TAX 1 - Exam 2

ch. 6, 14, 7, and 8

What are deductions for AGI?

above the line

What are the three general categories of deductions for AGI?

1. directly related to business activities

2. indirectly related to business activities

3. subsidizing specific activities

What are business activities?

motivated by profit and require a relatively high level of involvement or effort from the taxpayer

What are investment activities?

motivated by profit but do not require a high degree of taxpayer involvement or effort

What is the exception to for AGI deductions?

unreimbursed employee business expenses are not deductable

What investment activities are included in for AGI?

rental and royalty expenses

When are trade and business expenses deductible?

when they are ordinary and necessary for the activity

When are rental and royalty expenses deductible?

when the expenses are associated with the generation of income

What are some example of deductions directly related to business activities?

losses on the disposition of business assets and expenses from flow-through entities

What is an excess business loss?

the aggregate deduction for the year attributable to the taxpayer’s business less the gross income from the business less a threshold amount

What happens to excess business losses?

they are not deductible in the current year but can be carried forward

What are some examples of deductions indirectly related to business activities?

• moving expenses for those in the armed forces

• health insurance deduction for self-employed taxpayers (premiums paid are deductible)

• self-employment tax deduction (1/2 of self-employment taxes paid are deductible)

• Health savings accounts

• Penalty for early withdrawal of savings (interest income forfeited is deductible)

What are some examples of deductions subsidizing specific activities?

• alimony payments (dec. 31, 2018)

• certain retirement contributions

• interest expense on qualified education loans (used to paid qualified education expenses)

What are itemized deductions?

generally personal in nature but can subsidize desirable activities or provide relief to taxpayers whose ability to pay has been reduced

What is the purpose for dedications of medical expenses?

to provide relief to taxpayers whose ability to pay taxes has been reduced due to health-related circumstances

What health payments qualify for itemized deducations?

those that are paid out of pocket but is limited to 7.5% of the taxpayer’s AGI (must be for the taxpayer, spouse, or dependents)

What about long-term care facilities?

cost of meals and lodging is deductible but only if the primary purpose is medical care

What choice do taxpayers have inrelation to deductable taxes?

they can deduct state and local income or sales taxes

What are some other state and local taxes that is deductible?

real estate taxes on property not for a business and personal property taxes that is assessed based on the value of the property

What is acquisition indebtedness?

debt used in acquiring, constructing, or substantially improving the residence

What two kinds of interest are deductable?

1. mortgage interest

2. investment interest (loans to purchase stocks, bonds, or land)

What can you do with excess investment interest that isn’t currently deductible?

it can be carried forward indefinitely

What are the requirements for charitable contributions to be itemized deductions?

1. given to a qualified domestic charity

2. contribution is substantiated by written records

When are cash contributions deductible?

in the year paid

What do we first have to determine about property contributions?

whether it is a capital gain property or ordinary income property

When the property is a capital gain property, what can you deduct?

the FMV of the property contributed

What happens if the property is a capital gain but is not related to the charity’s operations?

the deduction is limited to the taxpayer’s basis in the property

What is something that generates ordinary income that isn’t normal?

assets with a values less than the basis

What do you use when thinking of ordinary income property?

the lesser of the property’s FMV or the basis

What is a public charity?

a charity that is publicly supported such as chruches and schools

What is a private operating foundation?

a privately sponsored foundation that actually funds and conducts charitable acitivities

What is a private nonoperating foundation?

a privately sponsored foundation that disburses funds to other charities

How long can excess charitable contributions be carried forward?

5 years

What kind of personal-use assets are not deductible?

when you are disposing it and generally casualty losses

What is a casualty loss?

a loss arising from a sudden, unexpected, or unusual event or a loss from theft

What are the exceptions for casualty losses?

the personal-use asset must be in a federally declared disaster area but is subject to limitations

What are some itemized deductions no subject to an AGI floor?

• gambling losses: as long as there are winnings

• casualty and theft on investment property

• unrecovered costs of a life annuity

What standard deduction does not go into whether you have to file?

the one relating to age or blindness

Why did congress create the standard deduction?

1. to help taxpayers with lower income

2. to simplify tax compliance

Why does the standard deduction simplify tax compliance?

because tax payers don’t have to compute itemized deductions and the IRS doesn’t have to audit as many itemized deductions  

What is bunching itemized deductions?

planning strategy in which a taxpayer pays two year’s worth of itemized expenses in one year to exceed the standard deduction in that year

What extra for AGI deduction do self-employed taxpayers get?

office in the home expenses if a portion of the residence is used exclusively on a regular basis as the principle place of business or to meet with customers.

What qualifies as a principal place of business?

• the office is used by the taxpayer to conduct administrative or management activities of a trade or business

• there is no other fixed location of the trade or business

What are the two methods for home office deductions?

the actual expense and simplified method

What are the steps in the actual expense method?

1. classify expenses into direct and indirect expenses

2. classify into tiers

3. calculate deduction

What is the difference between how direct and indirect expenses are treated?

direct are fully deductible while indirect are allocated between business and personal

What happens to any deduction that is disallowed for home offices?

it is carried forward

What 3 things go into the after-tax returns from an investment?

1. before-tax rate of return

2. the timing of tax payments or benefit

3. the tax rate applied to investment income

What are the two types of investment choices if you want a steady stream of cash?

• debt instruments generating interest income

• direct equity investments generating dividend payments

When do taxpayers typically recognize interest income?

when interest is received except when the bond is purchased at a discount or premium

What is the main difference between treasury and corporate bonds?

treasury bonds are exempt from state taxes and treasury bonds will always pay interest

What is included in interest income when the bond is issued at a discount?

the interest payment and the current year amortization

What is included in interest income when the bond is issued at a premium?

the interest actually received and the current year amortization (if they choose to)

What is included in income when a bond is purchased in the secondary market at a discount?

interest as it is received. then when the bond matures the new value is interest income. and if they sell again the extra money they et is interest income

What is included in interest income when a bond is purchased in the secondary market at a premium?

interest payments received and amortization (if they elect to)

What is the interest income for U.S. Savings Bonds?

they don’t pay interest so when they redeem the bond they recognize the basis excess as interest income

When are dividends taxed?

annually when they are received

What are qualified dividends?

stock is held for more than 60 days in 121 days and they receive preferential tax rates

What are capital assets typically?

investment-type and personal-use assets

What are the tax advantages of investing in capital assets?

gains are deferred until the asset is sold and have preferential rates

What are short-term capital gains taxed at?

ordinary rates

What are the 3 types of gains/losses that have to be netted?

1. short-term

2. 28% including capital losses from last year

3. 0/15/20%

What are 25% category?

only gains

How are losses applied assuming that only one category has losses?

losses are applied to the highest taxed gains first (short-term being last)

How do you apply losses from multiple categories?

use short-term capital losses first then any long term until you reach 3000 because any losses carry forward forever

What are any long-term capital losses carry forward applied to first?

28% gains

What marginal tax bracket must be full before moving to the 25% and 28% rates?

the 24% bracket

What is the limited for net capital loss deductions?

3000

What are some additional limitations on what kind of capital losses you can deduct?

losses on personal use assets or sales of capital assets between related parties are not deductible

What is a wash sale?

when an investor sells stock or securities at a loss and within 30 days either before or after the day of sale buys substantially identical stocks or securities making the loss not deductible

What is the loss added to in a wash sale?

the basis of the newly acquired stock

What is the risk associated with capital assets?

asset values will have declined by the time they want to sell the assets

What is investment interest expense?

interest paid on laosn used to purchase investment assets

Is investment interest deductible?

yes but is limited to the taxpayers net investment income

Are regular investment expenses deductible?

no

What happens if interest expense is more than net investment income?

the excess loss can be carried forward forever

What is the exception to investment interest expense deductions?

related to tax-exempt income not deductible

What are the 3 categories of income and losses?

1. active

2. portfolio

3. passive

What are the 3 rules relating to whether you can take a passive loss currently?

1. tax-basis limitation

2. at-risk limitation

3. passive limitation

What happens to excess losses from passive activity?

it carries forward to offset future passive income or until the thing generating passive income is sold

What is the exception to the passive activity losses rules?

losses from rental activity

What are the two requirements for rental activity losses to apply?

1. owner actively participates in real estate rental activity

2. owns 10% or more of all interest in the activity during the entire year

What is the marriage penalty?

when a married couple has a greater tax liability using MFJ than they would as single (hurts a two-wager earner couple)

What is the marriage benefit?

when a married couple has a lower tax rate liability using MFJ than they would as single (helps one-wage earners)

What does the Kiddie tax do?

it prevents parents from shifting unearned income to a young child by transferring the asset to the child

When will the kiddie tax rules apply?

1. under 18 at year end

2. is 18 at year end but earned income is less than half her support

3. between 18 and 24, a full time student, and earned income is less than half her support

What does the kiddie tax do?

taxes the unearned income at the parents marginal tax rate

What is the tax base for the kiddie tax?

the lesser of the gross unearned income - 2,700 or the child’s taxable income

Why do we have the AMT?

to ensure that taxpayers generating income pay a minimum amount of tax each year

What kind of income is AMT reflecting?

economic income

When will AMT result in additional tax liability?

when the AMT is higher than his regular tax liability

What is the AMT tax base?

more inclusive

What is the minimum tax credit?

taxpayers who pay the AMT are entitle to a tax credit to use in the future when their regular tax exceeds the AMT but can’t lower it below that

What are the 2 main differenced between those who are self-employed and those who are employees?

the amount of FICA taxes they must pay and the deductibility of business expenses

What are the 3 general categories of tax credits?

1. nonrefundable personal credits

2. refundable personal credits

3. business credits

What are the child and dependent tax credits for?

provide relief to taxpayers who provide a home for qualifying children and dependents

What is the age requirement to get a child tax credit?

they must be under age 17

What are eligible expenditures user the child and dependent care credit?

expenses to provide care for one or more qualifying persons

Who is a qualifying person for the child and dependent care credit?

1. under age 13

2. a dependent or spouse who is physically or mentally incapable of taking care of themselves and lives with the tax payer for more than half the year

How to find the amount of the child and dependent care credit?

less of:

1. total care expenses

2. 3000 for one person or 6000 for 2 or more

3. taxpayers earned income (if MFJ the lower earners wages)