Transcript BA 128A-1 Review Session 1

BA 128A-1 Review Session 1
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Briefly review Chapters 2,3,4
Chapter 5
Chapter 6
Questions
Chapter 2
• Individual tax formula
• Phaseout provision for Itemized deduction (3% over
excess and limit to 80% of total ID besides medical,
investment interest, casualty losses and wagering losses)
• Phaseout provision for personal exemption (2% per every
$2500 over excess (rounding))
• Dependency test (gross income, support test, can’t file
joint return), dependent cannot claim his/own exemption
• Child care credit ($400 per child; subject to phaseout)
• Kiddie Tax - kids under 14, unearned income taxed at
parent’s rate - get $700 statutory deduction
Chapter 3&4 Inclusions and Exclusions
• Cash basis vs. accrual basis
• Cash basis - constructive receipt
• Accrual basis - prepaid income generally taxable in year of
receipt
• Inclusions - Business income, rents and royalties, cash
dividends, interest, alimony (deductible by payor and
inclusive for recipient, recapture), sale of property, refund
of state or local income taxes, annuities (exclusion ratio),
pension (amt. contributed / # of anticipated payments =
amt. to exclude), income from flow through entities, social
security benefits (exclusion provision),
price/awards/gambling winnings, treasury finds, income
from illegal activities, non medical/life insurance proceeds
and court awards, group term life insurance premiums >
$50000
Chapter 3&4 Inclusions and Exclusions
• Exclusions: Gifts and inheritances, life insurance (face
amount) proceeds and dividends, adoption expenses ($5000
qualified employee assistance plan), scholarships (books,
supplies, tuition and equipment only), payments of injuries
and sicknesses (personal), foreign income exclusion (may
include housing allowance), Employee Fringe benefits
(premiums on medical, life and disability, benefits from medical
and life, employee awards, meals and lodging furnished under
employer’s premise, no additional cost benefits, qualified
employee discount, transportation and parking, cafeteria plans
and employee death benefits, ), Forgiven debt for bankruptcy
and insolvency
Chapter 5 Capital Gains and
Losses
• For AGI deduction
• Gains or losses from the sale and exchange
of property
• Realized gain - amount received from the
sale (if property is received - value at FMV)
• Selling expenses reduce the amount realized
• Compare to adjusted basis to derive gains
and losses
Definition of capital asset
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Not inventory or property used in trade or business
Not Accounts Receivable
Not copyright/literary/musical/artistic composition
Dealers in securities, sale of securities is usually
treated as ordinary gain or loss, but may identify
specific property for investment
• Non dealer of real estate, can identify real
property as capital asset subject to several requires
e.g. holding more than 5 yrs, no substantial
improvements made I5-15
Adjusted Basis
• Initial basis + capital additions - capital
recoveries
• Capital additions - prolong useful life or
increase value of property
• Capital recoveries - depreciation
• Costs of acquiring property increase the
initial basis of the property (e.g. Taxes,
interest, delivery and installation costs)
• Stock purchased at different times - if not
adequately identified - FIFO
Property transferred as gifts
• Generally donor’s basis
• If FMV < donor’s adjusted basis, donee has
dual basis; FMV if sold at loss and donor’s
basis if sold at gain
• If value sold in between FMVand donor’s
basis, no gain or loss is recognized
• If donor pays a gift tax, donee’s basis is
increased (only if donor’s basis is taken);
addition =
Gift tax paid * (FMV - donor’s basis)/$ of gift
Property received by decedent
• Transfer at FMV at date of death or an
alternative valuation date (6 months after
death) - restrictions on alternative date
election
• Community Property Law - 1/2 goes to
decedent’s estate and 1/2 goes to spouse at
FMV
• Common Law - same except the spouse’s
part is transferred at old basis
Property converted form personal
to business
• Lower of FMV or adjusted Basis - if asset
sell at loss, basis = FMV - depreciation; if
asset sell at gain , basis = adjusted basisdepreciation
• Prevent tax avoidance for assets that have
declined in value
Basis allocation/Stock div/rights
• For bulk assets purchase/sale - sales price must be
allocated according to FMV of each asset
• Common costs of purchase has to be capitalized and
apportion to each asset purchased
• Stock Divided - reduce existing stock basis, if stock type
is different, use FMV. Cost basis of stock/ new # of
shares owned
• Stock Right - if FMV of stock rights < 15% of FMV of
stock, basis of stock right = 0, unless election is made. If
basis is allocated to stock right, stock basis is reduced
too.
• If stock right is exercised later, basis is added to exercise
price for new stocks acquired. If stock right expires,
basis returned to existing stock.
Treatment of capital gains and
losses
• Short term <1 year of holding period
• Long term > 1year of holding period
• First - Net STCL with STCG = NSTCL/NSTCG, Net
LTCL with LTCG = NLTCL/NLTCG.
• Net Capital Gain (NCG) = Excess of NLTCG > NSTCL
• ANCG (Adjusted Net Capital Gain) is NCG without
collectibles gain (28%), unrecaptured section 1250 (25%),
section 1202 (Small business stock) - 28% but 1/2 is
income exclusion
Treatment of capital gains and
losses - cont
• NSTCL >NCTCG - deduct $3000 for AGI, excess
carryforward, retain original state
• NLTCL > NSTCG - deduct $3000 for AGI,
excess carryforward, retain original state
• If both NSTCL and NLTCL - use NSTCL first for
the $3000
• Net gains and losses with the same asset group
first and if there is still excess NSTCL over
NLTCG for different asset groups, net the 28%
group first, then the 25% and then 20% .
Holding period
• Long term asset - 1 year and 1 day after
date of acquisition
• Gift transfer - holding period include
donor’s if using donor’s basis
• Inherited property (from decedent) considered long term regardless
• Nontaxable exchange including stock rights
and dividends - holding period include
original stock’s
Miscellaneous
• Corporation - same in netting and classification
except no $3000 deduction, loss is carried forward
5yrs and 3 yrs forward - all treated as STCL
• Max rate is 35%
• Capital gains/losses between related parties e.g.
family members are scrutinized
• Worthless securities - assume sale/exchange on
last day of tax year, taxpayer has burden of proof.
Worthless securities owned by affiliated
corporations is not considered as capital asset
• Tax planning issues
Chapter 6- Deductions
• 3 types - Trade or business, production of
income, personal expenditures (Chapter 7)
• Production of income - include production
and collection of income, management and
conservation of property, collection or
refund of tax
Deductions for AGI
• Trade or business related expenses
• Employee expenses that are reimbursed (income
include in GI in the first place)
• Loss from sale of trade/bus/investment property
• Expenses derived from rent and royalty income
• Moving Expenses
• IRA
• Alimony
• Student loan
• 1/2 self employment tax
Deductibility
• Expenses related to tax-exempt income
• Capital expenditure
• related to illegal activities or violation of public
policy
• Specially disallowed by law
Distinction between business and investment
expense - business expense has to be:
• Profit motivation
• Ordinary/necessary/reasonable
• Properly documented
Deductibility
• Ordinary - customary, proximate
relationship to income
• Necessary - appropriate and helpful
• Reasonable - e.g. salary expenses <$1M
• Investment loss deduct as capital gains,
investment expenses deducted from AGI
(misc itemized deduction)
• Personal property used in business get
$18,500 deduction, if used in investment,
needs to be capitalized and amortized
Capitalization vs. Expense
• Goodwill - capitalized
• Add value to asset, prolong useful life capitalized
• Maintenance and repair that keep asset in
normal operating condition - expenses
• Capitalization of deductions - can elect e.g.
annual property taxes on unimproved land good if have NOLs in current year
Disallowance of deduction
• Illegal payments - bribes to government officials,
kickbacks/rebates/bribes under
medicare/medicaid, payments of fines and
penalties, damages under anti-trust lawsuit. Bribes
to foreign government is illegal if it is prohibited
under the Foreign Corrupt Practices Act. Bribes to
other people are illegal if it is unlawful
• Expenses related to illegal activity is deductible if
income is included. Exception - drug trafficking
• Political contributions and lobbying expenses
except at the local level and is a direct interest to
the taxpayer’s business
Disallowance of deduction
• Business start-up expenditure e.g. bus. Investigation
expenses, preopening or start-up costs - need to capitalized
and amortized
• Expenses on entertainment facility is not deductible exception - can deduct if facility is for the benefit of the
employees
• Club dues for bus., pleasure or recreation is not deductible
• Wash sales - not deductible if a loss is realized on
securities that are identical and was acquired 30 days
before and after it was sold. Prevent creation of artificial
loss. Identical security means similar in terms, can differ
in maturity.
Disallowance of deduction
• Transactions between related party - cannot deduct loss on
sale of property or expenses unpaid at the end of year
(accrual vs. cash)
• Concept of constructive ownership - if an individual owns
stock in ABC corp and its business partner also owns stock
in ABC, the ownerships will be combined to test for
related party transactions
• Hobby losses - not deductible for AGI - only from AGI
• Office in home - generally not deductible except if office is
regularly and exclusively used as 1) principal place of
business and 2) meets and deals with clients