Tax Exam Final. Ch 10, 11, 12, & Comprehensive

Cost Recovery

Business capitalize cost of assets with useful life of more than one year on balance sheet rather than expense the cost immediately

Types of cost recovery

depreciation, amortization, or depletion

Depreciation method is used on

Tangible assets (personal and real property - buildings - other than land)

Amortization method is used for

Intangible property

Depletion is used for

Natural resource (water, timber, oil)

Initial basis for cost recovery

all costs needed to purchase, prepare for use, and begin using it. same for book and tax purposes.

Adjusted basis for cost recovery

carrying value for tax purposes. Initial basis + capital improvements - depreciation/amortization

personal property (tangible assets) and real property (buildings)

depreciation method is used for

intangible assets (goodwill/patents)

amortization method is used on

method for natural resources (oil, coal, timber, gold)

depletion

Cost basis example:

Purchased building 175,000

Painting 15,000

2 years later roof improvements 50,000

Every 6 months 500 carpet cleaning

What is the initial basis of the building?

190,000

Cost basis example:

Purchased building 175,000

Painting 15,000

2 years later roof improvements 50,000

Every 6 months 500 carpet cleaning

What is the adjusted basis after 2 years?

240,000

Cost basis example:

Purchased building 175,000

Painting 15,000

2 years later roof improvements 50,000

Every 6 months 500 carpet cleaning

Does the carpet cleaning have an effect on the basis?

No effect on basis

What is needed to compute MACRS

Initial basis

date placed into service

depreciation method,

depreciable life

depreciation convention

Personal property deduction is on

All tangible property other than real property

(True/False) Personal property and personal-use property (for personal uses) are not the same

True

3 methods for personal property depreciation

• 200 percent (double) declining balance

• 150 percent declining balance

  • Straight-line

personal property depreciation recovery method

• Recovery period (depreciable life) based on its taxpayer-determined estimated useful life

• For tax purposes, useful life is under Rev. Proc. 87-56

personal property depreciation convention: half-year

• One half of full year's depreciation allowed in the first year and the other half in the assets last year of life

  • If disposed before fully depreciated, only one half of table's applicable depreciation percentage is allowed in year of disposition

personal property depreciation convention: mid-quarter

>40% of qualified property is placed in service in last quarter of tax year

depreciation of real property (buildings)

Uses mid-month convention and depreciated using straight-line method

179 expense

incentive for small business allowing them to immediately expense up to 1,080,000 of tangible property placed in service during the year if tangible assets are less than 2,700,000

recovery period for residential property

27.5 years

recovery period for non-residential property in service after 05/13/1993

39 years

recovery period for non-residential property in service before 05/13/1993

31.5 years

bonus depreciation

additional depreciation is allowed in the acquisition year for tangible personal property with a recovery period of 20 years or less. A primary way to depreciate qualified assets.

how long are 197 intangible assets amortized over

180 months

four categories of amortized intangible assets (straight-line method)

• 197 intangibles

• Start-up expenditures and organizational costs

• Research and experimentation

• Patents and copyrights

definition of realized gain or loss on disposition of asset

Amount of gain/loss taxpayer realizes on disposition

Realized gain or loss on disposition of asset formula

Amount realized - adjusted basis = gain (loss)

what is the Amount realized (proceeds)

Everything of value received from the buyer less any selling costs

Amount realized (proceeds) formula

Cash received + FMV other property + buyer's assumption of liabilities - seller's expenses

what is the Adjusted basis

• Initial basis reduced by depreciation or other types of cost recovery allowed on the property

  • Initial basis - cost recovery allowed

characteristics of recognized gain or loss on disposition of asset

• Gains/losses that increase/decrease gross income

• Must immediately recognize the vast majority of realized gains and losses

what are Ordinary assets

• Assets created or used in taxpayer's trade or business

• Business assets held for less than a year

what are Capital assets

• Assets held for investment, for production of income, or for personal use

• Qualification depends on the purpose of the asset

• Capital assets are preferred over ordinary income

what are 1231 assets

• Depreciable assets and land used in a trade or business held for more than one year

• Gain is treated as long-term capital gain

• Loss is treated as an ordinary loss

• FAVORABLE FOR TAXPAYER

what are Line-kind exchanges

• Exchanged "solely for like-kind property"

• Real property given up and real property received are used in trade for business or for investment

• Time restrictions are present

what are Inventory conversions

• Accident or natural disaster

• Basis of property directly converted is carried over from old to new property

• Indirect conversion

  • Gain recognized is lesser of gain realized or amount of reimbursement not reinvested in qualified property

• Replacement must be similar or related use to origional

what are Installment sales

• Seller receives sale proceeds in more than one period

• Must recognize portion of gain on each installment payment received

• Gross profit % = gross profit / contract price

• Does not apply to losses

characteristics of a salary

• Fixed amount of compensation for year no matter hours worked

• Eligible for bonuses

characteristic of wages

Paid by hour worked

_______ are taxed as ordinary income

Salary, bonus, and wages

Tax withholding is calculated by ER by

• EE complete W-4 to supply information needed to withhold the correct amount of tax

  • Anticipated filing status, multiple jobs, number of children qualifying for tax credit, other adjustments

Purpose of Form W-2

• Shows taxable salary and wages

• Annual federal and state withholding information

• Generated by ER on annual basis

purpose of Form W-4

• Supplies EE's withholding information to ER

• Generated by EE at start of employment

• Remains constant unless changes made

methods ER computes taxable income

• Cash method deduct salary and wages when paid to EE

• Accrual method deducts wages as EE earns wages

Compensation expenses accrued at end of year is deductible in year accrued if

• Paid to unrelated party

• Paid within 2.5 months of year end

Limits on salary deductibility

 use "facts and circumstances test"

• Duties of EE

• Complexities of business and amount of salary compared with the income of business

• $1,000,000 maximum annual compensation deduction per person

• Applied to CEO, CFO, three other highest compensated offices, and all covered EE from PY

Incentive stock options provide

Favorable tax treatment to EE

Nonqualified stock options are options that

Don’t meet requirements for being classified as incentive stock options

what is the Grant date

Date on which EE are initially allocated stock options

what is the Exercise date

date that EE purchase stock on their options

what is the exercise price

Amount paid to acquire shares with stock options

what are Fringe benefits

• Noncash benefits to EE in addition to cash compensation

• Range from health insurance to use of private jet

• Taxable to EE on receipt

characteristics of Taxable fringe benefits

• Recognize compensation income on all benefits received

• Treated like taxable cash compensation

• ER deducts cost and pays EE's share of FICA taxes on benefit

characteristics of nontaxable fringe benefits

• EE excludes benefit from taxable income

• Life insurance

• Health and accident insurance and benefits

• Meals and lodging for convenience of ER

• Educational assistance

• Dependent care benefits

What qualifies as a tax

payment required by a government that is unrelated to any specific benefit or service received from the government

what are the Components of a tax

• Payment required

• Payment imposed by government agency

• Payment not tied directly to benefit received by the taxpayer

how to calculate tax

• Tax = tax base * tax rate

• Tax rate

  • Level of taxes imposed on the tax base

• Tax base

  • What is actually taxed

what is Marginal tax rate

Tax rate applies to next additional increment of a taxpayer's taxable income

what is Average tax rate

Average level of taxation on each dollar of taxable income

what is Effective tax rate

Average rate of taxation on total income

what are the Types of taxes

• Federal taxes

  • Income, (un)employment, excise, transfer

• State and local taxes

  • Income, sales and use, property, and excise

• Implicit taxes

what are the Filing requirements

• Corporations all must file

• Estates and trust required to file is gross income > $600

• Individuals: determined by filing status, age, gross income

what are the due dates for filing

• Individuals are 15th day of 4th month following calendar YE

• C corp: 15th day of 4th month following end of tax year

• Partnership/s corp: 15th day of third month following end of tax year

what is a Correspondence exam

• Most common

• Mail - limited to 1 or 2 items on return

what is an Office exam

• Second most common

• Local IRS office - broad scope

what is a Field exam

• Least common

• Taxpayer's place of business - months to years

examples of primary tax sources

IRS, Supreme court opinion, treasury regulations

examples of secondary tax sources

USA Today, Article on supreme court opinion, RIA federal tax coordinator

how to calculate taxable income

• Gross Income

• Minus FOR AGI (above line)

• Equals AGI

• Minus FROM AGI (below line)

• Equals taxable income

How to calculate taxes due

• Taxable income

• Times tax rate

• Equals income tax liability

• Plus other taxes

• Equals total tax

• Minus credits

• Minus prepayments

• Equals taxes due (refund)

Excluded income

• Never included in taxable income

  • Municipal bond interest

  • Gain on sale of personal residence

Deferred income

• Included in subsequent tax year

• Tax rate is 0 in current year

  • Installment sales

  • Like-kind exchanges

Qualified dividends taxed at preferential rate of

 0, 15, or 20%

Deduction FOR AGI

• Above the line

• Determine AGI

• Reduce taxable income dollar for dollar

Deduction FROM AGI

• Below the line

• Determine taxable income

• Greater of standard/itemized deduction

USA has ______ tax rates

progressive

what items are taxed at preferential rates

Net capital gains and qualified dividends

dependency test

• Relationship

  • Child?

• Age

  • Under 18 or under 24 and full time student

• Residence

  • Lives there >6 months

• Support

  • Provide more than half

• Gross income

  • GI less than support

list of filing status

• MFJ

• MFS

• Qualifying widow(er)

• Single

• Head of household

when to Recognize gross income

• Receive economic benefit

• Realize income

• Not allowed to defer/exclude

Accounting methods

• Corp: accrual

• Individual: cash

characteristics of Constructive receipt of income

• Taxpayer must realize and recognize income when actually or constructively received

• Deemed to occur when income credited to taxpayer's account

what is Claim of right of income

Income recognized when no restrictions on use of income

Trade/business expenses must be

• Directly connected to business activity

• Ordinary and necessary for activity and appropriate to generate profit

• Reasonable amount

when work is done at Hospitals/Long-term care facility

can deduct Costs of medical care at hospitals/long-term care

Medical expense deduction

• Limited to amount of unreimbursed qualified medical expenses paid

• Reduced by 7.5% of taxpayers AGI

Taxes deduction

• State, local, foreign taxes

• Sales tax deduction in lieu of income taxes

• Total itemized capped at $10,000 (5,000 single)

• within an itemized deduction

2 characteristics of the Interest deduction

• Investment interest expense

• Carries forward indefinite

debt on Home mortgage deduction

• $1,000,000 before 12-16-2017

• $750,000 after 12-15-2017

Charitable contributions deduction

Qualified domestic charity

Nonqualified dividends are taxed as

Ordinary income

characteristics of a short-term/long-term sale of capital asset generates capital gain (loss)

• Long-term > 1 year

  • Taxed at max 28%

• Short-term < 1 year

Capital losses deduct up to _____ net capital loss against ordinary income. They carry over _______

$3,000; indefinitely

Investment expense

• Expenses other than interest incurred to generate investment income

• Not deductible

Investment interest expense characteristics

• Interest expense on loans used to acquire investments

• Deductible as itemized deduction

• Limited to investment income

• Carries indefinitely

Kiddie Tax

• Net unearned income taxed at parents' marginal rate

  • Net unearned income = unearned income in excess of $2,300

• Child < 18 or 24 full time student

• Earned income not greater than half child's support

purpose of Tax credits

Reduce tax liability dollar for dollar