ACC401 -Exam 1 Study Guide PDF

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Tax exam study guide. (midterm)...

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ACC 401

Exam #1 Study Guide

Note: “cheat sheet” included with exam will include: Basic standard deduction amounts Additional standard deduction amounts

F16

Alimony recapture formulas Social Security inclusion formulas

1. Are the US federal income tax rates proportional, progressive, or regressive?  Progressive 2. Identify and describe the 3 types of IRS audits.  Correspondence Audit (via email) – automated via PC  Office Audit (IRS agent’s office & usually restricted in scope) – bring documents to office  Field Audit (on Taxpayer premises & examines numerous items reported on return) 3. What is the statute of limitations for a deficiency assessment by the IRS?  3 years from the later of, due date (4/15) or filing date of tax return  >25% omission from Gross Income = 6 years  No return filed or fraudulent return = NO LIMITATIONS 4. What is the statute of limitations for a refund claim by a taxpayer?  3 years from date return filed or 2 years from date tax paid, whichever is later 5. Identify and understand the ethical guidelines for tax practitioners issued by the AICPA covered in class.  Do not take questionable position on client’s tax return in hope of not being audited (only take position if supportable by documents)  Client’s estimate may be used if reasonable (in preparer’s personal judgement)  Try to answer every question on tax return, even if disadvantageous to client  Upon discovery of an error prior to tax return year, advise client to fix. o Good to ask for at least last 3 years of filings to double-check 6. Describe the principles contained in the 1910 “cannons of taxation” for the federal income tax law.  Equality – based on withdrawal or ability to pay (similar incomes taxed similarly, different incomes taxed differently)  Convenience – easy to access and collect, benefits taxpayers  Certainty – tax rules and treatments are predictable  Economy – minimal compliance and collection costs, it should be easy for taxpayer to partake in federal income filing 7. Write the tax formula.

8. Name 3 general types of cash receipts or income that the tax law does not intend to tax.  Life Insurance (not taxed to beneficiary)  Scholarships (Everything EXCEPT Room and board is excluded)  Workers’ compensation (small amount so not taxed, physical injury)  Gifts, Inheritances, face value of annuities, welfare, physical injury damage compensation 9. Explain why AGI is such an important subtotal.  Basis for computing percentage limitations (thresholds) on certain itemized deductions such as medical expenses, charitable contributions, certain casualty losses Two Types of Deductions  For AGI (above line) *most powerful o Alimony, capital loss deduction, fees for tuition and expenses, etc.  Lower AGI = Less Tax Liability  From AGI (below line) o Greater of: Itemized (medical expenses >10% AGI, casualty losses >10% AGI, etc.) or standardized deductions o Personal and dependency exemptions (deduction) 10. Identify & describe the 2 components of the standard deduction.  Basic Standard Deduction (BSD) 1. Amount based on taxpayer’s filing status  Additional standard deductions (ASD) 1. Available taxpayers who are 65 years or older, and/or legally blind 2. Two additional standard deductions are allowed for a taxpayer who is age 65 or older and legally blind 3. Amount based on taxpayer’s filing status 11. Calculate the total standard deduction that is appropriate for a particular set of facts.  

Married Filing Jointly, one blind, both age 66 o 12600 (bsd mfj) + 1250 (mfj blind) + 1250 (mfj 65+) + 1250 (mfj 65+) = $16350 SD Single, blind, age 68 o 6300 (bsd single) + 1550 (single blind) + 1550 (single 65+) = $9400 SD

12. Describe and execute the dependency exemption tests for qualifying child and qualifying relative. Determining Dependency Exemptions (QC) A dependency exemption is available for one who is either a qualifying child or a qualifying relative •

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A qualifying child must meet the following tests: –

Relationship

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Abode

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Age, &

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Support

Congress has tried to establish a uniform definition of qualifying child for purposes of the: –

Dependency exemption

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Head-of-household filing status

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Earned income tax credit

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Child tax credit

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Credit for child and dependent care expenses

Relationship Test •

The child must be the taxpayer’s: (DOWNWARD LOOK OF TREE) –

Son or daughter

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Stepson or stepdaughter

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Brother or sister

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Stepbrother or stepsister

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Half brother or half sister, or

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A descendant of such individual (e.g., grandchildren, nephews, nieces)

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A child who has been adopted, or whose adoption is pending, qualifies

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A foster child with official paperwork qualifies

Abode Test •

A qualifying child must live with the taxpayer for more than half of the year –

Temporary absences from the household due to special circumstances (e.g., illness, education) are not considered

Age Test •

The child must be under age 19 (at year-end) or under age 24 in the case of a student –

A student is a child who, during any part of five months of the year, is enrolled full time at a school or government-sponsored on-farm training course

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Individuals who are disabled are not subject to the age test

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A qualifying child cannot be older than the taxpayer claiming the exemption.

Support – tests individual

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To be a qualifying child, the individual must not be self-supporting –

Cannot provide more than one-half of his or her own support

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In the case of a full-time student, scholarships are not considered to be support

-----------------------------------------------------Qualifying Relative •

In order to claim a dependency exemption for a qualifying relative, the following tests must be met: –

Relationship

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Gross income

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Support

Relationship Test (QR) •

The relationship test for a qualifying relative is more expansive than for a qualifying child. UPWARD AND DOWNWARD LOOK)

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Also included are the following relatives:

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Lineal ascendants (parents, grandparents)

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Collateral ascendants (uncles, aunts)

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Certain in-laws (son-, daughter-, father-, mother-, brother-, and sister-in-law)

The relationship test also includes unrelated parties who live the entire year with the taxpayer

Gross Income Test •

Dependent’s gross income must be less than the exemption amount ($4,050 for 2016).

Support Test – tests taxpayer •

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Taxpayer must provide more than 50% of the qualifying relative’s support . –

Only amounts expended are considered in the support test

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Scholarships are not considered in the support test

Two exceptions to the support test: –

Multiple support agreements

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Children of divorced parents

Multiple Support Agreements •

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Allows one member of a group providing > 50% of support to claim individual even though no one person provides > 50% support –

Eligible parties must provide > 10% of support

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Each eligible party must meet all other dependency requirements

Allows children of elderly parent (one per year) to claim exemption for parent when none individually meets the 50% support test.

13. Calculate gross income, AGI, and taxable income given a set of facts based on our studies to date. Gross income

14. When are federal income tax returns due for individuals?  Due on 15th day of 4th month after years’ end (4/15) 15. Identify and describe the 5 filing statuses and know when to use them.  Single o Unmarried (year end) or,  Marital status determined on last day of tax year  Spouse death = marital status on day of death  Dies 7/6/16… still files mfj for 2016 o separated from spouse by a decree/agreement and does not qualify for another status  Married, filing jointly o Married as of last day of taxable year or spouse dies during taxable year  Surviving Spouse/ Qualifying Widow(er) o Same tax rate bracket as MFJ (to help adjust during tough times) o Dependent child in house = file as SS for 2 years after year of death  Head of Household (abandoned spouse) o Unmarried or abandoned spouse o Pay > half the cost of maintaining a household of a dependent for over half the tax year o Dependent must be QR or QC o HH can be claimed if taxpayer maintains home for parents, and at least one is qualified dependent  Married, filing Separately o Choice to file separately although married o Loss of many tax benefits 16. Which filing status should an abandoned spouse use?  Head of Household o Paid > half the cost of maintaining home o Spouse did not live in home during last 6 months of tax year o Dependent child lived in residence > half the year 17. Calculate, classify, & properly treat long term, short term, capital & ordinary gains & losses.  Long-term = >1 year, Short-term = increases in cash value are treated as a recovery of capital until the cost recovered; additional amounts are included in income. Early distributions (before age 59.5 or disabled) may also be subject to a 10% penalty.

The exclusion ratio is applied to annuity payments received under a contract to determine excludable amount: Exclusion ratio =

Investment in contract____

Expected return under contract 10k spent on contract, 1000 a year for 15 years = 10000 / 15000 = 66.7% excluded from payment each year… therefore, 1000 * 66.7% = 667$ excluded & 333$ taxed each year 

Once the investment amount is recovered (face value), any remaining payments are taxable in full.

27. Describe the tax treatment of prizes and awards.  FMV of the item is included income (non-cash asset)  Excluded if: 1. Transfers prize directly (never takes ownership) to a qualified NFP or gov’t organization 2. Employee achievement award of tangible personal property made in recognition of length or service achievement can be excluded up to $400 ($1600 if qualified award) – military, teaching awards 28. Describe the tax treatment of unemployment compensation.  TAXABLE IN FULL 29. Calculate the taxable portion of social security benefits given a set of facts and the SS formulas.  MAGI = AGI (excluding SS) + foreign earned income exclusion + tax exempt interest **(you add exclusions back)  Test # = MAGI + ½ SS benefits  After figure out if in 50% or 85% zone, then apply formula for specific zone to find inclusion of SS benefits 30. Describe the criteria required for a transfer to be characterized as a gift for tax purposes.  Transfer has to be voluntary, without adequate consideration (one-way exchange)  Made out of affection, respect, admiration, charity, or donative intent 31. Describe & properly apply the tax rules for gifts, inheritances, & income earned on gifts & inheritances.

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Gifts o NONTAXABLE TO RECEIVER Inheritances o NONTAXABLE TO BENEFICIARY Income earned on gifts or inheritances o TAXABLE (gift daughter bond, interest earned after gift taxable to daughter)

32. Describe and properly apply the tax rules for life insurance proceeds & any related investment earnings received:  by a beneficiary due solely to the death of the insured o Life insurance proceeds = tax free income to beneficiary (not included) o Investment earnings from reinvestment of proceeds are TAXED o If proceeds in installments, separated into principal (excluded) and interest (included/taxed)  by the transferee when the policy was transferred for valuable consideration o Proceeds taxable to transferee, in excess of amount paid for policy plus transfer and prior premiums paid combined (100k policy, paid 60k transfer + 20k in premiums paid = 20k gain taxable)  Tax free if…  Transferred to facilitate buy-sell agreement  Pursuant of a tax-free exchange  Given as a gift 33. Describe and properly apply the tax rules for the cash surrender value of a life insurance policy received:  by the policy holder upon policy cancelation o Gain is taxed, (amount exceeding premiums paid on policy) … 50k premiums paid, 100k surrender value = 50k gain taxed o Loss not recognized  as accelerated death benefits o Gain by terminally ill person excludible (they will die soon) o Exclusion for chronically ill person, limited to amount used for long-term care (proper treatment) 34. Describe and properly apply the tax rules for scholarships and fellowships.  NONTAXABLE: tuition, fees, books, supplies, equipment required  TAXABLE: room and board  Qualified tuition waivers/reduction by nonprofit institutions are excluded from GI: o GR: undergraduate waivers = NOT TAXED o Exception: Graduate waivers for teaching or research assistants = TAXED AS COMPENSATION 35. Describe and properly apply the tax rules for damages received for: Two types of damages: Compensation (offset loss), Punitive (always taxed, in addition to compensation)  Loss of income o Taxed at same rate as income replaced, NOT TAXED IF DUE TO PHYSICAL INJURY  Reimbursement for expenses incurred (medical bills) o Not income, not taxed (qualifying medical expenses) o Damages awarded for recovery of qualified expenses are taxable under TB rule (deduct $5000 medical expense, next year add $5000 to GI)  Physical personal injury or illness o Excludible, damages not taxed if for physical situation  Nonphysical injury o Damages awarded for NONPHYSICAL are taxed (included)

36. Describe and properly apply the tax rules for worker’s compensation benefits.  Workers Compensation = EXCLUDED from GI, even though it may be for payment of loss wages (small amount of money, cannot work due to PHYSICAL injury)

37. Describe and properly apply the tax rules for accident and health insurance benefits received when the policy was purchased by: 1) the taxpayer and 2) the taxpayer’s employer.  Accident/Health Plan purchased by EMPLOYEE o Taxpayer pays premium = all benefits excludable from GI (even income substitute) 

Accident/Health Plan purchased by EMPLOYER o Premiums paid by employer for coverage not taxable to employee o Amounts received from insurance for qualified PHYSICAL medical expenses or permanent loss of body function NOT TAXED to employee… non-qualified expense reimbursements are taxed o Amount deducted in prior year for medical expenses must be included in employee current year return (TB rule)

38. Describe and properly apply the criteria needed for employee provided meals and lodging to be excludible.  NON TAXABLE IF: (meals) o Furnished by employer (free) o For convenience of employer (leftover food used to feed workers)  *LODGING = must be required to accept lodging as condition of employment contract (cannot be an option) 39. Identify the tax effect of choosing to receive cash from a cafeteria plan.  Cafeteria plan allows choice between: cash and certain nontaxable benefits o IF CASH CHOSEN = FULLY TAXED RECEIVED AMOUNT 40. Be familiar with and properly apply the tax rules for the employee benefits of no-additional-cost services, qualified employee discounts, de minimis fringes & parking fringes. ***ALL EXCEPT PARKING FRINGE MUST BE NONDISCRIMINATORY*** (non-taxable benefits)  No-additional cost services (Airline workers fly on empty seats free) o NONTAXABLE IF:  Employee receives services FREE, not property  Employer no extra costs to provide, same line of business  Qualified Employee Discounts o NONTAXABLE IF:  Discount is not on realty or investment property (must be product)  Discounted item same line of business (tv discount from tv store)  Discount cannot exceed normal Gross profit on property sale or 20% of customer price  TV sells for 850, cost 600, discount price 500 o Discount = 850 – 500 = 350, Gross Profit = 850 – 600 = 250  Excluded: 250  Included: 100  De minimis fringes (small benefits, accounting for them impractical) o Subsidized eating facilities operated by employer excludable if:  Located on/near employer premises  At least break even from providing benefit  Parking Fringe (not required for everyone… usually just the important people)

o EXCLUSIONS (threshold before reporting on GI)  $255 per month for Parking or transit passes  275 spent on parking, 255 excluded, 20 included/taxed  $20 per month qualified bicycle commute  EMPLOYER PROVIDES DIRECTLY OR GIVE CASH REINBURSEMENTS 41. Know the requirements for & calculate the foreign earned income exclusion (without housing).  Qualifications: o Bona fide resident of country or, o At least 330 days during a 12-month period present in country (2016 has 366 days)  2016 Exclusion limit = $101,300 o Max exclusion for individual = ($101,300 / 366) * qualifying days abroad  (ex) 276.80 per day excludible * 330 days = $91,344 max exclusion for year  If made less than max exclusion, all is excludible, otherwise excess income is taxed (regular tax brackets) 42. Describe and properly apply the general rule for taxation of interest income.  GR: Interest income is added to GI and taxed at same income bracket 43. Describe and properly apply the tax rules for interest earned on state and local government obligations.  Municipal Bonds – Interest tax exempt (state/local gov. bonds) o Reduces cost of state/gov. to borrow money (issuing bonds) o Higher tax bracket = more tax savings on municipal bonds  1000$ interest, 35% bracket, 350$ saved… 10% bracket, 100$ saved 44. Describe and properly apply the tax rules for stock dividends and stock splits.  Stock Dividends: IF shareholders can only receive stock dividends, NOT TAXED  IF choice between stock or cash dividend, both are taxable 45. Properly apply the tax benefit rule for a given a set of facts.  TB is applied over a period of two years  Deduction claimed one year, a year later recovers all or a portion of deduction, recovery is included in Gross Income (amount included limited to amount of TB received prior year)  Deduction in previous year must be offset by recovery in the following year 46. Describe and properly apply the general rule and the exceptions for the tax treatment of debt that is forgiven.  GR: Income from forgiveness of debt is taxable (amount forgiven add to GI and is taxed) *Antonio forgiven 10k debt, he must add 10k to GI and tax it*  Special Treatment (Not Taxable) o Creditor’s gifts o Forgiveness of certain student loans  Exceptions: BASIS REDUCTION (Property w/ basis involved) o Amount forgiven lowers Basis for property item (Basis 100k equipment, 50k debt forgiven… A/B = 50k) o Does not affect Gross Income, only A/B 47. Describe the tax benefits generally associated with qualified deferred compensation plans.  Qualified compensation plans (retirement) o Employer contributions – deductible by employer o Employees not taxed on contributions/earned income (Taxed when Withdrawn) – tax deferral o Income earned from plan not taxable (grows tax deferred) o Qualified contributions from employer avoids payroll tax

48. Describe the tax treatment of a lump-sum distribution from a qualified plan.  Taxable in year of distribution  May roll-over distribution funds to IRA/qualified plan to defer tax on lump-sum o Transfers within 60 days are excludible from gross income o one tax free roll over every 12 months  direct transfers not subject to this limitation 49. Describe and properly apply the limits on contributions ...