Income Tax - Exam 3

What is the Net Investment Income Tax (NIIT)?

High INC payers pay an additional 3.8% on the lessor of:

1. Net INV INC (Div, INT, annuities, royalties, rent, net gains

2. Excess of Modified AGI (MAGI)

   • $250K MFJ, QSS

   • $125K MFS

   • $200K HoH, Single

     • If MAGI is less than these AMT payer isn’t subject to NIIT.

   • MAGI= AGI + excluded foreign INC

Employee vs. Self-Employed:

2 differences:

1. AMT of FICA taxes payable

2. SE can deduct BUSA EXP. under “For” AGI.

Federal Insurance Contribution Act (FICA):

• SS tax is 12.4%, capped at $168.6K

• Medicare tax is 2.9%, w/ no limit

• Additional Medicare tax is 0.9%. Only applies if tax base is > $200K (Single, HoH, QSS), $125K MFS, or $250K MFJ.

Employee FICA Taxes:

• Employee & Employer must pay tax on salary/wages.

• SS tax @ 6.2%

• Medicare tax @ 1.45%

• Additional Medicare tax, solely payable by employee.

Self-Employment Tax:

1. Compute NI from SCH C

2. Multiply NI by 92.35%. This is “Net Earnings from Self-Employment… (NESE)”

3. Compute SS tax: take NESE or $168.6K times 12.4%

4. Compute Medicare tax: multiply NESE by 2.9%

5. Additional Medicare (if applicable): multiply by the greater of (1) Zero or (2) NESE less than $200K (Single, QSS, HoH), $125K MFS, or $250K MFJ by 0.9%.

• Why 92.35%? SE people pay employeer & employee portion of FICA taxes. 6.2%+1.45%=7.65% deduction.

• If NESE is < $400, no SE tax but owe INC tax.

Child Tax Credit:

• $2K/child under age 17, $500/ any other dependent.

• Phased out by $50 per every $1000 by which AGI exceeds $400K MFJ or $200K (MFS, HoH, Single).

Child & Dependent Care Credit:

• Non-refundable credit

• Helps payers provide childcare for dependents.

• Can be care outside home (daycare) or inside home (null/void if caregiver is QR or child to payer).

• Married must file MFJ to receive CR.

• Child must be under 13 or disabled.

  • Credit Calculation:

    Eligible Care Cost

    X Applicable %

    • Eligible Care Cost= lessor of (1) actual care cost. (2) $3K/1 child or $6K for 2+. (3) AMT of earned INC (If MFJ the lessor earning spouse).

    • Applicable %: provided on exam.

American Opportunity Credit (AOC):

• Only for the first 4 years enrolled in secondary EDU.

• Must be at least ½ time student

• MFS aren’t eligible.

• Eligible EXP: tuition, required fees, books, NOT HOUSING.

• EXP covered by grants/scholarships aren’t included.

• Allowed for payer, spouse, dependents.

  • If dependent PD, we treat it as if payer actually PD.

• Phase Out: AGI between $80-90K ($160-180K MFJ)

• 40% of CR is refundable.

CALCULATION:

100% for the first $2K, 25% of next $2K. MAX of $2500/student.

Lifetime Learning Credit:

• EDU cost beyond 4 yrs. (including continued EDU, professional or graduate school).

• MFS aren’t eligible.

• Eligible EXP: tuition & required fees. NOT BOOKS or Housing.

• EXP covered by grants/scholarships aren’t included.

• Allowed for payer, spouse, or dependents.

  • AMTs PD by dependent are viewed as if PD by payer.

• Phase Out: AGI between $80-90K ($160-180K MFJ).

• Non-refundable CR.

CALCULATION:

20% of a maximum of $10K. Limit of $2K.

Earned Income Credit (EIC):

• To encourage the economically disadvantaged to become contributing members of society.

• Refundable CR.

• Available to those who “earned” INC from being employed or SE.

• Cannot be a dependent of another.

• If INV INC > $11,600, not eligible.

• MFS aren’t eligible.

• Payers w/o children must be between ages 25-64

CALCULATION:

Earned INC. X Applicable %

Common Business Deductions:

Must be directly connected to BUSA. Must be ordinary, necessary & reasonable.

EX. advertising, depreciation, isurance, legal, rent, repairs, etc.

Expenses against Public Policy:

No ded. for fines or penalties. Allowing ded. would encourage wrong-doing.

Political Contributions & Lobbying:

Non-ded for political contributions and most lobbying. Allowing ded. would seem as if FED. govt. encourages BUSA to influence politics.

Expenses related to Tax Exempt Income:

EXP that don’t generate taxable INC aren’t allowed to offset taxable INC.

EX. INT exp, life INS premiums PD.

Capital Expense:

BUSA may capitalize EXP for tangibles and recover their cost through depreciation (minus land). For intangibles, BUSA reciver their cost through amortization or upon the disposition of the asset.

Personal Expenses:

Living EXP (food, clothing, shelter) aren’t ded. However, payers can deduct the cost of uniforms ONLY if the uniform is linked directly to the BUSA.

Entertainment & Meal Expenses:

EXP motivated by both BUSA & personal use.

1. Entertainment: (movies, country clubs, sports, concerts) aren’t ded.

   • Exception (1) primary beneficiary was payers employees or (2) EXP will be included in employee COMP.

2. Meals: may deduct 50% of cost of BUSA meals. Meals for employee appreciation, holiday, after tax season parties are 100% dedc as long as it wasn’t limited to higher-up’s.

Transportation & Travel Expenses:

• Deduct these costs on SCH C only if the EXP was for BUSA. The cost of getting payer to destination & back home.

• Must maintain sufficient records.

• If payer uses vehicle for BUSA, ded. cost 1 of 2 ways.

  1. Actual Cost: cost of operating vehicle + depreciation

  2. Standard Mileage RTE: uses a $0.67/BUSA mile ded.

• Ded. is for if payer is away from primary BUSA & of significant time to require rest.

• “Travel Mode” allows ded. for lodging & other incidentals.

• Doesn’t include driving to and from home and work

Domestic & Foreign Travel Expenses:

1. If travel is solely for BUSA, all costs are ded.

2. If travel is BUSA & personal, ded. depends on if the travel is domestic or foreign.

   A. Domestic: (1) Primary purpose is BUSA: transportation to arrive is fully ded. but meals, lodging, & incidentals are limited to BUSA portion of trip. (2) Primary purpose is personal: transportation to arive isn’t ded but, meals, lodging, and incidentals are limited to BUSA portion of trip.

   B. Foreign: (1) Primary purpose is BUSA: transportation to arive is pro-rated (BUSA Days/ Total Days) (Travel days are BUSA days). Meals, lodging, incidentals limited to BUSA portion of trip. (2) Primary purpose is personal: transportation to arrive isn’t ded. but meals, lodging, incidentals limited to BUSA portion of trip.

Business Casualty Losses:

• When assets are stolen/destroyed/damage by a force of nature. A.k.A “casualties”.

• Calculating the loss:

  1. Stolen/Destroyed:

     Adj. Basis - INS proceeds

  2. Partially Destroyed: pick the lessor of…

     A. Decline in Value:

     FMV Before - FMV After or receipt cost.

     B. Adj. Basis:

     Cost - Depreciation

  • Then subtract INS proceeds.

Accounting Periods:

1. Annual: usually full tax yr is 12-months. If first/last yr in BUSA, tax yr may be < 12 months.

2. Year-End: Calendar yr-end 12/31. Fiscal yr-end, last day of month other than December.

Accounting Methods:

• Adopted w/ first tax return

1. Cash: recognize INC/EXP when received/PD

2. Accrual: recognize INC/EXP when incurred.

   • Large corps. must use accrual.

Cash Method:

• Certain circumstances disallow ded. exp. @ time of PMT (such as INT).

• Rent & INS follow a “12-month” rule.

  • when a BUSA pre-pays its EXP, it may immediately ded. EXP IF:

  1. Contract period < 1 yr. &

  2. Contract period doesn’t expand beyond end of taxable yr in which PMT was made (PD in yr 0, can’t extend beyond yr 1).

• IF both criteria is met, prepaid AMT is capitalized & amortized over length of contract.

Accrual (unearned, deferred, prepaid, advanced” Method:

• Unearned INC: BUSA receiving PMT for goods/services.

• May elect to defer INC until following yr, unless…

  1. INC is earned

  2. INC was recognized for financial ACCT.

  3. Advancement was for unearned INT/rental INC (must be rental & INT INC upon receipt).

Cost Recovery Terminology:

1. Personal (Personalty) Property: tangible assets (auto, equip, machin.). Uses depreciation.

2. Real (Realty) Property: buildings and land (land is non-depreciable). Uses depreciation.

Tax Depreciation:

BUSA use Modified Accelerated Cost Recovery System (MACRS). To compute MACRS, we need the following:

1. Asset initial basis

2. Date placed in service

3. Applicable depreciation method

4. Assets recovery period

5. Applicable depreciation convention

• No Depreciation is took if the asset was placed in service & sold the same yr.

MACRS Personalty Property: Half-Year

Asset is treated as if it were placed in service/disposed of mid-tax yr regardless of when it was actually placed in service/disposed of.

MACRS Personalty Property: Mid-Quarter

When >40% of personalty is placed inservice during 4th quarter of yr. Asset is treated as if placed in service/disposed of mid-quarter regardless of when it was actually placed in service/disposed of.

MACRS Realty: Mid-Month Convention

Property placed in service any time during a month is treated as if it were placed in service in the middle of the month.

Immediate Expensing, Section 179:

• Created to incentivize small businesses purchasing personalty.

• BUSA must ELECT into section 179.

• Only EXP up to $1.22M of personalty property placed into service in 2024.

• Cannot EXP a building.

• If a BUSA elects to deduct just a certain AMT of 179 on a particular asset, they must reduce the basis of that asset before computing MACRS.

• When choosing between multiple assets, choose the asset with the longer life first.

LIMITATIONS:

1. Property: Subject to phase-out. BUSA reduce the $1.22M dollar-for-dollar for the AMT of tangibles over $3.050M.

2. Taxable INC: Can reduce profit but never a loss. Anything over allowed ded. is carry-forward indefinitely.

Bonus Depreciation:

• BUSA have ability to ded. 60% of the cost of qualifying assets.

• Payer must ELECT OUT annually and on a property-class basis.

• Qualifying Property: New/Used property (can’t have been used by payer w/in past 5 yr’s).

  • Have an IRS depreciation of <=20 yr’s.

  • Can include computer software.

Depreciation on Luxury Auto & Large SUV’s:

• Passenger vehicles weighign <= 6000 LBS. Doesn’t include SUV’s delivery trucks/vans, taxi cabs, limousines, or hearses.

• Application Process

  1. Compute regular MACRS

  2. Compare regular MACRS to MAX. set by IRS.

  3. Take lessor of the two.

  • Can only deduct depreciation on asset to extent of BUSA use, calculated after step 3.

• Section 179 on Large SUV’s (>6000LBS): capped @ $30,500/

• Bonus Depreciation on Large SUV’s: deduct 60%.

Start-up Costs:

• Cost incurred to start a BUSA.

• Not EXP because, incurred before BUSA activity begins.

  • EX: investing, marketing, architectural, legal, ACCT.

• Calculating Deduction: immediately EXP up to $5K of start-up costs.

• However, if start-up costs exceed $50K the $5K ded. is reduced by the AMT over $50K.

• Any cost not immediately EXP is amortized using S/L for 180 months (15 yrs).