)

Included in shareholder gross inc.

Results in double taxation

Earnings taxed at corporate level

Earnings taxed at shareholder level when distributed as a dividend

C corps allowed a 70, 80, or 100% div. rec. deduction based on ownership %

Relief from multiple levels of taxation

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Dividends
(2 of 3)

Individuals taxed up to 20% on dividends

Reduces effects of double taxation

Must hold stock for at least 60 days

Distributions to extent they are out of corporate E&P

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Dividends
(3 of 3)

Stock dividends

Not taxable

Basis in stock allocated to new shares

Capital gain dividends

Taxed at long-term capital gain rates

Constructive dividends

Taxed as regular dividends

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Alimony and Separate
Maintenance Payments

Only receipt of alimony is taxable

Alimony is deductible by one who pays

Child support not taxable

Property settlement not taxable

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Pensions and Annuities

Income portion of annuity taxable

Investment portion is excluded

Exclusion ratio

Basis in annuity ÷ Expected Return

Expected return

Payment x # of expected payments

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Income Passed Through
to Taxpayer

Income from flow-through entities taxed directly to owners

Income from partnership

Income from S corporation

Income in respect of a decedent

Income from an estate or trust

Income from ETF, RIC, or REIT

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Other Items of Gross Income (1 of 2)

Prizes, awards, gambling winnings, and treasure finds – taxable

Illegal income – taxable

Unemployment compensation – taxable

Social security benefits – up to 85% taxable

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Other Items of Gross Income (2 of 2)

Insurance proceeds & court awards

Special rules apply

Recovery of previously deducted amounts – taxable

Revenue received that is disputed must still be reported as income

Previously reported income that is subsequently refunded is deductible

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Tax Planning Considerations (1 of 2)

Shifting income

From high-income family members to low-income family members

Alimony

Deductible by payor and includible by payee

Prepaid income

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Tax Planning Considerations (2 of 2)

Taxable, tax-exempt, or tax-deferred bonds

Need to compare present value of after-tax returns

Reporting savings bond interest

Deferred compensation arrangements

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Compliance & Procedural Considerations

Form 1040 – Wages, Salaries & Tips

Schedule B – Interest and Dividends

Schedule C – Business Income

Schedule D – Capital Gains

Schedule E – Rents and Royalties

Schedule F – Farm Income

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Chapter 3

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Gross Income:
Exclusions

Chapter 4

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GROSS INCOME: EXCLUSIONS

Items that are not income

Major statutory exclusions

Tax planning considerations

Compliance and procedural considerations

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Items that Are Not Income

Unrealized income

Self-help income

Rental value of personal-use property

Selling price of property

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Unrealized Income

Example:

Land valued at $20,000 beginning of year appreciates to $45,000 at end of year

The $25,000 increase in value is unrealized income and not taxable

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Self-Help Income

The amount saved is not subject to tax

Cleaning your own carpet

Repairing your car

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Selling Price of Property

Only gain on sale of property is taxable

Selling price

– Basis in property

Gain on sale of property

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Major Statutory Exclusions (1 of 2)

Gifts and inheritances

Life insurance proceeds

Awards for meritorious achievement

Scholarships and fellowships

Distributions from qualified tuition programs

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Major Statutory Exclusions (2 of 2)

Payments for injury and sickness

Employee fringe benefits

Foreign-earned income exclusion

Income from the discharge of a debt

Exclusion for gain from small business stock

Other exclusions

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Life Insurance Proceeds

Paid by reason of death

Generally non-taxable

Policy surrendered not for death

Excess of proceeds over the premiums paid taxable to recipient

Dividends on life insurance and endowment policies non-taxable

Considered return of premiums paid

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Awards for Meritorious Achievement

Awards for religious, charitable, scientific, etc. are not taxable if ALL criteria are met:

Did not enter contest

Is not required to perform substantial future services

Designates a qualified charitable organization to receive the payment

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Scholarships and Fellowships

Scholarships excluded for degree candidates used for qualified tuition and related expenses

Required for courses of instruction at an educational institution

Tuition, fees, books, supplies, equipment

Not room and board

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Distributions from Qualified
Tuition Programs: §529 Plans (1 of 2)

No tax on earnings while in §529 plan

Exclusion for distributed earnings if used by beneficiary for qualified tuition and related expenses

Tuition, fees, books, supplies, equipment, AND

Room and board if ≥ half-time student

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Distributions of income not used for qualified tuition expenses

Income determined by annuity rules

Included in beneficiary’s income, AND subject to a 10% penalty

Beneficiary must be “family” member

No tax consequences if beneficiary changed

Distributions from Qualified
Tuition Programs: §529 Plans (2 of 2)

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Payments for Injury and Sickness

Injury includes physical and mental

Medical expense pmts. for emotional distress excluded if expenses attributable to a physical injury

Disability income policy is non-taxable if purchased by taxpayer

Taxable if purchased by employer

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Employee Fringe Benefits (1 of 2)

In general

Employer-paid insurance

§132 fringe benefits

Employer awards

Meals and lodging

Meals and entertainment

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Employee Fringe Benefits (2 of 2)

Employee death benefits

Dependent care

Adoption expenses

Educational assistance

Cafeteria plans

Flexible spending plans

Interest-free loans

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Employee Fringe Benefits in General

Compensation generally taxable

Law encourages certain types of fringe benefits by treating the benefits as

Nontaxable to the employee, AND

Deductible by the employer

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Employer-Paid Insurance
(1 of 2)

Premiums on health, accident, disability and qualifying group term insurance

Most employee life ins. premiums

Benefits from non-discriminatory self-insured plans

See Topic Review 1

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Employer-Paid Insurance
(2 of 2)

2010 Affordable Care Act

Penalizes individuals w/o med. ins.

Penalizes larger employers not providing adequate employee health benefits

Other taxes apply to high-income individuals and large employers who do not provide employee coverage

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§132 Fringe Benefits

No additional cost benefits

Employee discounts

Working condition benefits

De minimis benefits

Transportation fringes

Athletic facilities

See Topic Review 2

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Employee Awards

Employee achievement awards and qualified plan awards

Must be tangible personal property

Limited to avg. of $400 per employee

Max award $1,600

Includes safety or length of service

Must not discriminate in favor of highly paid employees

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Meals and Lodging

Provided on employer’s premises

For the convenience of employer

Lodging must be a condition of employment to be nontaxable

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Meals and Entertainment

50% of meal or cost of entertaining customers is deductible

Includes cost of employee’s meal or entertainment

Employer gets deduction if employer pays or reimburses employee

Employee does NOT recognize income

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Employee Death Benefits

§101(b) provides exclusion up to $5,000 ($2,500 MFS)

Amounts over $5,000 may be nontaxable gifts depending on facts and circumstances, including employer’s intention

Gift is NOT deductible by employer

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Dependent Care

Employer-financed programs

Employee may exclude up to $5,000 of assistance each year

$2,500 MFS

Cannot discriminate in favor of highly compensated employees

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Adoption Expenses

Exclusion for amounts paid pursuant to an adoption assistance plan created by an employer

Employee may exclude up to $12,970

Phased out between $194,580 -$234,580

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Educational Assistance

Employers pay employee educational costs

Employee may exclude up to $5,250 per year for tuition, fees, books, supplies, and equipment

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Cafeteria Plans

Also called flexible spending accounts

Employee has option of receiving any combination of benefits up to a certain amount, including cash

Only receipt of cash is taxable

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Interest-Free Loans

Interest must generally be imputed on interest-free loans

Imputed interest generally deductible by employer and taxable to employee

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Foreign-Earned Income Exclusion
Eligible Taxpayers

U.S. citizens subject to U.S. income tax on worldwide income

Subject to double taxation if foreign income taxed by foreign country

Foreign tax credit (FTC) mitigates double taxation

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Foreign-Earned Income Exclusion
Exclusion Amount

Foreign-earned income exclusion alternative to FTC

May exclude up to $97,600 of foreign earned income

Add’l exclusion for foreign housing costs

Foreign housing costs in excess of $15,616

Max housing exclusion is $13,664

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Foreign-Earned Income Exclusion
Residency Tests

To qualify for foreign-earned income exclusion

Must be bonafide resident of foreign country(ies) for entire taxable year, OR

Physical presence in foreign country for 330 days during a 12-month period

If 12-month period spans two tax years, exclusion prorated based on [# days/365]

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Income from the
Discharge of a Debt (1 of 2)

Generally, taxpayer may have to include amount of debt forgiveness in gross income

Exceptions: nontaxable situations

Discharge occurs in bankruptcy

Discharge occurs when taxpayer is insolvent

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Income from the
Discharge of a Debt (2 of 2)

Student loans

Discharge excluded from gross income if discharge contingent on performing certain public services for a specified time period in certain professions

Home mortgage forgiveness

Exclude debt up to $2M on acquisition or improvement of principle residence

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Exclusion for Gain from Small Business Stock (1 of 2)

% of gain may be excluded from gross income if held > five years

50% if acquired prior to 2/17/2009

75% if acquired 2/18/2009 – 9/27/2010

100% if acquired after 9/28/2010

Eligible amount limited to greater of $10M or 10x adjusted basis in stock

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Exclusion for Gain from Small Business Stock (2 of 2)

Taxable gain not recognized if proceeds reinvested in other small business stock w/in 60 days

Taxable gain recognized to extent amount realized > amount reinvested

Maximum tax rate on taxable amount is 28%

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Other Exclusions
(1 of 2)

Gain from sale of personal residence

Annuities paid to survivors of public safety officers

Certain military-related payments

Housing allowance for ministers

Campus housing

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Other Exclusions
(2 of 2)

Foster care payments

Rural letter carrier’s allowance

Roth IRA distributions

Education IRA distributions

Personal foreign currency gains

See Table 2

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Tax Planning Considerations

Employee fringe benefits

Cafeteria plans can help provide valuable benefits to employees or cash if they don’t need the benefits offered

Self-help income and use of personally owned property

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Fringe benefits and Form W-2

Nontaxable benefit may be excluded from employees’ W-2

Taxable benefits subject to withholding and reported on employees’ W-2

Compliance & Procedural Considerations

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©2014 Pearson Education, Inc.

END
Chapter 4

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Deductions and Losses

Chapter 6

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DEDUCTIONS AND LOSSES (1 of 2)

Classifying deductions as for vs. from adjusted gross income

Criteria for deducting business and investment expenses

General restrictions on the deductibility of expenses

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DEDUCTIONS AND LOSSES (2 of 2)

Proper substantiation requirement

When an expense is deductible

Special disallowance rules

Tax planning considerations

Compliance and procedural considerations

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Classifying Deductions
for Adjusted Gross Income (1 of 2)

Taxpayer benefits from deduction even if she claims the std. deduction

Reducing AGI: +/- benefits for t/p

+ Many deductions and credits phased out above certain AGI thresholds

+ Reduces AGI floors for certain categories of itemized deductions

– Reduces certain deduction ceilings

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Classifying Deductions
for Adjusted Gross Income (2 of 2)

Most common deductions for AGI

Trade or business expenses

IRAs and qualified pension contributions

Alimony

Losses on sale of bus/invest property

Moving expenses

Int. paid on qualified education loans

½ of self-employment tax

Health insurance paid by self-employeds

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Classifying Deductions
from Adjusted Gross Income

Itemized deduction only will have tax benefit if total deductions exceed the taxpayer’s standard deduction

Deduct the higher of the standard deduction or sum of itemized deductions

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Criteria for Deducting Bus. & Investment Expenses

Business or investment requirement

Ordinary expense

Necessary expense

Reasonable expense

Expenses and losses must be incurred directly by the taxpayer

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Business or Investment Activity
(1 of 2)

Activity engaged in for profit

Use facts and circumstances test

Trade or business (ToB) vs. investment classification

ToB losses are ordinary losses

ToB expenses are for AGI

Investment losses are capital

Invest. exp are from AGI

Subject to 2% of AGI floor

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Business or Investment Activity
(2 of 2)

Losses and expenses related to rents and royalties are for AGI deductions

Legal and accounting fees

For AGI deduction for ToB if incurred in ordinary course of business

Fees related to taxes also for AGI for ToB

Nonbusiness fees related to taxes from AGI deduction subject to 2% of AGI floor

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Ordinary Expense

Ordinary expense requirements

Reasonable in amount

Bear reasonable proximate relationship to income-producing activity or property

Must be customary or usual course of a particular industry or business community

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Necessary Expense

An expense is considered necessary if it is “appropriate and helpful” in the taxpayer’s business

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Reasonable Expense

Problems often occur with salaries for shareholder-employees of closely held businesses

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Expenses and Losses Must Be Incurred Directly by the Taxpayer

Generally, a taxpayer cannot take a deduction for a loss or expense of another person

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General Restrictions on the Deductibility of Expenses

Capitalization vs. expense deduction

Expenses related to exempt income

Not deductible

Expenditures contrary to public policy

Others specifically disallowed

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Capitalization vs. Expense Deduction

General capitalization requirements

Election to deduct currently

E.g., certain research and experimental expenditures, cost of qualified tangible personal property

Capitalization of deduction items

E.g., carrying charges on unproductive unimproved real estate

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Expenditures that Are
Contrary to Public Policy

Cannot deduct illegal payments or pmt. resulting from an illegal act

Fines and penalties

Bribes and Kickbacks

Expenses from illegal trade or business are deductible if taxpayer reports income from activity

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Other Expenditures Specifically Disallowed
(1 of 2)

Political contrib. & lobbying exp.

Bus. investigation & preopening exp.

Includes investment expenses

May immediately expense up to $5k

Deduction phased out $ for $ if > $50k

Amortize remainder over 180 months beginning when business commences

No amortization if business not begun

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Other Expenditures Specifically Disallowed
(2 of 2)

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Proper Substantiation Requirement (1 of 2)

The taxpayer has the burden of proof

The Cohan rule

Certain expenses may be estimated

More restrictive substantiation requirements for travel, entertainment, business gifts

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Proper Substantiation Requirement (2 of 2)

Documentation requirements for travel, entertainment, gifts, etc.

Amount

Time and place of travel/entertainment

Date and description of gift

Business purpose

Business relationship

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When an Expense Is Deductible Cash Method (1 of 2)

Generally deductible when actually paid

Prepaid expenses

No current deduction if expenditure creates an asset with a life substantially beyond end of tax year

Exception for prepaid rent if prepmt ≤ 1 year and lease requires the prepmt

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When an Expense Is Deductible Cash Method (2 of 2)

Prepaid interest

Amortize over period of loan to which interest charge is allocated

Points deductible over life of loan

Points paid in connection w/purchase or improvement of a principal residence are currently deductible

See Topic Review 3

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When an Expense Is Deductible Accrual Method (1 of 2)

Allowed to deduct exp. in period in which exp. accrue under all-events test & economic performance test

All-events test (AET) met

Amount of liability is established

Amount of liability is determined with reasonable accuracy

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Economic performance test (EPT) is met when EP deemed to occur

Exception for recurring liabilities

All-events test met

EPT occurs w/in 8½ mo (or a reasonable period) after close of tax year

Exp. consistently treated as incurred in tax yr.

Item not material, or better matching w/AET

See Table 1

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When an Expense Is Deductible Accrual Method (2 of 2)

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Special Disallowance Rules

Wash sales

Transactions between related parties

Hobby losses

Vacation home

Expenses of an office in the home

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Wash Sales

Wash sales occur when “substan-tially identical” stock or securities acquired by taxpayer w/in 61 days

Extends from 30 days before date of sale to 30 days after date of sale

Loss on wash sale disallowed

Disallowed loss added to basis of recently purchased stock or securities

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Transactions between
Related Parties In General (1 of 2)

§267 defines related parties

Loss on transaction between related parties disallowed

Disallowed loss may be used to offset gain from subsequent sale to unrelated party

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Unpaid expenses

Accrual basis taxpayer cannot deduct expense to cash basis related party until cash basis party recognizes payment as income

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Transactions between
Related Parties In General (2 of 2)

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Alice and Beth equal partners in the AB Partnership

First Corp:

Beth owns 60%

Craig, Alice’s husband, owns 40%

Alice:

Considered to own Craig’s 40% of First Corp

Not considered to own Beth’s 60% because only owns by attribution

Can recognize loss if she sells First Corp because she is deemed to own < 50%

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Transactions between
Related Parties Example 33 (1 of 2)

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©2014 Pearson Education, Inc.

Transactions between
Related Parties Example 33 (2 of 2)

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Same facts as in Example 33, except

First Corp owned

50% by AB Partnership

25% each by Beth and Craig

Alice considered to own 100% in First Corp

25% direct ownership

Craig’s 25% attributed due to marriage

AB’s 50% because she owns 50% of AB

Alice cannot recognize a loss on the sale of property to First Corp because she owns ≥ 50%

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Transactions between
Related Parties Example 34 (1 of 2)

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Transactions between
Related Parties Example 34 (2 of 2)

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Hobby Losses
(1 of 4)

Activity has more personal attributes than profit motive

IRS profit motive factors

Activity conducted in businesslike manner

Expertise of taxpayer or advisors

Time and effort expended

Expected asset appreciation

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Hobby Losses
(2 of 4)

IRS factors (cont’d)

Taxpayer’s success in similar activities

Profits earned and profit history

Taxpayer’s financial status

Personal pleasure or recreation in activity

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Hobby Losses
(3 of 4)

Profit motive assumed if activity profitable in 3 of 5 years

Three tiers of expenses

Deductible even if no hobby exists

Deductible if activity was for profit

But do not reduce basis of any assets

Deductible if activity was for profit

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Hobby Losses
(4 of 4)

Deductible hobby expenses

Hobby-related expenses deductible up to gross income of hobby activity

Deductible as miscellaneous itemized deductions subject to 2% of AGI floor

Special order of the deductions

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Vacation Home
Dwelling Unit Defined

More expansive than §280A

Requirements

Provides shelter

Place for eating and sleeping

Includes cooking facilities and toilet

Boats and motor homes could qualify

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Vacation Home
Rules for Deductibility (1 of 2)

Deductions on vacation home may be limited or disallowed

Vacation home if personal use greater of 14 days, or 10% of # of days property used as rental

Property rented < 15 days

No taxable inc. and no deductions

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Vacation Home
Rules for Deductibility (2 of 2)

Personal days< 15 days

Regular rental rules apply instead of

§280A vacation home rules do not apply

Expenses allocated based on days of use

# of rental days

Total # of days used

Total expenses

for the year

x

Rental use

expenses

=

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Expenses of an
Office in the Home

Office in the home expenses

Deductible only if office regularly and exclusively used for business AND

Principal place of taxpayer’s business OR a place where TP meets with clients

Employees must also use office for convenience of employer

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Tax Planning Considerations

Hobby losses

Control timing of hobby losses

Unreasonable Compensation

If IRS feels that a salary payment to an officer is excessive

Often recharacterize excess portion as a dividend

Timing of deductions

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Schedule C for sole proprietorship

Schedule E for rents and royalties

Other investment expenses reported on Schedule A Proper substantiation

IRS scrutiny

Statutory requirements

Travel and ent are of particular interest to the IRS

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Compliance & Procedural Considerations (1 of 2)

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Business vs. hobby

Form 8829 to claim home office deduction on Schedule C

Form 2106 to claim home office deduction by employees

Taxpayer may be willing to extend statute of limitation’s period to prove profit motive by filing Form 5231

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Compliance & Procedural Considerations (2 of 2)

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©2014 Pearson Education, Inc.

END
Chapter 6

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7-1

Itemized Deductions

Chapter 7

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ITEMIZED DEDUCTIONS
(1 of 2)

Medical expenses

Taxes

Interest

Charitable contributions

Casualty and theft losses

Miscellaneous itemized deductions

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ITEMIZED DEDUCTIONS
(2 of 2)

Tax planning considerations

Compliance and procedural considerations

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Medical Expenses

Qualified individuals

Qualified medical expenses

Amount and timing of deduction

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Qualified Individuals

Medical exp. paid for taxpayer, taxpayer’s spouse, or dependent

Certain dependency test failures do not disqualify dependent

Failing to meet gross income limit

Failing joint return test

Noncustodial parent may claim deduction for dependent

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Qualified Medical Expenses
(1 of 2)

Diagnosis, cure, mitigation, treatment, or prevention of disease

Transportation

$0.24/mile std. mileage rate

If overnight, includes

Meals (50%) & lodging (≤ $50)

Cost of living in institutions

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Qualified Medical Expenses
(2 of 2)

Capital expenditures

Excess of cost over amount by which value of home increases

Medical insurance premiums

Includes qualified L-T care premiums

No cosmetic surgery

Unless treats illness or promotes proper body function

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Amount and Timing
of Deduction

Deductible in year paid for qualified medical exp. exceeding 10% of AGI

7.5% for taxpayers > 65 until 2016

Medical insurance reimbursements

Only unreimbursed portion deductible

Self-employeds may deduct health insurance as a for AGI deduction

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Taxes
(1 of 2)

Definition of a tax

Deductible taxes

State and local income taxes

State and local sales taxes

Nondeductible taxes

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Taxes
(2 of 2)

Personal property taxes

Real estate taxes

Self-employment tax

Nondeductible taxes

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Definition of a Tax

Mandatory assessment levied under authority of a political entity for purpose of raising revenue used for public or governmental purposes

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Deductible Taxes

State, local, & foreign real prop. taxes

Some state and local personal prop. taxes

Foreign, state &, local income, war profits, and excess profit taxes

State & local sales tax election

Environmental tax

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State and Local Income Taxes

Deduct when paid or withheld even if the taxes are attributable to another tax year

Refund of previously deducted taxes are taxable in year of refund

May elect to deduct state & local sales taxes instead of deducting inc. taxes (expires at end of 2013)

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Personal Property Taxes

Tax must be an ad valorem tax on personal property imposed on an annual basis

Any portion of the tax which is a flat fee is not deductible

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Real Estate Taxes

Apportionment of taxes

Necessary when real estate is sold during the year

Real property assessments only against property benefited

Capitalized costs—not deductible

E.g., Sidewalk or new sewer lines

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Self-Employment (SE) Tax

Tax on SE income in lieu of Social Sec. (12.4%) Medicare taxes (2.9%)

Ceiling $113,700 for Social Sec. Tax

No ceiling for Medicare tax

Individuals with inc.> $200K ($250K MFJ) pay additional 0.9% on SE inc. & wages

½ of SE tax deductible for AGI

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Nondeductible Taxes

Taxes imposed by the Federal gov’t generally not deductible

Exceptions

Employer’s share of Social Security tax

Deductible by employer as bus. expense

Federal import tariffs & excise taxes

Deductible if for business or production of income

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Interest

Definition of interest

Classification of interest expense

Timing of the interest deduction

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Definition of Interest

Compensation for use or forbearance of money

Bank service charges and certain loan acquisition costs not considered interest for tax purposes

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Classification of Interest Expense
(1 of 2)

Determined by related activity

Active trade or business

For AGI deduction

Passive activity

Subject to passive activity loss limit

Used to compute net passive inc./loss

Investment interest

Deductible up to net invest. inc.

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Classification of Interest Expense
(2 of 2)

Qualified residence & home equity loans

Interest on up to $1M of acquisition debt

Also deduct points on acquisition indebtedness

May deduct interest on additional $100K of home equity indebtedness

Limited deduction for pmt. of mtg. insurance

Student loan interest

Up to $2,500 deductible for AGI

Phased out at higher income levels

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Timing of the Interest Deduction
(1 of 2)

Prepaid interest

Capitalized and amortized over period to which interest relates

Discounted notes

Cash method taxpayer deducts at time of repayment

Accrual method taxpayer amortizes over life of loan

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Timing of the Interest Deduction
(2 of 2)

Interest paid on debt used to pay another creditor generally deductible

Interest owed to a related party by an accrual method taxpayer

Cannot deduct interest until paid

Imputed interest

Applies to below-market loans

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Charitable Contributions

Qualifying organizations

Type of property contributed

Deduction limitations

Application of carryovers

Special rules for charitable contributions made by corporations

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Qualifying Organizations

U.S., D.C., state, or U.S. possession

A post or organization of war vets

Domestic fraternal society, or order, or association

Public Charities

Churches, educational Institutions, hospitals, medical schools

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Type of Property Contributed
(1 of 2)

Contribution of long-term capital gain property

Generally FMV

Use adjusted basis if

Contributed to private nonoperating foundation

Unrelated use by charitable organization

Certain intangibles

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Type of Property Contributed
(2 of 2)

Contribution of ordinary inc. prop.

Value generally adjusted basis

Exception for C corp donation of certain inventory

FMV – (50% x [ordinary inc. if sold])

Contribution of services

Only out-of-pocket and transportation expenses deductible

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Deduction Limitations
(1 of 2)

50% of AGI limitation

Applies to public charities

30% of AGI limitation

Contributions of capital gain property

20% of AGI limitation

Capital gain property contributed to private nonoperating foundations

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Deduction Limitations
(2 of 2)

Order of deductions

50% property

30% property

20% property

Combined contributions cannot exceed 50% of AGI

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Application of Carryovers

Current year contributions must be used before applying carryovers

Carried over and deducted in subsequent five years

Apply with regard to special limits

Contributions retain their % limitation

Use FIFO to apply carryovers

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Special Rules for Contributions Made by Corporations

Pledges made by accrual method corporations

Deductible in year pledged if paid by 15th day of 3rd month after year end

Limitation applicable to corps

Cannot exceed 10% of corporation’s taxable income

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Casualty and Theft Losses

Individuals can deduct casualty or theft loss on personal-use property as an itemized deduction

See Chapter 8

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Miscellaneous Itemized Deductions

Certain employee expenses

Expenses to produce investment income

Cost of tax advice

See Chapter 9

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Certain Employee Expenses

Unreimbursed employee business expenses

Include travel, transportation, dues to professional organizations, cost of job hunting

Generally misc. itemized deductions subject to a 2% of AGI floor

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Expenses to Produce Investment Income

Expenses to produce investment income other than rents or royalties

Miscellaneous itemized deductions subject to 2% of AGI floor

Investment interest NOT subject to the 2% of AGI floor

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Cost of Tax Advice

Includes

Tax return preparation fees

Appraisal fees in determining amount of casualty loss

Accountant fees for representation in a tax audit

Miscellaneous itemized deduction subject to 2% of AGI floor

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Reduction of Certain Itemized Deductions
(1 of 2)

Overall reduction for high-income taxpayers

$300K MFJ, $250K single, $275K HoH, $150K MFS

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Reduction of Certain Itemized Deductions
(2 of 2)

Reduction is lesser of

80% of itemized deduction other than medical, investment, casualty losses, and wagering losses OR

3% of excess over threshold amount

The 3% is applied after taking into account other limitations on itemized deductions

e.g. 2% of AGI on misc. deductions

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Tax Planning Considerations
(1 of 2)

Medical expense deduction

Bunch medical expenses into a single year to exceed 10% of AGI floor

Interest expense deduction

May deduct residential interest on any two residences

If vacation home used > of 14 days or 10% of rental days personal portion qualifies as a residence

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Tax Planning Considerations
(2 of 2)

Deduction for charitable contributions

Election to reduce amount of contribution

Donation of appreciated long-term capital gain property

Significant substantiation requirement

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Medical expenses

Dependent care credit vs. medical expense deduction

Compare dependent care credit rate with effective marginal tax rate for additional medical deductions

Compliance & Procedural Considerations (1 of 3)

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Charitable contributions

>$500 must file Form 8283

Property > $5,000 should have appraisal

>$250 require additional documentation

Compliance & Procedural Considerations (2 of 3)

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Taxes

Schedule C – related to taxpayer’s trade or business

Schedule E – related to the production of rents and/or royalties

Schedule A – if personal

Compliance & Procedural Considerations (3 of 3)

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Chapter 7

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9-1

Employee Expenses and Deferred Compensation

Chapter 9

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EMPLOYEE EXPENSES
AND DEFERRED COMPENSATION (1 of 2)

Classification and limitations of employee expenses

Travel expenses

Transportation expenses

Entertainment expenses

Reimbursed employee business expenses

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EMPLOYEE EXPENSES
AND DEFERRED COMPENSATION (2 of 2)

Moving expenses

Education expenses

Office in home expenses

Deferred compensation

Tax planning considerations

Compliance and procedural considerations

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Classification & Limitations of Employee Expenses
(1 of 3)

Employee vs. self-employed factors

Behavioral control

Financial control

Relationship of parties

If employee

Employer pays ½ FICA and Medicare

If self-employed

Taxpayer pays all FICA and Medicare

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Limitations on unreimbursed employee expenses

2% of AGI floor applies to

Unreimbursed employee business expenses

Investment expenses other than interest

Tax advice and return preparation fees, and other deductions

Classification & Limitations of Employee Expenses
(2 of 3)

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Limitations (cont’d)

2% misc itemized deduction limit

No tax benefit if total misc. itemized deductions ≤ 2% of AGI

Standard deduction limit

No benefit if total allowable itemized deductions do not exceed standard deduction

Classification & Limitations of Employee Expenses
(3 of 3)

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Travel Expenses

Deductibility of travel expenses

Definition of travel expenses

General qualification requirements

Business vs. pleasure

Foreign travel

Add’l limits on travel expenses

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Deductibility of Travel Expenses

Factors

Nature of expenditure

Deductible for AGI if taxpayers engaged in ToB or production of rents or royalties

Whether or not employee reimbursed

Deduction for AGI if reimbursed

2% misc. deduction if not reimbursed

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Definition of Travel Expenses

Expenditures include transportation, meals, & lodging

Reduced if lavish or extravagant

Requirements

Must be related to a ToB, or employee status

Incurred while away from tax home

Requires overnight stay

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General Qualification
Requirements (1 of 2)

Away-from-tax-home requirement

Tax home is work location

Assignment must be temporary

Assignment not temporary if

Assignment indefinite OR

Expected to last > 12 months

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General Qualification
Requirements (2 of 2)

Overnight requirement

Must be reasonable for taxpayer to be away overnight

Short rest stops on long day-trip not considered overnight

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Business vs. Pleasure

Travel to and from destination

If trip primarily personal, no deduction

If trip primarily business, all travel to and from destination deductible

Other travel-related expenses

Allocated to business and personal activities

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Foreign Travel

Generally disallowed

Allowed only if taxpayer shows activity directly related to business, AND

Reasonable for meeting to be held outside North America

Complex allocation for allowable expenses

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Additional Limitations on Travel Expenses

Travel expenses disallowed if actual travel is for education

E.g., French student traveling through France

Luxury water travel exp. limited

Travel to conventions, seminars not deductible if activity for production of income

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Transportation Expenses

Definition and classification

Treatment of automobile expenses

Reimbursement of automobile expenses

Excess expenses over reimbursement deductible as 2% misc itemized deductions

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Definition and Classification
(1 of 2)

Commuting costs generally nondeductible personal expenses

Commuting costs between multiple jobs for same taxpayer deductible

Transportation costs from employee’s regular work site to temporary one deductible

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Definition and Classification
(2 of 2)

Commuting costs between home and temporary work site deductible if taxpayer has regular place of business

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Treatment of
Automobile Expenses

Standard mileage rate $0.565/mile

Not available if use ≥ 2 vehicles

Does not include parking and tolls

Actual expenses

Includes gas, oil, maintenance and repairs, insurance, and depreciation

Based on ratio [Bus. miles]/[Total miles]

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Entertainment Expenses

50% disallowance for meal and entertainment expenses

Classification of expenses

Business meals

Ent. facilities and club dues

Business gifts

Limits on entertainment tickets

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Classification of Expenses

Criteria for deduction

Directly related expense

Goodwill is NOT a direct benefit

Must be in a clear business setting

Associated with expense

Must establish clear business purpose

Activity must directly precede or follow bona fide business discussion

Proper substantiation required

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Business Meals

Business meals must meet “directly related to” or “associated with” tests

Cannot be lavish or extravagant for circumstances

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Entertainment Facilities and Club Dues

No deduction permitted for costs related to maintenance of entertainment, amusement, or recreation facilities

No deduction for club dues

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Business Gifts

General annual ceiling of $25/donee

Exceptions include

Employee achievement awards < $400

Gift from employer to employee’s survivor

Not subject to 50% reduction for meals and entertainment

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Limitations on
Entertainment Tickets

50% limitation applies to face value of ticket

Further restrictions on skyboxes

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Reimbursed Employee
Business Expenses (1 of 2)

Substantiation

Employee must make adequate accounting of expenses to employer

Employee required to return excess reimbursement

Accountable Plan

Reimbursements and ded. not reported by employee if no excess deductions

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Reimbursed Employee
Business Expenses (2 of 2)

Non-Accountable Plan

Reimbursement taxable

Deductions miscellaneous subject to 2% of AGI floor

Employee subject to 50% M&E limitation

Meals & Lodging per diem allowance

IRS has special tables

Substantiation less burdensome

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Moving Expenses
Distance and Duration Requirements

For AGI ded. if requirements met

New job at least 50 miles farther from taxpayer’s old residence

New employee is employed full-time at new location for 39 weeks out of year following the move

78 weeks for self-employed individuals

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Moving Expenses
Definition of Moving Expenses

Qualified expenses

Cost of moving household good and personal effects from old to new home

Includes storage if < 30 days

Cost of traveling from old to new home

Includes lodging, but not meals

$0.24/mile per car driven

Employer reimbursement not taxable

Excess is For AGI deduction

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Education Expenses
(1 of 3)

Classification of education expenses

See Table 3

Deduction for higher ed. expenses

$4K for AGI deduction

$2K if AGI $65K-$80K ($130K-$160K MFJ)

No deduction if AGI > $80K ($160K MFJ)

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Education Expenses
(2 of 3)

General deduction requirements

Maintain or improve skills required for employment

Meet requirements imposed by law or by employer for retention of employment, rank, or compensation rate

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Education Expenses
(3 of 3)

Nondeductible if

Necessary to meet minimum educational requirements for qualifications in taxpayer’s employment

OR qualifies taxpayer for new trade or business

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Office in Home Expenses
General Requirements (1 of 2)

Office used on exclusive and regular basis and ONE of following

Office used as principal place of business for any ToB

Includes doing administrative work if no other fixed location available

Place for meeting clients in normal course of business

Located in separate structure

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An employee must also prove that the home office is for the convenience of the employer

Not just appropriate or helpful for the employee

Office in Home Expenses
General Requirements (2 of 2)

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Categories of expenses

Expenses directly related to office

Expenses indirectly related to office

Expenses related to whole home

Prorate based on square footage or other method

Total expenses cannot create loss

Office in Home Expenses
Deduction and Limitations (1 of 3)

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Order of expense deductions

Expenses not related to home office

Expenses directly related to home office

Pro-rata portion of indirect expenses

E.g., mortgage, interest, utilities

Disallowed expenses carried forward to future year

Office in Home Expenses
Deduction and Limitations (2 of 3)

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Optional safe harbor to determine amount of deductible home office expenses per Rev. Proc. 2013-13

$5 multiplied by
[sq. ft. of space for qualified use]

Limited to 300 sq. ft.

$1,500 maximum deduction

Office in Home Expenses
Deduction and Limitations (3 of 3)

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Deferred Compensation
(1 of 3)

Qualified pension and profit-sharing plans

Qualification requirements for a qualified plan

Tax treatment to employees and employers

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Deferred Compensation
(2 of 3)

Nonqualified plans

Employee stock options

Plans for self-employed individuals

Traditional Individual Retirement Account (IRA)

Roth IRA

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Deferred Compensation
(3 of 3)

Coverdell education savings account

Health savings accounts

Simplified employee pensions

Simple retirement plans

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Qualified Pension and
Profit-Sharing Plans (1 of 2)

Pension plans

Defined benefit

Defined contribution

Profit-sharing plans

Include 401(k) plans

Roth-type plans

Roth 401(k) similar to Roth IRA

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Qualified Pension and
Profit-Sharing Plans (2 of 2)

Stock bonus plans

DC plan where investments invested in company stock

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Qualification Requirements
for a Qualified Plan

Must be for employees’ exclusive benefit

Does not discriminate in favor of highly compensated employees

>5% owners or comp >$115K

Contributions proportionate to comp

Coverage requirements

Vesting requirement

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Tax Treatment to Employees and Employers (1 of 2)

Employer contributions immediately deductible

Employee contributions may come from pre-tax or after-tax earnings

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Tax Treatment to Employees and Employers (2 of 2)

Benefits generally taxed to employees if contributions from pre-tax earnings

Use exclusion ratio if contributions from after-tax earnings

Distributions from a Roth-type plan are not taxable

No deduction for the contributions

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Nonqualified Plans

Often used to provide incentives or supplementary retirement to execs

No nondiscrimination or vesting rules

Employer does not receive deduction until benefits available to employee

Unfunded compensation plans

Restricted property plans

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Employee Stock Options
Incentive Stock Options (ISOs)

No tax to employee on exercise date

LTCG treatment when employee sells stock

(amount realized – exercise price)

Employer receives no deduction

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Employee Stock Options
Nonqualified Stock Options (NQSOs)
(1 of 2)

Employee recognizes ordinary inc.

FMV – Exercise price

Traded on established exchange

Compensation on grant date

Options w/o readily ascertainable FMV

Compensation on exercise date

Employer receives deduction when employee recognizes income

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Employee Stock Options
Nonqualified Stock Options (NQSOs) (2 of 2)

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Plans for Self-Employed
Individuals

H.R. 10 plans

Also called Keogh plans

Generally same contribution and benefit limits as other qualified plans

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Traditional IRA
(1 of 2)

Fully deductible contributions

Lesser of $5.5K or earned income

$6.5K if at least age 50

Available only for following taxpayers

Non-active participants in a qualified employer retirement plan

Active participants w/ AGI ≤ $59K
( ≤ $95K MFJ)

Spouse active participant w/ AGI ≤ $178K

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Traditional IRA
(2 of 2)

Active participant AGI phase-out limit

Single $59K – $69K; MFJ $95K – $105K;
MFJ with active spouse $178K – $188K

Deduction for non-working spouse

$5.5K ($6.6K if ≥ age 50)

All distributions taxable

Exception if some nondeductible contributions are made

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Roth IRA
(1 of 2)

Nondeductible

Max contribution $5.5K

If qualify for both Traditional and Roth maximum contribution for both is $5.5K

Max contribution $6.5K if ≥ age 50

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Roth IRA
(2 of 2)

Contribution phase-out AGI limitations

$112K – $127K for Single

$178K – $ 188K for MFJ

Qualified distributions nontaxable

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Coverdell Education Savings Account
(1 of 2)

Nondeductible contribution

Maximum contribution $2K/year until beneficiary reaches age of 18

Elementary, secondary, & higher education expenses

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Coverdell Education Savings Account
(2 of 2)

Distributions excluded from gross income if ≤ qualified education expenses

May be used in same year as Hope & Lifetime learning credits

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Health Savings Accounts

Purpose to enable eligible individuals to accumulate funds on tax-free basis to pay qualified medical expenses currently or in the future

No employer-provided insurance

Must use high-deductible policy

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Simplified Employee Pensions (SEP)

Employer benefits from reduced administrative complexity

Employer contributions deductible in year of contribution

Tax on distributions subject to RIA rules

Available to self-employed persons

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Simple Retirement Plans

Savings incentive match plan for employees

For employers with < 100 employees who received at least $5K in comp

Employer matches employee contributions

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Tax Planning Considerations
(1 of 2)

Moving expenses requirements

Employee must secure full-time work before incurring moving expenses, OR

Self-employeds must carry on ToB prior to incurring moving expenses

Excess reimbursements are taxable compensation

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Tax Planning Considerations
(2 of 2)

Rollover from Traditional to Roth IRA

Considerations include marginal tax rate, age of taxpayer and payment of taxes from rollover from post-tax funds

Rollover included in gross income

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Travel and entertainment expenses may be disallowed if taxpayer does not maintain adequate records

Employee business expenses reported on Form 2106

Moving expenses reported on Form 3903

Compliance & Procedural Considerations (1 of 2)

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Home office expenses reported on Form 8829

Reports for qualified retirement plans required to be filed with IRS and, sometimes, with Dept. of Labor

Compliance & Procedural Considerations (2 of 2)

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Chapter 9

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Accounting Periods and Methods

Chapter 11

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ACCOUNTING PERIODS
AND METHODS (1 of 2)

Accounting periods

Overall accounting methods

Inventories

Special accounting methods

Imputed interest

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ACCOUNTING PERIODS
AND METHODS (2 of 2)

Change in accounting methods

Tax planning considerations

Compliance & procedural considerations

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Accounting Periods

Fiscal year is any 12-month period other than calendar year

Partnerships, S corps, and PSCs

Generally must have same tax year as majority owners (> 50% ownership)

Required payments and fiscal years

Changes in the accounting period

Returns for periods of < 12 months

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Required Payments and
Fiscal Years

C corporations, other than PSCs, can choose any fiscal year

Partnerships, S corps, and PSCs can choose a fiscal year if deferral is 3 months or less (§444 election)

Required payments must be made by April 15 to offset advantage of deferral from §444 election

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Changes in the Accounting Period
(1 of 2)

Generally need IRS approval to change accounting period

Must establish substantial business purpose to change accounting period

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Changes in the Accounting Period
(2 of 2)

IRS approval not necessary

Conformity of newly married spouses

Change to 52/53 week year ending in same calendar month as prior tax year

Certain corporations that have not changed accounting periods within 10 years

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Returns for Periods of
Less than 12 Months (1 of 2)

Taxpayer’s first or final return

No annualization of income required

Change from one accounting period to another

Annualization required

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Returns for Periods of
Less than 12 Months (2 of 2)

Annualization procedure

Compute modified TI (MDTI)

Must use itemized deductions

No personal and dependency exemptions

MDTI x [12 ÷ (short period # of mo)]

Compute tax on Step 2

Step 3 x [(short period # of mo) ÷ 12]

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Overall Accounting Methods

Overall accounting method for one trade or business not needed to be used in a second trade or business

Cash receipts and disbursements method

Accrual method

Hybrid method

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Cash Receipts and Disbursements Method
(1 of 2)

Report income for the tax year in which payments are received

Generally deduct exp. in year paid

Prepaid exp. capitalized and amortized if benefits extend beyond tax year

Must capitalize fixed assets and recover through depr. or amort.

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Cash Receipts and Disbursements Method
(2 of 2)

Most individuals and many service businesses use the cash method

Cannot use cash method in a business where inventory is material income-producing factor

Small business exception – see hybrid method

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Accrual Method
(1 of 2)

Report income under all-events test and economic performance test

All events test

Taxpayer’s right to receive inc. & amount determined w/reasonable accuracy

Economic performance test

Property or services actually rendered by other party

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Accrual Method
(2 of 2)

Deduction is met when liability established and amount of expense can be determined with reasonable accuracy

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Hybrid Method

Use accrual method for sales and purchases, but may use cash method for other income and expenses

Small business exception

Businesses with inventory whose annual gross receipts for 3 prior years ≤ $1M may use cash method for sales and accrual method for cost of goods sold

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Inventories
(1 of 2)

Uniform capitalization rules (UNICAP)

Required for taxpayers whose average gross receipts for 3 prior years >$10M

Must capitalize some period costs

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Inventories
(2 of 2)

If using LIFO for tax

Must also use LIFO for financial acctg.

May use lower of cost or market with any inventory method

Cycle inventory valuation

Congress specifically permits method

Inventory counted following a schedule

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Special Accounting Methods

Long-term contracts

Installment sales method

Deferred payment sales

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Long-Term Contracts
In General

For items that are not completed in same tax year in which they begin

For manufacture of unique item not normally carried in finished goods inventory

Services not eligible for long-term contract methods

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Long-Term Contracts
Completed Contract Method

Income and expenses reported in year contract completed

Only available for

Construction contracts < 2 years OR

Home construction contracts

Qualifying taxpayers

Small companies w/avg gross receipts for prior 3 years ≤ $10M in contracts

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Long-Term Contracts
Percentage of Completion Method (1 of 2)

Income and expenses reported in each year of contract based on estimated percentage of completed work

Modified percentage of completion

Income deferred until 10% of estimated cost accumulated

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Long-Term Contracts
Percentage of Completion Method (2 of 2)

Look-back interest

May apply if actual expenses paid are much different than calculated

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Installment Sales Method
(1 of 3)

Any disposition of property where at least one payment received after close of tax year of disposition

Elective provision

Not applicable for sale of

Inventory

Marketable securities

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Installment Sales Method
(2 of 3)

Computation under §453

Compute gross profit from sale

Determine contract price

Compute gross profit percentage

[Gross Profit] / [Contract Price]

Compute gain to be reported

[Proceeds] X [Gross Profit %]

Depr. recap. recognized in year of sale

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Installment Sales Method
(3 of 3)

Disposition of installment obligations

Selling price

– Adjusted basis of installment note

Gain recognized

Face amount

x [100% – gross profit percentage]

Adjusted basis in installment note

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Deferred Payment Sales

Installment method cannot be used when property sold at a loss

Obligations with indeterminate market value

E.g., mineral interest sold for 10% of value of future production

Value no lower than value of property sold less value of other prop. received

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Imputed Interest

Imputed interest computation

Generally must be at least 100% of applicable federal rate

Accrual of interest

Generally reported as it accrues

Several major exceptions

Special rules for gift, shareholder, and other tax avoidance loans

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Change in Accounting Methods
(1 of 3)

Accounting period chosen by using for first year in which it is applicable

IRS approval required to change methods

May change to LIFO method without IRS approval

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Change in Accounting Methods
(2 of 3)

Amount of change

Due to timing of income and deduction recognition due to changes between cash and accrual methods

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Change in Accounting Methods
(3 of 3)

Reporting the amount of the change

The amount

Change voluntary or involuntary

Any specific statutory mandates

Must obtain IRS consent

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Tax Planning Considerations

Accounting periods

Consider year-end and marginal tax rate in initial year

Accounting methods

Installment sales

Consider marginal tax rate & amount of gain to decide whether or not to elect out of installment method

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Installment Sales reported on Form 6252

Procedures for changing to LIFO

Advanced IRS permission required except for first year inventory carried

Form 970 in 1st year using LIFO

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Compliance & Procedural Considerations

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Chapter 11

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