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Filing status determines

-tax rate schedule to use to compute tax liability
-amount of the standard deduction
-eligibility for certain tax credits

Filing status depends on...

whether the taxpayer is married or single

five different filing statuses

1) married filing jointly
2) married filing separately
3) qualifying widow or widower (surviving spouse)
4) single
5) head of household

is the taxpayer married?

- determined on the last day of the tax year
- if a spouse dies during the tax year, a joint return is filed in the year of death
- gov't doesn't recognize same sex marriage

filing statuses for married taxpayers

1) married filing joint (MFJ)
2) married filing separate returns (MFS)
3) abandoned spouse considered unmarried


-both parties jointly and severally liable for tax liability
-combine all incomes, exclusions, and deductions
-2 personal exemptions


-married but file separate returns
-no joint and several liability
-tax rate schedules and standard deduction amounts are generally one-half of those MFJ
-typically not beneficial from tax perspective
-may be beneficial for non-tax reasons
-if one spouse itemizes deductions, the other spouse must also itemize deductions (even if less than the standard deduction)

When would MFS be better than MFJ?

-if you need to file separately
- to be claimed as dependent
- to keep finances completely separate
- divorce proceedings
-large income disparity may make it beneficial

Filing status for single taxpayers

- S-single
- qualifying widow(er) or surviving spouse
-HOH (head of household) [abandoned spouse]


unmarried taxpayers are required to file as single unless they qualify as head of household or surviving spouse

Qualifying widow or widower

-available for the 2 years following the year of spouse's death
-must remain unmarried for 2-year period
-surviving spouse must maintain household for dependent child for the whole year
-use MFJ tax tables but are not considered to be married (still receive only one personal exemption)
-dependent child cannot be foster child

Head of household (HOH)

-not as beneficial as MFJ or qualifying widow(er)
-more beneficial than single or MFS
-gives tax benefit to those single taxpayers w/ dependents
-unmarried at end of year
-not a qualifying widow(er)
-pay more than half the costs of keeping up a home during the year
-lived in taxpayer's home w/ a "qualifying person" for more than half of the year

HOH- qualifying person

-qualifying child
-qualifying relative who is taxpayer's mother or father
-qualifying relative who is not the taxpayer's mother or father

qualifying relative- parent

-parent does not need to live with the taxpayer
-taxpayer must pay > half cost of maintaining separate household for taxpayer's mother or father
-parent must qualify as taxpayer's dependent

qualifying relative- non parent

- person must have lived with taxpayer for more than half the year
-must qualify as taxpayer's dependent
-must be related to taxpayer through qualified family relationship [if related only because lived with taxpayer for entire year, not a qualified person]

Abandoned spouse

treated as unmarried and is eligible for head of household if
- spouse has not lived in home for last 6 months of year AND
- spouse who stay in home pays > half the cost of maintaining a household that serves as principal abode for qualifying child
- does not file a joint return with spouse

individual income tax formula

gross income
minus: FOR AGI deductions
equals: adjusted gross income
minus: FROM AGI deductions:
- greater of (a) standard deduction or (b) itemized deductions and
- personal and dependency exemption
equals: taxable income
times: tax rates
equals: income tax liability
minus: credits
minus: prepayments
equals: taxes due or (refund)

what is income?

- realized when it results from a transaction between the taxpayer and another party
- if realized, then is it recognized?

income recognition

-means to report the income on the tax return and pay tax onit
- if recognized for tax purposes is called gross income
- character of recognized income determines tax treatment

gross income

- all inclusive gross income concept
- from whatever source derived
- all realized income is included in gross income unless there is a specific exclusion

exclusions - income recognition

each exclusions is associated with an IRC section
- excluded income- never included in taxable income
- municipal bond interest
- gain on sale of personal residence
- inheritances
- some employee benefits


the timing of when some income is reported is affected by deferral provisions in the code
- installment sales
- like-kind exchanges

capital assets

all assets except
- a/r
-assets used in trade or business

capital gains and losses

-longterm capital gains taxed at 0% or 15%
- shortterm capital gains taxed at ordinary rates
- net capital losses (losses in excess of gains for year)
- $3000 deductible against ordinary income for year
- losses in excess of $3000 carried forward

exclusions vs deductions

exclusions= income concept
deductions = expenditure concept

legislative grace

no deductions are allowed except by code selection

FOR AGI deductions

all taxpayers receive benefits
"above the line" deductions
-deducted in determining AGI
-always reduce taxable income dollar for dollar
more beneficial for tax purposes than FROM AGI deductions

FROM AGI deductions

itemized deductions or standard deductions (only taxpayers who itemize benefit from these deductions)
personal and dependency exemptions
"below the line" deductions
- deducted from adjusted gross income to determine taxable income
- greater of standard deduction or itemized deductions
- personal and dependency deductions
why might a from AGI deduction not reduce taxable income?

Standard deductions amts

2012 standard deduction amts
- $11,900 MFJ
- $11,900 qualifying widow(er)
- $5,950 MFS
- $8,700 HOH
- $5,950 S

increased standard deduction

-the basic standard deduction is increased if the taxpayer is elderly or blind ($1150 if married and $1450 if single)

limitation on standard deduction

if taxpayer qualifies as another taxpayer's dependent, the taxpayer's standard deduction is limited to the larger of:
- earned income plus $300
- $900
but not more than the regular standard deduction

personal exemptions

for the taxpayer and spouse if MFJ
each taxpayer gets a personal exemption (exception: a taxpayer who qualifies as another taxpayer's dependent is not allowed a personal exemption)

dependency exemptions

for those who qualify as the taxpayers' dependents

tax calculation

US uses a progressive tax rate schedule
some items are taxed at preferential rates
- longterm capital gains
-qualified dividends
-tax on these items is calculated separately from income taxed at ordinary rates

other taxes include

alternative minimum tax
self employment tax

tax credits

reduce tax liability dollar for dollar

payments already made towards tax liability including...

- income taxes withheld from wages by employer
- estimated tax payments made during the year
- taxes overpaid in prior year and applied toward current year's liability
if prepayments exceed tax liability after credits, taxpayer receives a refund

Dependency requirements for all dependents

to claim an individual as a dependent, all dependents must meet 3 tests:
- dependent must have a social security number
- dependent must be a citizen of the US , Canada, or Mexico
- a married dependent must not file a joint return with his or her spouse

married dependent exception

a taxpayer can be claimed as a dependent if they file a MFJ if:
- the MFJ return reports 0 liability
- if they filed separately, neither spouse would have any tax liability

dependent debate

illegal immigrants filing tax returns (using ITIN's), claiming child tax credits for children, relative, neices/nephews in mexico [up to 10-12 dependents per return]
- collecting up to $14,000 in refunds
-- IRS reaction [says this is completely legal and encouraged to do]

qualifying child tests

1) relationship test
2) age test
3) residence (abode) test
4) support test

relationship test - QC

eligible children include
- the taxpayer's children and siblings
- any decedents of the above

age test - QC

child must be younger than the taxpayer and either
- under age 19 at EOY
- under age 24 at EOY and full time student
- permanently and totally disabled

residence test - QC

must have the same principal residence as the taxpayer for more than half of the year
- temporary time away is counted as living at the taxpayer's home

support test - QC

child may not provide more than one-half of his or her own support during the year
- scholarships of actual child (not grandchild, for example) are excluded from support computation

Tiebreaking rules - QC

-parents first
-days living with each parent if parents living apart
-higher AGI

dependency exemption for a qualifying relative

must not be a qualifying child and satisfy
- relationship test
- gross income test
- support test

relationship test - QR

a dependent must be a relative of the taxpayer or a member of the taxpayer's household for the entire year
- more inclusive than qualifying child test
relatives are:
- parents and their ancestors (also stepparents)
- children and their descendants (also stepchildren)
- siblings (also stepbrothers and stepsisters)
- aunts and uncles
- nephews and nieces (not cousins)

support test - QR

the taxpayer must furnish more than 50% of the dependent's support
- support is broadly defined
--includes almost any amt spent for an individual's benefit
-support includes welfare payments and social security benefits (even though they are not taxable)
-support does not include scholarships when the individual is the taxpayer's child

exceptions to the support test - QR

multiple support agreements
- more than half of an individual's support is provided by a group of people who are relatives and supply more than 50% of the individual's support
- anybody supporting more than 10% individually is eligible
- the group can agree which one of the group members will claim the exception

primary sources of tax law

statutory authority (congress)
administrative authority (US treasury)
judicial authority (courts)

statutory authority

US constitution
tax treaties
committee reports
internal revenue code

US constitution

-general authority to tax is in article I, sec. 7
- specific authority to levy income taxes is by the 16th amendment (passed in 1913)
- ability to tax income directly w/o approval by the states

tax treaties

US has tax treaties with many other countries that describe how residents of the 2 countries will be taxed on income from the other country
-tax treaties override the IRC

committee reports

as a tax bill makes it way through the legislative process, reports are prepared that describe the purpose of the legislation
--house ways and means committee
--senate finance committee
--joint conference committee
provides insight into understanding and interpreting law

Internal Revenue Code

title 26 of US code
- contains all federal statutes relating to tax
- the IRC is the most authoritative source of tax law

Organization of the IRC

The IRC is title 26 of the US code
- subtitles
- chapters
- subchapters
- parts
- sections
sections are the organizing unit of the IRC

citing the IRC

sec. 63
sec. 63(c)(2)
IRC Sec. 63(c)(2)

administrative authority

treasury department (treasury regulations)
internal revenue service (rev. rulings and rev. procedures)


treasury department's official interpretation of the IRC
3 forms:
final, temporary, proposed
3 purposes:
interpretative, procedural, legislative

revenue rulings

represent the IRS position on a specific factual situation
- rev. rulings are binding on the IRS until they are revoked
rev. rul. are published in the Cumulative Bulletin

revenue procedures

issued to explain internal IRS procedures and routine matters (i.e. standard mileage rate, depreciation tables)
revenue procedures are published in the cumulative bulletin

private letter rulings

-issued by the IRS to specific taxpayers requesting guidance on a tax matter
- binding on the IRS only with regard to the requesting taxpayer

judicial authority

trial level
- US tax court (also small claims division)
- US district court
- US court of claims
appellate level
- US court of appeals
--district circuits
--federal circuit
-supreme court

tax court

national court
tax experts
do not pay tax 1st

US district court

local court
possible jury trial
pay tax 1st

US court of federal claims

national court
pay tax 1st
appeals to US circuit court of appeals for the federal circuit

citing court cases

- tax court decisions are designated as regular decisions or memorandum decisions
- regular tax court decisions are published by the US government in reports of the United States Tax Court (TC)
-- cited as J.B. Linderman, 60 TC 609 (1973)
-memorandum decisions are not published by the gov't, but are published by private publishers
-the RIA citation is:
-- Kenneth J. Nissley, T.C. Memo 2000-178
for all other courts RIA publishes decisions in American Federal Tax Reports (AFTR2d)
--the RIA citation
----waxler towing v. US, 48 AFTR2d 81-5274 (W.D. Tn. 1981)
----or (Fed. Cl., 1993)
----or (5th Cir., 1991)
----or (S. Ct., 1997)


history of a court case
- which trial court and all appeals (if any)
- what happened at appeal (affirmed, reversed, remanded, or modified)
- all other cases or rev. rulings that cite the case are listed
history of revenue rulings
- has it been revoked, modified, or superseded?
- is this rev. ruling revoking, modifying or superseding another rev. ruling?

secondary sources of tax law

-tax services
--RIA checkpoints
-professional journals
-IRS publications

IRC: Primary or Secondary?


Tax article in USA Today primary or secondary?


article on supreme court opinion


supreme court opinion


RIA federal tax coordinator


treasury regulations


Tax research

step 1: understand the facts
step 2: identify issues
step 3: locate relevant authorities
step 4: analyze tax authorities
step 5: communicate the results

tax memo layout

facts- only state the relevant facts
issues- question format, professional tone
conclusion- your proposed solution
analysis- the reasoning, a recommendation

tax planning

structuring transactions to maximize the taxpayer's aftertax wealth while achieving the taxpayer's non-tax goals

timing strategies

when tax rates are constant across years
- defer income
- accelerate deductions
when tax rates change across years
- shift income to low tax years
- shift deductions to high tax years

doctrine of constructive receipt

- a cash method taxpayer reports income in the period that it is received or constructively received
- income is constructively received when it is made unconditionally available to the taxpayer w/o restrictions

Limitations of timing strategies

-doctrine of constructive receipt
-the tax deduction often cannot be accelerated w/o the actual cash outflow that generates the deduction
-deferral strategy may not be optimal if:
-- tax payer has cash flow needs
-- continuing investment generates low returns
-- subjects taxpayer to unnecessary risk

income shifting strategies

-transactions that shift income b/w family members
- transactions that shift income b/w owners and their businesses
- transactions that shift income across jurisdictions

transactions b/w family members

parents shift income to children
-employing children in a family business
-shifting investment income to children

transactions b/w owners and businesses

use of a corp in tax planning
- incorporating a sold proprietorship
- shifting income from corp to owner through tax deductible expenses
--compensation, rent, interest

shifting income across jurisdictions

different states w/in the US
different countries

limitations on income shifting

assignment of income doctrine
- "the one who earned the income is taxed on it regardless of who receives the proceeds"
related party rules
- "IRS scrutinizes these transactions because they are other not "arms-length transactions"

conversion strategies

tax rates can vary across different activities
- ordinary income is taxed at ordinary rates
- longterm capital gains are taxed at preferential rates
- some income is tax exempt
to implement the conversations strategy, you must:
- understand the differences in tax treatment across various types of income, expenses, and activities and
- have some ability to alter the nature of the income or expense to receive the more advantageous tax treatment

implicit taxes

indirect taxes that result from tax advantage government grants to certain transactions
- gm bond 10%
- state of iowa bond 8%
assuming 20% tax rate, investors are indifferent
- 2% difference is "implicit tax"

business purpose doctrine

a transaction must have a business purpose (other than tax avoidance) to be respected for tax purposes
- IRS has the power to disallow business expenses for transactions that don't have a business purpose

substance over form doctrine

when evaluating the legitimacy of a transaction, the IRS can look through the legal formalities to the substance of the transaction
- IRS can reclassify a transaction according to its substance (instead of its form)

step transaction doctrine

the IRS can collapse a series of transactions into one and determine the tax consequences of the arrangement in its entirety
- normally transactions that take place more than a year apart will be respected

economic substance doctrine

transactions must meet 2 criteria
- transaction must meaningfully change a taxpayer's economic position
- taxpayer must have a substantial purpose (other than tax avoidance) for the transaction

taxpayer filing requirements

- corps: must file regardless of taxable income
- estates and trusts: required to file if gross income exceeds $600
- individuals: filing is determined by taxpayer's filing status, age, and gross income

who has to file a tax return?

individual filing requirement is based on gross income
- must file if gross income is more than amt of standard deduction plus personal exemption(s)
- increase personal exemption for age but not blindness

tax return due date

individuals: 15th day of 4th month following end of tax year (usually april 15th)
corps: 15th day of the 3rd month following the end of tax year (march 15th for calendar year corps)

filing and payment requirements

- due dates on a saturday, sunday, or holiday are extended to next business day
- individuals and corps are allowed to apply for an automatic 6 month extension
---tax payments are due by the original due date of the return regardless

failure to file and pay penalties

combined penalty of 5% of balance due per month late for 5 months
- failure to file by itself is 5% per month of total tax due
- failure to pay by itself is .5% per month of total tax owed
penalties normally do not exceed 25% of tax due

statutes of limitations

the time in which the taxpayer can file an amended return or the IRS can assess a tax deficiency
- generally ends 3 years from the later of:
1)the date the tax return was actually filed or
2) the tax return's original due date

IRS computer programs used

- Discriminant function (DIF) system [scoring system] -based on most misused deductions/errors/$amts
- document perfection (checks for math errors etc) - 5 million return audited, 2011
- information matching programs (compares tax return data with other IRS information)- 4.7 million returns audited, 2011

IRS audit criminal prosecution

- 2011 1842 criminal investigations closed
-- 49% led to indictments
-- 37% closed w/o prosecutions
-- 14% not prosecuted despite IRS recommendation
87% of indictments led to conviction
77% of convictions led to incarceration
- avg. sentence:25 months

correspondence examinations

most common audit
- conducted by mail and are generally limited to 1 of 2 items on the return
- roughly 70% of all audits conducted are correspondence examinations

office examinations

second most common audit
- conducted in the local IRS office and tends to be broader in scope

field examinations

least common audit
- held at the taxpayer's place of business and an last months to years

when the audit is concluded

revenues agent's report is prepared by the agent with the proposed adjustments and balance due or overpayment
- taxpayer may agree w/ adjustments
- if taxpayer doesn't agree, will try to resolve w/ agent's supervisor or appeals officer at that time
---if not resolved, a preliminary notice of deficiency will be sent (30 days letter)

30 day letter

taxpayer has 30 days from date of notice of deficiency to request conference with appeals office (called filing a protest)
--an appeals officer has authority to settle on behalf of the IRS
if unable to settle, the appeals office issues a statutory notice of deficiency (90 day letter)

90 day letter

tax payer has 90 days to file a petition w/ tax court
- if a petition is not filed w/in 90 days, the deficiency is assessed and demand for payment is made
- after the 90 day period, the taxpayer cannot contest the assessment w/o paying the tax. filing a claim for refund, and institution a refund suit in District Court or the Court of Federal Claims

tax professional responsibilities

- tax professionals are subject to various statutes, rules, and codes of conduct
---AICPA code of professional conduct
---AICPA statement on standards for tax services
----IRS circular 230
----State board of Accountancy Statutes
failure to comply with statutes can result in being admonished, suspended, or barred from praticing

tax payer and tax practitioner penalties

a taxpayer and tax practitioner will not be subject to an underpayment penalty if:
- there is substantial authority that supports the tax return position or
- if there is a reasonable basis for the position and it is disclosed on the taxpayer's tax return

definition of tax

- payment to gov't required by law
- pursuant to the gov'ts power to tax
- to be used for public or governmental purposes
- special benefits are not received for making payment
- payment is not a penalty under other powers of government

taxes do not include

-fees or charges for specific goods or services
- regulatory fees
- fines or penalties

basic tax formula

t= r x b
tax=rate x base

tax base

the item, event, or value that a tax is levied upon - often "taxable income"

criteria for evaluating tax systems

certainty [easy to find out when/where/how much to pay]
convenience [easy to pay and collect]
economy [gov't has low costs of collection, taxpayer has low costs of compliance]


to be a good tax, it should raise enough revenue to supply the necessary public goods
- gov't needs to forecast tax revenues and taxpayer behavior to match revenue with expenses
---income effect
---substitution effect

income effect

taxpayer engages in more income producing activities to generate the same amt of after tax income

substitution effect

taxpayer engages in fewer income producing activities because the after tax value of working is less than the value of leisure


a good tax should be fair, in general a fair tax is based on ability to pay

horizontal equity

those with equal ability to pay should pay the same percentage of tax

vertical equity

those with a greater ability to pay should pay a greater percentage of income in tax

average tax rate definition

total tax / taxable income

effective tax rate definition

total tax / total income

marginal tax rate definition

rate at which the next increment of income will be taxed
change in tax / change in taxable income

what is included in gross income?

definition of gross income for tax purposes
- IR sec. 61(a) "gross income means all income from whatever source derived"
-reg. 1.61 (a) "includes income realized in any form, whether in money, property, or services"
taxpayers recognize gross income when
(1) they receive an economic benefit
(2) they realize the income, and
(3) the tax law does not provide for exclusion or deferral

economic benefit

think of as "revenue" or "gain" in financial accounting perspective
- loan proceeds no economic benefit because they represent a liability


no income or loss is recognized until it arises from a transaction with another party


-this is the amt of realized income or loss that is reported on the tax return
-all realized income unless exclusion or deferral applies

form of receipt

-includes all sources of economic benefit
-not just cash
-report FMV of property or services received

return of capital concept

taxpayer receives his investment back tax free
-cost of asset is "tax basis"
-return of capital does not represent economic benefit

tax benefit rule

refunds or recoveries of amounts previously paid by the taxpayer are taxable only if the taxpayer received a tax benefit from the payment in a prior year
- receiving a tax benefit means that the taxpayer deducted the item and it reduced the taxpayer's tax liability

accounting methods

corp- accrual method
individuals- cash method

when do you recognize income?

individuals- the period you actually receive it
receipt is defined as when it is made unconditionally available to you

claim of right doctrine

Income recognized when there are no restrictions on use of income (no obligation to repay)
- if potentially have to pay back bonus (clawback provision), you report income in the year you received it

assignment of income doctrine

-income from services is taxed to the service provider
-income from property is taxed to the owner of the property

community property systems

half of the income earned from services of one spouse included in gross income of the other spouse
- half of the income from property held as community property by the married couple is included in the gross income of each spouse

earned income

income from services
- income from labor most common source of gross income
includes non-cash compensation
-report FMV of non-cash items

unearned income

income from property
- include gain or losses from sale of property, dividends, interests, rents, royalties, and annuities
depends on type of income and type of transaction generating income

property dispositions

sales proceeds
less: selling expenses
= amount realized
less: basis (investment) in property sold
gain(loss) on sale

income from flow-through entities

-the most common flow-through entities are partnerships and S corporations
-a taxpayer reports his share of the partnership or S corp income when it is earned by the entity (not when it is distributed to him)

annuities and pensions

an annuity is a series of payments that will continue for a specified time period or until an individual's death
- tax rules for annuities are based on the return of capital concepts
calculate an exclusion amount based on the taxpayer's investment and expected return

exclusion ratio

original investment / expected value of annuity
- the percentage exclusion ratio is the portion of payment that is excluded

annuities over lifetime

must use IRS tables based on the life expectancy
- if you live longer than life expectancy, entire payment amount is gross income beyond life expectancy
- if you die before life expectancy, the unrecoverable investment taken on final return

pension plan payments

are purchased with pre-tax dollars are 100% taxable when received
- payments from a qualified employer's retirement plan or traditional IRA with fully deductible contributions


is income to the payee and deductible FOR AGI by the payer
- property settlements and child support are not income to the payee and are not deductible by the player
-if alimony payments stop or reduce in amount when child reaches a certain age, all or a portion of the payments will be treated as child support
- if payor is behind in payments, apply payments received first to child support, then to alimony

alimony requirements

-cash payment (can be made to a third party but must be in cash
- payments are pursuant to a written divorce or separation decree
- payor and payee must live apart
- payments must cease upon death of payee

alimony recapture

there is an incentive for the person paying to treat a property settlement as alimony
- property settlements are generally large dollar amounts
recapture occurs in year 3 if year 2 and year 3 alimony amounts are much smaller than year 1

prizes and awards

prizes are only excluded if:
- recipient designates that the prize be paid to a qualified charity, and
- prize is for a religious, charitable, scientific, artistic, literary or civil achievement and
-recipient did not "solicit" the prize (by entering a contest, writing an essay, etc)
- recipient does not need to perform substantial services as a condition of the prize

employee achievement awards

employee achievement awards are excluded from gross income of the employee if:
- given for a safety achievement or years of service
- the award is of tangible personal property and under $400 in value (not cash)
- not excluded if disguised compensation

gambling winnings

must include gross amount of winnings in gross income
- can deduct gambling losses to the extent of gambling losses, but as a FROM AGI deduction
- professional gamblers can deduct losses as a FOR AGI deduction

See more

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