Tax Exam 1

Major Sources of Tax Law (Legislative and Judicial)

The Consitution Internal Revenue Code Tax Treaties Court Interpretations

Major Sources of Tax Law (Administrative)

Treasury Regulations Revenue Rulings Revenue Procedures Letter Rulings

5 Criteria For Good Tax System

Sufficiency Equity Certainty Convenience Economy

Sufficency Criteria

Can the amount of tax needed be accurately estimated and generated

Equity Criteria

Is the tax system fair (Who pays more or less tax)

Certainty Criteria

Can TPs determine when, where, and how to calculate and pay taxes

Convenience Criteria

Is tax collected when the TP is most likely to have the money to pay

Economy Criteria

Does the tax system minimize the costs associated for the TP and the government

What are the key components of a tax?

Required by law Imposed by government Not tied directly to benefit receiveed by TP Not a fine/penalty

Tax Rate Structures

Proportional Regressive Progressive

Marginal Tax Rate

tax rate that applies to the net additional increment of a taxpayer's taxable income

Average Tax Rate

a TP's average level of taxation on each dollar of taxable income (TT/TaxableIncome)

Effective Tax Rate

TP's average level of taxation on each dollar of total income (TT/TotalIncome)

When are tax returns do?

15th day of 4th month A TP can file a request for 6 month extension Is an extension of time to file the return, not an extension to pay

Statue Of Limitations

period in which a TP can file an amended return or the IRS can assess a tax deficiency Generally 3 years from the later of the day the return was filed, or the return’s original due date

When is the Statue of Limitations 6 years?

If TP omits gross income that exceeds 25% of gross income reported

When is the Statue of Limitations open indefinetly?

If TP files a fraudulent return or fails to file

How does the IRS discover mistakes and cheating?

Document Perfection Program - math errors Information Matching Program - matching docs DIF - makes scores

What governing bodies do tax professionals follow?

AICPA's Code of Conduct AICPA's Standards for Tax Services

How to qualify as a dependent on tax return

Must be a citizen of the US or a resident of the US, Canada, Mexico

Must not file a joint return with spouse

Must be qualifying child or resident

Qualifying Child Tests

Relationship Test Residence Test Age Test Support Test

Relationship Test (QC)

Individual must bear a relationship to the taxpayer Child, Stepchild, foster child, brother, halfbrother, stepbrother, nieces/nephews

Residence Test (QC)

individual must have the same principal residence as the TP for more than 1/2 of the year

Age Test (QC)

individual must be younger than the TP, and must be under 19 at end of tax year, under 24 at end while a full time student, or permanenty disabled

Support Test (QC)

individual did not provide more than 1/2 of their own suppoer durin tax year (Scholarships don't count)

Relationship Test (QR)

Individual must bear a relationship to the TP Family (Excluding cousins) Any individual if the individual lives with the TP in home for the entire year

Gross Income Test (QR)

individual must have gross income for the tax year that is less than the tax year's exemption amount

Support Test (QR)

the TP must provide more than 1/2 of the individual's support for the year (Scholarships don't count in this calculation)

Single Filing Status

unmarried taxpayer that does not qualify for HOH status

Head of Household

TP is unmarried at end of tax year TP is not a Qualifying Surviving Spouse Have a QC or QR for more than 1/2 of the year TP maintains a home for a dependent mother or father

Qualifying Surviving Spouse

an extension of MFJ filing status for two years after spouse passing TP has not remarried A dependent son, stepson lives in the TP’s home, which they maitain, for the entire tax year

Married Filing Jointly

Sharing tax liability with spouse

Married Filing Separately

Married taxpayers not using MFJ Generally worse option than MFJ Often reserved for marital/financial adjustments

Abandoned Spouse

Can file as HOH if they satifsy requirements and have lived apart from spouse for last 6 months of the tax year

Exclusion

Realized income never required to be included in gross income (Interest in Municipal Bonds, Life Insurance)

Deferrals

Realized income that will be recognized on a future year tax return (Installment sales)

Ordinary Income

Income or loss subject to tax rates set forth in tax rate schedules

Capital Gains/Losses

Gains and losses on the disposition of capital assets

Capital Assets

All assets other than: A/R Inventory and other assets held for sale Assets used in a trade or business

Short-term gains

subject to tax at ordinary income rates

Long-term gains

subject to tax at preferential (lower) tax rates

Are losses llimited for individuals?

Yes (3,000 per year)

Qualified Dividends

Dividend income subject to long-term capital gain tax rates

What are deductions?

Results of legislative grace - congress must write specific law for each one Reduce taxable income dollar for dollar

For AGI Deductions

subtraced from gross income to yield AGI associated with business + investment activities generally fewer limitations than from agi deductions

From AGI Deductions

subtracted from AGI to yield taxable income Is the greater of:  -Standard Deduction  -Itemized Deductions And the qualified business income deduction Added through the OBBBA

Income Tax Calculations (Over/Under 100k)

Under 100k = use tax tables Over 100k = use tax rate schedules

Return of Capital Principle

when a TP sells property, the TP is allowed to recover cost of property tax free

Tax Benefit Rule

If a portion of an expenditure that wwas deducted in a prior tax year is refunded, the refund is included in gross income in year of receipt

Assignment of Income Doctrine

Prevents TPs from transferring taxation of thier income to other TP's

Accounting Method

all TPs must choose an acccounting method
Accrual: recognized income when earned, deduct expenses when paid
Cash: recongize income when it is received

Constructive Receipt Doctrine

Cash Basis TPs realize and recognize income when it is actually or constructively received

Claim of Right Doctrine

income is realized if a TP receives the income and there are no restrictions on funds

3 Categories of Gross Income

Income from Services Income from Property Other Sources of Income

Incomes from Services

Generated by the efforts of TP
-Salaries, Wages,
-Fees earned through self-employment, including illegal income
Unemployment compensation

Income from property

earnings from investments and gains/losses Interest/Dividend Income Income from rental and royalty producing activities Income from annuities/retirement Gains and losses from disposing of property generating unearned income

Other Sources of Income

Income from flow through entities
Alimony
Prizes,Awards,and Gambling Winnings
Social Security Benefits
Imputed Income
Discharge of Indebtedness

Annunity

Investment that pays a stream of equal payments over time Return of capital principle that allows TP to recover amount invested tax free Some of each payment is return of capital and some must be included in gross income

Annuity Exclusion Ratio

Original Investment/Expected Value of Annuity

Expected Value of Annuity

=number of expected payments * payment amount

Payment Amount * Annuity Exclusion Ratio =

Amount not included in gross income

Annuities paid over lifetime

Still uses annuity exclusion ratio but expected value is based on life expectancy
If TP receives payments after investment is fully recovered, subsequent payments are fully taxable

Social Security Benefits

0% to 85% of SS benefits must be included in income Amount depends on filing status or modified agi and amount of SS Benefits received

Social Secuirt for TP Filing Single

SS beneifts are not included if 25,000 or less

Alimony

Support payment of cash made to a former spouses

Other non alimony are not income if received, not deductible if paid

If divorce was ssettled before January 1st, 2019

Alimony received is included in gross income

Alimony paid is deductible for AGI

If divorce was settled after December 31st, 2018

Alimony received is not excluded from grosss income

Alimony paid is not deductible

Why does congress create exclusions? (2 Reasons)

To subsidize and encourage certain activities

To be fair to taxpayers (mitigate double taxation, help sick and injured)

3 Common Exclusions

Exclusion of Interest on Municipal Bonds

Exclusion of Gain on sale of a personal residence

Fringe Benefits

Exclusion of Interest on Municipal Bonds (State/Local Gov)

Interest on bonds issued by US government is included in income

Allows states and municipalities to pay lower interest rates

Exclusion of gain on sale of a personal residence

Exclude up to 250,000 (500,000 for MFJ)

Subject to several limitations

Fringe Benefits

Noncash Benefits provided to an employee as additional compensation

Education related Exclusions

Scholarships are excluded if they are used for equipment required for courses

Not required to perform services for scholarship

Gifts and Inheritance

Gift: Property transferred to recipient before transferor’s death

Inheritance: Property transferred to recipient after transferor’s death

Subject to transfer tax, not subject to income tax

Life Insurance Proceeds

Excluded from income usually

If paid in installments, some of each payment is included in income as interest

If sold to 3rd party, the 3rd party must include death benefit in excess as gross income

Foreign Earned Income

Exclude income from US income, up to a limit of 132,900

Or Include it, and claim a foreign tax credit

Or Include it, and deduct foreign tax paid from AGI deduction

Sickness and Injury related exclusions

Workers comp always included

Compensatory damage payments for injury is excluded

Include payments not related to injury

Punitive damages are always included

Health Care Reimbursement

Always excluded if for medical expenses

Disability Insurance

If TP purchases a private plan, or has premiums paid by employer, benefits are excluded

If TP receives coverage through employer as nontaxable fringe benefit, benefits are included.