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ACCT417: Final Exam Review
Terms in this set (85)
Definition of tax?
Involuntary payment required by law
US income taxes are proportional, regressive, or progressive? Examples of each? return
US Income tax is Progressive [tax rate↑ tax base↑]
Regressive [tax rate ↓ tax base ↑]
Proportional [tax rate ↔ tax base ↑] (sales tax)
Social Security tax and limit?
Social Security - 6.2% on first $118,500
Medicare - 1.45% on all, no limit
Three primary sources of Tax Law?
1. Legislative - Congress - IRC
2. Administrative - Treasury "Regs"
3. Judicial - Case law
General statute of limitations on federal returns? If 25% of gross income is omitted?
General is 3 years, if 25% omitted then it is 6 years.
Taxpayer files a fraudulent return?
Unlimited statute of limitation and gets audited and can be charged criminally.
Three Types of IRS Examinations?
1. Correspondence Examination - via mail
2. Office Examination - local district office
3. Field Visit - conducted at place of business
The difference in deductions FOR AGI and FROM AGI?
FOR AGI: - not subject to reduction based on income, loss limited to $3000, ex: alimony paid, capital loss, trade/business expense, (above the line)
FROM AGI: - greater of itemized deductions or
standard (single and MFS 6,300, HOH 9,250m MFJ 12,600)
Difference between tax evasion and tax avoidance?
Evasion - illegal, willfulness on the part of the tax payer, underpayment of tax, affirmative act by taxpayer to evade
Avoidance - legal, using legal methods to minimize taxes
The ability to pay general concept?
A fundamental concept that states that the tax levied on a taxpayer should be based on the amount a taxpayer can afford to pay.
The administrative convenience general concept?
This concepts states that items may be omitted from the tax base whenever the cost (time and effort) of implementing a concept exceeds the benefit of using it.
The arm's length transaction general concept? Significance on income taxes ex. Related Parties?
Transaction in which all parties have bargained in good faith and for their individual benefits, not for the benefit of the transaction group.
Self-dealing through Related Party Provisions -
Individuals and families
More than 50% of ownership in corp or partnership.
The pay-as-you-go general concept? Taxes based on this system?
Taxpayer pay as they generate income, implemented through withholding taxes. U.S income tax system.
The entity concept (accounting)? Difference between taxable and conduit entity?
Entity concept mean each tax unit must keep separate records and report the results of its operations separate from other tax units.
Taxable entity is liable for tax. 4 - individuals, C Corporations, estates, some trusts
Conduit entity is a nontaxable entity. Flows to 1 or more taxable owner. 2 - Partnerships, S Corporations, (some trusts)
The assignment of income doctrine (accounting)?
All income earned from services provided by an entity is taxed to that entity. Income from property is taxed to property owner.
The two methods of accounting that are recognized by the IRS? Differences?
Accrual and cash basis accounting.
Accrual: Report income as its earned and deductions as incurred, without regard to the actual receipt of cash.
Cash: Income as its received and take deductions as its paid.
The substance-over-form doctrine (accounting)?
The taxability of a transaction is determined by the reality of the transaction, rather than some (perhaps contrived) appearance. (Duck Rule)
The all-inclusive income concept?
All income received is considered taxable unless some specific provision says otherwise.
The legislative grace income concept?
Any tax relief provided is the result of specific acts of Congress that must be applied and interpreted strictly.
The capital recovery income concept?
No income is taxed until all capital previously invested in the asset is recovered.
The realization income concept?
No income is recognized for tax purposes until the taxpayer can realize it.
The construction receipt income doctrine? Example?
Cash basis taxpayers are deemed in receipt of payment when it credited to their account or made 'unconditionally available' to them. Example: Interest Income is taxed on the day it is credited to a savings account.
Non-issue for accrual basis taxpayers
The wherewithal-to-pay income concept? Differ from ability to pay?
Income should be recognized and tax paid on income when the taxpayer has the resources to pay it. Applies to cash and accrual taxpayers. Differ: to distinguish the general ability to pay concept with income recognition applications.
The business purpose deduction concept?
A deduction allowed only for expenditure that is made for some business or economic purpose that exceeds any tax avoidance motive. - connection with a profit-seeking activity.
What is "all-inclusive" income?
Any income received is assumed to be taxable unless some provision in tax law allows its exlusion
Differences between earned and unearned income? Examples?
Earned income is compensation paid for services, or labor for production of goods and services (illegal included).
Ex. Wages, salaries, income from active conduct of business
Unearned income is passive income from earnings from investments and gains from sales.
Ex. Interest income, dividend income.
What is an annuity and how does the capital recovery concept apply to annuities?
It is a string of equal payments received over an equal time periods for a determinable period.
Tax law views the amounts paid out under the contract as being partly a return of original capital investment (excluded) and partly a return on the capital investment (taxable income).
Based on annuity exclusion ration = cost of of contract/number of payments.
Are prizes and awards taxable?
Yes, except if won for scientific, literary achievements and immediately transferred to a charitable organization and winner did not take any actions to win and does not have to do any future services.
Or if award comes from employer. maxed at $400. or if qualified plan $1,600.
Is unemployment compensation taxable? Worker's comp?
State unemployment is considered to be earned income is is taxable. Worker's comp is for those injured on the job and is NOT taxable.
When is Social Security taxable and what is the maximum amount that is included in gross income?
Taxable portion is equal to the lesser of:
1. 50% of SS benefits received
2. 50% of the amount by which modified AGI (AGI + 50% of SS benefits + foreign earned income exclusion + tax-exempt interest) exceeds the base amount (individual-$25,000, MFJ-$32,000)
Social Security benefits for income greater than $32,000 for individuals and $44,000 MFJ are limited to?
85% of SS benefits are taxable.
Difference between alimony and child support taxation?
Alimony is taxable to the recipient and is deductible for AGI by payer. Child support payments are not taxable.
What constitutes a long-term capital gain?
Assets (property) held for more than 1 year and 1 day and is added in to regular income at a lower rate.
10-15% - 0%
15-35% - 15% of gain
39.6%+ - 20% of gain
Netting process for capital gains?
Net short term gains and losses first.
Then, net long term gains and losses.
Finally, net the two together and determine if short or long term.
Maximum net capital loss that can be deducted in one year? What happens to excess?
Maxed to $3,000 deductible FOR AGI, excess is rolled over to next year for netting.
Tax treatment on dividends? Qualified dividends? Tax rate for qualified dividends?
Dividends are double taxed (corp and individual)
Qualified dividends (domestic corp or qualified foreign corp - not: credit union, farmers co-op, or tax-exempt, non-profit org) are taxed at long-term capital gains rates (0, 15, or 20)
Who is responsible for paying the taxes on gifts? Business gifts?
Gifts received are not taxable (14,000 max per year). Donor pays taxes. In a business setting is suspect, because intent can be misleading. (Substance of form)
When are payments from life insurance and inheritances included in income?
Life insurance proceeds may be included in decedents gross income and subject to estate tax. Subsequent earnings from property inheritance are taxable.
What is the maximum amount of group term life insurance premiums that can be excluded? Flexible benefits plan? Monies not spend by year end?
Exclusion up to $50,000 of face amount of group term life insurance. Flexible benefits (salary reduction plan) - an employee has an annual amount withheld from salary to pay for medical expenses or child-care, the employer reimburses the employee into that account as costs incurred. Not included in employee's gross income. Must be used in the current year or else its lost.
What is the purpose of a Health Savings Account (HSA's)?
Those who have high-deductible health plans (Family $2,600, Single $1,300) can contribute up to (Family $6,650. Single $3,350). Unused contributions roll over to next year. Purpose is to closely monitor spending on medical services.
When are payments resulting from physical injury or sickness excluded from income? When are they taxable?
Excluded: Worker's comp, damage payments received from personal physical injury, payments made for medical expenses by health and accident insurance policies (employer or employee paid), all policies purchased by individuals are excluded.
Taxable: Unemployment, punitive damages, disability payments
When disability payments included in income?
Disability payments are taxed if they come from an employer-provided plan. Not taxable if from employee purchased plan.
What are municipal bonds and what are the tax consequences of receiving interest from municipal bonds?
Interest income is taxable BUT interest earned on municipal bonds is tax-free. Municipal bonds are issued by state and local governments in the U.S. and U.S. possessions (Puerto Rico, Guam). Not on interest from Treasury bills.
When is discharge of indebtedness taxable and not taxable to the borrower?
When the borrower is relieved of debt, that is considered to be taxable. However, if borrower is insolvent (liabilities>assets), then it excluded. The amount that is taxed is whatever is solvent.
What is the business purpose concept?
There must be a business purpose for an expense/
The two main categories of business expenses?
Trade or business expense and expenses for the production of income.
Three requirements to be met to be considered as engaged in a trade or business?
1. Profit motivation
2. Continuous and regular activity
3. Livelihood, not a hobby
Is rental activity automatically a trade or business?
No, it depends on scope and extent of taxpayer's involvement. Can be considered as investments.
What is ordinary, necessary, and reasonable in amount for business purpose expenses?
Ordinary - commonly incurred
Necessary - appropriate and helpful
Reasonable in amount - reasonable (fair market)
Can a taxpayer deduct expenses for illegal business? Illegal payments?
Yes, taxpayer can deduct legal ordinary and necessary expenses. Cannot deduct illegal payments. (Illegal drugs, only cost of goods sold is deductible)
Are contributions and involvement in political activities deductible?
No, contributions to political campaigns and expenditures to influence public opinion about legislation, a referendum, or how to vote in an election are Not Deductible.
When are investment expenses deductible and when are they not?
Investment expenses can only be deducted if they produce taxable income. The portion that produces tax-exempt income is not deductible.
What are some factors when determining a hobby?
Time and effort expended
Success in similar activities
History of income and losses
Taxpayer's financial status
Amount of occasional profits
Expectations that assets will appreciate
Elements of personal pleasure or recreation
(Hobby expenses up to hobby income)
What criteria must be met to take the home office deduction?
Used exclusively for business on a regular basis. Principal place of business. Meeting clients.
What percentage of meals and entertainment is deductible?
For business purposes, a taxpayer can deduct 50% of the cost of meals and entertainment.
What type of activities are considered business entertainment?
Activities that are directly related to the active conduct of business and there is a general expectation of deriving income or business benefit.
The two methods to calculate auto expenses? Commuting?
1. Standard mileage rate of $0.54. or
2. Actual cost method
Commuting from home to work is not deductible.
Which travel expenses are deductible? and when are they deductible?
Travel expenses include transportation, lodging, 50% of cost of meals, and incidentals.
If 50%+ is personal, transportation is not deductible, all else stays same.
If 50%+ business, transportation fully deductible, but all else depends on use.
Business gifts are deductible to what amount? What is not included in total?
Business expenses are deductible up to $25 per year per donee. Shipping, gift-wrapping, is not included in total (does not add value).
When can education expenses be deducted as an itemized deduction?
Education has to be a requirement, by law or employer, for the taxpayers continued employment OR the education maintains or improved the skills required in the taxpayer's current trade or business - can be deducted as an itemized deduction.
What criteria must be met for the deductibility for compensation for employees? What is the maximum amount that can be deducted for key executives?
Payments must be for services actually performed by the employee and the total payments must be reasonable in amount. Maximum amount for CEO and 4 highest paid executives is $1,000,000.
What is the distinction between business and nonbusiness bad debts for tax purposes? When and in what amount can each expense be recognized?
Business bad debt: any debt related to trade or business, deductible in the year of partial or total worthlessness, deducted as an ordinary business expense.
Nonbusiness bad debt: any bona fide debt that is not related to trade or business, deductible when the exact amount of the worthlessness is known, deducted as a short-term capital loss.
Limited to $3,000
What is the difference between an accountable and non-accountable reimbursement plan?
Accountable: if reimbursements = actual expenses, has no effect on gross income.
Non-accountable: if reimbursements received, full amount is included in gross income.
What is the difference between a traditional and a Roth IRA?
Traditional: Can contribute up to $5,500 (over 50, $6,500), deduction before taxes, so when withdrawn it is taxable.
Roth: Contributions withdrawn are not included in gross income (tax-free).
What is the maximum that is deductible for student loan interest?
The maximum amount of interest that can be deducted is $2,500.
Two tests for moving expenses deductibility? What is included?
The distance test - greater than 50 miles.
The time test - 39 weeks of 12 month basis, self-employed its 78 for 2 years.
The cost of moving household goods and personal effects.
The transportation and lodging costs of moving taxpayer and family.
No meals. Mileage is $0.19/mile.
Which method of accounting do most individuals use?
Individuals choose to use the simpler cash method.
What is a personal exemption and why does Congress allow it?
The personal exemption is $4,050. Congress allows it for personal living expenses.
What is the difference between a personal exemption and a dependency exemption?
Personal exemption is for taxpayer and spouse. Dependency is for qualified dependents.
What are the five tests for qualifying child that all must be met?
4. Principal residence
5. Citizen or residency
What are the five tests for qualifying relative?
1. Income ***
4. Citizen or residency
5. Joint return ***
What is a multiple support agreement? Who can partake?
In cases of 2 or more people providing 50%+ support for a qualifying dependent, they can agree to one person to take the exemption. Also in divorced parents.
What are the 4 qualifying filing statuses? Why is qualifying widow(er)
1. Married, filing jointly
2. Married, filing separately
4. Head of household
Qualifying widower has a dependent child and can file MFJ the year and 2 years later.
What day of the year determines the taxpayer filing status?
Year end or last day of the year determines the filing status.
What is the criteria for an "abandoned spouse"?
If a dependent child lives in taxpayer home for more than half a year and the spouse did not live at home for the last half of the year.
What is an itemized deduction and when would a taxpayer choose it?
Medical expenses, taxes, interest, charitable contributions, casualty and theft losses, and other miscellaneous expenses can be itemized deductions. If greater than standard deduction (6,300 12,600)
How are medical expenses defined? Examples of deductible and nondeductible medical expenses?
For diagnosis, cure, mitigation, treatment, or prevention of disease.
Deductible: prescription drugs, dr visits, transportation to appts, health and accident insurance premiums
Nondeductible: cosmetic procedures, OTC drugs, funerals, life insurance premiums.
What must medical expenses be reduced by?
Total medical expenses limited to the excess of 10% if AGI (7.5% if over 65)
What taxes are deductible and nondeductible?
Deductible: state and local taxes, real estate taxes, personal property taxes.
Nondeductible: federal taxes, Social Security taxes, excise taxes, assessments for local benefits (sidewalks).
What happens if a taxpayer get a refund for state and local taxes in a subsequent year?
The taxpayer must include the refund in taxable income.
What two types of interest that is deductible as an itemized deduction?
Qualified home mortgage interest and investment income.
When is investment interest deductible and what are the limitations?
It is limited to the investment income of that year. Earned from property held for investment purposes (not passive)
What organizations are qualifying for charitable contribution deductions?
501(c)(3), churches, public & private foundations, veterans. NOT individuals.
What is the limit on property contributions to charity?
50% of AGI
What items are deducted as miscellaneous itemized deductions? Which are fully and partially deductible?
Fully: Gambling loss (not to exceed winnings), impairment related work expense for disabled, unrecovered annuity due to death.
Partially: unreimbursed employee business expense, investment expense, fees for tax prep and advice, hobby-related. - deductible for whatever exceeds 2% of AGI.
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