REG - Notes Chapter 1

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Individual Taxation – Filing Status
Due date April 15th
An extension is only for filing your paperwork and not your payments, so with an extension the due date for tax
payments remains April 15th

Determine filing status based on status as of December 31st.

If one spouse dies during the year, a joint return may still be filed

Can file as a qualifying widower for two years after spouses death, if they don’t remarry
The surviving spouse must maintain a household that for the whole entire taxable year was the principal place
of abode of a son/daughter, stepson/step daughter (either by blood or adoption)

Head of household – individual maintains a household that for more than half the taxable year is the principal
residence of dependents:
• Son or daughter – Working families act – child must either be a qualifying child or qualify as the taxpayers
dependent
• Father or mother – not required to live with, nursing home
• Dependent relatives – must live with, not free loading friends

Individual Taxation – Exemptions

Generally, an individual is entitled to a personal exemption that is indexed annually for inflation, $3,300

Persons eligible to be claimed as dependents on another’s tax return will not be allowed a personal exemption
on their own return. If the folks claim you, you lose it.

Each spouse receives a personal exemption

Spouse as personal exemption on a separate return – a married taxpayer, who files separately, may claim his or
her spouses personal exemption if both of the following tests are met:
1. the taxpayers spouse has no gross income
2. the taxpayers spouse was not claimed as a dependent by another taxpayer

If a person is born or dies during the year, he or she is entitled to a personal exemption for the entire year.
Exemptions are not prorated

Dependency exemptions – qualifying child or qualifying relative

Qualifying child – CARES
• Close relative – direct descendant, legally adopted, foster child
• Age limit – Under 19 (24 if full time student), no age limit for permanently disabled
• Residency requirements – same household as taxpayer for more than half of the tax year
• Eliminate gross income test – the gross income test (SUPORT) does not apply
• Support test changes – child did not contribute more than half of his/her support

Qualifying relative – SUPORT, could be free loading friend

• Support over 50% of the persons needs
- if two or more people support more than 50%, only one can claim the dependent (must contribute
more than 10%)
• Under exemption amount ($3,300) of taxable gross income test (no income test if meet age limit, CARES)
• Precludes dependent filing joint tax return test, can’t claim dependent if they file jointly with someone else
• Only citizens (residents of U.S/Canada or Mexico) test
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• Relative test, or
• Taxpayer lives with individual for whole year test, if not related, (foster kids and cousins fall here)

No additional exemption for being

• Over 65
• Blind
It’s an increased standard deduction

Phaseout of personal and dependency exemptions by 2% of each $2,500 increment (1,250 for married) by
which AGI exceeds certain thresholds based on filing status

R1-15 (threshold amounts and example)

Individual Taxation – Gross Income

Event Income Basis
Taxable = FMV FMV
Non-taxable = N-0-N-E NBV

Realization = real world

Recognition = record for tax purposes

Specific items of income and exclusions

• Money
• Property – the FMV of all property received is included in GI
• Cancellation of debt
• Life insurance premiums above the first $50,000 of coverage is TI to the recipient
- interest income from life insurance proceeds on a deferred payout is fully taxable
• Premium insurance payments made by employer are excludable (Accident, medical and health insurance)
• Employer payment of employees educational expenses (up to 5,250) are excluded from TI
• Payments made by employer in a qualified pension, profit-sharing and stock bonus plan are excluded
- Benefit received from such plans are taxable

Taxable interest
• Federal and corporate bonds
• Premiums received for opening a savings account (prizes and awards) are included at FMV
• Interest paid by federal or state govt’s for late payment of tax refunds

Tax-exempt interest (reportable but not taxable)

• State and local gov’t bond interest
• Series EE savings bonds interest (for higher educational expenses), there is a phaseout
• Net unearned income (dividends, interest, rents, royalties) of a dependent child under 18 is taxed at the
parents tax rate, “Kiddie Tax”

Dividend Income
• Cash and property = FMV is TI
• Special lower tax rate 15% or 5% for the very poor (10%/15% income brackets)– qualifying dividends,
stock must be held for 60 days during the 120 day period, beginning 60 days before the ex-dividend date
• Capital gain distribution

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Tax-free distributions
• Return of capital
• Stock splits
• Stock dividend
• Life insurance dividend

Used itemized deductions in prior year = taxable income

Used standard deduction in prior year (1040 EZ) = non taxable income

Alimony/Spousal support (income to the person receiving it)

• Payments must be legally required pursuant to a written divorce
• Payments must be in cash/cash equivalent
• Payments cannot extend beyond the death of the payee-spouse

Child support
• Non-taxable to receiving ex-spouse
• Non-deductible by the spouse making the payments
• If spouse is required to make both alimony and child support payments, but falls short, the money paid will
be allocated first to child support

Property Settlements
• Non-taxable to receiving ex-spouse
• Non-deductible by the spouse making the payments

Net income from self employment is computed on schedule C

Income from farming activities is computed on schedule F

Gross Income = Cash + Property at FMV + Cancellation of debt

Business Expenses – need to be incurred and paid for to be tax deductible for a cash basis payer
• COGS, salaries, etc
• State and local business taxes paid
• Employee benefits
• Business meals and entertainment expenses at 50%
• Interest expense on business loans
• Bad debts actually written off for accrual basis tax payer (direct write off method)

Non-deductible expenses (on schedule C)

• Salaries paid to the sole proprietor (they are considered a “draw”)
• Federal income tax
• Personal expenses
• Bad debt expense of a cash basis tax payer

There are two taxes on net taxable income

• Income tax, and
• Federal self employment tax

A business with a loss may deduct the loss against other sources of income
• 2-year carry back
• 20-year carry forward

Uniform Capitalization rules – for inventory, even a sole proprietor will be required to
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• Capitalize DM, DL and Mfg OH, then expense when sold
• Period expenses – SG&A and R&D

Gains and losses on disposition of property

Amount realized – adjusted basis of asset = g/l
Traditional IRA
• Taxed as ordinary income when withdrawn at 59 1/2
• 10% additional penalty tax if withdraw early
Exceptions to penalty rule
• 1st time home buyer – $10,000 max
• Medical insurance
• Medical expenses in excess of 7.5% of AGI
• Permanent disability
• Higher education
• Death

Annuities – treat like depreciation

Schedule E is used to calculate passive income from

• Rental real estate
• Royalties
• P/S, Estates, Trusts (from schedule K-1)

Passive activity losses (PALs) – can only be deducted to extent of passive activity income
• Unlimited carryforward
• If sell asset and losses unused, losses become fully tax deductible in the year the property is disposed

PAL exceptions
• Taxpayers may deduct up to $25,000 per year of net passive losses attributable to rental real estate annually
if the individuals actively participate (Mom and Pop exception)
• Phase out – the 25,000 allowance is reduced 50% of excess of AGI over $100,000 and eliminated when
AGI exceeds $150,000

Unemployment compensation – must include in gross income the full amount received
Social security income
• Low income (below S $25,000/ MFJ $32,000) – no social security benefits are taxable
• Upper income (above S $34,000/ MFJ $44,000) – 85% of social security are taxable

Taxable Misc Income

• FMV of prizes and awards is TI
• Gambling winnings is TI
• Gambling losses may be deducted to the extent of gambling winnings. (can be an itemized deduction but
are not subject to the 2% of AGI limitation on misc itemized deductions

Partially Taxable Misc Items

Scholarships and fellowship grants are excludable only on amounts spent of tuition, books and supplies
• Taxable is used for room and board or services are required to get scholarship

Non-taxable Misc Items

• Life insurance proceeds
• Gifts and inheritances
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• Medicare benefits
• Workers compensation for personal injury or sickness
• Personal (physical) injury award
• Accident insurance proceeds (if premiums were paid by taxpayer)

Individual Taxation – Capital Gains and Losses

Real property – items permanently affixed to the land (land, building, paving, etc)

Personal property – all property not classified as real property (machinery and equipment)

Non-capital assets
• Inventory held for sale in the ordinary course of business
• Depreciable personal property and real estate used in trade or business (Section 1231, 1245, 1250)
• A/R received in trade or business
• Music copyrights
• Treasury stock

Amount realized – Adjusted basis of asset sold = gain/loss

Amount realized
• Cash received (boot)
• Cancellation of debt (boot)
• Property received at FMV
• Services received at FMV
• Reduce amount realized by any selling expenses (like brokers commissions)

Adjusted basis of asset sold

• Purchased property basis = cost
- increase basis for capital improvements
- reduce basis for accumulated depreciation (= NBV)
• Gift property basis = donors basis
- exception: if at the date of gift, the FMV is lower than the NBV, the basis will depend on the future
selling price
Sell higher  use donor’s basis to calculate gain
Donor’s basis -------------------------
Sell between  no gain or loss
Lower FMV at date of gift ----------
Sell lower  use lower FMV at date of gift to calculate loss
Only go to this crazy exception when the FMV of the gift is less than the donor’s basis

The recipient of the gift normally assumes the donors holding period

Inherited property basis

• At date of death, the FMV becomes the basis for the new individual
• Alternate valuation date – if validly elected, the asset is valued at FMV at the earlier of:
- Distribution date of asset
- Alternate valuation date (earlier of 6 months after death or date of distribution/sale 6 months max)

A gain is not taxed if the tax payer can HIDEIT

Gain to the extent of boot is taxable

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Homeowners Exclusion – sale of primary residence S $250,000/ MFJ $500,000
• Must have used the home as principal residence for 2 years during a five year period
• For joint returns, both spouses have to meet the ownership requirement
• No age requirement
• No rollover to another house required
• The exclusion is renewable

Involuntary Conversions – insurance proceeds from destruction, theft, condemnation

• Must use proceeds to replace property lost
- 2 years from year end for personal property
- 3 years from year end for business property

Divorced Property Settlement

Exchange of Like-Kind Business/Investment Assets (tangible)

• Like kind exchange of property used in the trade or business or held for investment
- not inventory, stock securities, P/S interests, real property in different countries
- There is a gain recognized when boot is received

Installement Sale
• Recognize when cash is received
• Gross profit = Sale – COGS
• Gross Proft % = Gross profit/ Sales price
• Earned Revenue = Gross profit % * cash collections

Treasury and Capital stock transactions (by corporation)

• Sale, repurchase and reissuing of stock are exempt from gains

Non-deductible losses – WRaP these losses up because they are non-deductible

Wash Sale Loss

• A security is sold for a loss and is repurchases within 30 days before or after the sale date

Related Party Transactions

• Entities that are more than 50% owned by individuals, corporations, trusts or P/S
• Capital losses on disallowed on most related party transactions even if they were made at an arms-length
FMV price
• Basis rules are the same as Gift rules

And

Personal Losses – no deduction is allowed for the loss on a non-business disposal or loss

Individual capital gain/loss rules

• Long term – held for more than a year and receive 15% tax rate (5% if in 10% or 15% income bracket)
• Short tem – held for less than a year, treated as ordinary income
• $3000 maximum deduction
• Excess net capital loss can be carryforwarded for unlimited time, no carryback

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Corporation Capital gain/loss rules (applies to C Corps only)
• No special tax rate for long term capital gains. Lumped with short term as ordinary income
• Can’t deduct any capital losses from ordinary income
• Net capital losses are carried back 3 years and forward 5 years
Excess
Offset income Carryback Carry forward
Operating losses yes 2 yrs 20 yrs
Indv capital losses $3,000 no Forever
Corp capital losses no 3 yrs 5 yrs