Income Tax - Exam 2

Realization Principle:

INC. is realized when a payer engages in transaction w/ another party & there is a measurable change in property rights.

Form of Receipt:

Payer recognizes INC. when they receive cash, property (@FMV), or services.

Return of Capital Principle:

• When a payer sells assets, you determine the sale proceeds to include in GI. The cost (tax basis) is excluded when CALC. a Gain/Loss.

• Sale Proceeds

  - Selling EXP.

  = AMT. Realized

  - Tax Basis

  = Gain/Loss

When do individuals recognize INC?

Most file a return on a calendar YR period. Most individuals use the cash method.

When do corporations recognize INC?

Most file a return on fiscal YR period. Most corps. use the accrual method.

Constructive Receipt Doctrine:

Payers using a cash method may shift INC. from current YR to next YR if PMT is received @ YR end. Doctrine states we realize & recognize INC when it is received (available to payer, aware of availability, no restrictions).

Claim of Right Doctrine:

Timing of recognition. Receiving PMT in one period & returning in another. Doctrine states we realize INC when payer receives INC & there aren’t restrictions (not obligated to re-pay @ current time).

Assignment of Income Doctrine:

Payer who earns INC, recognizes INC.

Earned Income:

• From Services.

• Source of GI.

• INC from labor.

• Generated by salary, wages, sole-prop, etc.

Unearned Income:

• From property.

• G&L from selling property.

• Generated from DIV, INT, rent, royalties, annuities).

Income from Flow Through Entities:

Partnerships, S-corps, the INC/deductions “flow” to partners. Reported on their 1040 based on % of ownership. Reported on K-1.

4 requirements of Alimony”

1. Cash PD by divorce decree.

2. Decree doesn’t say PMT is “non-alimony.

3. Ex-spouses don’t live together when PMT is made.

4. PMT cannot continue after death.

Divorced before 2019, alimony is included in recipients GI, payers deductions. After 2018 not included on 1040.

Prizes & Awards:

• Gambling, raffle, lottery, sweepstakes included in GI.

• 3 Exceptions:

  1. Used for scientific/literary use, or charity.

  2. Awarded for employee service (limit to $400/yr/employee).

  3. Team USA olympics (AGI must be under $1M).

Social Security Benefits:

May be required to include up to 85% of SS depending on filing status, AMT of SS, and AMT of modified AGI.

Municipal Bond Interest:

Bonds issued @ state/local govt. Not recognized on federal return. T-bills (issued by feds) only taxable on federal level.

Gain on Sale of Personal Residence:

Payer may exclude $250K ($500K MFJ) of gain. Excess gain goes to LTCG.

Fringe Benefits:

Medical/dental & life INS is excluded from INC. Life INS up to $50K.

Education Related EXP:

Excludes scholarships from INC if those monies were used for certain higher education EXP.

Gifts & Inheritances:

Not included in recipients INC. May be subject to federal transfer taxes.

Life Insurance:

Proceeds received due to death of insured are excluded in beneficiary INC if it was a lump sum. PD overtime INT is included in GI.

• Early cash-out: Payer will recognize INC to the extent that proceeds > premiums PD.

• Losses aren’t deductible.

• Exception: Terminally ill cash-out isn’t taxable. Chronically ill cash-out isn’t taxable if proceeds are used for long-term care.

Workers COMP:

fully taxable for 2024.

Foreign Earned INC:

To avoid double taxation, you can exclude this INC from GI with from 2555. Max AMT is $126,500.

• Exemption Requirements:

  1. Be a resident of country for entire calendar YR.

  2. Live there for 330 consecutive days in a 12-month period.

Personal Injury:

Awards/Settlements for physical injury are excluded from GI. Punitive damages are taxable.

Flow-Through Entities:

EXP & losses from partnership or S-corp. that’re passed down to owners and reported on PG 2 of SCH E.

Capital Losses:

$3,000/year. Anything over $3K is carry-forward reported on SCH D.

Health INS. by Self-employed:

A self-employed person is paying the employers and employees part of premiums. Payer is allowed to deduct employers part on SCH 1. Can cover spouse, dependents, and children under 27 who aren’t dependents.

Penalty for Early Withdrawal of Savings:

INT INC forfeited as penalty for withdrawing a CD can be deducted.

Self-employed Tax Deduction (SE Tax):

SE individuals pay the “SE tax” in lieu of SS & medicare. Can deduct employer portion of tax on SCH 1.

Qualified Education Loan INT:

• Up to $2,500.

• AGI > $80K (single, HoH, QSS) or $165K (MFJ) deduction is phased out.

• AGI >= $95K (single, HoH, QSS) or $195K (MFJ) deduction is eliminated.

• MFS don’t qualify.

Medical EXP:

EXP incurred for care, prevention, diagnosis, cure ,injury, disease, or infection.

• MED transportation cost up to $0.21/mile.

• Cosmetic surgery isn’t deductible unless medically necessary.

• Meals & lodging while in hospital.

• Nursing home: sole purpose is medical care, not convenience.

• Subject to 7.5% AGI floor.

Taxes:

• Deduct up to $10K ($5K MFS).

• Deduct state/local taxes

  • foreign income taxes

  • real estate taxes

  • property taxes

INV Interest EXP:

INT paid on loans used to purch. assets (stock, bond, land).

• Personal credit/loan not included.

Home Mortgage INT:

INT paid on loan of primary residence.

• If purchased before 12/16/17 limit of $1M.

• After 12/15/17 capped @ $750K.

MISC Deductions:

Gambling losses to the extent of their winnings, unrecovered cost of a life annuity.

QBI Deduction:

“From” AGI in addition to itemized or standard deduction. Payers w/ partnership, S-corp, or sole-prop. Excludes BUSA in health, law, consulting, athletics, or financials or when BUSA principle is skills of it’s owners

• IF payers tax. INC is < $191,500 ($383,900 MFJ) can’t take deduction.

• QBI deduction=20% of QBI

Interest Income:

INT from CD’s, savings account, corporate/govt bonds. Taxed @ ordinary RTE.

Dividend Income:

1. “Qualified DIV” @ preferential RTE.

2. “Non-Qualified DIV” @ ordinary RTE.

   • Qualified DIV: paid by domestic corp. Must have held INV for 60+ days in a 121-day period.

Capital Gains & Losses:

Capital assets: investment type/personal use assets held for appreciation. EX. stocks, land, personal (residence, auto, furniture), collections.

• Computing Capital G/L:

  Selling Price of Stock

  - Broker Fees

  = AMT Realized

  - ADJ Basis

  =Realized G/L

FIFO & Specific Identification Method:

Payer purch. stock from same co. @ different prices, @ different periods, when they go to sell stock generally use a FIFO method.

• If payer tracked price and AMT of shares they can use specific identification to increase losses, reducing tax liab.

Capital Gains Treatment:

1. STCG @ ordinary

2. LTCG @ preferential

   • $3,000 of capital losses can be deducted/yr. ST used first followed by LT.

   • Anything over $3K is carry-forward until all used up.

Treatment of Small Business Stock (1202 Stock):

• Must meet 2 criteria:

  1. Payer received stock @ original issue of C-corp.

  2. Corp. tax basis in assets before and after issuance of <= $50M.

• LTCG @ max RTE of 28%.

Netting Process:

1. Net G/L by holding period

   • ST (<=1 yr)

   • LT (>1 yr)

2. Then…

   • If signs are same STOP!

   • If signs are different, net together.

Limitations for Capital Loss Deductions:

1. Selling personal assets: G are taxable, losses aren't deductible.

2. Sale to “related parties”: not deductible.

Wash Sale:

Disallows loss if payer purch. the same stock w/in a 61 day period. 30 days before sale, day of sale, 30 days after sale.

1. Realized losses aren’t recognized.

2. Unrecognized loss is added to basis of newly acquired stock.