Final Review Session BA 128A

• Final Exam 5/18 12:30- 3:30 C230

• Questions from last lecture

• Review Chapter 13

• Final Review Ch I5,7,8,9,10,12,13,14; C2,3,4,9,11,12

Chapter 13 Estate Tax

Estate tax formula

Gross estate

- deductions (expenses, debts & losses)

=Adjusted gross estate

- deductions (marital and charitable)

= Taxable Estate

+ Adjusted taxable gifts (post 1976)

= Estate Tax Base

Tentative tax (current uniform transfer tax rates)

- Post 1976 gift taxes (current uniform transfer tax rate) - unified credit taken in year gift taxes are paid

- unified credit (full amount)

- other credits

= Estate Tax payable

Deductions

• Expenses - administrative expenses for managing the estate, funeral expenses

• Debts - personal liabilities e.g. mortgage

• Casualty and theft losses - incurred while estate is being settled

• Marital and Charitable deductions - no ceiling

Valuation of estate

• FMV at date of death or alternate valuation date

• Alt. Valuation - all or nothing

• FMV at date of death - price at which property would change hands between a willing buyer and seller

• exception - life insurance - valued at face value

• listed stock - average of low and high price; if sale takes place within a few days of death date, use wtd average of high and low stock price on the nearest trade dates before and after date of death

• Other valuation - Block stock, non-public stock, real estate, annuities

Chapter 5 Capital G/L

• ST < 1yr, LT > 1yr; deduct loss up to $3000, gain taxed at 20% except uncolletibles, 1250 unrecapture and section 1202

• Netting of CL and CG– net STCL and STCG– net LTCL and LTCG– NLTCG > NSTCL = NCG– adjusted NCG is NCG without uncollectibles, section 1250

unrecapture and then sec1202 small bus stock– both NLTCL and NSTCL - use NSTCL first - retain character of

loss– NSTCL > NLTCG - net highest rate group first (ie 28%, 25% and

then 20%)

Chapter 5• Realized vs. recognized gain• Property basis

– received as gift - usually donor’s basis except if FMV < basis, donee has 2 basis (if sold at gain later, basis = donor’s basis, else basis = FMV)

– Gift tax paid by donor increase donee’s basis– property from decedent - FMV– property convert from personal to business - lower of FMV or

adjusted basis– basis of stock dividend– basis of stock rights

Chapter 7- itemized deductions• Deduct only if it exceeds standard deduction• Subject to phase out - 3% of amount exceeds threshold. Qualified

medical expenses• Taxes• Qualified interest• Casualty and theft losses• Miscellaneous deductions

– Non reimbursed employee expenses

– Investment expenses

– Cost of tax advice

• Charitable Contributions

Qualified Medical Expenses• Deduct the amount that exceed 7.5% of AGI• No deduction it it is reimbursed• Include taxpayer, taxpayer’s spouse and dependent• Diagnosis, cure, mitigation, treatment and prevention of disease,

medical procedures involving function or structure of body - except cosmetic surgery unless for deformity correction

• Transportation for medical reasons• Long term care• Capital expenditures for medical care - add a swimming pool,

remove physical barriers• Medical insurance premiums

Classification of interest

• Active trade and business - for AGI

• Passive activity - e.g. rental activity - for AGI - Chapter 8

• Investment interest - offset investment income - from AGI

• Personal interest - not deductible

• Qualified residence - from AGI

• Student loan - for AGI

Investment Interest• Investments - generates portfolio of income such as interest,

dividends, annuities and royalties, not personal or business, not passive and not tax exempt securities

• Net investment income = Investment income - investment expenses. Investment income include net gain to the extent that net gain exceeds net capital gain

• Taxpayer can elect to include net capital gain in investment income that will be subject to regular tax rates

• Investment expenses only deductible to the extent that it is >2% of AGI - ie this is the amount used to calculate net investment income

Other interest• Qualified residence interest

– Principal + secondary residence– Secured by home– Acquisition indebtedness - up to $1,000,000– Home equity interest - can only deduct the amount applied to the lesser

of FMV of qualified residence in excess of acquisition indebtedness or $100,000

• Student Loan interest– For higher education expenses– FOR AGI deduction– Maximum deductible amount = $1000 in 1998.– Phased out ratably for AGI between 40,000 and 50,000

Charitable Contribution -limitation amount

• Max - 50% of AGI

• depends ORGANIZATION contributed to and TYPES of property contributed

• Excess is carry forward for the subsequent 5 years

• Capital gain property contributed to public charity is limited to 30% of AGI

• Ordinary and cash property contributed to private nonoperating foundation is also limited to 30% of AGI

• Contributions of capital gain property to private nonoperating foundation are limited to the lesser of 20% of taxpayer’s AGI or 30% of taxpayer’s AGI reduced by capital gain contributed to public charity

• Contributions to athletics events in return for the right to purchase tickets (80% limitation)

• Apply 50% limitation contributions first and then the 30% limitation

• Carryover amounts subject to the same % limitations. Deductions for current year is applied first.

Charitable contributions - basis• Except capital property contributed to public

charity (at FMV), all other transactions, used adjusted basis (or FMV - capital gain)

• Transactions include ordinary and capital gain property to private nonoperating foundations, capital gain property that is unrelated use in nature - special circumstances - donation of inventory and scientific equipment - higher than adjusted basis

Chapter 8 loss and bad debts

• Sale or exchange of property - capital asset result in capital loss, property in bus/trade e.g. inventory, accounts receivable, depreciable property and land used in a trade or business - ordinary loss (section 1231 subject to netting rules (I13)

• Abandonment of property - ordinary loss• Demolition of property not deductible - add to basis of land• Other disallowed loss - wash sales, like kind exchange,

related party transaction, transfer of property to a controlled corp in exchange for stock

Passive loss• Definition - any rental activity or any trade/business

where taxpayer does not materially participate• Passive loss can only net against passive income and

can be carried over (each activity). Suspended losses of passive activity is deductible against ordinary income upon disposition ownership interest

• Rental activity excluding real property trade/business• $25000 deduct against ordinary income if actively

participates and own at least 10% of value of activity; loss is subject to phase out

Casualty loss• Identifiable event that was sudden, unexpected or unusual

• Theft is included (proper substantiation e.g. police report)

• only allowed to deduct up to adjusted basis

Bus/investment Personal

Total destruction adjusted basis smaller of

adjusted Basis or reduction in FMV

Partial destruction smaller of

--------> ad. Basis or <------------ reduction in FMV

Bad Debts and NOL

• Bad Debts

– Bus bad debt - ordinary loss

– Personal bad debt - ST capital loss

• NOL

• Adjust taxable income(loss) with

– non-bus capital loss deduction

– non-business deductions e.g. personal exemption and standard/itemized deduction

NOL

• Carry back to get tax refund

• Carry forward to deduct subsequent year income

• Can elect not to carryback

• Adjust back other deductions– non-bus capital loss deduction– non-business deductions e.g. personal exemption

and standard/itemized deduction

Chapter 9 Employee Reimbursed Expenses

• Reimbursed employee expenses – accountable plan - substantiation, excess is returned

to employer - not include in GI and not deductible, if excess is not return, include in income

– not accountable plan - include in GI, expenses deducted as misc. itemized deduction

• Unreimbursed employee expenses - deductible from AGI - misc. itemized deduction

What is deductible• Travel expenses - transportation, meals and lodging. Meals - 50%, has to be

away from tax home• Automobile expenses - standard vs. actual• Entertainment expenses - 50%• Moving expenses - for AGI deduction• Education expenses • Office in home expenses• Deferred compensation

– Qualified plans - exclusive for employees, not discriminating and other vesting and funding requirements

– Employer can deduct contribution and employee not taxed on earnings from contributions until withdrawn

– Traditional IRA $2000 deductible for AGI - subject to salary limit

Chapter 10 - Depreciation• For assets/property used in trade or business or held for production of income• Personal use property - no depreciation• Personal property - equipment, vehicles, furniture• Real Property - land and structure permanently attached to the land• MACRS - personal

– Personal property - half year convention, conversion to straight line if yields larger amount, amount reduced by half in year of disposition, recovery period is 3,5,7,10,15 years

– Requires the use of mid-quarter if aggregate basis of all personal property in service in the last 3 months > 40% of the cost of all personal property placed in service during the tax year

– Disposal calculation needs to be consistent, half year or quarter• MACRS - real property

– Residential - 27.5 years recovery period– Non-residential, 39 years– mid-month, st line

Chapter 10 Section 179

• Apply only to tangible personal business property• $18500 in 1998 in year of acquisition • Not applied to real estate• Election made on annual basis

• Limitations – cannot be related party transaction– Phase out >$200,000 property acquired $ for $– Cannot exceed taxpayer’s income

Chapter 13• Section 1231 - treatment of character of gains and

losses

• Section 1245 - depreciable personal property + limited nonresidential real property (depreciation recapture)

• Section 1250 - real property - excess depreciation

• Section 1250 recapture - all st. line depreciation recapture at 25% LTCG

Section 1231 continue

• Net section 1231 gains and losses

• If gain -> LTCG

• If loss -> ordinary loss• exception- Casualty loss - if loss > gain, non section

1231 ordinary loss, if gain> loss, section 1231 gain

• Subject to 5 year look back rule - ordinary loss in the past five years needs to be recaptured as ordinary income instead of capital gain - loss recaptured apply to net 1231 gain in the 25% group first and then the 20% group

Section 1245• Apply only to gains on disposition on property

• Depreciation recapture as ordinary income

• cannot exceed amount of realized gain

• 1245 property

– property subject to depreciation and amortization besides real property

• applies mostly to depreciable personal property

• property under section 179

• exception nonresidential real estate placed in service between 1981-1986 that used ACRS accelerated cost recovery method instead of straight. line

Section 1250 and Unrecapture 1250 gain

• Includes most depreciable real property except nonresidential real estate placed in service between 1981-1986, low income housing and depreciable residential rental property. Section 1250 usually applies to real estate place in service before 1986 since straight line is used after 1986

• Recapture only the additional depreciation over straight line into ordinary income

• Unrecapture 1250 gain - rest of the depreciation (ie straight line) will be recaptured at long term capital gain rate of 25% instead of 20%

Section 1231 netting procedure

• Determine casualty gains and loss– if loss -> non 1231 loss - business casualty loss is a for AGI

deduction, personal casualty loss is a from AGI (itemized deduction)

• Compute net 1231 gains/loss– net casualty gain– gains and losses from sale/exchange of section 1231

property– gains and losses from condemnation of property

• If net 1231 gain, check unrecaptured 1231 loss from previous years

Chapter 14 AMT• Taxable income

plus tax preference items

plus personal and dependency exemption

plus standard deduction if itemized deductions is not used

plus adjustments - disallowed itemized deductions, timing difference adjustments, disallowed AMT tax credits

= AMTI

- AMT exemption - 45000 for married filing jointly, 33750 for single tax payers - subject to phase out 25% for AMTI > 150000 for married filing jointly and 112500 for single

= AMT Base

Tax rate = 26% for the first 175000

28% for amount >175000

= Tentative minimum tax

- regular tax

= AMT

C2 -Forms of organizations

• Sole Proprietorship

• Partnerships

• S-corp

• C-corp

• Know the tax advantages and disadvantages and liability consequences

Tax considerations in forming corporations

• Tax free and taxable transfer of property

• Section 351 - allows the deferral of gains and loss upon incorporation, apply to new and existing corporation

• Requirements -

– for stock

– transfer in control immediately after exchange (no prearranged plan to sell)

– Property must be transferred

• Control - >= 80% of total voting stock and >=80% of each class of nonvoting stock

• Property - money, A/R, inventory, equipment, intangibles and etc.

• Exclusions - services, indebtedness with no security

Receipt of Boot• SH receives cash, notes instead of stock

• SH recognized gain up to lesser of realized gain or FMV of boot

• Character of gain depends on asset received

• SH basis = adjusted basis of property transfer + gain recognized - (boot received, cash received or liability assumed by transferee (ie corp))

• SH holding period - include property’s holding period

Transferee Corp’s Recognition• No recognition if transfer stock even if 351 is not

applied• If transfer appreciated property as part of section

351- recognized gain but not loss • Transferee corp basis = transferor’s adjusted basis

for property + gain recognized by transferor• Holding period includes holding period of

transferor + any depreciation recapture potential

C3 - corporations deductions and losses

• No itemized deductions, hobby losses, net investment interest deduction limitations, personal exemption, non-bus bad debts, alimony, IRA contribution

• Casualty losses are fully deductible• No deduction for interest expenses incurred to

borrow tax-exempt securities

Capital Gains and Losses

• Same process of netting LTCG, LTCL; STCG, STCL

• Additional 20% depreciation recapture for section 1250 property

• No $3000 capital loss offset against ordinary income; carry back 3 and forward 5

• No capital gain rate preferential; same treatment as ordinary income

Charitable Contributions

• 10% of adjusted taxable income

• adjusted taxable income excludes charitable contribution deduction, NOL carryback, capital loss carryback, dividends-received deduction but INCLUDEs NOL carryover

• Similar rules regarding ordinary income and capital gain property as individuals

Special deduction - Dividends-received deduction

• Include dividends in Gross Income

• receive dividends deduction <20% - 70% deduction, >=20% but < 80% - 80% deduction

• limitation - lesser of 70%(80%) of dividends or 70%(80%) of taxable income without regard to any NOL deduction, capital loss carryback or dividends-received deduction itself

• Does not apply if an NOL results after the deduction is taken into account

• If ownership >=80% - receive full 100% dividends deduction with no limitations - members of affiliated group

Net Operating Loss

• Carry back 2 (earliest of the 2 first) and forward 20 (first preceding year)

• May elect not to carry back, once elected for the year, irrevocable

• Deduction sequence– Charitable Contribution (include NOL carryover)

– Dividends received deduction (not include NOL carryover)

– NOL

C4 - current E&P• Calculating current earnings and profits

– start with taxable income or NOL

Permanent differences– plus income excluded from taxable income but included in E&P

• life insurance proceeds, tax-exempt interest income– plus deductions that reduce taxable income but not allowed in E&P

• dividends-received deduction• NOL, charitable contribution, capital loss carryover

– minus expenses and losses not deductible in taxable but allowed in E&P• federal income taxes• excess capital loss not allowed• excess charitable contributions• non deductible fines and penalties etc.

Temporary difference– plus income deferred to a later year when computing taxable income but included in E&P in current year– plus or minus income and deductions items that is recomputed for E&P

• depreciation - ADS for MACRS• LT contracts - % of completion for E&P

Non-liquidating distributions• Dividend - distribution made out of corporation’s

E&P

• Property as contribution - $, securities of other corporation, and any other property except stock, stock right of distributing corporation

• if distributions > E&P - > return of capital, reduce ownership basis

• if distributions> ownership basis, excess treated as gain of sale of stock - capital gain

Property Distributions- tax consequences to SH

• Amount of distribution to shareholder is the property’s FMV, value determined at date of distribution, distribution amount reduced by any liability assumed by shareholder

• Basis to shareholders is the FMV (regardless of liability assumed)

• Distribution is dividend to the extent of the corp’s E&P

Property Distributions- tax consequences to corp

• Corporation must recognized gain on distributed property that has appreciated in value

• Property’s FMV must be at least the amount of liability assumed by shareholder

• Does not recognized loss on distributed property

Effect on E&P of corporation• gain recognized by distributed property increase E&P• Tax on the taxable gain on distributed property decrease E&P• Property’s adjusted basis/FMV reduce E&P (if adjMusted basis

>= to FMV, reduce E&P with adjusted basis, else reduce E&P with FMV

Partnership profits and losses• Partnerships - tax reporting entity• partner reports his/her share of income from partnership from the partnership

return• partnership has its own tax year and accounting methods• partnership income can office personal losses of individual partners• Partner’s Basis

– contribution increase a partner’s basis in the partnership– liability assumed by the partner also increase his/her basis– gain increase partner’s basis– loss decrease partner’s basis until the basis =0– partner’s personal liabilities assumed by partnership decreases the partner’s

basis

– partnership distributions are tax free

Contribution of property to partnerships

• No gain or loss recognized for the partner and partnership if property is cash, tangible and intangible property, services - need to recognized gain

• if personal liabilities assumed by partnership exceed basis in partnership, recognize gain

• partnership basis of property contributed = partner’s basis before the transfer

• Unrealized receivables, basis = 0

• holding period includes the transferor’s holding period

• character of gain also transfers over

• depreciation recapture also transfers over

• apply the same rules after formation of partnership

Partnership’s distributive share• Depends on partnership agreement, profits and losses share may be

different

• Varying interest rule - if partnership interest % changes during the year, income and loss allocation is prorated between the different days of ownership and interest %

• Special allocations

– pre-contribution gain or losses for contribution to partnership after 3/31/1984

– gain/loss at the time of contribution allocated solely to the SH who contributed the property

– other special allocations allowed if criteria is met for substantial economic effect - appropriate decrease/increase in capital account of partner and partners will make up negative capital balance - see C9-19