Personal Tax Planning

IRS Form 1040

The basic income tax form that is the basis for calculating personal income tax.

Basic Steps to Income Tax Calculation

1. Determine Filing Status
2. Determine number of personal examptions
3. Add up income from all sources (Gross Income)
4. Make Certain Adjustments to Gross Income (AGI)
5. Subtract from AGI the standard deduction or the dollar amount of itemized deduction

Married filing jointly

Taxpayer must be legally married on the last day of the tax year.
Or be a widow or widower in the year of the spouse's death (and for 2 years afterwards if he or she continues to provide a household for the dependent child and remains unmarried).

Innocent Spouse Relief

When married filing jointly, spouses are considered 1 taxpayer, and are jointly and severally liable for any taxes owed.
In certain cases, where one spouse misfiles taxes without the other spouse having "actual knowledge or reason to know" about the misfi

Same Sex Marriages

If a same sex couple is married in a state the recognized the marriage, the couple will be treated as married under the federal tax law, even if they move to a state that does not recognize same-sex marriage (2013).

Single Taxpayer

Unmarried, divorced or legally separated on the last day of the tax year.

Marriage Penalty

In some tax brackets (starting with the 25% bracket and moving up) married people who both have income pay more that if they were not married and filed singly.

Head of Household

Single (or have lived away from your spouse for the last 6 months of the tax year), and provide for at least half the cost of providing a household that is the principal place of abode for a child or dependent for at least half the year.
More favorable st

Married filing Separately

A married taxpayer must file a separate return from his or her spouse. Usually taxes will be higher than if filing jointly because many limitations to the tax law apply to those who use this filing status.
However, it does avoid the joint liability of mar

Personal Exemption

Every tax payer is entitles to one personal exemption unless he or she is eligible to be claimed as a dependent on another tax payer's return.
One exemption may also be claimed for each dependent child, for each additional qualifying dependent, and for th

Dependent Definition

1. Must be a citizen of the U.S., Canada, or Mexico
2. Must not file a joint return with another tax payer unless that return was filed in order to claim a refund.
3. Must not claim another person as a dependent.

Children and (and spouse's children) qualify as Dependent's If...

1. Under 19, or under 24 if a full time students for at least 5 months during the year, or any age if permanently and totally disabled, AND
2. Lives with the taxpayer for more than half the year, AND
3. Does not provide more than half of his or her own su

Children and other family members who fail to meet the 4 part test can qualify as dependents the following are true:

1. The taxpayer or taxpayer's spouse provides more than half of their total support, AND
2. Their income is less than $4000.

Nonfamily members will qualify as dependents can still qualify as long as the following are true:

1. The nonfamily member lives with the tax payer, AND
2. The taxpayer or taxpayer's spouse provides more than half of the individual's total support, AND
3. The dependent's income is less than the $4000 exemption amount.

Total Support

The definition to determine dependent status includes any third party benefits (AFDC, Social Security, etc.) if the benefits are spent on the potential dependent's normal living expenses.

Unclaimed Children

If a child can be claimed by a parent, but no parent claims the child, no other taxpayer can claim the child unless the other taxpayer's AGI exceed's the highest AGE of the child's two parents.

Gross Income includes (but is not limited to)

1. Compensation for services in whatever form received
2. Gross income from business after reasonable and necessary expenses are deducted
3. Gains from dealings in property
4. Interest
5. Rents
6. Royalties
7. Dividends
8. Alimony and Separate Maintenance

Gross Income Excludes

1. Death proceeds from Life Insurance
2. Benefits paid from a life insurance policy to those who are terminally ill.
3. Return of investment on annuity contract.
4. Worker's comp. payments
5. Damages received because of physical injury or illness
6. Reimb

Gross Income can be reduced by

Losses in capital transactions (up to $3000 with carry over available), business activities, and farm operations.

Separate schedules are required for:

1) Calculating Capital Gains and Losses
2) Business Income
3) Farm Income or Loss
4) Taxable Income from Pensions, SS, Rents, Royalties, and Partnerships

Adjusted Gross Income (AGI)

Used by individuals but not corporations.
Used to determine:
--limits on itemized deductions for medical expenses, casualty losses, and charitable contributions
--limits on Tier II itemized deductions
--Whether IRA contributions are deductible, and if Rot

Converting Gross Income to AGI

Involves making the following adjustments (aka Above the line deductions)
--IRA deductions
--Student Loan Interest
--Moving Expenses (unreimbursed by employer)
--50% of self employment taxes
--100% of self employed health insurance premiums
--Self-employe

Student Loan Interest Deduction (above the line)

- Loans must be incurred for tuition, fees, room and board, supplies, and related expenses for higher education.
-Loans can be take out by taxpayer, and his or her spouse or dependents, but the interest deduction can only be taken by the person responsibl

IRA Deduction (above the line)

May be claimed by taxpayers who are not active participant in employer-maintained retirement plans.
Some active participants and spouses may claim the deduction (subject to phase out limits).

Medical Expenses Deduction

The amount spent on medical expenses in excess of 10% of AGI can be deducted as an itemized deduction, including:
--Prescription Drugs and Medicine
--Eye Surgery, Eye Exams, and Eye Glasses
--Insurance Premiums for Long Term Care and General Health Care o

Medicare Expenses Deduction -- over 65

If the taxpayer or spouse reached age 65 or older by the end of 2013, then they can use the 7.5% AGI threshold rather than the 10% threshold, through the end of 2016.

Deductible Taxes

State and local taxes, personal property taxes, and real estate taxes, and state and local sales tax (in lieu of a state or local income tax) may be taken as an itemized deduction.
There is no deduction for excise taxes, vehicle registration frees, or sim

Mortgage and Consumer Interest Deductions

Mortgage interest on the principal and second residence is deductible as an itemized deduction up to a maximum acquisition cost of $1 Million.
Interest on home equity loans, up to a maximum of $100,000 is also deductible.
Consumer Interest like credit car

Mortgage Insurance Deduction

For taxpayers whose AGI is less than $100,000, Payments made for mortgage insurance on houses purchased in 2007 or later are completely deductible.
For every $1000 above $100,000 ($50,000 if married filing separately), the deduction is decreased by 10%, a

Charitable Contributions

Constitute an itemized deduction, and can be itemized up to 50% of taxpayers AGI.
If the property transferred is long term capital gain property - then the limit is 30% of AGI. The deduction is the FMV of the property, and no capital gains tax is due.

Charitable Contributions from IRA

Contributions to charity can also be made from an IRA, up to $100,000 annually if the IRA owner is over 70 1/2... in which case the deduction does not apply, but the distribution--which meets RMD requirements, is not taxable.

Casualty and Theft Loss Deductions

Losses due to fires, floods, storms, car accidents, boat accidents, and many other unexpected events constitute casualty losses.
The allowable deduction for a casualty loss is calculated by subtracting $100 from the amount of each loss, adding together th

Tier I Miscellaneous Deductions

taxpayer gambling losses to the extent of gambling winnings.
Impairment-related work expenses incurred by handicapped individuals in order to be able to continue to work.
Tier I items are fully deductible.

Tier II Miscellaneous Deductions

Items associated with generation of earned and unearned income -- union dues, costs of uniforms, unreimbursed employee business expenses, business use of a home office (when tax payer is an employee), investment advisory fees, tax preparation fees, safe d

Itemized Deduction Phaseout (aka Pease Limitation)

Begins with AGI of $259,400 ($311,300 for married couples filing jointly).
Reduces Itemized Deductions by 3% of the amount by which AGI exceeds the threshold, with a maximum of 80% reduction in the otherwise allowable itemized deductions -- excluding medi

Personal and Dependent Exemptions

Subtracted from AGI after itemized or standard deduction is taken. A taxpayer may take one for him or herself, one for his or her spouse, and one for each dependent.
Subject to a phaseout at $259,400 ($311,300 for MFJ) of 2% of the exemption for every $25

Taxable Income

AGI minus deductions (standard or itemized) and personal exemptions.

Applying Tax Credits

After the tax liability is calculated using the taxable income, applicable tax credits are applied to to the tax liability on a dollar for dollar basis.

Child and Dependent Care Tax Credits

Include cost of day care, nursery school, babysitters, housekeepers, etc.
A tax credit is allowed for taxpayers who maintain a household for a dependent under age 13, a dependent incapable of self-care, or a spouse incapable of self-care.

Child and Dependent Care Tax Credit Calculation

Up to $3000 of qualifying expenses for taxpayers with one dependent, and $6000 for taxpayers with two or more dependents.
From there, the credit is calculated as:
35% of qualifying expenses for AGI up to $15,000. It is decreased by 1% for each $2000 (roun

Daycare FSA Accounts

Any amount contributed to a daycare FSA account reduces the maximum amount of eligible expenses on a dollar for dollar basis.
So if a parent with two young children contributed $4000 to a daycare FSA this year, she could only claim $2000 of eligible expen

Child Tax Credit

A $1000 tax credit that is available for each qualifying dependent child who is under 17 at the close of the tax year.
Children, stepchildren, and foster children who live with the tax payer for at least half the year are eligible.
The credit is phased ou

Other available tax credits

Adoption expenses, tuition costs, and taxes paid on foreign earned income, healthcare exchange purchases (aka premium credit)

Refundable Tax Credits

Can reduce a taxpayer's tax liability to below zero, resulting in a refund.
Child Tax Credit, Earned Income Credit, the American Opportunity Credit, and Premium Credit are refundable tax credits.
All other tax credits are nonrefundable (can reduce liabili

Adding other taxes to tax liability

The last step in calculating the taxpayer's liability to the IRS is to add in any other taxes for which the taxpayer is responsible.
This includes, but is not limited to self-employment tax, AMT, and taxes on IRA transactions (like the 10% penalty for ear

Self-Employment Tax

Consists of the SS tax and Medicare Tax.
For 2016: 12.4% for SS up to $118,500, and 2.9% for Medicare. Both are applied to NET Self-Employment Earnings. (Plus the additional 0.9% for high income earners).

Net Self-Employment Earnings

92.35% of the total self-employment earnings.

3 Ways to keep taxes as low as possible

1) Avoidance - finding legal ways to not pay
2) Deferral - Delaying income to a later date
3) Conversion - Changing income from one type to another which will have a lower tax rate.

Avoiding Taxes

Not the same as tax evasion, which is a federal crime.
Entails maximizing the use of types of income that are excluded from tax, and ensuring all possible deductions and tax credits are applied.

Tax Deferral

Deferring Income or Accelerating deductions delays the time until taxes will be due.

Conversion of Income

Generally means finding ways to change ordinary income into more favorable taxed long term capital gains.

Transferring Income Producing Property

By transferring income producing property to family members with lower tax rates, (as long as the transfer is legitimate and the property, rather than a person or service is producing income).
This must be coupled with an understanding of gift and estate

Net Short Term Gains (less than 1 year)

Treated as ordinary income and taxed at the taxpayer's marginal tax rate.

2 Classifications of Property

Real Property (Realty)
Personal Property (Personalty)

Real Property

Land or anything attached or added to land, such as buildings, fences, or parking lots.

Personal Property

All property that is not Realty -- such as machinery, office furniture, securities, etc.

Tangible Property

Has a physical existence that can be seen or touched -- like a car or bulldozer.

Intangible property

Has no physical existence -- for example, business goodwill, patent rights, accounts receivable, or securities.

Property is Classified According to Purpose in 4 Ways

1) Trade or Business Property
2) Income Producing Property
3) Inventory
4) Personal-Use property

Trade or Business Property

Used in business to produce income on a regular and continuous basis. For example, a factory machine.

Income Producing Property

Held for the production of income, but does not require a huge amount of management time and energy to produce income.
There is no distinction between trade/business property and income producing property in terms of cost recovery, but there is a distinct

Inventory

Property held for resale in the normal course of business. There are no cost recovery or depreciation deductions for inventory.
An example is a sweater produced in a sweater mill.

Personal Use Property

The owner of this property keeps it for personal enjoyment only. An example would be a boat used for recreational purposes only. It may not be depreciated or amortized.

Depreciation (Cost Recovery)

Is permitted on business and income producing property, with limitations.
Is NOT permitted on Inventory or Personal Use Property.

Use Splitting and Conversion

An asset's use may be split between the different categories of use, and the percentage allocated to each category can change from year to year.
Assets can also be converted from one use to another, for example turning a primary residence (personal use) i

Three types of Expenses in the Ownership of and Use of Assets

1) Never deductible.
2) Currently Deductible
3) Not currently deductible, but may be charged against over time (Capital Expenses)

Currently Deductible Expenditures

IRC Code Sec. 162 states that ordinary and necessary expenses incurred to carry on a trade or business are deductible to the taxpayer in the year they are incurred.
Examples include supplies, incidental repairs, and advertising, assuming they are legitima

Capital Expenses

Incurred when an individual acquires a piece of property, or pays expenses on improving property he or she already owns, and the benefits of the purchase extend beyond the current tax year.
The taxpayer is not allowed a full deduction for the expenses in

Improvements vs. Repairs

Repairs maintain or return a piece of property or other asset to its normal working condition -- they are currently deductible expenses
Improvements extend the expected life of a property or other asset, or prepare if for new use. Improvements are Capital

Basis

The purchase cost of an asset, adjusted by capital factors. It is used to determine the depreciation or amortization expense for the property for a given year.
It can be increased by capital additions, delivery, installation costs, commissions, and legal

Adjusted Cost Basis

Used to calculate the the ultimate gain or loss. It is the basis adjusted for any additions or adjusted down for any depreciation taken.

Basis of Gift Property

Is the donor's adjusted basis, provided the FMV is equal to or greater than the donor's adjusted basis.
If the FMV is less than the donor's adjusted basis, then the FMV will be used as the basis in a calculation of loss upon the disposition of the propert

Acquisition Costs

Are added to the Cost basis to calculate the adjusted basis:
1) purchase-related expenses such as commissions and legal fees
2) expenses involved in getting the purchase up and running, such as installation costs.

Basis of Inherited Property

When assets are received through inheritance, the deceased's basis is stepped up to the FMV at the date of death, or at an alternative valuation date (6 months after the date of death or an intermediate date corresponding to the disposal of the asset).

Basis of Converted Property

If property is converted from personal use to business use, its basis is the FMV at the time of conversion.

Depreciable Property

Property that gradually loses its usefulness.
This loss over time may be deducted by the taxpayer.
Land, Inventories, Stock-in-trade, and money instruments are not depreciated because they are not used up and don't lose their usefulness over time.

Modified Accelerated Cost Recovery System (MACRS)

ACRS was designed in 1986 to encourage businesses to invest in new tools, plants, and equipment in 1981, and was modified in 1986. At that time, the concept of using "useful life" for depreciation calculations was eliminated.

MACRS does not apply to

Intangible Property
Property that should be amortized
Property the owner elects to depreciate using a method not expressed in terms of years

MACRS period for depreciation of personal property

3, 5, 7, 10 years - specified acceleration rates.
15, and 20 years - 1.5 times straight line depreciation.

MACRS period for depreciation of real property

27 1/2 years, 31 1/2 years, 39 years
Depreciated on a Straight line Basis

The half year convention

Most often assets acquired by a client in a given year are treated as being acquired on July 1. Therefor, half-year depreciation is taken in the year of acquisition and a half-year in the year of disposition.
However, if more than 40% of the personalty is

Mid-Quarter Convention

If more than 40% of the personalty is acquired in the fourth quarter, the mid-quarter convention applies to all personalty.
The mid-quarter convention means that the acquisition date of the property is assumed to acquired in the middle of the quarter in w

Mid Month Convention

All realty acquired is treated as if acquired in the middle of the month it was acquired for depreciation purposes for the year. So an apartment building, whether purchased on June 3 or June 27th, would be treated as if it were purchased on June 15th for

Straight Line Depreciation

The deductible depreciation expense is uniform for the useful life of the property.
Annual depreciation is the the adjusted cost basis minus the salvage value, divided by the number of years remaining in the useful life of the item.
For property acquired

The Declining Balance Depreciation Method

Applies the depreciation rate against the non-depreciated balance. Assumes that an item is more useful/productive in its earlier years than in its later years of life.
For example, if an asset that costs $1,000 is depreciated at 25% each year, the deducti

Sum of Year's digits method of Depreciation

Another accelerated depreciation method. You use the following formula to calculate it:
Percentage = years of estimated life remaining/SYD
SYD = n(n + 1)/2 where n = estimated useful life

Double Declining Balance Method of Depreciation

The depreciation rate applied in year one is 2x what it would be in the straight line amount.
(Remaining Value x 2) / (years over which depreciation occurs)

Automobile (5 year) depreciation limits

$3,160 in year 1 (really half a year)
$5,100 Year 2
$3,050 in Year 3
$1,875 in all subsequent years
Truck and Van limits are slightly higher.

Part-Time Business Usage of Automobiles

For business usage between 50% and 100% depreciation is prorated for the percentage of usage (using double declining balance).
For business usage less than 50% only the straight line method can be used.
If business use starts above 50% but converts to bel

Standard Mileage Depreciation

A taxpayer using a vehicle for business may elect to compute the deductible costs by using the standard mileage rate -- which is 54 cents per mile.
This deduction takes the place of depreciation, gas, tires, oil, repairs, and insurance.

Amortization of Intangibles (IRS Sec. 197)

Certain intangible assets acquired after 1993 may have their costs recovered ratably over a 15 year period (aka amortization)
Intangible assets that are eligible to be amortized include goodwill, patents, copyrights, and customer lists.

Start Up Expenses

Taxpayers can deduct the first $5,000 of startup expenditures in their first year of business (unless startup expenses exceed $50,000, in which case the $5,000 is reduced dollar for dollar on the amount in excess).
All remaining startup expenses are amort

Bonus Depreciation Eligibility in 2016

For property placed in service after Dec. 31, 2015, 50% bonus depreciation is available for qualified property that meets the following requirements:
New MACRS property with a recovery period of 20 years or less, computer software, water utility property,

Bonus Depreciation Calculation

Let's say the property is worth $1,000,000.
The bonus is subtracted from the basis after any 179 current expense deductions, and before MACRS depreciation is calculated, and is in addition to the MACRS depreciation amount.

Currently Deductible Expenses

Section 179 of the IRC permits a taxpayer to treat all or part of qualifying property as a currently deductible expense, up to $500,000 or the taxable income of the business for the year plus any outside earned income of the taxpayer, whichever is less. (

Currently Deductible Expense Carryover

If the currently deductible expense amount exceeds $2M or the taxable income of the business plus any outside earned income of the taxpayer, the amount not eligible for the deduction can be carried forward.

Partial Section 179 Expensing

Is available for mixed-use property, as long as it is used more than 50% in trade or business.

Section 179 Expensing is not available for

1) Property used in production of income (example: furnishings in a rental apartment)
2) Property acquired from a related party (example: members of the same family, a corporation, and any 50% or more shareholder)
3) Property acquired as a gift or bequest

Section 179 SUV, Truck, Van Limitations

$25,000 is the maximum amount of a section 179 deduction that can be taken for SUVs, trucks, or vans.
Luxury automobiles are not eligible for a section 179 deduction as they are limited by the luxury auto rules.

Section 1231 Property

Section 1231 Assets are most of the assets used in a taxpayer's business or held for the production of income which are eligible for a depreciation allowance.
The assets must also meet long term holding period requirements of more than 1 year.

Not included in Section 1231

Inventory, Stock-in-trade, money instruments (stocks, bonds, notes), copyrights, artistic creations in the hands of the creator or donee, and certain other special items.

1231 Assets can be divided into two property classes

Section 1245 and Section 1250 Assets

Section 1245 Assets

1. Tangible and Intangible Personal Property which has been subject to the depreciation allowance
2. Nonresidential real property placed into service between 1981 and 1986

Section 1250 Assets

All depreciable real property that is not a Section 1245 asset.

Disposition of 1231 Property

1) If there is a loss on the sale of the property, there is no recapture of depreciation, and it is Section 1231 ordinary loss.
2) If the property has been held for less than 12 months, any and all depreciation claimed is, to the extent of any gain, recap

Selling Section 1245 Property

All or part of the gain is taxable as ordinary income or capital gain. The portion taxable as ordinary income is that part which results from the depreciation taken on the property.
In short - any gain that is less than or equal to the amount of appreciat

Selling Section 1250 Property

Only the part of the depreciation which is in excess of the straight line method will be taxed as ordinary income.
Any depreciation captured with the straight line method, or any other gain not accounted for by depreciation, is taxed as capital gain.

Taxing real property depreciated with MACRS

MACRS depreciates all real property on a straight line basis, so there is no "excess" depreciation.
Instead, any gain realized to the extent of depreciation is taxed at the 25% rate, and the remaining gain is taxed at the 15% capital gains rate.

Like-Kind Exchanges and Depreciation

Do not trigger depreciation recapture

Inheriting Property

Does not trigger depreciation recapture

Section 1231 Netting

All Section 1231 gains or losses within a year (whether short term or long term, ordinary or capital, 1245 or 1250) are combined to determine if there is a net gain or loss.
A net loss is treated as an ordinary loss.
A net gain is treated as a capital gai

Realized Gain on a Sale

Amount Received minus the adjusted basis.
The amount received may be a cash sale price, but it can also include property received or debt assumed by the buyer.

Like-Kind Exchanges

Nontaxable exchanges of property of similar (like-kind) property.
The basis for the old property is carried over and becomes the basis for the new property, though some adjustments can occur in the like-kind exchange.
Tax law treats the exchange as if no

Like-Kind Properties

Those properties that are similar in nature and character.
It must be qualifying property, which is either held for investment use, or in a business or trade.
It does not include inventory, securities, or personal-use property.
Although domestic realty ca

Boot

It is often impossible for a client to find an exactly similar property to exchange with another.
In this case, other assets (boot) are involved to equalize the deal. It can include cash, securities, inventories, a mortgage, or any other non-qualified pro

Exchanging Mortgages

If 2 parties exchange mortgages on the property traded in a like-kind exchange, the party assuming the mortgage of the lesser amount is in receipt of taxable income, equal to the difference between the two mortgages.

Realized and Recognized Gain in a True Like-Kind Exchange

If no boot is involved, the gain recognized (the amount that is currently taxable) on a like-kind exchange is 0.
But the gain realized (The amount of improvement in economic position) is the difference between the FMV of the property transferred and the b

Losses on a Like-Kind Exchange

You cannot recognize a loss on a like-kind exchange.

Substituted Basis

The substituted basis is:
the FMV of the like-kind property received
minus the gain not recognized.

3 and 4 way like-kind exchanges

Are permitted, often with one buyer wanting to sell using a like-kind exchange, so they agree to the exchange if the buyer can find a suitable property to buy and exchange it for.

Like-Kind Exchanges with Related Parties

A client may exchange properties with a related party such as a controlled corporation or partnership, but both parties must retain the property for 2 years, or risk having the exchange treated as a normal sale.

Nonsimultaneous (AKA "Starker") Exchanges

Also involve a third party, but are even more flexible.
A client sells a property and designates a third party, such as an escrow agent or a facilitator to receive all of the proceeds.
As long as the seller has no access to the proceeds, he or she can des

Exclusion of Capital Gains on a Principal Residence (Taxpayer Relief Act of 1997)

Single Taxpayers can exclude up to $250,000 of capital gains on their principal residence when they sell it (MFJ $500,000).

Conditions for Principal Residence Exclusion

Can be used more than once, but nor more often than every 2 years. (Unless a job change, health condition, or other unforeseen circumstance require the move).
Property must have been owned and used as a personal residence for at least 2 of the preceding 5

Qualfications for Principal Residence Exclusion Prior to 2 years ownership

Job Change, Health Condition, Unforeseen Circumstance
The amount of the exclusion is reduced in proportion to the length of time the taxpayer lived in the residence. (# of months in house/24 months)(Full Exclusion Amount)

Rules for Widows

Widowed spouses are able to claim the full $500,000 exclusion when they sell their primary residence where they lived with their deceased spouse if the house is sold within 2 years of the deceased's spouse's death.
The surviving spouse is allowed to claim

Depreciation Claimed on Primary Residence

Any depreciation claimed after 1997 cannot be part of the exclusion of gain from sale. Thus the taxpayer has to recognize gain to the extent of depreciation deductions for rental or business use of the property.

Excess Gain on Principal Residence

Any gain in excess of the exclusion amount may be subject to the additional 3.8% Medicare Tax on Unearned Income in addition to the regular capital gains tax imposed on the income.

Installment Sales

Require payments on the purchase of property to be made over more than 1 year, and they are a good strategy for taxpayers wishing to delay the recognition of income from the sale of property.
Losses may not be recognized under an installment sale, and ins

Installment Sales to Related Parties

The property given in exchange for the installment payments may not be sold within 2 years of the purchase date.

Installment Receivable as Collateral

If an installment receivable is pledged as collateral for a loan, then all of the gain on the original sale is included in income in the year that the receivable is sold or pledged.

Depreciation Recapture on Installment Sales

Any depreciation recapture must be immediately included in income, even with an installment sale.

Gross Profit Percentage

Capital Gain/Total Sales Price
Multiplied by the amount of payment in an installment payment to determine how much of each payment is subject to tax.

Imputed Interest

Will be calculated as a portion of the deferred payment being made on an installment payment, whether it is actually charged or not. The seller must recognize as taxable income the imputed interest included in the payments each year.

Opting Out of Installment Sale Treatment

Installment Sale Treatment is Automatic when a payment toward a purchase occurs after the year of sale, but it can be opted out of. Once the seller opts out, this choice is considered irrevocable.
Sellers who may want to opt out of installment reporting a

Ineligible for Installment Sales

Installment Sale treatment is not available to dealers in real or personal property (who hold and sell that property in the normal course of business) unless it is used in farming or consists of time shares or residential lots.
The sale by non-dealers wit

Non-reimbursed Casualty Losses

Are includible in itemized deductions to the extent that each loss exceeds $100 and the total loss amount in more than 10% of the taxpayer's AGI.
An insurance claim MUST be filed if the property is covered by insurance in order to be eligible for the dedu

Valuing Casualty Losses

FMV Before Casualty minus Fair Market Value After Casualty

When can Casualty losses be claimed?

Only in the year that they are sustained, unless the loss is due to theft or embezzlement not discovered until a later year. In these cases, the loss must be claimed in the year of discovery.

Casualty Gains

If an insured involved in a casualty receives reimbursement payments in the amount greater than their adjusted basis in the property, then he or she must report the gains as income in the year the reimbursement is received.
The gain can be postponed if th

Basis in Property Purchased with Casualty Gains

Cost of the Purchased Property minus the amount of casualty gain postponed.

Involuntary Conversion

A process where a taxpayer is involuntarily forced to dispose of property that has been stolen, condemned, destroyed or repossessed, and another piece of property or cash is received in lieu of the property.

Recognized Loss on an Involuntary Conversion

Can occur if the property that in involuntarily converted is used in trade or business, or held for the production of income.
Loss is also available to the owner of personal use property, but only if the involuntary conversion is due to casualty or theft.

Involuntary Conversion Gains

If a gain results from an involuntary conversion, the taxpayer may defer recognition of the gain by the purchase of qualified replacement property within the specified replacement period
Replacement Property must be similar or related in use to the origin

The Specified Replacement Period for Involuntary Conversion

The earlier of the date that the property was stolen, destroyed or condemned, or the date that condemnation was threatened and extending 2 years beyond the end of the tax year in which the gain was realized.
For business and investment real property, the

Tax Reform Act of 1986

Severely restricted the ability of taxpayers to use tax shelters.

Tax Shelters

Basically depend on their ability to assign certain income, expenses, and gains or losses to specific taxpayers who stand to gain the most tax advantage from the assignment.

Direct Participation Programs (DPPs)

Investments that generate tax benefits for the investor in the form of losses or credits that may be used to reduce taxable income.
Function as tax conduits which flow through items of income, expense, and gain or loss.

Special Allocation

Under DPPs, items of income, expense, gain, or loss do not have to be allocated pro rata among all shareholders.
Special Allocations will be allowed only if there are economic reasons or justifications. The economic effect of these allocations is the test

Special Allocation Justification

Involves keeping track of capital accounts which show the allocation, and upon liquidation of the partnership:
1) Partners with negative capital accounts must restore them to 0, and
2) Distributions are then made on the basis of the capital account balanc

Borrowing and Tax Shelters

Borrowing can be used by tax shelters to magnify the tax advantages passed through to owners.
For example, by accepting $100,000 of money from investors, and borrowing an addition $900,000, a conduit entity can create losses on $1 million that would great

At Risk" Rules (TRA 1986)

The taxpayer's loss deduction is limited to the amount he or she has at risk at the end of the tax year. The amount at risk is determined by:
1) Adding the cash and property contributed to the entity.
2) Adding the owner's share of activity, or the entity

Who do "At Risk" Rules apply to?

At Risk Rules apply to Direct Participation Programs. Individuals, Trusts, and certain closely held regular and personal service corporation are subject to passive activity rules.
In general, they do not apply to C corporations, provided they are not clos

Active Income

The recipient must be able to show material participation in the activity generating the income. Salaries, wages, bonuses, and self-employment income are all examples.

Portfolio Income

This includes income from traditional investment activities, such as interest income, dividends, and capital gains or losses generated from purchasing securities.

Passive Income

Income received from tax-sheltered investments in which the taxpayer does not materially participate or has limited participation.
Typically comes from limited partnerships or rental real estate activities. Specifically, income or loss from trade, busines

Rental Income for a Tax Payer who actively participates

Can be offset up to $25,000 in passive losses from the activity against non passive income. The maximum amount deductible is reduced by 50% of the taxpayer's AGI in excess of $100,000.

Passive Losses

Cannot be used to offset either portfolio or active income.
Passive losses may only be used to offset passive income, and excess losses can be carried forward to offset passive income in future years.
Passive losses can be used to offset active or portfol

Publicly Traded Limited Partnerships (PTLPs)

Passive losses from a PTLP cannot be used to offset passive income from any other source (including passive sources) and passive gains from a PTLP cannot be offset by losses from any other source.

2 Types of Passive Activities

Activity for Profit where the taxpayer does not materially participate in the activity.
Rental activity, or activity that generates payment for the use of any kind of tangible property, rather than payment as compensation for substantial services.

Material Participation

Regular, continuous, and substantial involvement in operations on an active, year round, basis.

Rental Activity - Passive Rule Exceptions

Short Term (less than 7 days) rentals (cars, vacation homes, hotels).

Material Participation Requires at least one of the following

1) Participation in the activity for more than 500 hours per tax year.
2) Participation wherein the individual supplies substantially all of the business services for the activity.
3) Participation for more that 100 hours per year, which is greater than t

Real Estate Professionals

Are not subject to passive income rules on real estate rental income and loss.
To qualify as a professional, the real estate agent must participate materially in the real estate rental activity and must provide more than 750 hours of services and more tha

Active Participation in Rental Activities

Less rigid than the material participation requirement.
Requires making active management decisions, such as approving tenants, approving lease terms, and approving major repairs, and active participation requirements can be met even if an agent handles t

Active Participation Exceptions

For active participants in real estate investments, up to $25,000 in real estate losses may be deducted from nonpassive income.
This is phased out at a rate of one-half the taxpayer's AGI in excess of $100,000, and is therefore completely phased out at AG

Working Interest Oil and Gas Property

The investor who has a working interest (the burden of the costs of acquiring, developing, and operating a property, and who has liability for tort losses) in an oil and gas property are exempted from passive loss rules.
There is no limit or phaseout prov

Additional Real Estate Exception

Costs associated with rehabilitation of older, historical homes, or low-income rental housing allow for passive loss credits to be used (within limits) to offset nonpassive income.

Rehabilitation of Older Homes

A 10% credit is provided for costs of rehabilitation of a home placed into service before 1936 (20% for historic structures).
To qualify for this credit, the structure must remain on the same site and keep 75% of the existing external walls and 75% of the

Construction and Rehabilitation of Low Income Housing

The 1986 TRA provides credits for the construction or rehabilitation of low income housing (qualifying units cannot be use on a transient basis -- hotels, dorms, hospitals, nursing homes, and retirement facilities do not qualify).
The maximum credit to of

Closely held corporation

A corporation which, in the latter half of the tax year, has five or fewer individuals holding more than 50% of the stock.
Closely held corporations which are not personal service corporations are allowed to offset active income, but not portfolio income,

Ways to structure direct participation investments

Partnerships, S - Corporation, LLC, or fractional direct ownership.
Limited partnership is the form most often chosen because of the limited liabilities of the limited partners.

Disadvantages of structuring a direct participation program as a limited partner.

It is illiquid --- partner mist wait until completion of the partnership or termination to get back his original investment (assuming the partnership is successful)
Limited partners cannot participate in the management of the venture.
Partners can deduct

Special Allocations of Income and Deductions

Direct Participation Programs can allocate various items of income, deductions, and credit to the partner who will benefit the most, as long as the allocations have substantial economic effect (can't just be for tax avoidance).
The exception is that S cor

Substantial Economic Effect Test

The test is met if
a) Capital accounts are kept which reflect the allocation of expenses, income, and credits
b) Upon liquidations, partners with negative capital accounts must restore them to zero.
c)Distributions are then made on the basis of the capita

DPP Holding Period

Most Direct Participation Programs have holding periods of at least 5 years - making them illiquid. They are only appropriate for clients who will not need the funds committed ruing this period.

Death while invested in a DPP

If a taxpayer dies before disposing of a DPP investment, only the amount of previously disallowed loss that would have been deductible if the vehicle had been sold becomes deductible.

If a DPP interest is gifted

Any previously disallowed losses are added to the basis of the property. The donor has no deduction, but passed on the accumulated losses to the donee.

AMT and Passive Losses

All passive losses deducted by a taxpayer can cause preference items in calculating the AMT that may be applicable to the taxpayer. This must be taken into consideration when determining whether a tax shelter is an appropriate tool for a client.

Investment Interest Expense Deductibility

TRA 1986 states that net investment interest expenses are only allowed up to the net investment income (interest, dividends, and capital gains).
However, dividends and capital gains are only included to the extent that the taxpayer elects to have them tax

Investment Interest Expense

The interest on money you borrow to purchase taxable investments. For example, you can deduct the interest on a margin loan you use to purchase stock, but not if you use the margin loan to buy a car or tax-exempt municipal bonds.

Net Investment Income

The total investment income minus allowable investment expenses (other than interest).
Essentially, it is the amount remaining after the application of the 2% AGI limitation on itemized deductions.

Allowable Investment Expenses

All investment expenses (other than interest) minus 2% AGI adjustment.

Investment Interest Expense Carryover

If investment interest expenses are in excess of the net investment income, then any excess is disallowed in the current year but may be carried forward to future years.

Vacation Home Rules

If personal use of a vacation home exceeds 14 days or 10% of the rental days, then expenses must be allocated between personal and rental use in the following order:
1) Direct expenses (e.g. advertising and management fees) of the rental are used to offse

Pure Investment Vacation Home Rules

If a taxpayer holds a property as a pure investment property (no personal use), then there is no residence test.
He or she can then use the rental to generate "expenses for the production of income," which can result in a tax loss that becomes a deduction

Life Insurance Taxation

Proceeds of all policies payable by reason of death are excluded from the beneficiary's gross income.
If a policy owner surrenders a life insurance policy for its cash value, the difference between the cash value payable and the policy-owner's cost basis

Life Insurance Deductibility

Life Insurance Premiums are not deductible when paid by someone for coverage on his or her own life.
A business can deduct the premiums paid for life insurance covering its employees if the amount paid is included in the reasonable compensation of the emp

Life Insurance Dividends

Are treated as nontaxable refunds of nondeductible premiums.

Life Insurance Investment Income

The annual accumulation of investment income during a policy owner's lifetime is income-tax-deferred. If the insured dies without surrendering the policy for its cash value, then the IRS never collects any tax on the investment income. It is essentially t

Installment Payments of Life Insurance Policies

Installment payments of both lump-sum death benefits and cash surrender values are treated more favorably than other investments.
Investment income left with the insurance company for future installment payments is not included in the payee's gross income

Life time annuity payments on Life Insurance

In the case of a life-annuity, the government requires the use of an exclusion ratio. The amount excluded it the return of capital indicated by the ratio of the payee's investment to the payee's expected return.
For example: a $20,000 death benefit is con

Transfer-for-Value Rule

The transfer of a policy for valuable consideration makes the policy's death proceeds taxable income to the extent that the proceeds exceed the consideration payed for the policy.
The rule does not apply in the following situations:
1) If the policy benef

Exchanges

A life insurance replacement is not a taxable event under the IRC if the life insurance policy is exchanged for another life insurance policy or annuity.

Single Premium Life Policies

Are purchased with a large lump-sum premium. At one time, these were very attractive because the cash value grew on a tax deferred basis.
Since 1988, these single premium policies may be classified by the IRS as MECs, in which case, withdrawals are taxed

For a death-benefit to qualify for tax-favored life insurance treatment, it must meet these 3 requirements

1) It must qualify under applicable state law as life insurance.
2) The cash surrender value cannot exceed the single premium needed to fund future benefits.
3) A comparison between the cash surrender value and the death benefit must be within an acceptab

Endowment Contracts

Pays a lump sum at the end of a fixed period. May be a life insurance contract if it meets all of the requirements, but usually it fails the test because the cash surrender value is too high in relation to the death benefit.

Modified Endowment Contracts

Defined by the Technical Corrections Act of 1988.
A policy is classified as a MEC if the premiums paid within the first 7 years exceed the total of 7 annual level premiums which would buy a policy of the same value.
Applies to all contracts issued after 1

Material Changes" to a Life Insurance Contract

Policy Exchanges, Conversions from Term to Permanent, Increases in future benefits, Increases of more than $150,000 in death benefits.
After material changes happen, the 7-premium test for a MEC must be reapplied, and policies that fail the test are class

Taxation of Cash Distributions

Borrowing from the interest of a life insurance policy is not a taxable event unless the policy is classified as an MEC.
If the policy is an MEC, any cash distribution up to the amount of inside buildup (investment income) is taxable as current income.
Di

Taxation of MECs

Withdrawals are taxed on a last-in, first-out basis (meaning all investment income is the first income to come out, and must be included in the taxpayer's gross income, before any of the money coming out can be considered a return of premium), and there i

Taxation of Surrendered Life Insurance Contracts

If a permanent life insurance contract is not a MEC when it is surrendered for cash value, then the difference between the cash surrender value and the total of premiums paid over the contract's life is considered income to the recipient.
Loans against th

Annuity Taxation for Lump Sum Distributions

Lump Sum withdraws from deferred annuities are subject to much the same treatment as MECs.
After 982, any cash withdrawal from an annuity accumulation account prior to age 59 1/2 is subject to a 10% penalty. Lump sum withdrawals up the amount of inside ac

Income Tax Treatment of Fixed Annuities Payments received during the payment period.

Similar to Life Insurance Installment treatments. Annuity payments are subject to an exclusion ratio.
Total Premiums Paid/Expected Return = Exclusion Amount
Expected Return = Annual Payment x Life Expectancy.
Any remaining amount of the annuity payments i

Other Tax Considerations with Annuities

Annuities have the advantage of tax deferred growth, but premium payments are not currently deductible like contributions to a retirement plan are.
Also, all income received from an annuity (in excess of premiums paid) is ordinary income taxed at ordinary

Variable vs. Fixed Annuity

In a variable annuity the dollar amount of the periodic payout to the annuitant varies, depending on how successfully the insurance company invests the money in their aggregate account. The investment risk is accepted by the annuitant.
In a fixed annuity,

Taxation of Variable Annuities

The investment contract is divided by the number of years the annuity will pay benefits (life expectancy) to calculate the amount excluded from tax each year.

Short Term Assets (for gain and loss)

Held for 12 months or less. Gains are taxed as ordinary Income.

Long Term Assets (for gain or loss)

Held for more than 12 months, gains are taxed at long term capital gains rates.

3.8% Tax on Investment Income

The patient protection and affordable care act added a 3.8% tax on investment income for those tax payers with an AGI > $200,000 ($250,000 MFJ).
This effectively made the capital gain rate 23% for those in the 39.6% tax bracket, and 18.8% for those in the

Collectibles Capital Gains Rate

When a taxpayer sells collectible items, such as coins, artwork, antiques, and precious stones, the long term capital gains rates do not apply.
Instead, the taxpayer owes tax at their ordinary tax rate, with a cap of 28%. As is the case with all assets, s

Capital Gain on Unrecaptured Depreciation on Real Estate

Capital Gain attributable to unrecaptured depreciation on real estate (Section 1250 property) is taxed at a maximum rate of 25% (Ordinary Income rate if < 25%)
The gain on assets held one year or less is still treated as short term gain and is taxable at

Gain Loss Offset

Short Term Losses Can Offset Short Term Gains -- Results in Net Short-Term Gains or Losses.
Long Term Losses can offset Long Term Gains -- Results in Net Long Term Gains or Losses.
Net short term capital losses can offset net long term capital gains -- Re

Losses and gains from brackets with different tax rates

Long term losses are first used to offset long term gains taxed at the highest rate class (for example, a long term loss would first be used to offset a long term gain from the sale of collectibles at 28%, then real estate at 25%, then the general rate cl

Net Capital Losses and Ordinary Income

If a taxpayer has a net capital loss, the loss can be deducted from ordinary income, up to the lesser of the taxpayer's ordinary income or $3,000.
Any unused capital losses may be carried forward indefinitely to be applied against capital gains in future

Long and Short Term Losses in the Same Year

The net amount of loss is always limited to $3000 available to offset other types of income.
If a taxpayer has both long term and short term losses in the same year, then the up to $3000 of the combined losses can be used to offset other income, and the r

Redeeming Mutual Fund Shares

A taxpayer may choose to use any one of three methods to determine his or her capital gain or loss when redeeming mutual fund shares:
1) Specific Identification Method - The taxpayer identifies the specific shares being sold (usually the highest cost shar

The Average Cost Method

Is only available for calculating basis in mutual fund shares, it is not available with other securities.
Investor divides the total price paid for all shares of the mutual fund by the total number of shares owned. The total cost includes an dividends and

Telephone Transfer

Transfer of account balances from one account to another, or from payer to recipient made by telephone order, rather than traditional written authorization or instrument.

Transferring funds within a Mutual Fund Family

A transfer from one fun within a mutual find family to another fund within the same fund family is a taxable event.
The shareholder must report as taxable gain or loss the difference between his or her cost basis and the selling price each time such a tra

Wash Sale Rules

These exist to prevent a taxpayer from taking a loss on the sale of a security (or a substantially identical security) held for a relatively short period of time. (61 days - 30 days before, the day of sale, and 30 days after)
Losses incurred in a wash sal

Wash Sale Rules Apply To...

Investors, but not traders or dealers.
With the advent of online trading, more clients may fit the definition of a trader. To be considered a trader the trading must be frequent, and the time spent trading must be substantial.

Tax advantages of being considered a trader

1) Wash sale rules do not apply
2) Expenses become deductible for AGI, rather than as a miscellaneous itemized deduction (which is subject to the 2% floor) This includes the home office deduction if trading takes place at home.
3) Expenses incurred in tra

Tax Disadvantages of being considered a trader

All gains will be considered short term, and thus subject to higher tax rates.

Qualified Small Business Stock

The stock must be in a domestic C corporation (not an S corporation or LLC, etc.), and it must be a C corporation during substantially all the time you hold the stock.
The corporation may not have more than $50 million in assets as of the date the stock w

Qualified businesses do not include

Financial Services, Personal Services (health, law, accounting), farming, mining, hospitality.

Qualified Small Business Tax Advantages

Taxpayers other than C Corporations can take advantage of an exclusion from gains for QSBS.
If you've held stock qualifying as QSBS for at least five years when it's sold a portion of your gain can be excluded from federal tax.
The remaining capital gain

Percentage of gain on QSBS that can be excluded

Acquisition Period:
BEFORE FEBRUARY 18, 2009 50%
FEBRUARY 18, 2009-SEPTEMBER 27, 2010 75%
SEPTEMBER 28, 2010 AND LATER 100%

Other considerations with QSBS

For AMT Purposes, 50% of the amount excluded is treated as a tax preference item.
Within 60 days of the sale of QSBS the gain may also be rolled over into another QSBS and no gain needs to be recognized.

Section 1244 Stock

Stock issued for money by a small business corporation whose revenues are not primarily (more than 50%) from rents, royalties, interest, dividends, and gains on sales of securities.
Also, the corporation must have received lass than $1 million from the is

Tax Treatment of Section 1244 Stock

Losses on Stock qualified as section 1244 stock can be used to offset ordinary income of up to $100,000 (MFJ), and $50,000 for all other filers.
1244 treatment is only available to the original purchaser of the stock. It cannot be purchased on the seconda

Investment Income

For tax purposes, investment income (which can be offset by investment interest expense) only includes capital gains and dividends if the taxpayer elects to have these taxed as ordinary income, rather than at the lower capital gains rate.

Ordinary Dividends

--distributions of money or property
--made out of earnings and profits for the year or out of earnings and profits accumulated after February 28, 1913.
--taxable to the recipients to the extent that the dividends paid out are earnings and profits
--Any a

Distributions of Capital

Any dividend that is considered a distribution of capital is not taxable unless it is a distribution of property.
For example, if a liquor distiller paid the value of its dividends in the form of whiskey, then the value of the whiskey would be considered

Taxpayer Relief Act of 2012

Permanently set the qualified divided rate at the same rate as the long term capital gains rate.
The taxpayer must have owned the stock for at least 60 days, and the 60 days of ownership must be in the 120 day period that starts 60 days before the stock g

Ineligible Dividends

Mutual fund dividends are considered distributions of interest (short term capital gains) and are not eligible for this reduced rate.
Dividends from Money Market funds, REITs are not eligible for capital gains treatment.
S Corporation dividends are not el

Constructive Dividends

A concept in U.S. taxation in which various distributions to shareholders are not labeled as dividends but are still considered dividends by the IRS and taxed as such.
Dividend payments (and constructive dividends) are not an expense deduction. In effect,

Examples of Constructive Dividends

Excessive Royalties and Rents.
Securities Purchased by shareholders from the corporation at less than FMV.
The sale of corporate property to shareholders from the corporations at less than FMV.
Purchase of property from a shareholder at more than FMV.

Stock Dividends

Distributions of the corporation's own stock to its stockholders.
Stock dividends are usually not taxable, but are taxable when
1) the stockholders could have elected to take cash or corporate property instead.
2) The distribution is disproportionate
3) T

Disproportionate Distribution

Refers to when some stockholders receive cash, corporate property or preferred stock, while others receive common stock.

Employee Stock Options

Give the employee the right, but not the obligation, to purchase stock at a set price if certain conditions exist (usually an employment vesting period after receiving the option).
Can be qualified or nonqualified for tax purposes.

Incentive Stock Options (Qualified Employee Stock Options)

It must provide an exercises price which is at least the FMV of the stock on the date of grant.
Must be to purchase the stock of the employer, a parent, or subsidiary company, and must be issued to an employee who owns less than 10% of the company.
May no

Qualified Employee Stock Options Taxation (AKA incentive stock options)

Not taxable at grant or exercise. Upon the sale of the of the stock the difference between the price paid for the stock and the sale price is a long term capital gain, as long as it is held for the longer of 2 years since the date of the option grant, or

Non qualified options

Are included in the income of the employee when exercised, and the difference between the price paid for the stock and the FMV on the date of purchase is taxed as ordinary income.

Stock Rights

Certificates issued to stockholders, giving them the privilege (right) to subscribe to new issue of a corporation's stock.
Rights usually have a market value because they permit the stockholders to acquire newly issued stock for less than the market value

Taxable Stock Rights

Are treated as distribution of property and are valued at their FMV.

Nontaxable Stock Rights

Receiving a nontaxable stock right does not trigger a taxable event. Income taxes become payable only when the nontaxable right is sold or exercises and the stock is sold.
The stockholder's basis for the right is zero if the value of the right is less tha

Bond Right

A certificate issued to a corporation's stockholders that permits the holder to subscribe to a new issue of bonds.
Nonconvertible bond rights are taxable as a distribution of property dividends, at their FMV.
If the rights issued are for convertible bonds

Distributions of Corporate Property

May take the form of inventory items or the securities of other corporations.
The value of the distribution is the FMV of the assets distributed on the date they are distributed. The FMV is taxable as ordinary income to the extent that the corporation has

Liquidating Dividends

Dividends Received by stockholders in exchange for their stock.
The amount received by a stockholder is the redemption of his or her stock - taxed as a capital gain, to the extend that the amount received exceeds the stockholder's basis.

Redemption of Stock

An exchange of a taxpayer's stock in the corporation for cash or property.
Treated as the sale of a capital item, and is therefore not a dividend if one of the following conditions is met:
1) it is not essentially equivalent to a dividend (purpose, source

Dividend Taxability

Dividends received payable near the year end (Oct, Nov, Dec) are treated as having occurred before December 31st of that year, provided payment occurs before the end of January in the following year.
Dividends received (whether reinvested or not) are incl

Dividend Reinvestment

Change the investor's basis in his or her existing shares if the average cost method is used. But does not affect the basis calculation if specific identification or FIFO method are used.

Short Sale

An individual sells a security - usually borrowed from a broker, which he or she will replace at a later date.
If, in the intervening period, the price of the security drops, then the investor will realize a profit.
If, in the intervening period, the pric

Short Sale Taxation

Regardless of the time between the short sale and the replacement, the capital gain or loss realized is considered short term provided:
1) Identical or substantially identical property is acquired in the period between the short sale and its replacement.

Selling Short Against the Box

The short sale of securities already held by an investor.
It is used to defer gain or loss to a subsequent year.
For example, if an investor holds securities which cost $120,000 and could be sold for a FMV of $200,000 in the current year. To lock in his o

Limitations to Selling Short Against the Box

Under the Taxpayer Relief Act of 1997 an investor must clos a short-against-the-box sale before January 30 of the subsequent year.
If an investor delivers a long position to close a short position, the taxable gain will be treated as if it occurred the pr

When to buy Mutual Funds

Ideally, an investor should find out when a mutual fund plans to make a distribution and wait until after that distribution to buy the fund.
This is recommended because after the distribution the value of the shares will decline by the amount of the distr

Kiddie Tax

Applies to the unearned income of minors.
For minors under 19 (24 if a student), the unearned income is taxed to the minor, who is entitled to a special standard deduction of $1050 - so no taxes are due on this portion.
The next $1050 is taxed at the mino

Kiddie Tax with Earned and Unearned Income

If a dependent has both earned and unearned income, there is an additional rule regarding the standard deduction.
The allowable standard deduction is the greater of $1050 or Earned Income + $350 (up to the amount of the regular standard deduction, which i

Family Partnerships and Family S-Corporations

Other methods to complete intra-family transfers.
Neither one functions as a taxable entity, both function as conduits to distribute income from the family enterprise in direct proportion to each member's ownership in the partnership or corporation.
Thoug

Gifts of limited partnership shares

Because limited partnerships do not include control of a business, they can be significantly discounted (the value of the gift is less than the value of the underlying property.)
As a result, by using the annual gift tax exclusion, substantial ownership p

Gifting shares in Personal Service S Corporations

An advantage to using an S Corp is limited liability.
However, a disadvantage is that if income in an S Corp is mostly derived from the personal services of a few people (rather than from capital resources), but is distributed among family members, the IR

Gift Leasebacks and Sale Leasebacks

Gifting or sale of business or trade property to a lower-income family member. Following the property transfer, lease payments in proper amounts are made by the former owner to the new owner.
The payment is deductible by the former owner as a business exp

Clifford Trusts

Was designed to terminate after a minimum of 10 years and 1 day, or on the death of the trust beneficiary. The principal of the trust, at its expiration, would return to the grantor.
Before 1986, the Clifford trust could be used to transfer ownership (and

Spousal Remainder Trusts

Could be established for any length of time for a beneficiary, and the principal of the trust passed to the spouse of the grantor at the end of the trust period.
Before 1986, the Spousal Remainder Trust could be used to transfer ownership (and income) to

Clifford and Spousal Remainder Trusts funded prior to 1986

Are not subject to the 1986 TRA, so they are considered beneficiary trusts for income tax purposes.

2503(c) Trust

Permits the accumulation of income within a trust until the beneficiary reaches age 21.
During the years prior to 21, the trustee must have the right to use the trust income or corpus for the benefit of the minor. Trust income that is not distributed is t

Gift/Estate Tax lifetime exemption amount

$5.45 million in 2016.

Custodian Account

Less costly and inconvenient to set up than a trust. Can be set up under the UGMA and the UTMA.
The transfer of property to the custodian account is the same as an outright gift or a nongrantor trust, in that it is irrevocable, and the income and corpus a

Installment Sale/Leaseback Combo

Lease payments provide an income stream to the property purchaser, who can use the lease payments to make the installment purchase payments.
An installment sale also has the advantage of spreading the payments over a number of years, so the seller does no

Proportionate Disallowance Rule

Places a limit on installment sales of inventory and business or rental property. The limit is based on the taxpayer's allocable installment indebtedness, which is calculated based on the timing and magnitude of the transactions.
Can apply if the selling

Private Annuity

Involves one family member selling property to another, in return for a series of periodic payments to be made by the purchaser over the seller's lifetime or the lifetimes of the seller and his or her spouse.
If the annuity payments are secured by propert

Major Differences Between Installment Sales and Private Annuities

Installment sales are always secured against default by the property transferred, private annuities do not have to be secured by property.
The value of property is completely removed from the seller's estate in a single life private annuity, but the resid

Employment of Young Family Members

Technically does not constitute a transfer of property - but the diversion of income to lower-bracket taxpayers can result in significantly lower total family income tax.
Inasmuch as the income is "earned" it is not subject to the kiddie tax. The income t

Best Investments for Custodian Account

Deferred Income Securities - such as small stock funds or deep discount-tax exempt bonds.

American Opportunity Tax Credit

Up to $2500 per year per student for tuition expenses incurred in the first 4 years of post-secondary education.
100% of the first $2000, and 25% of the next $2000, subject to AGI phaseouts.
Expenses cannot be for room, board, or textbooks. The student mu

Using Education Funding Tools together

The American Opportunity Tax Credit cannot be taken at the same time (for the same student) as the lifetime learning credit, but the two credits could be claimed on the same tax return for different eligible students.
Both credits can be claimed when expe

The Lifetime Learning Credit

20% of qualified tuition up to $10,000 - for a total credit of up to $2000, subject to an AGI phaseout.
Available for undergraduate, graduate, and professional degrees, as well as for expenses related to acquiring or improving job skills.
No half time att

Interest on Education Dedution

TRA 97 added a deduction for interest paid on qualified higher education loans.
It is an above the line deduction - so a person can use it whether or not they itemize. The debt must be incurred for higher education expenses, which include room, board, boo

Coverdell ESA

Taxpayers can make annual nondeductible contributions to an ESA of up to $2000 per child under the age of 18.
There is no restriction on who can make contributions, as long as the contributions do not exceed $2000 per account to not exceed $2000 annually.

ESA Distributions

When ESA distributions are taken, there is no income tax if the child's education expenses for the year are equal to or exceed the amount of the distribution.
Education expenses include tuition, books, fees, and supplies, and also include room and board i

Excess ESA Money

If the beneficiary of an ESA completes schooling and there are remaining funds in an ESA, the balance may be rolled over or transferred income-tax free to an ESA for another family member.
Any remaining funds must be distributed when the beneficiary reach

2 Types of Qualified Tuition Programs (QTP)

--Prepaid tuition credits purchased for the beneficiary.
--Investment accounts to create tax-deferred income (529 Plans).
Withdrawals on either type of plan can be used income-tax free to pay tuition, fees, books, supplies, room, and board.

Beneficiary Designations on QTPs

The beneficiary on a qualified tuition plan can be changed from one family member to another member of the same family.

Contributions to QTPs

Are considered gifts of present interest, and therefore qualify for the $14,000 annual exclusion. The contributor can also make a larger gift (up to $70,000) and elect to have it treated as if gifted over 5 years.

Refunds to Contributors

Although neither contributors nor beneficiaries can direct the investments in a QTP, amounts may be refunded to contributors, and contributors will only have to pay income taxes on the excess amount of the refund over the amount contributed.

Series EE Bonds

Can also be used to fund education.
Interest on qualified U.S. savings bonds redeemed for qualified higher education expenses is exempt from income tax for certain tax payers.
The bonds must be purchased by someone over 24 years of age, cannot be placed i

Tuition related expenses - Above the line deduction

Taxpayers are able to take up to a $4000 above the line deduction in calculating AGI for tuition and related expenses for higher education expenses paid for themselves and their dependents.
The amount eligible for an above the line deduction is reduced by

Considerations in Education Funding

Time - Credits are best for when time is short for saving, given a longer time horizon, ESA and state tuition programs are better.
State QTP are getting better and better, and are not subject to income phaseouts.

Trusts

A trust is created when a grantor gives property to a trust and a legal title is held by a trustee for the benefit of one or more beneficiaries.
This transaction may create a separate taxable entity which will pay taxes on any income not distributed from

Simple Trust

Distributes only income, not corpus, and distributes said income on an annual basis.
Trust income is taxable to the beneficiaries in the year in which the income is distributed, or required to be distributed.
A simple trust cannot accumulate income or mak

Complex

Any trust in which the trustee may or may not accumulate income.
The beneficiaries bear the tax liability for income which is distributed, and the trust pays the tax on income which is accumulated.
Distributions of the corpus and charitable contributions

Distributable Net Income Rule (DNI)

The highest amount taxable to the trust beneficiary is the DNI, which is calculated using the trust's taxable iincome and certain adjustments and deductions.
Usually, DNI will not exceed trust income.

Grantor trust

When a grantor retains certain rights over property given to the trust, the trust is considered a grantor trust, according to tax law, and is ignored for tax purposes.
Any income from the trust property is taxable to the grantor.

Grantor Trust Qualifications

1. The grantor retains the power to revoke, terminate, alter, or amend the trust either himself, or through another person who is not a party to the trust.
2. Income from the trust is constructively distributed or held for distribution to the grantor or h

Retained rights that may also cause a trust to be considered a grantor trust

1) retention of reversionary interest
2) retention of the right to revoke
3) retention of administrative rights
4) retention of the right to retain or allocate the corpus or income without approval of an adverse party.
5) Retention of the right to change