Chap1: Individual Tax Types of income 1.

Income from services Including salary, wages, taxable fringe benefit and fees that a taxpayer earns through services in a nonemployee capacity (for example, consulting work outside of employment). Income from services is also referred to as earned income because it is generated by the efforts of the taxpayer). All compensation (such as fringe benefits) should be taxed on FICA. Taxable fringe benefits include such things as below-market interest rate loans, gym memberships, season tickets to the local NBA team, an automobile allowance for a personal automobile, or anything else not specifically excluded by the tax laws. Taxable fringe benefit: group-term life insurance, employees must recognize a certain amount of gross income when employers pay life insurance premiums for the employee for policies with a death benefit in excess of 50,000. Consequently, a portion of the group-term life insurance benefit is taxable and a portion is nontaxable. The steps to calculate the annual taxable benefit: (1) Subtract 50,000 from the life insurance policy (2) Divide the step 1 result by 1,000 (IRS provides a table with cost per 1,000 insurance) (B12-23) (3) Multiple result from step 2 by the cost per 1,000 insurance for one month based on the age (4) Multiply the outcome of step 3 by 12. Note1: the calculation is about the taxable portion of premium paid by the company. However, the entire amount of insurance proceeds paid by the reason of death will be excluded (that is classified as life insurance) Note2: employee death payment paid by the company should be included in gross income. Note3: Tips. (1) If an individual receives less than 20 tips during one month while working for one employer, the tips do not have to be reported to the employer and the tips are included in the gross income when received. (2) If an individual receives more than 20 tips during one month while working for one employer, the tips have to be reported to the employer by the 10th day of the next month and the tips are included in the gross income when reported. 2. Income from property Often referred to as unearned income and includes gain or loss from the sale of property, dividends, interest, rents, royalties, and annuities. A. Annuities (same rules apply to pension benefits) An annuity is an investment that pays a stream of equal payments over time. Individuals often purchase annuities as a means of generating a set income stream during retirement. There are two types of annuities: (1) annuities paid over a fixed period and (2) annuities paid over a person’s life (for as long as the person lives). For both types of annuities, the tax law deems a portion of each annuity payment as a nontaxable return of capital and the

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Regulation Notes By Tomato

remainder as gross income. Taxpayers use the annuity exclusion ratio to determine the portion of each payment that is a nontaxable return of capital. Annuity exclusion ratio=original investment/number of payments=return of capital percentage. The number of payments is uncertain for annuities paid over a person’s life. For these annuities, taxpayers must use IRS tables to determine the number of payments (it is called expected return multiple). If the taxpayer dies before receiving the expected number of payments, the amount of the unrecovered investment (the initial investment less the amounts received that is treated as a nontaxable return of capital) is deducted on the taxpayer’s final income tax return. B. Dividends (R1-22) Qualified dividends generally are taxed at a 15% preferential rate. Qualified dividends holding period: The stock must be held for more than 60 days during the 120-day period beginning 60 days before the ex-dividend dates (ex-dividend date is the date on which a purchased share no longer is entitled to any recently declared dividends). C. Interest Imputed interest: when employees borrow money from an employer at a below-market interest rate. Imputed interest= loan * (actual interest rate – an applicable federal interest rate) The imputed rule does not apply to loans of 10,000 or less. A taxpayer’s income include interest on state and federal income tax refunds and interest on federal obligations, but excludes interest on state obligations. D. Rents (1) Net rent income (rent revenue –related expenses) is included in gross income. (2) Advance payments and lease cancellation must be included in gross income when received, regardless of the period covered or whether the taxpayer uses the cash or accrual method. (3) A security deposit is included in income when not returned to tenant. E. royalties F. Gain or loss from sale of an asset Tax basis: the cost or capital investment in the underlying property. Taxpayers are allowed to recover their investment in property (tax basis) before they realize any gain. A loss is realized when the proceeds are less than tax basis in the property. Sales proceeds-selling expenses=amount realized Amount realized- tax basis in property sold=gain or loss on sale 3. Other sources of gross income A. Income from flow-through entities B. Alimony The tax law defines alimony as (1) a transfer of cash made under a written separation agreement or divorce decree, (2) the separation or divorce decree does not designate the payment as something other than alimony, and (3) the payments cannot continue after the death of the recipient. 2 Regulation Notes By Tomato

(a) If the payment is alimony, then the amount of the payment is included in the gross income of the person receiving it and is deductible for AGI by the person paying it. (b) If a transfer of property between spouses does not meet the definition of alimony, the recipient of the transfer excludes the value of the transfer from income, and the person transferring the property is not allowed to deduct the value of the property transferred. (c) If a divorce agreement specifies both alimony and child support, but less is paid than required, then payments are first allocated to child support, with only the remainder in excess of required child support to be treated as alimony. Alimony recapture It occurs if payments sharply decline in the second and third years: (1) Recapture for year2 occurs if the alimony paid in year2 exceeds the third-year alimony by more than 15,000; Recapture amount = payment in year2 – (payment in year3+15,000) (2) Recapture for year1 occurs if the alimony in year1 exceeds the average alimony in year2 and year3 by more than 15,000. Average alimony in year2&year3= (year2 payment – recapture in year2 + year3 payment)/2 Recapture amount= year1 payment – (average alimony in year2&year3+15,000) (3) Recapture will not apply to any year in which payments terminate as a result of the death of either spouse or the remarriage of the payee. (4) Recapture does not apply to payments that may fluctuate over three years or more and are not within the control of the payor spouse. For the recapture amount (payment – 15,000), the payor includes it in his gross income in ). the third year and the payee deduct the same amount ( C. Prizes, awards, and gambling winnings The fair market value of prizes and awards is taxable income. An exclusion from income for certain prizes and awards applies where the winner immediately transfer the award to a governmental unit or charitable organization. Second exception is for employee awards for length of service or safety achievement, which is limited to $400 of tangible property other than cash per employee each year. D. Social security benefits (SSB) Taxpayers may be required to include up to 85% of the benefits in gross income depending on the level of modified AGI and the SSB, which is AGI (before including social security benefits) +tax-exempt interest +50% of SSB (1) Low Income = No Social Security benefits are taxable (modified AGI below: single $25,000/MFJ $32,000) (2) Upper Income = 85% of Social Security benefits are taxable (income over: single $34,0OO/MFJ $44,000) (3) Taxpayers not in group (1) and (2) above include a portion of their benefits up to 50% of the total SSB

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Regulation Notes By Tomato

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Note: social security retirement benefits are fully excluded by low-income taxpayers (provisional income less than 25,000); 85% of benefits must be included in gross income by high-income taxpayers (provisional income more than 60,000) E. Distribution from traditional 401k plan F. Stock option 1. Incentive stock option (a) No income is recognized when option is granted or exercised. (b) Recognize gain when the stock exercised is sold If employee holds the exercised stock at least two years from the grant date, and holds the stock itself for at least one year, then Employee: long-term capital gain Employer: no deduction Otherwise, Employee: ordinary income = FMV at exercise date – exercise price Employer: deduction equal to the amount employee reports as ordinary income. 2. Nonqualified stock option If option has a determinable FMV when it is granted, then include it in the income, otherwise, Recognize income= FMV at exercise date- exercise price at exercise date Employee: income is ordinary income Employer: deduction equal to the amount employee reports as ordinary income. 3. Employee stock purchase plan not discriminating against rand and file employees (a) No income is recognized when option is granted or exercised. (b) Recognize gain when the stock exercised is sold If employee holds the exercised stock at least two years from the grant date, and holds the stock itself for at least one year, then Employee: ordinary income is the lesser of (1) FMV at grant date-option price or (2) FMV at disposition date – option price. Employer: no deduction Otherwise, Employee: ordinary income = FMV at exercise date – exercise price Employer: deduction equal to the amount employee reports as ordinary income. G. Imputed income Taxpayers sometime realize indirect economic benefits that they must include in gross income. E.g., taxpayers realize an economic benefit when (1) they are allowed to purchase products or services from an employer at less than the market price or (2) they are allowed to borrow money at less than the market rate of interest. These benefits are named as imputed income. A. Employees must recognize income to the extent they receive a greater than 20 percent discount from their employer for the employer’s services or purchase goods from their employer at a price below the employer’s cost.

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Regulation Notes By Tomato

Cash reimbursement for medical care D. 1. G. This 100 discount is not qualified discount. Municipal interest Interest on municipal bonds (bonds issued by state and local governments located in the US) Interest on obligations of a state or one of its political subdivisions.0 included in her compensation. Employees can exclude form income up to 5. (2) If the discharge of indebtedness makes the taxpayer solvent. Working condition fringe benefits 5 Regulation Notes By Tomato . Congress allows most exclusions and deferrals for two primary reasons: (1) to subsidize or encourage particular activities or (2) to be fair to taxpayers. C. Nontaxable fringe benefits (R1-18) A. the District of Columbia. Employee educational assistance. including tax liabilities.B. Julie purchased a laptop from her company at 1. Eg. exceeding their assets.250 are taxed as compensation to the employee. The imputed interest rules do not apply to loans of $10.600 (MFV 2. Meals and lodging for the convenience of the employer E.700. Health and accident insurance paid for an employee and their spouse and dependents. and US possessions is generally excluded from income if the bond proceeds are used to finance traditional governmental operations.600 (MFV 2. No-additional-cost services. Employees can exclude the value of No-additional-cost services.000 group term life insurance B. This discount is qualified discount. These are services employers provide to employees in the ordinary course of business that generate no substantial costs to the employer. H. Discharge of indebtedness (1) Taxpayers with liabilities.000 or less. F.250 of employee educational assistance benefits covering tuition.100) with a cost basis of 1.000 for benefits paid or reimbursed by employers for caring for children under 13 or dependents or spouses who are physically or mentally unable to care for themselves. books and fees. Eg. Imputed income=loan principal* (federal interest rate – interest rate paid).100) with a cost basis of 1.500. The first 50. 2. Amounts over 5. the taxpayer recognizes taxable income to the extent of his solvency. Exclusion provisions There are specific types of income that taxpayers realize but are allowed to permanently exclude from gross income or temporarily defer from gross income until a subsequent period. 100 included in her compensation I. Julie purchased a laptop from her company at 1. Exclusions and deferrals are the result of specific congressional action and are narrowly defined. Qualified employee discounts as long as they don’t acquire (1) goods at a price below the employer’s cost or (2) services at more than a 20 percent discount of the price of the services to customers. a discharge of indebtedness is not taxable if the taxpayer is insolvent before and after the debt forgiveness. H. Employees can exclude up to 5.

and reasonable room and board. 5. books. fees. and other equipment required for the study. These bonds don't generate any cash in the form of interest until the taxpayer redeems the bonds. If an employee chooses qualified benefits. Scholarships that represent compensation for past. Small benefits. books. fees. College students seeking a degree can exclude from gross income scholarships that pay for tuition.000 to 220. Education. supplies. 3. This is an investment account. C. The investment returns accumulate tax-free. current. And the maximum exclusion for the qualified parking benefit is also 230/month. it should be included in gross income. and the cost of qualified parking near the work place. or future services are fully taxable. 3. The maximum exclusion of the car pool vehicle and mass transit pass is 230/month. If an employee chooses cash.000 contribution limit is phased out as AGI increases from 190.J. The 2. L.000 for married filing jointly. When distributions are made from this account. Qualified transportation fringe: the value of company-owned car pool vehicle for commuting.000 for all other taxpayers. employees may select their own menu of benefits.related exclusions An incentive for taxpayers to participate in higher education (education beyond high school) A. De Minimis fringe benefits. 2. At redemption. the distribution is taxable and incurs 10% penalty. the cost of mass transit passes. and from 95. supplies. This contribution is not deductible. earnings are excluded provided they are used for qualified education costs of kindergarten through 12th grade and qualified higher education expenses such as tuition. Education IRA (Coverdell educational saving account) 1. 4. Any excess scholarship amounts (such as for room or meals) are fully taxable. Thus.000 to 110. The amount left in an education IRA before the beneficiary reaches age 30 can be rolled over to another family member’s education IRA without triggering income taxes or penalities. it is includible in the gross income. they are excluded from the employee’s gross income to the extent allowed by law. B. Yearly contributions to the account are limited to 2. The federal government issues bonds that allow taxpayers to acquire the bonds at a discount and redeem the bonds for a fixed amount over stated time intervals. This applies only if the recipient is not required to perform services in exchange for receiving the scholarship. That is. the amount of the redemption price in excess of the acquisition price is interest 6 Regulation Notes By Tomato .000 for each beneficiary (until the beneficiary reaches age 18). Qualified moving expense reimbursement Cafeteria plan: employer-sponsored benefit packages that offer employees a choice between taking cash and receiving qualified benefits (such as accident and health insurance). When distribution is made directly to a beneficiary instead of paying the qualified education expenses. K.

600 (9. The decedent is generally subject to estate taxation on the amount of the insurance proceeds. Amount included in the gross income= insurance proceeds – purchase price 6. In order to avoid potential double taxation. 4. Thus. When the owner of the life insurance policy dies. During 2009. Qualified distribution from Roth 401k plans 7. (3) The exclusion rule does not apply if the life insurance is obtained by the beneficiary in exchange for valuable consideration from a person rather than the insurance company.included in gross income. the beneficiary receives the death benefit proceeds.000) can be excluded from gross income. Exceptions: (1) In the event the life insurance policy is cashed in before the death of the insured individual.000/10. (4) The redemption proceeds must be used to pay the tuition and fees incurred by the taxpayer. the difference between the cash surrender value and the premiums invested. Gifts and inheritances Individuals may transfer property to other taxpayers without receiving or expecting to receive value in return. U.. (2) When the insurance proceeds are paid over a period of time (installment) rather than in a lump sum. (3) The owners must be at least 24 years old before the bond’s issue date. Assuming qualified higher education expenses total 9. Theses transfers are generally subject to the federal gift tax and federal estate tax (i. 5. If the property is transferred from the decedent’s estate. Requirements for tax exemption of accumulated interest on Series EE US saving bonds: (1) The bonds must be issued after Dec 31. the exclusion is subject to phase out. Series EE bonds fall into this category. 1989. only a pro rata amount of interest can be excluded.. a portion of the payments represents interest and must be included in gross income. It is taxed at ordinary rates on the total investment gains from the policy.e. However.g. Foster child payments They are excluded from income to the extent they represent reimbursement for expenses incurred for care of the foster child. The amount included in gross income= payment – principal/payment period. a married taxpayer redeems series EE bonds receiving 6.000*4. not the income tax. E. Life insurance Life insurance proceeds are similar to inheritances. Moreover. (2) The purchaser of bonds must be the sole owner of the bonds (or joint owner with spouse). the beneficiary receives the cash surrender value of the policy. or dependents to attend a college or university or certain vocational schools. Note: if the redemption proceeds exceed the qualified higher education expenses. accrued interest of 3. spouse.000 of principal and 4.that is.S. If the transferor is alive at the time of the transfer.000. In this case. cash surrender value is not tax exempt. gift and estate taxes are imposed on transfer of the property and not included in income by the recipient. an exclusion is available for interest from Series EE bonds. transfer tax).000 of accrued interest. 7 Regulation Notes By Tomato . the property transfer is called a gift. it is called an inheritance. the tax law allows taxpayers receiving life insurance proceeds to exclude the proceeds from taxable income.

Damages taxpayers receive for emotional distress associated with a physical injury are nontaxable.8.S. B. Exclude foreign earned income up to an annual maximum amount (91. Sickness and injury-related exclusions Payments for sickness or injury should not be taxable. How much of her expected 120. Disability insurance 8 Regulation Notes By Tomato . citizens are subject to tax on all income whether it is generated in the US or in foreign countries.400 in 2009). deduct the foreign tax paid on their foreign earned income as itemized deductions C. However.000 salary will she be allowed to exclude from gross income? 94. A. which is fully taxable. C. Health care reimbursement Any reimbursement a taxpayer receives from a health and accident insurance policy for medical expenses paid by the taxpayer during the current year is nontaxable regardless of whether the taxpayer or the taxpayer’s employer purchased the insurance policy. Be considered a resident of the foreign country B. she can exclude up to 85. Any payments a taxpayer receives from a state-sponsored workers’ compensation plan are excluded from the taxable income. How much of her expected 60. But up to 2. Note: This treatment is opposite that of unemployment compensation. Individuals must meet certain requirements to qualify for the foreign earned income exclusion. Or live in the foreign country for 330 days in a consecutive 12-month period Note: because the exclusion is computed on a daily basis.100 * 340/365=85. Payments associated with personal injury Payments on account of a physical injury or physical sickness are nontaxable. Under the condition that the taxpayer does not deduct the medical expenses as itemized deductions. B. A. Taxpayers must choose to (by comparing the tax effects of each option) A.000. claim the foreign tax credit for foreign taxes paid.140 Assume Courtney agrees to rotation but she expects to live in the foreign country for only 340 days. Workers’ compensation Taxpayers receive workers’ compensation benefits when they are unable to work because of a work-related injury.400 of unemployment compensation can be excluded from gross income for tax years beginning in 2009.000 salary will she be allowed to exclude from gross income? All 60. Punitive damages are fully taxable. the maximum exclusion is reduced pro rata for each day during the calendar year the taxpayer is not considered to be a resident of the foreign country or does not actually live in the foreign country Assume Courtney agrees to rotation but she expects to live in the foreign country for only 340 days. taxpayers receive damages for emotional distress that are not associated with a physical injury must include those payments in income and only exclude payments for medical expenses attributable to the emotional distress. D.140 of salary from income. 9. Foreign-earned income U.

Business expenses are deducted for AGI with one exception. (1) If the premiums paid on the employee’s behalf are taxable compensation to the employee. not any disability benefits are nontaxable. Only payments taxpayers receive from an employee-purchased policy are nontaxable. Deductions directly related to business activities. Deductions Deductions for AGI are generally preferred over deductions from AGI because deductions above the line reduce taxable income dollar for dollar. Three categories of deductions for AGI: 1. Deductions directly related to business activities Differentiate business activities with investment activities: Business activities require a high level of involvement or effort from the taxpayer. Instead. Further. Disability insurance may also be purchased on an individual’s behalf by an employer. 2.It is also called wage replacement insurance. Deductions indirectly related to business activities. Deferral provisions Deferral provisions allow taxpayers to defer the recognition of certain types of realized income. 9 Regulation Notes By Tomato . Deductions subsidizing specific activities. If an individual purchases disability insurance directly. which pays the insured individual for wages lost when the individual misses work due to injury or disability. deductions from AGI sometimes have no effect on taxable income. and contributions to non-Roth qualified retirement accounts. The lone exception is unreimbursed employee business expenses are deductible as itemized deductions. Transactions generating deferred income include installment sales. because many of the limitations on tax benefits for higher income taxpayers are based upon AGI. investment activities are profit-motivated activities that do not require a high degree of taxpayer involvement or effort. like-kind exchanges. A. investment activities involve investing in property for appreciation or for income payments. 1. B. the cost of the policy is not deductible. Expenses associated with rental and royalty activities are deductible for AGI regardless of whether the activity qualifies as an investment or business. In contrast. Investment expenses are deducted from AGI with one exception. 3. deductions for AGI often reduce these limitations thereby increasing potential tax benefits. the policy is considered to have been purchased by the employee. (2) If the premium paid for by the employer is a nontaxable fringe benefit to the employee. Business expenses. involuntary conversions. the policy is considered to have been purchased by the employer.

and royalties. the operating income or loss from their trade or business and rental activities flows through to the taxpayer and is treated as ordinary income or ordinary loss. dividends. However. this includes salary and self-employment income. 3. The tax basis in the activity=initial investment + share of the activity’s debt + share of income from the activity – distributions of cash and losses. The impact of segregating income in these baskets is to limit taxpayer’s ability to apply passive activity losses against income in the other two baskets. The passive loss rules are applied to any losses remaining after applying the tax basis and at-risk loss limits. They do not appear directly on the front page of Form 1040. Losses 4. Instead. either from the passive activity. Income and loss categories 1. Portfolio income: income from investments including capital gains and losses. If the losses from an activity exceed the tax basis. taxpayers report it on their tax returns and pay taxes on it. Taxpayers transfer the net income or loss form Schedule C to Form 1040 line 12. and S corporations. these deductions are reported with business revenues on Schedule C (profit of loss from business). rental and royalty deductions are reported with rental and royalty revenues on Schedule E (Rental or royalty income). and substantial. continuous. For individuals. the losses are suspended until the taxpayer generates enough tax basis to absorb the loss (2) At risk amount. 2. annuities. B11-33) With partnerships. interest. including rental real estate. if the activities generate losses.They are not readily visible on the front page of Form 1040. Rental and royalty expenses. the losses must clear three hurdles to be currently deductible: (1) Tax basis. (3) Passive loss limits. 3. The tax basis hurdle limits a taxpayer’s deductible losses to the taxpayer’s tax basis in the activity. Instead. or until the taxpayer sells the activity that generated the passive loss. Taxpayers transfer the net income or loss from Schedule E to line 17. (WP377) 10 Regulation Notes By Tomato . 2. limited liability company. Losses from the passive category cannot offset income from other categories. If trade or business or rental activities generate ordinary income. Participants in rental activities. The rule limits ordinary losses to a taxpayer’s amount at risk in an activity. When a loss clears the tax basis hurdle. Taxpayers are allowed to deduct their expenses associated with generating rental or royalty income for AGI. Active business income: income from sources in which the taxpayer is a material participant. Passive activity losses are suspended and remain in the passive income or loss category until the taxpayer generates current year passive income. and limited partners in partnerships are generally deemed to be passive participants and participants in all other trade or business activities are passive unless their involvement in an activity is regular. Passive activity income or loss: income or loss from an activity in which the taxpayer is not a material participant. it next must clear an at-risk amount. Flow-through entities (confusing part.

4. But this deduction cannot exceed the individual’s net earnings from the trade or business with respect to which the plan providing for health insurance was established. or taxpayer is laid off for other than willful misconduct. Moving expenses Deductions for AGI if they meet two tests: A. Self-employed individuals must be employed 78 weeks out of 24 months following move. 2. 3. No deduction is allowed if the self-employed individual or spouse is eligible to participate in an employer’s subsidized health plan. 1.279 in moving expenses. taxpayer’s job at new location ends because of disability. A business test associated with the move Taxpayer is employed at least 39 weeks out of 12 months following move. e. EWD agreed to reimburse Courtney for 2. Note: indirect moving expenses such as pre-move house-hunting. moving company: 5. She would not include the reimbursement in income and she would not deduct the 2. Maximum annual contribution The lesser of (1) 49. This test does not have to be met in case of death. Self-employment qualified retirement contribution A self-employed individual may contribute to a qualified retirement plan called a Keogh plan.000 of expenses for which she was reimbursed. and can deduct their actual moving expenses for AGI.000 of actual moving expenses.Deductions indirectly related to business activities Taxpayers can incur expenses in activities that are not directly related to making money but that they would not have incurred if they were not involved in a business activity.000. Self-employment tax deduction Self-employed taxpayers are allowed to deduct one-half of the self-employment tax they pay. house-hunting trip 520). 3. A distance test (R2-12) Distance from new job to former residence is at least 50 miles further than distance from old job to former residence. Taxpayers who receive a flat amount as a moving allowance from their employers are required to include the allowance in gross income. Courtney could deduct 3. and dependents in arriving at AGI. 1. spouse. B.279. what amount would Courtney deduct for moving expenses (transportation: 156. temporary living expenses and meals while moving are not deductible.g. Health insurance premium deduction by self-employed taxpayers A self-employed individual can deduct 100% of the premiums for medical insurance for the individual. lodging: 123.000 or (2) 100% net earnings from self-employment 11 Regulation Notes By Tomato . meals 75.

25% net earnings from self-employment = 20% of self-employment income before after one-half of the self-employment tax. Deductions subsidizing specific activities 1. An employee is allowed to deduct the amount of jury duty pay that was surrendered to an employer in return for the employer’s payment of compensation during the employee’s jury service period. Educator expenses a. Gram invested 100.2. From 2007 through 2009. Alimony payment 2.000 in a CD. e. b. Net earnings from self-employment = net earnings from self-employment . principal or aide working in a school for at least 900 hours during the school year. less a 410 early withdrawal penalty. Jury duty pay remitted to employer a.500) depends on 12 Regulation Notes By Tomato .100 of interest income the CD had generated up to the withdrawal date. These expenses include tuition and fees. She receives the 4.100 as interest income this year and deducts the 410 early withdrawal penalty as a deduction for AGI. room and board. Penalty for early withdrawal of saving. How will Gram report the interest and early withdrawal for tax purposes? Gram reports 4. supplies. Interest on qualified education loans Qualified education loans are loans whose proceeds are used to pay qualified education expenses. Contribution to retirement savings (IRA) 3. b. 5.g. books and expenses required for enrollment.. The amount of the maximum education expense deduction (up to 2. This provision allows a deduction for AGI for any interest income an individual forfeits to a bank as a penalty for prematurely withdrawing a certificate of deposit or similar deposit. She decided to cash out the CD before it is due.Keogh deductions. Qualified education expenses encompass expenses paid for the education of the taxpayer. Thus. An eligible educator is a kindergarten through grade 12 teachers. but before the Keogh deduction.One-half self-employment tax . Both regular compensation and jury duty pay must be included in gross income. and other necessary supplies and expenses including travel. Maximum annual deductible amount The lesser of (1) 49.000 or (2) 25% net earnings from self-employment 3. eligible educators are allowed deduction up to 250 for unreimbursed expenses for books. computer equipment and supplementary materials used in the classroom. or a taxpayer’s dependent to attend a postsecondary institution of higher education. the taxpayer’s spouse. counselor. 4. 5. instructor.

prevention.000 but less than 80. (2) Personal and dependency exemption deductions.filing status and the level of modified AGI. This deduction is phased out for single taxpayers with modified AGI between 60.000 and for married taxpayers with modified AGI between 120.000 (130. d. dentists. or cure of injury. or are not paid for through a flexible spending account. diagnosis.000 and 75. Deductible medical expenses include those incurred by a taxpayer.000 for individual with AGI above 65. 13 Regulation Notes By Tomato . dependents of the taxpayer. a. Itemized deductions (Schedule A) 1. Married individuals who file separately are not allowed to deduct this expense under any circumstance. The amount of the maximum education expense deduction depends on filing status and the level of modified AGI. Qualified education expenses (R2-11) Here qualified education expenses are limited to the tuition and fees required for enrollment at a postsecondary institution of higher education.000 and 150.650 or more. (Book 6-10) b. or bodily function that are not reimbursed by health insurance or employer. Deductions from AGI These deductions consist of (1) The greater of itemized deductions or the standard deduction. or any person for whom the taxpayer could claim a dependency exemption except that the person had gross income of 3. The education expenses must relate to a period when the student was enrolled on at least a half-time basis.000 for joint) The deduction is limited to 2.000 The deduction is 0 for individual with AGI above 80.000.000 for joint) Married individuals who file separately are not allowed to deduct this expense under any circumstance. The deduction is limited to 4. Modified AGI here is AGI before deducting interest expense on the qualified education loans and before deducting qualified education expenses. 6. Common medical expenses include: (1) Prescription medication and medical aids (2) Payments to medical care providers such as doctors. Medical expenses (R2-20) Qualifying medical expenses include any payments for the care.000 (160. or filed a joint return. c. taxpayer’s spouse.000 for individual with AGI at or below 65. and nurses and medical care facilities such as hospitals. Modified AGI here is AGI after deducting the education loan interest expense but before deducting qualified education expenses. This deduction is not allowed if the individual is claimed as a dependent on another taxpayer’s tax return. disease.

Interest paid (1) Home mortgage interest (Interest paid on loans secured by a personal residence) a.g. (Note: taxpayers may elect to deduct state and local sales taxes instead of deducting state and local income taxes) B.(3) (4) (5) (6) Transportation for medical purposes Hospital and long-term care facilities Health insurance premium and insurance for long-term care service.5%)=150 2. the residence will qualify if the taxpayer’s personal use of the home exceeds the grater of (1) 14 days or (2) 10 percent of the number of rental days during the year.400-(30.g. If the taxpayer rents the second residence for part of the year. real estate taxes (state.5% of AGI.000. Nonitemizers are allowed to increase their standard deduction for the state and local real property taxes paid. local and foreign income taxes. the taxpayer can choose to deduct interest related to a particular second home one year and a different second home the next. Taxes (R2-21) A. 14 Regulation Notes By Tomato . Both types of indebtedness must be secured by a qualified residence to qualify.000 for a married couple filing jointly) 3. This year Courtney incurred 2. which property is treated as the second qualified residence is an annual election-that is. Another nonitemizer deduction exists for state and local property taxes. or (2) $500 (1. Eyeglasses Note: non-prescribed medicines and drugs are not deductible (e.400 in unreimbursed qualifying medical expenses. state. This addition is limited to the lesser of: (1) The amount of real property taxes paid during the year. over-the-counter medicines) The deduction for medical expenses is limited to the amount of unreimbursed qualifying medical expenses paid during the year reduced by 7. Given that Courtney’s AGI is 162.000? 2. Qualified residence interest is interest paid on the principal amount of acquisition indebtedness and on the principal amount of home-equity indebtedness.000*7. Taxpayers are allowed to deduct only qualified residence interest as an itemized deduction. e.000*7. Personal property taxes (state and local) that are assessed on the value of the specific property.5%)=0 What amount of deduction if AGI is 30. b. what is the amount of itemized medical expense deduction? 24000-(162. the deduction is apportioned between the buyer and seller on a daily basis within the real property tax year) C. Qualified residence: the taxpayer’s principal residence and one other residence. For a taxpayer with more than two residences. local and foreign) on property held for personal or investment purposes (when real property is sold..

including cash. However. and royalty income not derived in the ordinary course of a trade or business. scientific. Charitable contributions (R2-24) Qualifying charitable organizations include organizations that engage in educational. c. However. and payroll deductions. they are not allowed to deduct the value of the services they provide. Any investment interest in excess of the net investment income limitation carries forward to the subsequent year when it is subject to the same limitations. investment income generally does not include net long-term capital gains and qualifying dividends because this income is taxed at a preferential rate. d. total qualifying home-related debt cannot exceed the total value of the home. 15 Regulation Notes By Tomato . constructing. Interest paid on loans used to purchase investment assets such as stocks. Qualified mortgage insurance premiums paid in connection with acquisition indebtedness are deductible as qualified residence interest. for every 1. e. electronic funds transfers. religious. (2) Investment interest expense (interest expenses on loans used to acquire investments)(R222) a. and other public activities. (1) Contributions of money. check. governmental. That is.c. Home-equity indebtedness: any debt. the amount of premium treated as interest is reduced by 10%.000 if married filing separately) regardless of how the loan proceeds are used. It also includes net short-term capital gains. However. or substantially improving the residence. bonds.000 (50. b.000. While taxpayers are allowed to deduct their transportation costs and other costs of providing services for charities. Cash contribution is deductible in the year paid. Interest on acquisition indebtedness is deductible up to 1 million (500. credit card charges. congress allows taxpayers to elect to include preferentially taxed income in investment income if they are willing to subject this income to tax at the ordinary tax rates. d. Deductible investment expenses are investment expenses that actually reduce taxable income after applying the 2% of AGI floor. Donations are only deductible if the contribution is substantiated by written records. (2) Contributions of property other than money. Acquisition indebtedness: any debt secured by a qualified residence that is incurred in acquiring. except for acquisition indebtedness. This deduction does not apply to mortgage insurance contracts issued before Jan 1 2007. annuity. The carryover amount never expires. 4. The amount the taxpayer is allowed to deduct depends on whether the property is capital gain property or ordinary income property. and non-qualifying dividends. Interest on home-equity indebtedness is deductible up to 100.000 by which the AGI >100. for purposes of deducting interest. Note: investment interest expense is different from investment expenses below. secured by the qualified residence to the extent it does not exceed the FMV of the residence minus the acquisition indebtedness.000 if married filing separately). The deduction of investment interest is limited to a taxpayer’s net investment income (gross investment income-deductible investment expenses. Gross investment income includes interest. e. net capital losses (short-term and long-term). or land. Note: investment interest expense is not an investment expense).

Charitable contribution deduction limitations (3) Out-of-pocket expenses to main a student (domestic and foreign) in a taxpayer’s home are deductible (limited to $50/month for each month the student is a full-time student) if a. Based on a written agreement between taxpayer and qualified organization c. 16 Regulation Notes By Tomato . Capital gain assets are any appreciated assets that would have generated a long-term capital gain if the taxpayer had sold the property for its FMV instead of contributing them. Student is in 12th or lower grade and not a dependent or relative b. Ordinary income property is property that if sold would generate income taxed at ordinary rates. Taxpayer receives no reimbursement Private operating foundations: privately sponsored foundations that actually fund and conduct charitable activities Private non-operating foundations: privately sponsored foundations that disburse funds to other charities. Certain contributions of capital gain property do not qualify for a FMV deduction. Inventory the taxpayers sell in a trade or business C. Assets’ FMV < the taxpayer’s basis in the assets (assets have declined in value). Ordinary income property includes: A. The deduction for capital gain property that is tangible personal property is limited to the adjusted basis of the property if the charity uses the property for a purpose that is unrelated to its charitable purpose. Contribution type Public charity and private Private non-operating operating foundation foundations Cash Amount Cash amount Cash amount AGI limit 50% 30% Capital gain property Amount FMV on the date of donation Basis AGI limit 30% 20% Ordinary income property Amount Lesser of FMV or Basis Lesser of FMV or Basis AGI limit 50% 30% When taxpayers make contributions that are subject to different percentage limitations.Taxpayers are allowed to deduct the FMV of capital gain assets on the date of donation. follow the steps: (1) Determine the limitation for the 50% contributions. Business assets held for more than a year to the extent the taxpayer would recognize ordinary income under the deprecation recapture rules if the taxpayer had sold the property. D. Assets that taxpayer has held for a year or less B. Taxpayers contributing ordinary income property can only deduct the lesser of (1) FMV or (2) the adjusted basis of the property.

100 -500 16. unexpected. A casualty loss is a loss arising from a sudden.000 Theft 325 0 325 350 325 -0 -500 0 Accident 20000 0 20.400 Total FMV before casualty FMV after the casualty (1) Decline in FMV (2) Tax basis Loss before reimbursement Less reimbursement Less 500 per casualty floor Unreimbursed casualty loss Less 10% of AGI Casualty loss deduction after AGI limit 16.000 20. Casualty losses must exceed two separate floor limitations to qualify as itemized deductions: (1) 500 for each casualty event during the year (100 for years other than 2009). Courtney has 325 stolen and her car was worth 20. 5. storm. The 30% contribution limit is the lesser of (a) AGI*30% or (b) AGI*50%-amount from step (1) (3) Apply the limitations to the 20% contribution. the excess contribution is treated as though it was made in the subsequent tax year and is subject to the same AGI limitations in the next year. The 20% contribution limit is the lesser of (a) AGI*20% or (b) AGI*30%-amount from step (2) When a taxpayer’s contributions exceed the AGI ceiling limitation for the year.000 and completely destroyed in the accident.400 -16.(2) Apply the limitations to the 30% contribution. and (2) 10% of AGI for the whole year Eg.000 22. She only received 3. Casualty and theft losses on personal-use assets Individuals cannot deduct losses they realize when they sell or dispose of assets used for personal purposes (opposed to business and investment assets). The excess contribution can be carried forward for five years before it expires. The loss is reduced by any reimbursements the individual is eligible to receive. AGI: 162. The amount of the tax loss is the lesser: (1) The decline in the value of the property caused by the casualty or (2) The taxpayer’s tax basis in the damaged or stolen asset. or unusual event such as a fire. individuals are allowed to deduct unreimbursed casualty and theft loss realized on personal use assets. or shipwreck or loss from theft.100 from insurance reimbursement.000 -3.200 200 Miscellaneous itemized deduction 17 Regulation Notes By Tomato . However.

but not for the first job. Tax preparation fees Ordinary and necessary expenses incurred in connection with determining tax obligations. Unreimbursed employee business expenses Expenses that qualify include those that are appropriate and helpful for the employee’s work such as the cost of professional dues. 2. These deductions are called miscellaneous itemized deductions and mostly subject to an AGI floor (only amounts over the floor are deductible) Miscellaneous deductions subject to 2% AGI floor 1. the cost of commuting-from a residence to work place is personal and non-deductible. half of the meals and lodging also qualify as employee business expenses. As a general rule. Hobby losses Taxpayers may engage in certain activities for primarily personal enjoyment but these activities may also generate revenue and losses (hobby). The cost of education qualifies if it serves to maintain or improve the employee’s skill in the business. The costs of job hunting qualify if the job is in the employee’s current trade or business. if an employee is required to submit documentation supporting expenses to receive reimbursement and the employer reimburses only legitimate business expense. The cost of travel and transportation associated with the employee’s work responsibilities may also qualify as miscellaneous itemized deductions. However. Taxpayers must include the revenue from hobby activity in gross income and deduct the expenses to the extent of the gross income from the activity. then the employer’s reimbursement plan qualifies as an accountable plan. If the expenses exceed the reimbursements. taxpayers may also deduct other related expenses such as the cost of property appraisals for tax purposes and the costs of contesting tax liabilities.There are a variety of deductions that address specific objectives but do not fit into any category. 4. However. employees include reimbursements in gross income and deduct employee business expenses as miscellaneous itemized deductions. the excess is deductible as an employee business expenses. Investment expenses (expenses other than interest incurred to generate investment income) Investment expenses are treated as miscellaneous itemized deductions subject to the 2% of AGI floor. Thus. employees exclude expense reimbursements from gross income and do not deduct the reimbursed expenses. Federal estate tax paid on income respect of a decedent 18 Regulation Notes By Tomato . Miscellaneous deductions not subject to 2% AGI floor (that is. full deduction) 1. Gambling losses (up to gambling winnings) 2. While the most common of tax preparation fees are the costs of preparing taxpayer’s tax returns. When employees travel on business trips long enough to be away from home overnight. 3. but not if the education is required to qualify for a new business or profession. uniforms and subscriptions to publications related to employment. Many employees are reimbursed for their business expenses by their employers.

Phase-out of itemized deductions 1. and gambling losses are subject to phase out. investment interest expense.300 earned income could claim a standard deduction of $1 . casualty losses. it is taxed at a 0 percent preferential rate. The standard deduction (R2-16) The standard deduction is a flat amount that most individuals can elect to deduct instead of deducting their itemized deductions. The product is the amount of the itemized deduction phase-out. Note that the income that is not taxed at the preferential rate is taxed at the ordinary tax rates using the tax rate schedule for the taxpayer’s filing status. to the extent that this income would have been taxed at 15% or 10% if it were ordinary income. 2. Note: to ensure that taxpayers receive some tax benefit from preferentially taxed income. 3. Phase-out for 2009 is determined in 2 steps. a dependent taxpayer with $1.360 + $300).700). limited to 5. for single. Add both taxes. Split taxable income into the portion that is subject to the preferential rate and the portion taxed at the ordinary rates. (check Becker R2-16) Standard Deduction-Dependent of Another For 2009. Individual income tax computation and tax credits Following three steps to determine tax liability if a taxpayer has long-term capital gain or qualifying dividends (those are taxed at a preferential rate 15%) 1. That is. The amount o standard deduction depends on filing status. Alternative minimum tax (AMT) (paid in addition to regular tax liability) Regular taxable income 19 Regulation Notes By Tomato .400 for married filing separately) or (b) 80% of the total itemized deductions subject to phase-out (2) Multiply the amount determined in step 1 by one-third. The dependent's standard deduction remains limited by the regular standard deduction for the tax year (that is. Thus. Taxpayers who are at least 65 years of age on the last day of the year or blind are entitled to additional standard deduction amounts above and beyond their basic standard deduction. (1) Determine the lesser of (a) 3%* (AGI – 166. Compute the tax separately on each type of income. taxpayers generally deduct the grater of their standard deduction or their itemized deductions.600 ($1. The amount of a taxpayer’s total itemized deductions other than medical expenses. Dependent taxpayers may claim the same additional standard deduction as other taxpayers for blindness and/or age 65 or over status. (MGICA) 2.800 or 83. the amount is the greater of $950 or his earned income plus $300.

not including longterm capital gain and qualifying dividends) 20 Regulation Notes By Tomato . Miscellaneous itemized deductions in excess of the 2 percent floor (+) c.500 for married filing separately) (2) 28% on the AMT base in excess of 175.000 (regular AMT bases. Exclusion for gains on sale of certain small business stock 3.500 4. 5. If the AMT depreciation exceeds the regular tax depreciation. Adjustment to taxable income a. Tax preference items a.495 75. Exemption The exemption is phased out by 25%* (AMTI – phase-out threshold) Filing status Exemption Phase-out begins at this level of AMTI Married filing jointly 70.000 Married filing separately 35. b.700 112. Gain or loss on sale of depreciable assets (due to the difference in depreciation method). Personal and dependency exemption and standard deduction if applies (+) b. Home-equity interest expense (+) f.950 150. For AMT tax purposes long-term capital gain or qualifying dividends are taxed at the same preferential rate.Adjustments + Tax preferences = alternative minimum taxable income (AMTI) -exemption amount =alternative minimum tax base *26% or 28% = tentative before foreign tax credit -AMT foreign tax credit =tentative minimum tax -regular tax liability =AMT tax (if positive) 1. Tax-exempt interest d. Depreciation. this is a plus adjustment. 2. Excess intangible drilling costs c. Real property and personal property taxes deducted as itemized deductions (+) d.000 AMT base (87. AMT computation (1) 26% on the first 175. g. Pre-1987 accelerated depreciation or amortization e. State income or sales taxes (+) e.+/.000 Head of household and single 46. If the regular tax depreciation exceeds the AMT depreciation. this is a minus adjustment. that is. The excess of the percentage depletion deduction over the adjusted basis of the property.

000 for two or more qualifying persons (3) The taxpayer’s earned income or net earnings from self-employment. This credit is subject to phase-out based on AGI.000. The total amount of credit is phased out. The amount of credit is calculated by multiplying qualifying expenditures by the appropriate credit percentage (between 20% and 35%). They can use the credit to offset regular tax but not below the tentative minimum tax for that year. plus (2) 25% of the next $2. by 50 for each 1. but if the amount of the credit exceeds the amount of the taxpayer’s gross tax liability. Child tax credit (B7-24) 1. The amount of expenditures eligible for the credit is the lesser of the following amounts: (1) The total amount of dependent care expenditures for the year (2) 3. The amount of credit is based on the amount of the taxpayer’s expenditures to provide care for one or more qualifying persons. but not below 0. Education credit Congress provides the Hope scholarship credit and the lifetime learning credit to encourage taxpayers and their dependents to obtain higher education. Child and dependent care credit This credit is a tax subsidy to help taxpayers pay the cost of providing care for their dependents to allow taxpayers to work or look for work. the credit in excess of the gross tax liability is not refunded to the taxpayer and expires without ever providing tax benefits. Married taxpayers must file a joint tax return and the amount of earned income for this purpose is the earned income of the lesser-earnings spouse. For 2009.000 in 2009-2010 of expenses paid during the year. (2) A dependent or spouse who is physically or mentally incapable of caring herself and who lives in the taxpayer’s home for more than half the year. The credit is equal to (maximum credit of $2. the credit phases out pro rata for taxpayers with AGI 21 Regulation Notes By Tomato . (1) The Hope Scholarship Credit is available for a student's first four years of postsecondary education (post high school) at an eligible educational institution (those eligible to participate in the federal student loan program). which is based on the taxpayer’s AGI and begins at 35% for taxpayers with AGI less than 15.000 for one qualifying person or 6. B.000 credit for each qualifying child under age 17 at the end of the year and claimed as dependent.500 in 2009-2010): (1) 100% of the first $2. C. Thus. Married taxpayers filing separate returns are not eligible for this credit.6. Nonrefundable personal credits Nonrefundable personal tax credits may reduce personal tax liability to zero.500 for each dependent. The Hope credit is applied on a per student basis. Qualifying expenditures for either credit include amounts paid by dependents of the taxpayer and amounts paid by third parties on behalf of the taxpayer’s dependents. under age 13. To qualify. (the carry-forward is forever) Tax credit (copy Ex7-10 P7-33) 1. Taxpayers who pay the AMT are entitled to a minimum tax credit to use when the regular tax exceeds the tentative minimum tax. a taxpayer with three eligible dependents can claim a maximum Hope credit of 2.000 in 2009-2010 of qualified expenses. students must be enrolled in a qualified postsecondary educational institution at least half time. A.000 over the applicable threshold. A qualifying person includes (1) A qualifying child.

000 (150.000 and 60. if a taxpayer claims any educational credit for an individual’s educational expenditures. Earned income credit The credit is available for qualified individuals who have earned income for the year.000 for a joint return). Foreign tax credit When taxpayers pay income taxes to foreign countries. the taxpayer may not claim any for AGI deduction. In contrast to the Hope scholarship credit. but who lives in the US for more than half the year.000-180.2% of earned income or (2) 400 (800 MFJ). but they may not claim both credits for the same student in the same year. When business tax credits other than the foreign tax credits. B. Business credits (nonrefundable) This credit is designed to provide incentives for taxpayers to hire certain types of individuals or to participate in certain business activities. and the amount of earned income.000 and 90. (2) Lifetime learning credit applies to the cost of tuition and fees (but not books) for any course of instruction to acquire or improve a taxpayer’s job skills. Note: in 2009. The credit phases out pro rata for taxpayers with AGI between $50. taxpayers may choose which credit to use.000. they may treat the payment in one of three ways: (1) Taxpayers may exclude the foreign earned income from U. 3. Making work pay credit The amount of the credit is the lesser of (1) 6. 40% of a taxpayer’s allowable Hope credit is refundable. The amount of credit depends on the filing status. the number of qualifying children who live in the home for more than half of the year. The credit is computed by multiplying the appropriate credit percentage times the taxpayer’s earned income up to a maximum amount. a taxpayer with multiple eligible dependents can claim a maximum lifetime learning credit of only 2.000 MFJ). taxpayers may choose to either (1) deduct qualifying education expenses of an individual as a for AGI deduction or claim an education credit. 2. In addition. exceed the gross tax for the year.000-120. Thus. A. and is not a dependent of another taxpayer. However.000 ($100. Taxpayer must reduce the credit by 2% of AGI in excess of 75. Taxpayers who are dependents of other taxpayers are not eligible for the credit. The credit is equal to 20% of eligible expenses up to an annual maximum of 10. Refundable personal credits Refundable credits in excess of a taxpayer’s gross tax liability are refunded to the taxpayer.000 ($160. is at least 25 years old but younger than 65 years old at the end of the year.between $80. For expenses that qualify for both the Hope and lifetime learning credits.000 for a joint return).000. the credits are carried back one year and forward 20 years to use in years when the taxpayer has sufficient gross tax liability to use the credits.S taxation 22 Regulation Notes By Tomato . the lifetime learning credit limit applies to the taxpayer. Qualified individuals include (1) Any individual who has at least one qualifying child or (2) An individual who does not have a qualifying child for the taxable year.

S tax rate.(2) Taxpayers may include the foreign income in their gross income and deduct the foreign taxes paid as itemized deductions (3) Taxpayers may include foreign income in gross income and claim a foreign tax credit for the foreign taxes paid. taxpayers may carry back their unused credit one year and carry forward up to 10 years. When the use of a foreign tax credit is limited. 23 Regulation Notes By Tomato . Foreign tax credits are limited to the lesser of: (a) Foreign taxes paid or (b) (Taxable income from all foreign operations/taxable income +exemptions)*U.

2. A partner’s tax basis in her partnership interest is her outside basis. partners may transfer cash. Partnership interests represent the bundle of economic rights granted to partners under the partnership agreements. and afterwards. If the partnership does have debt. and the right or obligation to receive a share of future profits or future losses. Nonrecourse debt is allocated to partners’ profit-sharing ratios. other tangible or intangible property. Otherwise. and services to it in exchange for an equity interest called a partnership interest. 2. If the debt securing the contributed property is nonrecourse debt. Tax basis = adjusted basis of contributed property of the partner 24 Regulation Notes By Tomato 担分 有所由债 过超,担承人本由债 .(differentiate recourse debt and nonrecourse debt) Basis=tax basis of the property and cash they contributed+ their share of the partnership’s debt. and the remaining debt is allocated to all partners according to tax basis partner ) their profit-sharing ratios (B20-6) (tax basis Partner’s holding period in partnership interest 1.Chap 2 Partnerships When a partnership is formed. When property secured by debt is contributed to a partnership. then it includes the period of time the property was held by the partner. the partnership’s basis in its assets is its inside basis. If the contributed property is capital assets or 1231 assets. called a capital interest. partners’ initial basis=0 Partner’s initial tax basis Partners need to determine the tax basis in their partnership interests to properly compute their taxable gains and losses when they sell their partnership interest. the contributing partner must treat her debt relief as a deemed cash distribution from the partnership that reduces her outside basis. it begins on the day the partnership interest is acquired. a. Partners’ basis in their partnership interest=tax basis of the property and cash they contributed. Partnership’s tax basis and holding period in contributed property 1. the amount of the debt in excess of basis of the contributed property is allocated solely to the contributing partner. called a profits interest. but. When the partnership assumes debt of the partner secured by property the partner contributes to the partnership. As a general rule. neither partnership nor partners recognize gain or loss when they contribute property to partnerships. If the partnership does not have debt. Capital gain = debt relief – tax basis in partnership before deducting debt relief In this case. 1. These rights include the right to receive a share of the partnership assets if the partnership were to liquidate. Recourse debt is only allocated to partners with ultimate responsibility for paying debt b. Exceptions: 1.

When the profit interest is generated.2. services contributed in exchange for partnership capital interests may create immediate tax consequences to both the contributing partner and the partnership. Like the adjusted basis of contributed property.. it begins on the day the partnership interest is acquired. For partnership: 1. Nonservice partners will not receive deductions. 2. For partnership: 1. Partners’ holding period will begin on the date he receives the capital interest. the holding period of contributed assets also carries over to the partnership. For partners: 1. 2. the partnership must adjust debt allocations based on profit-and-loss-sharing ratios to reflect the service partner’s new or increased share of profits and losses. =debt allocation if only profits interest received =cash + debt allocation begins on the day the partnership Regulation Notes By Tomato . begins on the day the partnership interest is acquired. Partners’ recognized ordinary income= the amount they would receive if the partnership were to liquidate. it allocates the deduction only to the partners not providing services. The partnership either deducts or capitalizes the value of the capital interest. capital interests shift from nonservice partners to service partner) If the service is exchange for profit interest: For partners: No income is recognized. Otherwise. (i. because they have effectively transferred a portion of their partnership capital to the service partner. Tax basis= Partners’ recognized ordinary income 3. Acquisition method Contribute property Outside basis =basis of contributed propertydebt relief +debt allocation+ gain recognized Holding period capital assets or 1231 assets. Partnership should create a tax capital account for each new partner.e. reflecting the tax basis of any property contributed and cash contributions. When the partnership deducts the value of capital interest used to compensate partners for services provided. Partners contribute services to exchange partnership interest Unlike property contributions. depending on the nature of the services the partner provides. the holding period of the contributed property tacks on to the partnership interest. Contribute service Purchase 25 =Liquidation value of capital interest + debt allocation. or liquidation value of the capital interest 2.

When gathering this information for their partners. If the taxable year of one or more partners who together own more than 50% of the capital and profits interests in the partnership. Ordinary business income (loss) and separately stated items Although partnerships are not taxpaying entities. Accounting period of partnership Step1: Majority interest taxable year. they are required to file tax returns annually. Tax-exempt income E. Common separately stated items (determined at partnership level rather than partner level) include: A. Because this payment is similar to salary payments. Guaranteed payments Guaranteed payments are fixed amounts paid to partners regardless of whether the partnership shows a profit or loss for the year.interest is acquired. then taxable year= majority interest taxable year Otherwise: Step2: principal partners test. Investment interest expense G. C. partners treat them as ordinary income. they supply information to each partner detailing the amount and character of items of income and loss flowing through the partnership. Section 179 deduction 26 Regulation Notes By Tomato . Interest income B. Principal partners: who have more than a 5% interest in the partnership profits and capital. Partners must report these income and loss items on their tax returns even if they do not receive cash distributions during the year. Total tax deferral achieved is calculated by weighting each partner’s months of deferral under the potential tax year by each partner’s profits percentage and then summing the weighted months of deferral for all the partners. Net earnings (loss) from self-employment D. Net rental real estate income F. partnerships must determine each partner’s share of ordinary business income (loss) and separately stated items. then Tax year=tax year providing the least aggregate deferral to the partners. In addition. Note: they are typically deducted in computing a partnership’s ordinary income or loss for the year. Separately stated items are treated differently from ordinary business income from tax purposes (tax rates are different). If there is majority interest taxable year. These partners must have same year-end. Otherwise: if step1 and step2 fail. then the required tax year =the taxable year the principal partners all have in common. If there is principal partners’ taxable year in common.

etc) 5. Decrease for actual and deemed cash distributions during the year. Loss limitations Ordinary losses from partnerships are deductible against any type of taxable income. (debt relief by the partnership is considered as deemed cash distribution) 4. However. same as limited partners. who have authority to contract on behalf of the LLC. ( increased share of debt in partnership is considered as deemed cash contribution) 2. they are deductible on the partner’s tax return only when they clear three separate hurdles: 1. They may receive automatic five-month extension by filing form 7004 2. Increase for partner’s share of ordinary business income and separately stated income/gain items 3. General partners: pay tax on guaranteed payments for services they provide and their share of ordinary business income (loss) 2. At-risk limitation=tax basis limitation – tax basis related to nonrecourse debt 27 Regulation Notes By Tomato . Partnership prepare schedule K-1 for each partner detailing her individual share of the partnerships’ ordinary income and separately stated items with Form 1065 Partners’ adjusted tax basis in partnership interest The basis in partnership is dynamic and must be adjusted in the order listed: 1. penalties. Any losses allocated in excess of their basis must be suspended and carried forward indefinitely until they have sufficient basis to utilize the losses 2. Basis adjustments that decrease basis may never reduce a partner’s tax basis below 0. Tax basis limitation A partner’s basis limits the amount of partnership losses the partner can use to offset other sources of income. LLC members: same as general partners if LLC members have personal liability for the debts of the LLC by reason of being an LLC member. Partnership filing 1. or who participate more than 500 hours in the LLC’ trade or business. Otherwise.Self-employment tax (depends on the extent the partners involve in regular management) 1. Limited partners: pay tax only on guaranteed payments 3. File Form 1065 return of partnership income with the IRS by the 15 day of the 4th month after their year-end. Increase for actual and deemed cash contributions to the partnership during the year. Decrease for partner’s share of nondeductible expenses (fines. Decrease for partner’s share of ordinary business loss and separately stated expense/loss items.

the partner’s share of certain nonrecourse debts is not included in the at-risk amount. These assets are called hot assets. This debt is called qualified nonrecourse financing. Unrealized receivables include the right to receive payment for (1) goods delivered or to be delivered or (2) service rendered. 2. 3. 1245 Depreciation recapture is also considered as unrealized receivable.their at-risk amount. However. because partnership interests are capital assets. Passive activity loss limitation The passive activity loss limits the ability of partners in rental real estate partnerships and other partnerships they don’t actively manage from using their ordinary losses from these activities to reduce other sources of taxable income. sell to another partner. Specifically the only nonrecourse debt considered to be at risk is nonrecourse real estate mortgages from commercial lenders that are unrelated to borrowers. Because selling partner is no longer responsible for her share of partnership liabilities. and 1231 assets When a partner sells her interest in a partnership that holds hot assets. with one exception. The process for determining the gain or loss follows: 28 Regulation Notes By Tomato . 4. Sales of partnership interests Partners may dispose of their interest in several ways: sell to a third party. Hot assets: 1. or to be rendered. Seller issues 1. The character of the gain or loss from a sale of a partnership interest is generally capital. a portion of the gain or loss will be ordinary if a seller realizes any amounts attributable to unrealized receivables or inventory items.The at-risk rules were used to limit the ability of partners to use nonrecourse debt as a means of creating tax basis to use losses from tax shelter partnerships expressly designed to generate losses for the partners. Any losses allocated in excess of their at-risk amount must be suspended and carried forward indefinitely until they have sufficient basis to utilize the losses 3. Inventory: Assets other than cash. 2. she modifies her calculation of the gain or loss to ensure the portion that relates to hot assets is property characterized as ordinary income. Partners apply the at-risk limitation after the tax basis limitation. Sellers’ gain or loss = the amount realized-her outside basis. The at-risk rules limit partner’s loss to their amount “at risk” in the partnership. capital assets. or transfer the interest back to the partnership. A partner’s at-risk amount is the same as her tax basis except that. any debt relief increases the amount the partner realizes from the sale.

Step2: calculate the partner’s share of gain or loss form hot assets as if the partnership sold these assets at their FMV. Distribution > tax basis gain=distribution – tax basis and new tax basis=0. Operating distributions of money only Neither the partnership nor the partners recognize gain or loss on the distribution of property or money (general rule). The partner simply reduces her outside basis in the partnership interest by the amount of the distribution. This represents the ordinary portion of gain or loss. other property. the general partners determine the amount and timing of distributions. new outside basis= remaining outside basis. Usually. partners often receive distributions of the partnership profits. Money. A distribution from a partnership is an operating distribution when the partners continue their interest afterwards. hot assets. Distribution < tax basis gain=0 and new tax basis=old tax basis-distribution. Step 2: if remaining outside basis > property basis (the partnership basis in the property). 1.property basis 29 Regulation Notes By Tomato . Allocation of outsider basis in an order: 1. 2. Operating distributions that include property other than money Neither the partnership nor the partners recognize gain or loss on the distribution of property or money (general rule).Step1: determine the total gain or loss by subtracting outside basis from the amount realized. then a. In a sale of a partnership interest. Step3: subtract the ordinary portion of the gain or loss obtained in step2 from the total gain or loss from step1. The new partner’s share of inside basis is equal to the selling partner’s share of inside basis at the sale date. Step 1: remaining outside basis= old outside basis – money. 2. the selling partner’s tax capital account carries over to the new investor. known as operating distributions. Buyer and partnership issues The sale of partners’ interest does not generally affect a partnership’s inside basis in its assets. Ordinary gain or loss=the gain or loss from hot assets * the partner’s interest percentage. This remaining amount is the capital gain or loss from the sale. For specific partner. Thus. Operating distribution Like shareholders receiving corporate dividend distributions. the tax basis can never be below 0. and 3.

unrealized receivables. the increase is treated as a cash contribution to the partnership. Ideally. In essence. then adjust outside basis based on the debt change.b. Partner’s outside basis > inside basis of distributed assets 1. there are exceptions. If distributed assets only include money and hot assets Recognized capital loss= partner’s outside basis-inside basis of distributed assets. Liquidating distributions Liquidating distributions terminate a partner’s interest in the partnership. a partner may recognize a loss from a liquidating distribution. In general. and the asset bases would be the same in the partner’s hands as they were inside the partnership. then: a. and/or inventory. a partner treats a reduction of her share of debt as a distribution of money. partners’ basis on property= the partnership basis in the property Otherwise. 30 Regulation Notes By Tomato . adjust the outside basis according to the debt change first before step1 and step2. If there is any change in a partner’s share of partnership debt resulting from a distribution. Any reduction in the partner’s share of liabilities is considered a distribution of money to the partner and reduces the outside basis available for allocation of basis to other assets. and (2) the partner’s outside basis is greater than the sum of the inside bases of the distributed assets. Gain or loss recognition in liquidating distributions The rationale behind the rules for liquidating distributions is simply to replace the partners’ outside basis with the underlying partnership assets distributed to the terminating partners. If the partner increases her share of debt. The tax issues in liquidating distributions for partnerships are basically twofold: (1) to determine whether the terminating partner recognizes gain or loss and (2) to reallocate her entire outside basis to the distributed assets. These conditions are (1) the distribution includes only cash. there would be no gain or loss on the distribution. Basis in distributed property Note: if there is change in debt liability. but only when two conditions are met. The loss on the distribution is a capital loss to the partner. In contrast to operating distributions. including inventory and unrealized receivables. neither partnerships nor partners recognize gain or loss from liquidating distributions. The terminating partner’s share of partnership debt decreases after a liquidating distribution. b. Partners’ basis on property= remaining outside basis. new outside basis=0. However.

then decrease tax basis by (FMV-tax basis) (A assume) Step3: then allocate remaining required decrease (required decrease from step 1. 2. Step 2: for other property (i. Character and holding period of distributed assets 1. 2.inside basis of distributed assets (assign a basis to all distributed property= partnership’s basis in those assets. Organizational expenditures The concept of matching income with the expense of generating that income would require that partnership organization costs be capitalized and amortized over the life of the partnership. Distribution of money and hot assets (No gain recognized) Step1: required decrease= inside basis of distributed assets (assign a basis to all distributed property= partnership’s basis in those assets) – outside basis. Organization costs include legal fees for drafting the partnership agreement. A partnership may deduct up to 5000 of organization costs for the tax year in which the partnership begins business. Distribution includes other property No gain recognized.e. The partners’ holding period generally includes the partnership’s holding period. decrease tax basis by (FMV-tax basis) (A assume) Step3: then allocate remaining required decrease (required decrease from step 1. accounting fees to organize the partnership. For both operating and liquidating distributions. Recognized loss=0. But decrease the basis in the other property. Distribution of money only Recognized capital gain= cash-partners’ outside basis 2.A) to the other property in proportion to their adjusted basis. 3. Step2: if FMV of other property < tax basis. Other property included in distributions. the character of the distributed assets usually stays the same for the partner as it was in the partnership.Basis in distributed property= inside basis of distributed assets. Step1: required decrease= inside basis of distributed assets (assign a basis to all distributed property= partnership’s basis in those assets) – outside basis.. with any remaining expenditures deducted ratably over the 180-month period beginning with the month in which the partnership begins business (rather than the date the partnership is organized) (same for the corporation) 31 Regulation Notes By Tomato . and state and local filing fees. Step 1: remaining outside basis1= outside basis.A) to the hot assets in proportion to their adjusted basis. Partner’s outside basis < inside basis of distributed assets 1. Step 2: if FMV of hot assets < tax basis. assets other than cash and hot assets) If FMV > tax basis then assign (FMV-tax basis) to the property’s basis Step 3: allocate remaining outside basis2 (remaining outside basis1– sum(FMV-tax basis)) to other property in proportion to the relative FMV of other property.

000 amount is reduced by the amount by which the organizational expenditures or start-up costs exceed 50. with any remaining expenditures deducted ratably over the 180-month period beginning with the month in which the active trade or business begins Syndication costs The costs of issuing and marketing interests in a partnership syndication. A partnership may deduct up to 5000 of start-up costs for the tax year in which the partnership begins business. and printing costs. The partnership is not restricted to using the same method as used by its principal partner. Note: for corporation. must be capitalized and are not subject to amortization. Depreciation method The method is an election made by the partnership and may be any method approved by the IRS. such as commissions. professional fees.Start-up expenditures Costs are defined as (1) costs paid or incurred in connection with the investigation or acquisition of an active trade or business. or (3) pre-activity costs. respectively. each 5.000. (2) costs paid or incurred in the creation of such a trade or business. 32 Regulation Notes By Tomato .

The excess contribution for individuals also expires in five years. Form 1120 schedule M-1: provides the change in retained earnings during the year and reports the ending balance (book) Form 1120S: S corporation tax Form 1065: partnership tax (unincorporated entities with more than one owner) Schedule K: Return of partnership income For C corporation. Firms making current year charitable contributions in excess of the 10% modified taxable limitation may carry forward the excess for up to five years after the year in which the carryover arises (FIFO order). 1. Net operating loss carries back 2 years and forwards 20 years. 33 Regulation Notes By Tomato . 3.LLC with only one individual owner) Schedule D: Capital gains and losses Form 1120: C corporation tax Form 1120 schedule M-1: reconciling to taxable income before the DRD and NOL deductions. 2. Net capital loss carries back 3 years and forwards 5 years.

FMV> Rollover basis basis=rollover basis + gift tax paid if any Gift tax=Net appreciation value (FMV-Rollover basis)/Taxable amount of gift *gift tax paid 2. In this case. then tax basis=adjusted tax basis of decedent. FMV<Rollover basis A. Note: if the property carries passive activity loss. furniture. Exception: if the decedent get the appreciable property as a gift and pass the property to the donor or donor’s spouse. Otherwise. If sales price of gifted property < FMV then basis=FMV B. Personal property denotes any property that is not real property while personal-use property is any property used for personal purposes. if the basis= FMV. However. Note: property received from decedent is deemed to be held long-term regardless of actual holding date. If alternate valuation date is not elected.Chap 3 Property classification Personal property includes all tangible property. other than real property (building and land). and equipment. Personal property and personal-use property are not the same thing. machinery. tax basis=FMV on the six month date or FM on the distribution date (whichever is earlier) 3. If sales price>rollover basis Note: the holding period of the gift normally assumes the donor’s holding period. such as computers. Tax basis for stock dividend: 1. then decrease the basis. Tax basis for property acquired from decedent 1. Tax basis for property acquired by gift 1. the basis= FMV Property exchange 34 Regulation Notes By Tomato 东股变改不即 即 Stock dividend is nontaxable (1) if the stock distribution be made with respect to common stock ( ) and (2) it must be pro rata with respect to all shareholders ( ) 例比股持的 利股票股的股通普是 . then the shareholders’ original stock basis is allocated between old stock and new stocks based on relative FMV. the holding period of the dividend stock includes the holding period of the original stock. tax basis=FMV 2. If FMV<sales price<rollover basis then basis=sales price then basis=rollover basis C. Otherwise. 2. If stock dividend is nontaxable. automobiles. then the holding period starts the date of the gift.

b. a. Both the property given up and the property received in the exchange by the taxpayer are either used in a trade or business or are held for investment. For an exchange to qualify as a like-kind exchange. a. Note: liabilities assumed on either or both sides of the exchange are treated as boot. Liability boot given does not offset boot received in cash or unlike property. Meet the time restrictions: (1) the taxpayer must identify the like-kind replacement property within 45 days after transferring the property given up in the exchange and (2) the taxpayer must receive the replacement like-kind property within 180 days after the taxpayer initially transfers property in the exchange. no gain/loss is generally recognized. If liabilities are assumed on both sides of exchange and no cash is involved.1. then the basis of property received= the basis of property transferred b. If boot is given. Boot given in cash or unlike property does offset liability boot received. any realized gain is recognized to the extent of the lesser of (1) the realized gain or (2) FMV of the boot received. Taxable exchange The basis of property received =FMV Gain or loss recognized = FMV – the adjusted basis of the property exchanged 2. The holding period of boot received begins on the date of its receipt. c. No loss is recognized due to the receipt of boot. the transaction must meet three criteria: a. Basis of property received =basis of property transferred (including boots) + gain recognized-loss recognized. If liabilities are assumed on both sides of exchange and cash is involved. However. (1) Like-kind exchange a. If boot is received. Like-kind property: 35 Regulation Notes By Tomato . b. Liability relief = boot received liability assumption=boot given b. not including personaluse property) c. Nontaxable exchange: defer recognizing gain or loss realized on the exchange if they meet certain requirements. gain/loss is recognized if the boot’s FMV ≠ boot’s basis. The property is exchanged solely for like-kind property. No boot. The realized gain =FMV of property received (including boots) –basis of property transferred The basis of property received= tax basis of like-kind property transferred + gain recognized– boot received The basis of boot received= FMV of the boot. (that is. they are offset to determine the net amount of boot given or received.

c.deferred gain (=realized gain-recognized gain) Note: Losses on involuntary conversions are recognized whether the property is replaced or not. 36 Regulation Notes By Tomato . such as a natural disaster or accident. or notes). However they may realize a gain for tax purposes if they receive replacement property or insurance proceeds in excess of their basis in the property that was stolen or destroyed.a. or seized via eminent domain by a governmental agency. (2) Involuntary conversions Taxpayers may involuntarily dispose of property due to circumstances beyond their control. condemned. No gain recognized in this case. Personal property: tangible personal property qualifies as like-kind if the property transferred and the property received in the exchange is in the same general asset class by IRS (i. It was destroy in an accident and reimbursed 15..e. Direct conversion: receiving a direct property replacement for the involuntarily converted property No gain recognized. This loss is deductible as a casualty loss. Non like-kind property: inventory held for resale (including land held by a developer). Teton’s delivery van had a FMV of 15. Tax basis of replacement property = FMV of the replacement property. Congress provides special tax laws to allow taxpayers to defer the gains on such involuntarily conversions. bonds.000 and an adjust basis of 11. Real property.000. domestic property exchanged for foreign property. Eg. a. Tax basis of replacement property= tax basis of the involuntarily converted property b. and partnership interests. a loss on condemnation of property held for personal use is not deductible. Taxpayers can defer realized gains on indirect conversions if they acquire qualified replacement property within a prescribed time limit. b. which is generally two years (three years in case of condemnation). All real property is considered to be like-kind with any other type of real property as long as the real property is used in a trade or business or held for investment. Taxpayers recognize realized gain to the extent that they do not reinvest the reimbursement proceeds in qualified property.000 by insurance company. Recognized gain= the lesser of (1) the gain realized on the conversion (=reimbursement amount – Tax basis) or (2) the amount of reimbursement the taxpayer does not reinvest in qualified property. stolen. exchanged assets have the same general use to the taxpayer). Indirect conversion: Indirect conversion involves taxpayers receiving money for the involuntarily converted property through insurance reimbursement or some other type of settlement. most financial instruments (such as stocks. The property must be similar and related in service or use to qualify. Teton was considering two alternatives for replacing the van: (1) Purchase a new delivery van for 20. However.000.

A. 1231 assets: depreciable assets and land used in a trade or business held by taxpayers for more than one year.000 (15. Depreciation recapture (R3-30.000-14. Note: depreciation recapture changes the character of the gain but not the amount of the gain. (2) 1245: personal property and intangibles. (B10-10) 2. When depreciation recapture applies. 1. literacy. The computation of depreciation recapture depends on the type of 1231 asset. Capital assets: assets held for investment (stocks and bonds). It happens because depreciation deductions relating to the asset could reduce the adjusted basis of the asset by more than the actual economic decline the asset’s value. 1250 asset.000-11. and (3) 1250: depreciable real property (buildings) Note: an easy way to remember that is building is so high so it takes the highest sec number 1250 instead of 1245 Note: copyrights or artistic. AR and equipment used for one year or less.000-(15. 1. Congress introduced the concept of depreciation recapture.The basis of the new van=20. If a taxpayer recognizes a net 1231 gain.000 (2) Purchase a used delivery van for 14. 3.000 Property dispositions In order to determine how a recognized gain or loss affects a taxpayer’s income tax. The basis of the new van=14. (B10-6) 2. the taxpayer must determine the character or type of gain or loss recognized: 1. for the production of income or for personal use. corporations selling depreciable real property recapture as ordinary income 20% of the lesser of the (1) recognized gain on the sale or (2) total 37 Regulation Notes By Tomato . If a taxpayer recognizes a net 1231 loss.000-1. For corporations. Under 291.000)=11. compositions created by the taxpayers are not capital assets but if they are purchased by taxpayer. the depreciation recapture does not affect 1231 losses.000-(15.000-0)=16. For this situation. 1245 depreciation recapture does not apply to it.000. then they are capital assets. 291 depreciation recapture applies to corporations but not to other types of taxpayers.000-11. the net gain is treated as a long-term capital gain. Ordinary assets: assets created or used in a taxpayer’s trade or business such as inventory.31) It is possible that a 1231 asset other than land could be sold at a gain in situations when the asset has not appreciated in value and even in situations when the asset has declined in value since it was placed in service. it recharacterizes the gain on the sale of a 1231 asset from 1231 gain into ordinary income. 1245 asset. The amount of ordinary income taxpayers recognize when they sell 1245 property is the lesser of (1) recognized gain on the sale or (2) total accumulated depreciation. However. 1231 assets consist of three types: (1) pure 1231: land. The remainder of any recognized gain is characterized as 1231 gain.000) gain recognized in this case. the net loss is treated as an ordinary loss.

when a taxpayer sells depreciable property to a related party and the property is depreciable property to the buyer.000 long-term capital gain. suppose that Teton began business in year 1 and that it recognized a 7000 net 1231 loss in year 1 and 2000 net 1231 loss in year 5. There are some exceptions: 1. Unrecapured 1250 gain: 25% 38 Regulation Notes By Tomato . depreciated it 15.000 (adjusted basis=275. 350. tax policy makers determined that the portion of the gain caused by depreciation deductions reducing the basis (unrecaptured 1250 gain) should be taxed at a maximum rate of 25%.000 (gain) 90. we should apply 1231 look-back rule.000-15. the net loss is treated as an ordinary loss. Teton bought its warehouse for 275. e. The remainder of the gain is taxed at a maximum rate of 15%. The definition of the related party: R1-54 After recharacterizing 1231 gain as ordinary income under the 1245 and 291 depreciation recapture rules and the 1239 related party rules. That is. during that period.000 ordinary income and 16. the remaining 1231 gains and losses are netted together.g. the net gain becomes a long-term capital gain. Capital gains and losses The amount realized by a taxpayer from the sale or other disposition of an asset is everything of value received from the buyer less any selling costs.000 for the year.000.000.000)=90. and sold it for 350. the entire gain on the sale is characterized as ordinary income to the seller.000(gain) =15. If the gains exceed the losses. The taxpayer must recharacterized the current year net 1231 gain as ordinary income to the extent of that prior five year uncrecaptured 1231 losses. The amount of gain taxed at a maximum rate of 25% is the lesser of the (1) recognized gain on the sale or (2) total accumulated depreciation. For the capital gain. the taxpayer must look-back to the five year period preceding the current tax year to determine if. For individuals.accumulated depreciation. Eg. B. Assume that the current year is year 6 and that Teton reports a net 1231 gain of 25. the taxpayer recognized any unrecaptured 1231 losses.000 (unrecaptured 1250 gain)+75.000.000 (amount realized) – 260. The remainder of any recognized gain is characterized as 1231 gain. If the losses exceed the gains.000 (remaining 1231 gain) Exception: under 1239. Then 9. Amount realized=cash received + fair market value of other property + buyer’s assumption of liabilities -seller’s expenses (R1-44) Adjusted basis=cost basis – cost recovery deductions Gain or loss realized= amount realized – adjusted basis Although most long term capital gains are taxed at a maximum 15% rate.

B. they may exclude half of the gain on the sale from regular taxable income (75% if the stock was acquired after Feb 17. He originally acquired the home for 100. Net all long-term gains and long-term losses. Net capital losses in excess of 39 Regulation Notes By Tomato . 2011). consist of works of art. (2) qualified small business stock held for more than five years. When taxpayers sell qualified small business stock after holding it for more than five years. capital losses first offset capital gains. any stamp or coin. not all long-term capital gains are taxed at a maximum 15% rate. Gains from collectibles and qualified small business stock: 28% Taxpayers selling capital assets that they hold for a year or less recognize short-term capital gains or losses.000.and long-term outcomes against each other to yield a final net gain or net loss (might be short or long-term) For individuals.000 2. what tax does he own on the gain if he did not sell any other property during the year? 100. then the netting process ends. certain long-term capital gains are taxed at a maximum rate of 25% and others are taxed at a maximum 28%. 2. Assume his marginal ordinary tax rate is 35%. Net all short-term gains and short-term losses. or other similar items held for more than one years. For Individual taxpayers.000. taxpayers selling capital assets that they hold for more than a year recognize longterm capital gains or losses. and the capital gain not excluded from income is taxed at 28%. and then are allowed as a deduction up to 3. long-term capital gains are taxed at preferential rates. net the short. 3. Short-term capital gains are taxed at ordinary rather than preferential rates. However. Gains from two types of capital assets are taxable at a maximum 28%: (1) collectibles. Assume Jeb sold a rental home for 160. Unrecaptured 1250 gain is subject to a maximum tax rate of 25%. 1.2.000)*15%=34. A. Alternatively.000-100.000 and with at least 80% of the value of its assets used in the active conduct of certain qualified trades or business. otherwise. any rug or antique. Capital gain Short term Long term Held >5years Long-term Long term type all Collectibles Qualified small business stock Unrecaptured 1250 gain Not included above Maximum rate 35% 28% 28% 25% 15% Netting process for gains and losses (if there is no different maximum tax rate on long-term capital gains) 1. In contrast. 2009 and before Jan 1. and he has fully depreciated it for tax purposes. Eg.000*25%+ (160.500 if married filing separately) against ordinary income. any alcoholic beverage.000.000 (1. if step 1 and step2 both yield gains or losses. any mental or gem. Qualified small business stock is stock received at original issue from a C corporation with a gross tax basis in its assets both before and after the issuance of no more than 50. net short-term capital gains are taxed as ordinary income.

Net gains remain in the 15% group.3. Net the gains and losses in the 15% group. Losses on the sale of personal-use assets. move the net loss into 28% group. Wash sales. 2.000 retain their short-term and long-term character and are carried forward forever. 3. instead. Any long-term capital loss carried forward from the previous year is placed in the 28% group. Net the gains and losses in the 28% group. Then: 1. Netting process for gains and losses (if there are different maximum tax rates on long-term capital gains) (P11-14) 1. A wash sale occurs when an investor sells or trades stock or securities at a loss and within 30 days before or after the day of sale buys substantially identical stocks or securities. 5. they are not able to deduct the loss. These losses are not deductible. Net the 15% gain from step1 with the net loss from step 4. 2. move the loss into the 28% group. long-term loss) a. When taxpayers sell capital assets at a loss to related parties. Net the 25% gains with the net loss from step3. If step1 >0 but step2<0. Net gains are taxed at 28%. then there is a net long-term capital loss if step1<abs (step2). then there is a net short-term gain if step1>abs (step2). Short-term losses are applied first to reduce ordinary income when the taxpayers recognize both short-term and long-term net capital losses. If step1 >0 but step2<0. Net all long-term gains and long-term losses (including carry forward). Net all short-term gains and short-term losses (including carry forward) 2. All capital loss carryback and carryover are treated as short-term capital losses. b. A net capital loss is carried back three years. 3. The gain is taxed at 15% 15% group ----28% group----25% group---15% Limitations on capital losses 1. the unrecognized losses are added to the basis of the newly acquired stock. separate all long-term capital gains and losses into the three separate rate groups. then there is a net short-term loss and net long-term capital loss. If the result is a net loss. Net losses move to the 15% group. Net gains are taxed at 25% rate. If step2>0. In contrast. and therefore never become part of the netting process. These losses (but realized) are not recognized. corporation capital losses are only allowed to offset capital gains. If step1 (means the short-term) <0. c. not ordinary income. If step2 <0 (that is. Gain recognized but not loss. If step 1 <0. and forward five years to offset capital gains in those years. 4. Net losses move to the 25% group. 40 Regulation Notes By Tomato .

The basis of Cisco stock purchased on Jan 3. Later.000 long-term capital losses but recognizes 0 capital loss. 2010.g. Nick must disallow 40% or 400 of the loss and he is allowed to deduct the remaining 600 loss. On Dec 21. Nick sells the shares for $40 a share. 2010 is 4100+1000 Assume Nick only purchases 40 shares of Cisco stock on Jan 3. Nick purchase 100 shares of Cisco stock for $41 a share on Jan 3.000. Nick realizes 1. Since Nick only acquired 40% of the shares he sold at a loss within the window. 2009. This sale generates a capital loss of 1. Nick owns 100 share of Cisco stock that they purchased in June 2008 for $50 a share.e. Note: This wash sale rule does not apply to dealers in stock and securities where loss is sustained in ordinary course of business. 2010. 41 Regulation Notes By Tomato .

a real estate investment practice termed flipping. the taxpayer cannot exclude gain from the deprecation amount after May 6. the loss is a nondeductible personal loss. when a taxpayer sells a personal residence at a gain. taxpayers meeting certain home ownership and use requirement can permanently exclude from taxable income all. Ownership test: the taxpayer must have owned the property for a total of two or more years during the five-year period ending on the date of sale. Note: this exclusion is determined on an individual basis. a taxpayer can only have one principal residence. a single individual who otherwise qualifies for the exclusion is entitled to exclude up to 250. If a residence is transferred to a taxpayer incident to a divorce. 1997.000 applies if the sale or exchange is due to a change in place of employment (meet the distance test of moving expense). Use test: the taxpayer must have used the property as her principal residence for a total of two or more years during the five-year period ending on the date of sale.depreciation. exclusion= realized gain. 4. 2.Sale or exchange of principal residence (Wiley P495) When a taxpayer sells a personal residence at a loss. However. 5. The exclusion is increased to 50. the taxpayer sold another residence at a gain and excluded all or part of that gain from income. This exclusion applies to a sale of residence that had been jointly owned and occupied by the surviving and deceased spouse if the sales occur no later than 2 years after the date of death of the individual’s spouse. A taxpayer’s period of ownership of a residence includes the period during which the taxpayer’s deceased spouse owned the residence so long as the taxpayer does not remarry before the date of sale. 3. That is. 42 Regulation Notes By Tomato . If the taxpayer does not meet the ownership or use tests. That. fixing it up. It prevents a taxpayer from purchasing a home. health (instructed by doctors). An individual may exclude from income up to 250. a pro rata amount of 250.000 for married filing jointly if either spouse meets the ownership test. or at least a portion of the realized gain on the sale.000 of gain even though his spouse has used the exclusion within 2 years before marriage. b.000 of gain that is realized on the sale or exchange of a residence. and both spouses meet the use test. and soon thereafter selling it and excluding the gain.000 or 500. If a taxpayer was entitled to take depreciation deductions because the residence was used for business purposes or as rental property. By definition. the time during which the taxpayer’s spouse or former spouse owned the residence is added to the taxpayer’s period of ownership. or unforeseen circumstances. Gain from the sale of a principal residence cannot be exclude if during the two-year period ending on the date of the sale. 1. a.

Note: the periods of ownership and use need not be continuous nor do they need to cover the same two-year period. Sales and exchange of securities (Wiley 497) Related-party exchange (Wiley 498) 43 Regulation Notes By Tomato .

Life insurance premiums for which corporation is beneficiary pay on policies that cover the lives of officers or other key employees and compensation the business for the disruption 44 Regulation Notes By Tomato . The loss may be treated as an ordinary loss or a capital loss. Capital expenditures 5. 2. the amount of loss is the lesser of (1) the decline in the value of property and (2) the adjusted basis of property. 4. No deduction or credit is allowed for any amount that is paid or incurred in carrying on a trade or business which consists of trafficking in controlled substances. Political contributions and lobbying costs.Chap 4 Corporations Business income and deductions Income from business includes gross profit from inventory sales. 4. interest expenses for business that borrow money and invest the loan proceeds in municipal bonds. the firm must capitalize the cost and amortize it over a 60 months or longer. income from services provided and income from renting property to customers. Expenditures against public policy. the amount of casualty loss = property’s tax basis. For example. However. the cost of goods sold is still deductible. Ordinary and necessary expenses are deductible only to the extent they are also reasonable in amount. Businesses are not allowed to deduct fines. R&D expenditures: the firm can elect to deduct qualifying R&D as a current expense if the firm so elects for the first taxable year in which the cost is incurred. If only partially destroyed. If the amount of expense is the amount typically charged in the market by unrelated parties. 3. Business expenses must be made in the pursuit of profits rather than the pursuit of others. An expenditure is not reasonable when it is extravagant or exorbitant. the amount is considered to be reasonable. 3. 2. Business expenses must be both ordinary and necessary to be deductible. The IRS tests for extravagance by comparing the amount of the expense to a market price or an arm’s length amount. or illegal kickbacks. Otherwise. If business property is completely destroyed. Limitation on business expenses (nondeductible) 1. penalties. Casualty loss: (different from individual) 1. Only the loss not reimbursed by insurance is deductible. Expenses associated with the production of tax-exempt income. illegal bribes. depending on the type of asset involved in the casualty.

such as customers. the transportation costs to arrive at the location is deductible. Unincorporated entities (including LLC) with more than one owner are taxed as partnership (Form 1065) 2. B. Business associates are individuals with whom the taxpayer reasonably expects to do business. The death benefit from the life insurance policy is not taxable. Meals Only 50% of actual business meals are deductible and satisfy (1) the amount must be reasonable under the circumstances. 7. The rules for determining the amount of deductible mixedmotive expenditures depend on the type of the expenditure. Then they would make a second election to treat the “corporation” as an S corporation for tax purpose. The deduction for business gifts is limited to $25 per recipient each year. (2) the amount must be reasonable under the circumstances and (3) the entertainment must be directly associated with the active conduct of the taxpayer’s business. business entities can be classified as either separate taxpaying entities or as flowthrough entities. (2) the employees must be present when the meal is furnished and (3) the meal must be directly associated with the active conduct of the taxpayer’s business. but meals (50%). 2. even though funded by the business. and meals (50%). C. (Schedule C) 3. Personal expenditures. Unincorporated entities (including LLC) with only one individual owner and single-member LLCs are taxed as sole proprietorships. or advisors. 8. lodging and incidental expenditures are limited to those incurred during the business portion of the travel. lodging and incidental expenditures are limited to those incurred during the business portion of the travel. Entities For tax purposes. are not deductible. suppliers. A. Entertainment Only 50% of actual expenses are deductible and satisfy (1) business associates are entertained. 1. These expenditures. S corporation Note: owners of LLCs can elect to have their business taxed as taxable corporations instead of as flow-through entities. Many business owners may be in a position to use business funds to pay for items that are entirely personal in nature. If the primary purpose of a trip is business. taxable corporation 4. If the primary purpose of a trip is personal. 45 Regulation Notes By Tomato . Business gift. 6. the transportation costs are fully deductible. Mixed-motive expenditures. employees.and lost income they may experience due to a key employee’s death. Travel and transportation 1.

FICA and self-employment tax 1. 4. Taxable corporation: employee-shareholder pays 7. Exception: may use cash method if its annual average gross receipts do not exceed 5 million for the three previous tax years. They do not pay taxes on dividends. Dividends are subject to the corporate shareholder’s ordinary rates. After-tax earnings distributed by a corporation Corporate shareholders are subject to double taxation because they pay a second level of tax (the first level of tax is corporate tax). the year-end of its owner is not relevant.65% 2. tax shelters. 2. Dividends are not entitled to the reduced dividend tax rate (15%) available to individual shareholders. The second level of tax depends on whether corporations retain their after-tax earnings and on the type of shareholders 1. Taxable corporation: any time. Taxable corporation: accrual method. Partnership: guaranteed payment is subject to 15. Institutional shareholders. Exception: accrual if they have a C corporation. Partnership: three methods to determine 3. Corporate shareholders. Income allocation received by general partners is subject to 15. 2. S corporation: an income allocation received by employee-shareholders is not subject to FICA or self-employment tax.Accounting periods: 1. 3.65% FICA tax and corporations pay 7. S corporation: calendar year.3% self-employment tax.3% self-employment tax. If merchandise inventories are necessary to clearly determine income. S corporation: accrual or cash. Accounting method: 1. Individual shareholders. 3. Pension and retirement funds are some of the largest institutional shareholders of corporations. only the accrual method of tax reporting can be used for purchases and sales. Ultimately. If the firm previously was a C corporation. Partnership: cash. 3. retirees pay the tax when they receive the distributions from these funds. all prior accounting methods carry over to the S corporation. Sole proprietorships: the same year-end as the individual proprietor. 46 Regulation Notes By Tomato . Elect tax year when they file their first income tax returns. and certain taxexempt trusts as a member or partner and the partnership reports annual average gross receipts in excess of 5 million for the three previous years. 15% tax rate on dividends 2. But not the income allocation received by limited partners.

Interest expense on loans for tax-free investment: not deductible. Federal income taxes are not deductible. Tax-exempt organizations such as churches and universities are exempt from tax on their investment income. b. Prepaid interest expense: must be allocated to the proper period to which it is related. rental income and royalty income received in advance. General business interest expense: paid or accrued during the taxable year incurred for business purposes are deductible. All state and local taxes and federal payroll taxes are deductible when incurred on property or income relating to business. c. Interest expense: a. Foreign income taxes may be used as a credit. Taxable Corporation Corporations generally compute their taxable income by starting with their book or financial accounting income and make adjustments for book-tax differences. result in schedule M-1 items.4. Any book-tax difference that requires an add-back to book income to compute taxable income is an unfavorable book-tax difference. items of income and deduction whose book and tax treatment differ. Interest expense on loans for taxable investment: limited to net taxable investment income. Taxes: a. c. Note: cash received in advance of accrual GAAP income is taxed such as interest income. Common permanent book-tax difference (copy B16-5 EX16-2 ) Federal income tax expense should be added back to book income to compute taxable income. Generally. b. 1. Book income Substract: Nontaxable income (interest from municipal bonds and death benefits from life insurance on key employees. (permanent book-tax differences and temporary book-tax differences) Each tax-book difference can be considered to be unfavorable or favorable depending on its effect on taxable income relative to book income. However. schedule M-1 reconciles to taxable income before the DRD and NOL deductions. Schedule M1 of tax return form provides a reconciliation of income reported per books with income reported on the tax return. Foreign investors may be eligible for reduced rates on dividend income depending on the tax treaty with US. d. the beneficiary muse be company) Expenses deducted on the tax return but not on the books 47 Regulation Notes By Tomato . Tax-exempt and foreign shareholders.

Common temporary book-tax differences A. B.Dividends received deduction Add: (mostly are nondeductible business expensens) Federal income tax expense Fines and penalties and political contributions Premium on life insurance for which corporation is beneficiary 50% of business meals and entertainment Interest expense on loans to acquire investments generating tax-exempt income Domestic manufacturing deduction (DMD) Charitable contribution in excess of 10% limitation The compensation of CEO and other four highest paid officers in excess of 1 million 2. With any remaining expenditures deducted ratably over the 180-month period beginning with the month using the straight-line method. 48 Regulation Notes By Tomato . E.000 for start-up costs for the tax year in which the business begins. Note: organization costs apply to partnership or corporation. Bad debt For tax purpose. For tax purpose: may deduct up to 5000 of organization costs and 5. the amount (Dividend received – DRD) is included in the corporation’s ordinary income For books purpose: 1. but start-up costs apply to all types of business forms.000. starting with the month of acquisition for tax purpose. dividend is included in income 2. Note: the deduction for organization and start-up costs are calculated separately. Organizational expenditures and start-up costs For books purpose: expensed when they are incurred. No any dividend income is recorded. licenses. The receiving corporation include the amount (=distributing corporation’s income*ownership) in the income rather than actual amount of dividend. Goodwill acquired in an asset acquisition For tax purpose. businesses are allowed to deduct bad debt expense only when the debt actually becomes worthless within the taxable year (direct write-off method). Depreciation expenses C.000 is reduced by the amount by which organization or startup costs exceeds 50. Dividends For tax purpose. respectively. and trademarks may be amortized using straight-line basis over a period of 15 years. If ownership < 20% of distributing corporation. If 20% of distributing corporation =< ownership<=50% of distributing corporation. intangibles such as goodwill. For book purpose. If ownership > 50% of distributing corporation. D. 3. allowance method. franchises. Each 5. consolidated financial statements are prepared.

Charitable contribution limit modified taxable income is taxable income before ducting the following: A. Corporations can only deduct capital losses to the extent they recognize capital gains in a particular year. Thus to determine the temporary book-tax difference associated with purchased goodwill. Generally. if modified taxable income=0. firms recover the cost of goodwill only when and only to the extent goodwill is impaired (FMV of goodwill is less than purchased price of goodwill). all net capital gains (long and short-term) are taxed at ordinary income rates. NOL carrybacks carry forward is deductible D. The dividends received deductions C. corporations using the accrual method of accounting can deduct contributions in the year before they actually pay the contribution when (1) the board of directors approves the payment and (2) they actually pay the contributions within two and one-half months of their tax year. then deductible charitable contribution=0 49 Regulation Notes By Tomato 年次在即( ) ) ( ( )付支前号 . Charitable contributions. it is treated as a short-term capital loss whether or not it was short-term or long-term when sustained.3. Corporate-specific deductions and associated book-tax differences Stock options Net capital losses For corporations. Money+ FMV of capital gain property (property that would generate long-term capital gain if sold) + the adjusted basis of ordinary income property. Any charitable contributions B. Net operating losses Firms can carry current year net operating losses back two years and forward 20 years to offset taxable income and reduce taxes payable ( or already paid) in those years. Capital loss carrybacks carry forward is deductible That is. firms need only compare the amount of goodwill they amortize for tax purposes with the goodwill impairment expense for book purposes. For book purposes. Corporations carry the capital losses back three years (capital loss carryback) and forward five years (capital loss carryover) to offset net capital gains in the three years preceding the current tax year and then to offset net capital gains in the five years subsequent to the current tax years (carryover must be in an order: three years back first and five years forward next) Note: when a corporation has an unused net capital loss that is carried back or carried forward to another tax year. However. (1) (2) (3) (4) For book purpose.15 Deductible charitable contributions for the year may not exceed 10% of its charitable contribution limit modified taxable income. corporations are allowed to deduct charitable contributions at the time they make payment to charitable organizations. The domestic manufacturing deduction (DMD) E. 2. corporations deduct all net capital losses in the year they sell the property.

but merely serves to reduce the income taxes the business must pay and thereby increase the after-tax profitability of domestic manufacturing. c. However. If ownership > =80% of distributing corporation. 80% C. DMD is 6% times the lesser of (1) the business’s taxable income before the deduction (or modified AGI for individuals) or (2) qualified production activities income (QPAI). The amount (Dividend received – DRD) is included in the corporation’s ordinary income. corporations are allowed to deduct a dividends received deduction (DRD) to mitigate the extent to which corporate earnings are subject to three levels of taxation. personal holding companies and personally taxed S corporation (Do not take it personally) e. This deduction is artificial because it does not represent an expenditure per se. The DRD 2. this limitation does not apply if after deducting the full DRD a corporation reports a current year net operating loss. If ownership < 20% of distributing corporation. Note: to qualify a DRD. 100% a. The DMD b. Any NOL deduction (carryover or carryback) 3. DRD modified taxable income is the taxable income before deducting the following: 1. the investor corporation must own the investee’s stock for more than 46 days (90 days for preferred stock) during the 91-day period beginning on the date 45 days before the ex-dividend date. Members of an affiliated group of corporations (80% or more common ownership) may deduct 100% of the dividends received from a member of the same affiliated group. 50 Regulation Notes By Tomato . A. d. (6) Domestic production deduction or domestic manufacturing deduction Business that manufacture goods are allowed to deduct an artificial business deduction for tax purposes called DMD or DPD. DRD =dividend amount * deduction percentage. f. However.Firms making current year charitable contributions in excess of the 10% modified taxable limitation may carry forward the excess for up to five years after the year in which the carryover arises (FIFO order). Capital loss carrybacks 4. (5) Dividends received deductions (R3-22) When corporations receive dividends from other corporations they are taxed on the dividends at ordinary tax rate. deduction percentage=70% B. QPAI is the net income from selling or leasing property that was manufactured in the US. If 20% of distributing corporation =< ownership<80% of distributing corporation. Note: the DRD does not apply to personal service corporations. not the preferential 15% rate available to individual taxpayers. It is designed to reduce the tax burden on domestic manufacturers to make investments in domestic manufacturing facilities more attractive. DRD is limited to the product of the applicable DRD percentage and DRD modified taxable income.

To be exempt for its third year.The final deduction cannot exceed 50% of the wages the business paid to employees for working in qualifying production activities during the year. (4) Income from long-term contracts must be determined using the percentage of completion method: the difference between completed contract revenue and percentage of completion revenue. (5) ACE (adjusted current earnings) adjustment ACE adjustment= 75% * (ACE.5 million for the three years prior to the current tax year. ACE adjustment= 75% * the sum of the modifications to AMTI 51 Regulation Notes By Tomato . (3) The installment method cannot be used for sales of inventory-type items: the difference between full accrual revenue and installment sales revenue. Small corporations are exempt from the AMT. (2) Gain or loss on disposition of depreciable assets. Tax exempt interest on private activity bonds issued in 2009 or 2010 is not an AMT tax preference item. To be exempt for the fourth year (and sequent years). Depreciation differences for regular tax and AMT purposes cause differences in the adjusted basis of the assets for regular tax purposes and AMT purposes. Adjustments Adjustment is positive (unfavorable) or negative (favorable) (1) Depreciation: depreciation is different for regular tax and AMT purpose. average annual gross receipts for all three prior years are below 7.5 million. assets are not depreciated as quickly as for regular tax. Preference items Common preference items include percentage depletion in excess of cost basis and tax-exempt interest income from a private activity bond (a municipal bond used to fund a nonpublic activity. New corporations are automatically exempt from the AMT in their first year. the interest is not a preference item).5 million or less. For this purpose. It is exempt for its second year if its first year’s gross receipts were 5 million or less. it is no longer exempt from the AMT. small corporations are those with average annual gross receipts less than 7. Once a corporation fails the AMT gross receipt test. Corporate alternative minimum tax It is designed to require corporations to pay some minimum level of tax even when they have low or no regular taxable income due to certain tax breaks they gain from the tax code. 2. Corporate AMT formula Taxable income or loss before NOL deduction+ Preference items +/.Adjustment items= Alternative minimum taxable income (AMTI) AMTI-Exemption=AMT base AMT*20%=Tentative minimum tax 1. For AMT purpose. the average gross receipts for the first two years must be 7.AMTI before the ACE adjustment) As a practical matter.if the bond is for a public purpose.

Note: ACE adjustment can be negative or positive. then AMT=0. That. +death benefit from life insurance contracts +70% DRD (not the 80% or 90% DRD) + organizational costs that were expensed during the year +/. Alternative minimum tax Tentative minimum tax (TMT) = (AMTI – exemption) *20% If regular tax > TMT. 2.difference between gain reported under the installment method and gain otherwise reported (installment method not allowed for ACE purposes) 3.000 Then in year 1: AMT = 183.000. and 12th months of their tax year. they generate minimum tax credit that they can carry forward indefinitely to offset their regular tax liability down to their AMT in years when regular tax liability > TMT.690.000 Phase out = 25% * (AMTI – 150.000.000.183. Year 1: TMT: 1. Minimum tax credit When corporations pay AMT. tax credit carryover= 183. 5. 52 Regulation Notes By Tomato . Otherwise.difference between AMT depreciation and ACE depreciation. +/-difference between AMT and ACE gain or loss on asset disposition +/. 3. Corporations can request an extension for six months. ACE=AMTI + Tax-exempt interest income from tax-exempt bond that funds a public activity.000. If bond was issued in 2009 or 2010 it is not a modification.000 Then in year 2: tax liability: 900. Regular tax liability: 1.000-900.690. AMT = TMT – regular tax.000 4. 6th.000) and completely phase out for AMTI at 310.000) =83. AMTI: alternative minimum taxable income= regular taxable income + preference items +/adjustment items ACE is computed by making certain modifications to their AMTI.000.690 ---tax credit for future Year 2: TMT 900.9th. the installments are due on the 15 days of the 4th. Regular tax liability: 1. Tax return due date is two and one-half months after the corporation’s year-end. Corporations with a federal income tax liability of 500 or more are required to pay their tax liability for the year in quarterly estimated installments. AMT exemption Full exemption: 40. but a negative ACE adjustment is limited in amount to prior year’s net positive ACE adjustments.690 Personal holding company and accumulated earnings tax (W P576) Corporate tax return due date and estimated tax 1.(1.

100% of tax liability on the prior year’s return. The controlled group is treated as one corporation for purposes of using the tax rate schedule. Large corporations defined as corporations with over 1 million of taxable income in any of three years prior to the current year may use the prior year tax liability to determine their first quarter estimated tax payments only. And its estimated tax payments must be at least equal to 100% of current year liability. Affiliated group (R3-33) An affiliated group exists when one common corporation directly owns at least 80% of (1) the total voting power and (2) the total stock value of another corporation. each of which is a member of either a parent-subsidiary or brother-sister controlled group and one of the corporations is the parent in the parentsubsidiary controlled group and also is in a brother-sister controlled group. 75% and 100% of their required annual payment with their first.4. Parent-subsidiary: one corporation owns at least 80% of the voting power or stock value of another corporation on the last day of the year 2. 5. 100% of the estimated current year tax liability using the annualized income method. The required annual payment is the least of A. Brother-sister: two or more corporations of which five or fewer persons own more than 50% (including 50%) of the voting power or stock value of each corporation on the last day of the year. If each member of the group files a consent. but only if there was a positive tax liability and the prior year return covered a 12-month period. third and fourth installment payments. 53 Regulation Notes By Tomato : . a brother-sister controlled group or a combined controlled group. Corporations are subject to underpayment penalties if they did not pay in 25%. Controlled group A controlled group is a group of corporations that is controlled or owned by the same taxpayer or group of taxpayers. 6. second. 1. 50%. A controlled group could be parent-subsidiary controlled group. 100% of the current year tax liability C. Combined: three or more corporations. B. respectively. 3. an affiliated group of corporations may elect to file a consolidated tax return in which the group files a tax return as if it were one entity for tax purposes.

Any distribution out of accumulated E&P is allocated to the recipients in the chronological order in which the distributions were made. it is a nontaxable return of capital) 3. the amount distributed out of current E&P is allocated pro rata to all of the distributions made during the year.000+15. Ginny is allocated only 10. Assume SCR reported current E&P of 40. 4. Eg. Deferral of deductions or acceleration of income due to separate accounting methods required for E&P purposes. The balance in accumulated E&P was 15.000). Distribution within total E&P is treated as taxable dividend. The portion of the distribution that is a dividend is included in gross income. The portion of distribution that is not a dividend and is in excess of the shareholder’s stock tax basis is treated as capital gain from sale or exchange of the stock (capital gain) The IRC requires a corporation to keep two separate earnings and profits (E&P) accounts: one for the current year (current E&P) and one for undistributed E&P accumulated in all prior years (accumulated E&P) Adjustment on current E&P 1.000 Because Jim’s distribution took place before Ginny’s distribution.000 to Jim and 15.000 (15. On Dec 31.000-10.000=(45. The amount paid from current and accumulated E&P is considered as taxable dividend. 2009.Corporate distribution (R3-39) Corporate distribution to shareholder in their capacity as shareholders can be summarized as follows: 1. Disallowance of certain expenses that are deducted in computing taxable income but do not require cash flow.000). The excess distribution is treated as a nontaxable reduction of her basis in the SCR stock. leaving her with an excess distribution of 5.000. A. 3. 54 Regulation Notes By Tomato . SCR distributed 45.000/(45. The portion of the distribution that is not a dividend reduces the shareholder’s tax basis in the corporation’s stock (that is. Deduction of certain expenses that are excluded from the taxable income but do require cash outflow.000 to Jim and 10.000 in 2009. Inclusion of income that is excluded from taxable income. Whether a distribution is characterized as a dividend depends on whether the balances in the two accounts are positive or negative.000 of E&P. Positive current E&P.000 to Ginny.000 to Ginny) 30.000))*40. the accumulated E&P is allocated to Jim first (15. The distribution is first deemed to be paid from current E&P (30. 2. If distributions exceed current E&P. 2. 1. positive accumulated E&P Distributions are deemed to be paid out of current E&P first.

On June 30. A shareholder’s tax basis in noncash property received as a dividend=the property’s FMV For corporation: 55 Regulation Notes By Tomato .B. (6 months/12 months*20. 3. (Check W P594 question 83) Distributions of noncash property to shareholders For shareholder: 1. 2009. none of the distribution is treated as a dividend.000 to Jim and 16. Any excess over their stock basis is treated as capital gain from sale or exchange of the stock (capital gain) Eg.500 To Ginny: 50. SCR distributed 48. Any excess over their stock basis is treated as capital gain from sale or exchange of the stock (capital gain) Note: any distribution should not increase the negative balance of E&P. Positive current E&P.500 Adjusted tax basis of Ginny: 10.000-3. positive accumulated E&P Prorate the negative current E&P to the distribution date and add it to accumulated E&P at the beginning of the year to determine total E&P at the distribution date.500=6.25=12.000.000). Distribution=cash received + FMV of property received – liabilities assumed by shareholder on property received 2.000)=37. Jim has a tax basis of 24. negative accumulated E&P In this case.000 to Ginny. negative accumulated E&P Distributions deemed paid out of current E&P are taxable as dividends.500 4. Assume SCR reported negative 20.000 is added to the beginning balance of 60. Negative current E&P.500=13.000*0.000 to get total E&P as of July 1 of 50. Taxable distribution to the extent that it is paid out of current and accumulated E&P. SCR prorates its full year negative current E&P to June 30. Distributions would first be treated as nontaxable reduction of basis in the corporation’s stock. distribution is not out of E&P account when the account balance is negative.000. Distributions in excess of total E&P would first be treated as nontaxable reduction of basis in the corporation’s stock. That is. To Jim: 50. The balance in accumulated E&P at the beginning of the year was 60. Any excess over their stock basis is treated as capital gain from sale or exchange of the stock (capital gain) 3. 2. Distribution over total E&P is treated as nontaxable reduction of basis in the corporation’s stock.500 Adjusted tax basis of Jim: 24. Check W P595 question 85 and 89. Negative current E&P.000=10.000-10. The negative 10.000* (48000/48000+16. Distributions in excess of current E&P would first be treated as nontaxable reduction of basis in the corporation’s stock.000 E&P in 2009.000 and Ginny’s tax basis is 10.000.

the shareholder is considered to have received a constructive dividend (taxable) = FMV – priced paid. and parents. children. SCR has a tax basis in the land of 20.000. Constructive dividends (B18-14) 1. if the FMV < the liability assumed. Eg.000 and a remaining mortgage is 75. Distribution of property to shareholders reduces E&P by the greater of the tax basis or FMV. 2. 2. Jim should recognize (75.1.000-20. The FMV of the land is 60. If a corporation sells property to a shareholder for less than FMV. Stock owned constructively through the family attribution rule cannot be reattributed to another family member through the family attribution rule.000. Recognized gains on property=FMV.000) capital gain. no deductible loss is recognized if FMV < basis. Stock dividend Family attribution: individuals are treated as owning the shares of stock owned by their spouse. However.tax basis if the FMV of property > basis. However. The effect of distribution on E&P=gain recognized–step1 outcome+ liability assumed. Assume Jim received a parcel of the land as dividend. then the gain= liability assumed – tax basis 3. grandchildren. 56 Regulation Notes By Tomato .

This “something” often is referred to as boot. recognition is postponed to a future period). the transferors must meet the requirements of IRC 351. (that is. 1. and intangible assets. Section 351 applies to transfers of property to both C corporations and S corporations. The requirement of IRC 351: One or more shareholders transfer property to a corporation in return for stock. the shareholder providing service is not counted) If a shareholder receives stock in return for property and services in a 351 exchange. Shareholder: including individuals. Services are excluded from the definition of property. or options. reorganization and liquidation Tax consequences to the shareholders Gain or loss from property exchange not recognized when realized falls into one of two categories: (1) the gain or loss is excluded from gross income (that is. the shareholder’s tax basis in the stock received = the tax basis of property transferred. and 80% or more of the total number of shares of each class of nonvoting stock.Corporation formation. The IRS has stated 57 Regulation Notes By Tomato . Whether the control test is met is based on the collective ownership of the shareholders transferring property to the corporation immediately after the transfer. 4. and immediately after the transfer. That is. tangible assets. rights. 2. everything other than services. Gain or loss deferred in the transfer of property to a corporation in return for stock is reflected in the shareholder’s tax basis in the stock received in exchange for the property transferred. 3. Section 351 transaction For shareholders to receive tax deferral in a transfer of property to a corporation. Control: 80% or more ownership of the total combined voting power of all voting stock that is issued and outstanding. the gain or loss will never be recognized) or (2) the gain or loss is deferred from inclusion in gross income (that is. The deferral of gain or loss in a 351 transaction is mandatory if the requirements are met. Property: includes money. In essence. 5. The transferor cannot receive something other than qualifying stock from the corporation in return for the property transferred. Stock for purposes of 351 does not include stock warrants. in the aggregate. all of the stock received is included in the control test provided the FMV of the property transferred is not of relatively small value in comparison to the value of the stock received in return for services. partnerships. Incorporations involving transfers of property to a corporation are transactions in which gain or loss realized may be deferred if certain tax law requirements are met. control the corporation to which they transferred the property. corporations. and fiduciaries (estates and trusts). these same shareholders.

2. Tax basis on stock=FMV of stock received Tax consequences when a shareholder receives boot Shareholder: 1. If any of the liabilities assumed by the firm are assumed with the purpose of avoiding the federal income tax or if there is no corporate business purpose for the assumption. Tax basis of boot = FMV 5. The character of gain recognized is determined by the type of property to which the boot is allocated. allocating the boot received pro rata to each property using the relative FMVs of the properties. 58 Regulation Notes By Tomato . Shareholders’ tax basis of stock= tax basis of property contributed + gain recognized on the transfer –FMV of boot received – liabilities assumed by the corporation on property contributed If the corporate assumes shareholders’ liability attached to the property transferred: General rule: the debt is not treated as boot.that for ruling purposes. Recognized gain= lesser of (1) gain realized (=FMV-tax basis) or (2) the FMV of the boot received. (2) The tax basis of stock received in an exchange that does not meet the 351 requirement. If the liabilities assumed > aggregate tax basis of the properties transferred. 2. Tax basis of stock= tax basis of property contributed – liabilities assumed by the corporation on property contributed. Exceptions: 1. 4. then the liability is treated as boot. Recognized gain= FMV of stock received 2. Tax basis of stock= FMV of the stock received When shareholders provide services to exchange stocks To shareholder: 1. Tax basis of stock (1) The tax basis of stock received in a tax-deferred 351 exchange =the tax basis of the property transferred. If there are more than one boot. 3. Tax consequences to the transferee corporation A corporation will never recognize gain or loss on the receipt of money or other property in exchange for its stock. including treasury stock. recognized gain=liabilities assume – aggregate tax basis of the properties transferred. property will not be of relatively small value if it equals at least 10% of the value of the services provided.

Section 1244 allows a shareholder to treat a loss on the sale or exchange of stock as an ordinary loss up to 50. Exception: if the aggregate adjusted tax basis of property transferred > aggregate FMV. Or adjustment by the shareholder: tax basis of stock = aggregate FMV Section 1244 stock Normally. The issuing corporation must be a small business corporation when the stock is issued. Requirements: 1. the aggregate tax basis in the hands of corporation cannot exceed aggregate FMV.1. The corporation receiving property in exchange for its stock in a 351 transaction: No gain or loss recognized on the transfer. A small business corporation: the aggregate amount of money and other property received in return for the stock or as a contribution to capital did not exceed 1 million. 2. The tax basis of property received by the corporation= the property’s tax basis in the transferor’s hands. then the ordinary loss is limited to (exchange price. 2. The shareholder must be individual or partnership shareholder and the original recipients of the stock. For the five taxable years preceding the year in which the stock was sold. Then: 1.FMV) 59 Regulation Notes By Tomato . the holding period of 1231 property or a capital asset also carries over to the firm.000 per year (100. The stock must be issued for money or property (other than stock and securities) 5. 3.000 of ordinary income per year. 2. Losses can offset capital gains plus 3. 4. the corporation must have derived more than 50% of its aggregate gross receipts from an active trade or business. if the FMV < tax basis. stock is a capital asset for shareholder and gains or losses from sale of stocks are capital. For individuals.000 for married filing jointly). If the shareholder recognizes gain as result of the property transfer: The tax basis of property received by the corporation= tax basis of property contributed by the shareholder+ gain recognized on the transfer by the shareholder. Adjustment by the corporation: the aggregate reduction in tax basis is allocated among the assets transferred in proportion to their respective built-in losses immediately before the transfer. The issuer must be a domestic corporation Note: When the property contributed to the firm. In this case. long-term capital gains are taxed at a maximum 15%.

retired. regardless of redeemed stock being canceled. the shareholder’ ownership < 50% of the total combined voting power of all classes of stock entitled to vote b. the redemption proceeds are treated as an ordinary distribution. treat stock redemption either as a dividend distribution or as a sale of the stock redeemed. The distribution is in complete redemption of all of a shareholder’s stock. For shareholder. 3. The distribution is to a non-corporate shareholder in partial liquidation. For corporation. 4. 5. If any of the following conditions are met. Capital gain/loss= FMV of property received. the exchange is treated as a sale. Corporation liquidation A complete liquidation occurs when a corporation acquires all the stocks from all of its shareholders in exchange for all of its net assets after which time the corporation ceases to do business. Tax basis of property received =FMV For corporation: 60 Regulation Notes By Tomato . Note: no deduction is allowed for any amount paid or incurred by a corporation in connection with the redemption of its stock. The distribution is received by an estate. or held as treasury stock.debt assumed – tax basis in stock 2. Meet stock ownership tests: a.Stock redemption Stock is redeemed when a corporation acquires its own stock from a shareholder in exchange for property. The redemption is substantially disproportionate. except for interest expenses on loans to repurchase stock. Otherwise. c. and the gains or losses are capital gains and losses. The shareholder’ ownership of voting stock after redemption < 80% of his ownership before the redemption. The redemption is not essentially equivalent to a dividend. 1. 2. taxable as dividend to the extent of the distributing corporation’s earnings and profits. For shareholders 1. Immediately after the exchange. The shareholder’ ownership of the aggregate FMV of common stock (including both voting and nonvoting) after the redemption < 80% of his ownership before the redemption. recognize gain or loss as if the sale of stocks.

the liquidation is treated as a mere change in form and the parent corporation will not recognize any gain or loss on the receipt of liquidating distributions from its subsidiary. As a result. Disqualified property: property acquired within 5 years of the date of distribution in a tax deferred 351 transaction or as a nontaxable contribution to capital. and tax credit carryovers. 61 Regulation Notes By Tomato . Related party: a shareholder who owns more than 50% of firms’ stock. as well as carryover of all of the subsidiary’s tax attributes to the parent corporation. professional fees. 3. a corporation will recognize gain or loss on the distribution of its property in complete liquidation just as if the property were sold to the distributee for its FMV. the subsidiary corporation will not recognize any gain or loss on distributions to its parent corporation. 4. there will be a carryover basis for all of the subsidiary’s assets that are received by the parent-corporation. Exception: when a parent corporation completely liquidates its 80% or more owned subsidiary. capital loss carryovers. accounting methods.1. The subsidiary’s tax attributes that carryover to the parent include such items as earnings and profits. and net operating loss. Exception: the firm does not recognize loss if the property is distributed to a related party and either (1) the distribution is non-pro rata. Note: the general expenses incurred in the complete liquidation and dissolution of a corporation are deductible by the corporation as ordinary and necessary business expenses. and other expenditures incurred in connection with the liquidation and dissolution. Similarly. These expenses include filing fees. Generally. Gain/loss= FMV of property distributed – tax basis in the property 2. or (2) the asset distributed is disqualified property. as well as unused excess charitable contributions.

(even if the shareholder sold his stock in the current year. the corporation remains an S corporation until the election is terminated. and certain tax-exempt organizations may be shareholders. 2. Domestic corporations. A revocation after this period is effective the first day of the following tax year. no corporations and partnerships. All shareholders on the date of the election must consent to the election.S. Involuntary terminations 62 Regulation Notes By Tomato 经曾他要只 有拥 . Elections after the first two and half months after the beginning of the year are effective at the beginning of the following year.Chap 5 S corporation Requirements: 1. either in the prior tax year or within the first two and half months after the beginning of the current tax year. Note: NOL losses for C corporations can’t be carried over to the S corporation. Only U. Exception: when the corporation makes the election within the first two and half months after the beginning of the current tax year. certain trusts. ) 3. Have only one class of stock. a corporation may specify the termination date as long as the date specified is on or after the date the revocation is made. 100 shareholders or less S corporation election An eligible corporation must make an affirmative election to be treated as an S corporation. 3. the election will not be effective until the subsequent year if (1) the corporation did not meet the S corporation requirements for each day of the current tax year before it made the S election. or (2) one or more shareholders who held the stock in the corporation during the current year and before the S corporation election was made did not consent to the election. Voluntary terminations The corporation can make a voluntary revocation of the S corporation if shareholders holding more than 50% of the S corporation stock agree (including nonvoting shares). 1. the corporation uses Form 2553. Alternatively. Once the S election becomes effective. citizens or residents. To formally elect S corporation status effective as of the beginning of the current tax year. The termination may be voluntary or involuntary. 4. 4. Voluntary revocations made during the first two and one-half months of the year are effective as of the beginning of the year. 2.

Sarah Walker. Chance sold his CCS shares to his solely owned C corporation. 1. this provision does not apply.000 S corporation reelections After terminating or voluntarily revoking S corporation status. interest. S corporation election terminations due to excess passive investment income are effective on the first day of the year following the third consecutive tax year with excess passive investment ). dividends. Or it may use the corporation’s normal accounting rules to allocate income to the actual period in which it was earned (the specific identification method). The termination is effective on the date it fails the S corporation requirement.000/365*165 Specific identification: S corporation: 100. and annuities. C corporation : 265. the corporation may elect it again.000 Jan 1 through Dec 31 (365 days) 365.Involuntary terminations can result from failure to meet requirements or from an excess of passive investment income. rents. the corporation takes the necessary steps to meet the S corporation requirements ( ). Suppose CCS was formed as a calendar-year S corporation with Nicole Johnson. within a reasonable period after the inadvertent termination.000 Daily method: S corporation short tax year=365. 2009.000. A corporation’s S selection is automatically terminated if the corporation fails to meet the requirements. Failure to meet requirements. Chanzz Inc. 63 Regulation Notes By Tomato 效生刻即 效生刻即是不 . On June 15. income ( Short tax years S corporation election terminations frequently create an S corporation short tax year (a reporting year less than 12 months) and a C corporation short tax year. If the S corporation never operated as a C corporation or does not have C corporation earnings and profits. Eg. and (2) if the S corporation has passive investment income in excess of 25% of gross receipts for three consecutive years. Excess of passive investment income.000 June 15 through Dec 31 (200 days) 265. terminating CCS’s S election on June 15. The corporation must then allocate its income for the full year between the S and C corporation years using the number of days in each short year (daily method). but it generally must wait until the beginning of the fifth tax year after the tax year in which it terminated the election. it may allow the corporation to continue to be treated as an S corporation if. Passive investment income includes royalties. 2. and Change Armstrong as equal shareholders. 2009. Assume CCS reported business income for 2009 as follows: Jan 1 through June 14 (165 days) 100. If the IRS deems the termination inadvertent. (1) If an S corporation has earnings and profits from a previous C corporation year (or through a reorganization with a corporation that has earnings and profits).

An S corporation generally allocates income or loss items to shareholders on the last day of its tax year. Like partnership. 5. 4. 9. 7. 2. An S corporation generally allocates income or loss items to shareholders on the last day of its tax year.S corporation must allocate profits and losses pro rata. they supply information to each shareholder detailing the amount and character of items of income and loss flowing through the S corporation. S corporations are required to file tax returns (Form 1120 S) annually. 6. with a couple of exceptions. per day basis). she will report her share of S corporation income loss allocated to the days she owned the stock using a pro rata allocation. based on the number of outstanding shares each shareholder owns on each day of the tax year. If a shareholder sells her shares during the year. per share. In addition. 3. ordinary business income (loss) is all income (loss) exclusive of any separately stated items of income (loss). Shareholders must report these income and loss items on their tax returns even if they do not receive cash distributions during the year.FMV of boot received Purchased from other shareholder: tax basis in stock received = purchase price Annual basis adjustment 64 Regulation Notes By Tomato . The list of common separately stated items for S corporations is similar to that for partnerships. based on the number of outstanding shares each shareholder owns on each day of the tax year (that is. Separately stated items are tax items that are treated differently from a shareholder’s share of ordinary business income for tax purposes. S corporations determine each shareholder’s share of ordinary business income and separately stated items. 10. Lists of common separately stated items: 1. 8. Income and loss allocations S corporation must allocate profits and losses pro rata. Short-term capital gains and losses Long-term capital gains and losses Section 1231 gains and losses Dividends (S corporation are not entitled to claim the DRD) Interest income Charitable contributions Tax-exempt income Net rental real estate income Investment interest expense Section 179 deduction Shareholder’s basis (same as C corporations& Section 351 also applies) Tax basis in stock received = tax basis of property transferred – liabilities relief + gain recognized.

At-risk limitation (applies to S corporation shareholders rather than at the corporate level) At risk amount= cash contributed + tax basis of property contributed + direct loan made to S corporation 6. S corporation shareholders are not allowed to include any S corporation debt in their stock basis. Tax basis limitation Any losses allocated in excess of their basis must be suspended and carried forward indefinitely until they have sufficient basis to utilize the losses Shareholders can mitigate the disadvantage of not including S corporation debt in their stock basis-by loaning money directly to their S corporation. 9. Self-employment income (different from partnerships) S corporation shareholders’ allocable share of ordinary business income (loss) is not classified as selfemployment income for tax purposes. Like stock basis. Increase for any contributions to the S corporation during the year. Passive activity loss limitation Limit the S corporation shareholders to deduct losses unless they are involved in actively managing the business. Increase for shareholder’s share of ordinary business income and separately stated income/gain items 8. debt basis cannot be decreased below 0. any net increase in basis for the year first restores the debt basis (up to the outstanding debt amount) and then the stock basis. Basis adjustments that decrease basis may never reduce a partner’s tax basis below 0. Decrease for partner’s share of ordinary business loss and separately stated expense/loss items. If the total amount of items (besides distributions) that decrease the shareholders’ basis for the year > stock basis. However. recognize gain= repayment amount. they are deductible only when they clear three separate hurdles: 4. If the S corporation repays the debt before the debt basis is restored. penalties.The basis must be adjusted in the order listed: 6. Decrease for shareholders’ share of nondeductible expenses (fines. In subsequent years. Different from partnerships.debt basis. Loss limitation (similar to partnerships) Ordinary losses are deductible against any type of taxable income. etc) 10. 7. Decrease for distributions during the year. These loans creates debt basis. the excess amount decreases the debt basis. 5. Fringe benefits 65 Regulation Notes By Tomato . even when the shareholder actively works for the S corporation.

Shareholder. Operating distributions 1. it gets a tax deduction for qualifying fringe benefits. and included in the shareholder-employees’ gross income in Form W-2. the S corporation receives C corporation tax treatment. S corporation with no C corporation accumulated earnings and profits The rules are very similar to those applicable to partners. That is. and they create capital gains if they > stock basis.Ordinary losses . recognize capital gain=distribution. The beginning year of AA balance + Separately stated income/gain items (excluding tax-exempt income) + Ordinary income . but distributions cannot cause the AAA to go negative or become more negative.tax basis. 2. these benefits are deductible as compensation by the S corporation. the S corporation receives partnership tax treatment. shareholder distributions are tax-free to the extent of the stock basis (determined after increasing the stock basis for income allocations for the year). If a distribution > tax basis.Separately stated losses and deductions . S corporation distributions are deemed to be paid from the following sources in the order listed: 1.1. if the adjustment on AAA is due to distribution. which represents the cumulative income or losses for the period the corporation has been an S corporation. then maximum decrease AAA to 0. That is. That is.employees who own 2% or less of the entity.Nondeductible expenses that are not capital expenditures (except deductions related to taxexempt income) . The AAA account (to the extent it has a positive balance) Distribution from AAA is nontaxable to the extent of the stock basis. 66 Regulation Notes By Tomato . S corporation with C corporation accumulated earnings and profits The S corporation is required to maintain an accumulated adjustments accounts (AAA).Distributions out of AAA = End of year AAA balance AAA may have negative balance. Shareholder. Existing accumulated earnings and profits from years when the corporation is C. and the benefits are nontaxable to all employees.employees who own more than 2% of the entity. 2. 2. That is.

1. If FMV < tax basis. 3.built-in gain tax recognition period. Property distributions S corporation: if appreciated property. 3. If taxable income limits the net recognized built-in gain for any year. (2) The net unrealized built-in gains – net recognized built-in gains previous years (3) Taxable income for the year using the C corporation tax rules exclusive of the DRD and NOL deduction. Tax basis in property= FMV S corporation tax Although S corporations are flow-through entities generally not subject to tax. Increase the stock basis by the share of recognized gain by S corporation. Built-in gain tax (taxed at 35%) It only applies to S corporation that (1) has a net unrealized built-in gain at the time it converts from a C corporation and (2) subsequently recognize net built-in gains during its first 10 years operating as an S corporation (first 7 years for assets sales in 2009 and 2010). Shareholders: 1. no loss is recognized. the excess is treated as a recognized built-in gain the next tax year.Distribution from this source is taxable as dividend to shareholders. recognized gain= FMV-tax basis. Excess net passive income tax (35%) 67 Regulation Notes By Tomato . three potential taxes apply to S corporations that previously operated as C corporations. and they create capital gains if they > stock basis. Distribution= FMV – debt assumed. Net unrealized built-in gain= FMV of all assets – tax basis of all assets on the conversion date Recognized built-in gains for an S corporation year include: (1) The gain for any asset sold during the year (limited to the assets at the conversion date) (2) Any income received during the current year attributable to pre-S corporation years Recognized built-in losses for an S corporation year include: (3) The loss for any asset sold during the year (limited to the assets at the conversion date) (4) Any deduction during the current year attributable to pre-S corporation years The net recognized built-in gains for any year are limited to the least of: (1) The recognized built-in gain – losses-NOL or capital loss carryovers from C corporation eyars. 2. 2. The shareholders’ stock basis Distribution from this source is nontaxable to the extent of the stock basis.

the applicable depreciation method. The amount =inventory basis computed using the FIFO method – inventory basis computed using the LIFO method at the end of the corporation’s last tax year as a C corporation. LIFO recapture tax (taxed at C corporation’s marginal tax rate) C corporations that elect S corporation status and use the LIFO inventory method are subject to the LIFO recapture tax. and the applicable depreciation convention (the amount of depreciation deductible in the year of acquisition and the year of disposition). Excess net passive income tax is limited to taxable income computed as if the corporation were a C corporation. 3. the business need only know the asset’s original cost. Depreciation Businesses calculate their tax depreciation using the Modified Accelerated Cost Recovery System (MACRS). 68 Regulation Notes By Tomato . The final three annual installments are due each year on or before the due date of the S corporation’s tax return. Net passive investment income=passive investment income – any expenses connected with producing that income. The corporation pays the LIFO recapture tax in four annual installments. Gross receipts are the total amount of revenues including passive investment income and capital gains and losses. Estimated tax S corporations with a federal income tax liability of 500 or more due to the built-in gains tax or excess net passive income tax must estimate their tax liability for the year and pay it in four quarterly estimated installments. the asset’s recovery period. an S corporation is not required to make estimated tax payments for the LIFO recapture tax. To compute MACRS depreciation for an asset. The first installment is due on or before the due date (not including extensions) of the corporation’s last C corporation tax return.It only applies to the S corporation which has accumulated earnings and profits from a prior C corporation year. However. The C corporation must include the LIFO recapture amount in its gross income in the last year it operates as a C corporation. increase the adjusted basis in inventory. At the same time.

and equipment. recovery. and continues to take twice the straight-line percentage on the asset’s declining basis until switching to the straight-line method in the year that the straight-line method over the remaining life provides a greater depreciation expense. Note: Under MACRS. Depreciation method MACRS provides three acceptable methods for depreciating personal property: 200% declining balance. Personal property and personal-use property are not the same thing. furniture. Depreciation conventions For personal property. Business elects the depreciation method for the assets placed in service during that year. taxpayers must use either the half-year convention or the mid-quarter convention. The 200% declining balance method is the default method. and convention vary based on whether the asset is personal property or real property. Personal property denotes any property that is not real property while personal-use property is any property used for personal purposes.The method. If a business acquires several different machines during the year. Personal property depreciation Personal property includes all tangible property. salvage value is completely ignored for purposes of computing depreciation. 7 year: office furniture and fixtures. 10 years 150% declining method 15 years: telephone distribution plants. This method takes twice the straight-line amount of depreciation in the first year. other than real property (building and land). railroad track. 20 years: sewer pipes. Depreciation recovery period For tax purposes. 150% declining balance and straight-line. 69 Regulation Notes By Tomato . period. duplicating equipment. equipment and property. the fact that the assets are used does not change its MACRS recovery period. machinery. such as computers. 200% declining method 3 year recovery period: 5 year recovery period: automobiles/light trucks/computers/typewriters/copiers. When firms purchase used assets. it must use the same method to depreciate all of the machines. recovery period is predetermined by the IRS and based on the category of the assets. automobiles.

Business must use the mid-quarter convention when more than 40% of their total tangible personal property that they place in service during the year is placed in service during the fourth quarter. Step 2: sum the total basis of the tangible personal property that was placed in service in the fourth quarter. tax depreciation is calculated using the depreciation percentage table provided IRS. The depreciation expense for a particular asset is the product of the percentage from the table and the asset’s original basis. Step 1: sum the total basis of the tangible personal property that was placed in service during the year. the business uses the half-year convention for depreciating all property. Step 3: divide the outcome of step2 by the outcome of step1. Step2: multiply the full year deprecation (outcome from step1) by the applicable percentage provided by IRS. The percentage is determined by the quarter of which the asset is actually sold. recovery period. Otherwise. Half-year convention for year of disposition Step1: calculate depreciation for the entire year as if the property had not been disposed of. That is.Half-year convention It allows one-half of a full year’s depreciation in the year the asset is placed in service. the product of the percentage from the table and the asset’s original basis. That is. If the quotient is greater than 40%. Mid-quarter convention Business treats assets as though they were placed in service during the middle of the quarter in which the business actually placed the assets into service. it is not allowed to claim any depreciation on the asset. Mid-quarter convention for year of disposition Step1: calculate depreciation for the entire year as if the property had not been disposed of. and convention for personal property. regardless of when it was actually placed in service. 70 Regulation Notes By Tomato . Note: if a business acquires and disposes of an asset in the same year. Calculate depreciation for personal property Once a business has identified the applicable method. the product of the percentage from the table and the asset’s original basis. the business must use the mid-quarter convention to determine the depreciation for all personal property the business places in service during the year. Step2: multiply the full year deprecation (outcome from step1) by 50%.

000) Phase-out of maximum 179 expense 120.000 Phase-out of maximum 179 expense 120. taxpayers can elect to immediately expense 50% of qualified property.000 MACRS depreciation rate for 7-year machinery 14.Immediate expense (179 expense) It is designed to help small businesses purchasing new or used tangible personal property.000 71 Regulation Notes By Tomato . it carries the excess forward and deducts in a subsequent year. the property must be acquired by purchase from an unrelated party for use in the taxpayer’s active trade or business. Qualified property must have a recovery period of 20 years or less (no real property).000 in 2008). Eg. They may also elect to deduct less than the maximum.000 179 expense 80.29% MACRS depreciation expense 25. Property placed in service in 2009 920. Qualified property 285.000 Bonus depreciation To stimulate the economy. Requirement: to qualify. The bonus depreciation is calculated after the 179 expense but before MACRS depreciation. Under the phase-out limitation.000 maximum available expense dollar for dollar for the amount of tangible personal property purchased and placed in service during 2009 over an 800. To reflect his immediate depreciation expense.000 threshold. Machinery 260.000 Maximum 179 expense before phase-out 250. Deductible 179 expense is limited to the business’s net income after deducting all expenses except the 179 expense. businesses must reduce the 250.722 Limits on immediate expensing 1.000 Remaining basis in machinery 180. Under 179. In 2008 and 2009. 2. the property must be new rather than used and the property must be placed in service during 2008 and 2009. If a business claims more 179 expense than it is allowed to deduct due to the taxable income limitation.722 Total depreciation 105. policy makers occasionally implement bonus depreciation.000 Maximum 179 expense after phase out 130. businesses may elect to immediately expenses up to 250.000 Threshold for 179 phase-out (800. they must reduce the basis of the asset or assets to which they applied the expense before they compute the MACRS depreciation expense on the remaining bases of these assets.000 of tangible personal property placed in service during 2009 (also 250.

179 expense 250,000 Remaining amount eligible for bonus depreciation 35,000 Bonus depreciation rate 50% Bonus depreciation 17,500 Real property Real property is classified as land, residential rental property, or nonresidential property. Land is nondepreciable. Residential rental property consists of dwelling units such as houses, condominiums, and apartment complexes. Nonresidential property consists of all other buildings (office buildings, manufacturing facilities, shopping malls, and the like). If a building is substantially improved at some point after the initial purchase, the building addition is treated as a new asset with the same recovery period of the original building. Recovery period: Residential rental property 27.5years Nonresidential property placed in service after Dec 31, 1986 and before May 13, 1993 31.5years Nonresidential property placed in service on or after May 13, 1993 39years

Applicable method: straight line method Applicable convention: mid-month convention. It allows the owner of real property to expense one half of a month’s depreciation for the month in which the property was placed in service regardless of whether the asset was placed in service at the beginning or at the end of the month. Full depreciation is for the months following the purchase month. IRS also provides depreciation tables for real property. Mid-month depreciation for year of disposition= Full year’s depreciation * (month in which asset is disposed of -0.5)/12 If it is sold in March Amortization Section 197 intangibles 1. It occurs when a business purchases the assets of another business for a single purchase price. These intangible assets have a recovery period of 180 months regardless of their actual life. 72 Regulation Notes By Tomato

2. Full-month convention applies to both the purchase month and in the month of sale or disposition. 3. If, at the time of sale or disposal, the business does not hold any other 197 assets that the business acquired in the same initial transaction as the asset being sold or disposed of, the business may recognize a loss on the sale or disposition. Otherwise, the taxpayer may not deduct the loss on the sale or disposition until the business sells or disposes of all of the other 197 intangibles that it purchased in the same initial transaction. The same loss disallowance rule applies if a 197 asset expires before it is fully amortized. In either case, the loss is allocated to the remaining 197 assets that were initially acquired in the same transaction pro rata, based on the relative adjusted bases of the remaining 197 assets. The new basis allocated to each remaining 197 assets is amortized over the remaining years of the initial 15-year recovery period. That is, new basis = remaining basis + allocated loss. Organizational expenditures and start-up costs (see the partnership section) Research and development expenses 1. For capitalized R&D, amortize them using the straight-line method over a period of not less than 60 months, beginning in the month benefits are first derived from the research. 2. Firms must stop amortizing the R&D costs if and when the firms receive a patent relating to the costs. Instead, firms add any remaining basis in the costs to the basis of the patent and it amortizes the basis of the patent over the patents’ life. Patents and copyrights 1. For purchased patents and copyrights (not in an asset acquisition to which 197 applies), amortize the cost over the remaining life. 2. For self-created patents and copyrights, amortize the cost over the legal lives – up to a maximum of 17 years for patents and 28 years for copyrights. The cost includes legal costs, fees, and unamortized R&D expenses related. Depletion Business computes annual depletion expense under both the cost and percentage depletion method and they deduct the larger of the two. Cost depletion Because the cost depletion method of depreciation requires business to estimate the number of units of the resource they will actually extract, it is possible that their estimate will prove to be inaccurate. 1. If they underestimate the number of units, they will fully deplete the cost basis of the resource before they have fully extracted the resource. Once they have recovered the entire cost basis of the resource, businesses are not allowed to use cot depletion to determine depletion expense. However, they may continue to use percentage depletion. 73 Regulation Notes By Tomato

2. If a business overestimates the number of units to be extracted, it will still have basis remaining after the resources has been fully extracted. In this case, the business would deduct the unrecovered basis once it had sold all the remaining units. Percentage depletion It is determined by multiplying the gross income from the resource extraction activity by a fixed percentage based on the type of natural resource prepared by IRS. Businesses deduct percentage depletion when they sell the natural resource and they deduct cost depletion in the year they produce or extract the natural resource. Also percentage depletion cannot exceed 50% of the net income from the natural resource business activity before the depletion expense, while cost depletion has so such limitation.

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Regulation Notes By Tomato

FICA taxes FICA (Federal Insurance Contributions Act) tax consists of a Social Security and a Medicare component that are payable by both employees and employers. The Social Security tax (12.4%) is intended to provide basic pension coverage for the retired and disabled. The Medicare tax (2.9%) helps pay medical costs for qualifying individuals. FICA tax is equally shared by employees and employers. However, selfemployed taxpayers must pay the entire FICA tax burden on their self-employment earnings. FICA taxes on employees’ salary, wages, and other compensation provided to them by their employers. The wage base on which employees pay Social Security taxes is limited to an annually determined amount (106,800 in 2009). However, there is no wage base limit for the Medicare tax. Self-employment taxes 1. Compute the amount of the taxpayer’s net income from self-employment activities. 2. Multiply the amount from step 1 by 92.35 (one-half of self-employment tax is deductible). The product is called net earnings from self-employment. 3. If the taxpayers’ net earnings from self-employment are less than 400, the taxpayer is not required to pay any self-employment tax. If the taxpayers’ net earnings from self-employment are less than 106,800, then multiply the amount from step by 15.3 percent. If the taxpayers’ net earnings from self-employment are less than 400 is more than 106,800, calculate Social Security tax and Medicare tax separately. Self-employment taxes (if taxpayer receives both employee compensation & self-employment earnings) 1. Determined the limit on the Social Security portion of the self-employment tax base by subtracting the employee compensation from the Social Security wage base (106,800 in 2009). (not <0) 2. Determine the net earnings from self-employment (self-employment * 92.35%) 3. Multiply the lesser of step 1 and step by 12.4%. This is the amount of Social Security taxes due on the self-employment income. 4. Multiply step 2 by 2.9%. This is the amount of Medicare taxes due on the self-employment income. 5. Add the amounts from step 3 and 4 to calculate the self-employment taxes.

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Regulation Notes By Tomato

including educational institutions). and the employer’s vesting schedule. and 457 plans (used by government agencies). A taxpayer vests as she meets certain requirement set forth by the employer. Whenever possible. Defined contribution plans (1) Employers maintain separate accounts for each employee participating in a defined contribution plan. the maximum annual benefit an employee can receive is the lesser of (1) 100 percent of the average of the employee’s three highest years of compensation or (2) 195. The formula is a function of years of service and employees’ compensation levels as they near retirement. When an employee works for an employer for only a short time before leaving. (4) Employees are free to choose how amounts in their retirement accounts are invested. 76 Regulation Notes By Tomato . To ensure that employers are able to meet their defined benefit plan obligations. employers are required to contribute enough to the plan to fund their expected future liabilities under the plan. many employers have begun replacing defined benefit plans with defined contribution plans. For employees who retire in 2009. employers deduct actual contributions to the plan for a given year as long as they make the contributions by the extended tax return due date for that year. relative to defined benefit plans. (2) Specify the up-front contributions the employer will make to the employee’s separate account rather than specifying the ultimate benefit the employee will receive from the plan. 2. 403(b) plans (used by nonprofit organizations. (3) Employees are frequently allowed to contribute their own defined contribution plan. the number of full years she worked. With a graded vesting schedule. Employers may provide different types of defined contribution plans such as 401(k) (used by forprofit companies). Many employees also match employee contributions to these plans. For tax purposes. Defined benefit plans: provides standard retirement benefits to employees based on a fixed formula. employees should contribute enough to receive the full match from the employer.000. benefits vest all at once. Vesting is the process of becoming legally entitled to a certain right or property. the employee’s vested benefit increases each year she works for the employer. In recent years.4. Thus. her benefit depends on her salary. Under the cliff vesting option. after a certain period of time. and others. defined contribution plans shift the funding responsibility and investment risk from the employer to the employee. Employer matching Employees contribute to 401k type plans. Retirement (B13-12) Qualified retirement plan can be classified as: 1.

The amount of the minimum required distribution for a particular year is the taxpayer’s account balance at the end of the year prior to the year to which the distribution pertains multiplied by a percentage from an IRS Uniform Lifetime Table. employer contributions to an employee’s 401k account must go the employee’s traditional 401k account 77 Regulation Notes By Tomato . employees may elect to contribute to the Roth 401k instead of or in addition to contributing to a traditional 401k plan.5 years of age or (2) 55 years of age and have separated from service are subject to a 10% nondeductible penalty on the amount of the early distributions. the distributions are taxed as ordinary income. when employees receive distributions from defined contribution plans either too early or too late. However.000 for employees who are at least 50 years of age by the end of the year) Vesting When employees contribute to defined contribution plans. When employers provide Roth 401K plans.000 (54. However. Employee contribution to the 401k plan is limited to 16. For defined Distributions When employees receive distributions from defined contribution plans. The percentage is based on the taxpayer’s age at the end of year to which the distribution pertains. the sum of employer and employee contributions to an employee’s defined contribution account is limited to the lesser of: (1) 49.Contribution limits For 2009. they are fully vest in the accrued benefit from their own contributions (employee contributions + earnings on the contributions).5 years of age or (2) the year after the year in which employee retires. Taxpayers incur a 50% nondeductible penalty on the amount of a minimum distribution the employee should have received but did not. Taxpayers must receive their first minimum distribution from the account by April 1 of the later of (1) the year after the year in which taxpayer reaches 70.500 for employees who are at least 50 years of age by the end of the year) (2) 100 percent of the employee’s compensation for the year. employees vest in the accrued benefit from employer contributions (employer contributions + earnings on the contributions) based on the employer’s vesting schedule.500 (or 22. Employees who receive distributions before they reach (1) 59. However. Roth 401(K) plans Employers that provide traditional 401k plans to employees may also provide Roth 401K plans. they must pay a penalty in addition to the ordinary income taxes they owe on the distributions.

The differences between employer-sponsored 401k plans and self-managed IRAs 1. In contrast to contributions to traditional 401k plans. Taxpayers who meet certain eligibility requirements can contribute to traditional IRAs. Nonqualified deferred compensation plan It permits employees to defer or contribute current salary in exchange for a future payment form the employer. to Roth IRAs. When a taxpayer receives a nonqualified distribution from a Roth 401k account. Nonqualified distributions of the taxpayers’ account contributions are not subject to tax.rather than the employee’s Roth 401K plans. employee contributions to Roth 401K plans are not tax deductible. All other distributions are nonqualified distributions. tips and other employee compensation plus the amount of the taxpayer’s net earnings from self-employment.5 years of age. If less than the entire balance in the plan is distributed. the nontaxable portion of the distribution is determined by multiplying the amount of the distribution by the ratio of account contributions to the total account balance. tax laws restrict who can make deductible contributions to traditional IRAs. The government provides IRAs primarily to help taxpayers who are not able to participate in employer-sponsored retirement plans and to help taxpayers with relatively low levels of income to save for retirement. the balance in an employee’s Roth 401K account must consist of only the employee’s contributions and the earnings on those contributions. Nonqualified distributions of the account earnings are fully taxable and are subject to the 10% earnings distribution penalty. Qualified distributions from Roth 401k accounts are those made after the employee’s account has been open for five taxable years and the employee is at least 59. The tax consequence is same as qualified defined contribution plans. In most respects. In this case. the tax consequences of the distribution depends on the extent to which the distribution is from the account earnings and the extent to which it is from the employee’s contributions to the account. Thus. qualified distributions from Roth 401K plans are excluded from gross income. the tax characteristics of traditional 401k plans mirror those of traditional IRAs and tax characteristics of Roth 401k plans mirror those of Roth IRA accounts. Individual retirement accounts (IRA) IRA is the most common of the individually managed retirement plans.000 if age 50 or older) or the amount of earned income if it is less. Earned income generally includes income actually earned through the taxpayer’s efforts such as wages. salaries. The limit for deductible IRA contributions is 5. However. or to both.000 in 2009 (6. 78 Regulation Notes By Tomato . there is no phase-out of IRA deductions. Alimony income is also considered as earned income for this purpose. taxpayers must (1) Not be a participant in an employer-sponsored retirement plan. To be able to deduct contributions to traditional IRAs.

On distribution. Roth IRAs are subject to the same annual contribution limits as traditional IRAs. All other distributions are nonqualified distributions. (3) attributable to the taxpayer being disabled or (4) used to pay qualified acquisition costs for first-time homebuyers (limited to 10. (2) made to a beneficiary (or to the estate of the taxpayer) on or after the death of the taxpayer.000 if age 50 or older).000 and below can make fully deductible contributions to an IRA account.000 and 176. the taxpayer is taxed on the earnings generated by the nondeductible contributions but not on the deductible contributions.000 and 65. Note2: Special rule: a taxpayer whose AGI is not above the applicable phase-out range can make a 200 deductible contribution regardless of the proportional phase-out rule.000 deductible each spouse for married couple.000 overall deduction limitation (6. The maximum deductible IRA contribution for an individual who is not an active participant.000) .000 deduction limitation is phased-out proportionally for single taxpayers with AGI between 55. This 200 minimum applies separately to taxpayer and his spouse. Note2: The earnings on contributions grow tax-free until the taxpayer receives distributions from the IRA. b. 79 Regulation Notes By Tomato . The phase-out amount is also calculated separately for each spouse. Contributions to Roth IRAs are not deductible and qualifying distributions from Roth IRAs are not taxable. unmarried taxpayers with an AGI of 55. Note1: total IRA contributions (whether deductible or not) are subject to the 5. c.(2) Taxpayers who do participate in an employer-sponsored retirement plan or keogh plan can still make deductible contributions to traditional IRAs subject to certain AGI restrictions. will be proportionately phased out at a combined AGI between 166.000 or 100% of compensation limit. subject to the 5. Up to 5. An individual will not be considered an active participant in an employer plan merely because his spouse is an active participant for any part of the plan year. but whose spouse is. taxpayers meeting certain requirements can contribute to Roth IRAs. The 5. For 2009.000. a. The early or late distribution requirement and penalty for traditional 401 apply to IRA.5 years of age.000 and for married taxpayers filing jointly with AGI between 89000 and 109000. A qualifying distribution is a distribution from funds or earnings from funds in a Roth IRA if distribution is at least five years after the taxpayer has opened the Roth IRA and the distribution is (1) made on or after the date the taxpayer reaches 59. Roth IRAs An alternative to deductible IRAs.000 and below and married taxpayers filing jointly with AGI of 89.

000 or (2) 25% net earnings from self-employment 6. 2. but before the Keogh deduction. 1. If a sole proprietor has hired employees. For 2009. the entire amount taken out of the traditional IRA is taxed at ordinary rates but is not subject to the 10% penalty tax as long as the taxpayer contributes the full amount to a Roth IRA within 60 days of the withdrawal from the traditional IRA. When taxpayers do this. The owner of a sole proprietorship can make annual contributions directly to her SEP IRA. Thus. Maximum annual deductible amount The lesser of (1) 49.The tax laws allow taxpayers to transfer funds from a traditional IRA to a Roth IRA. however. and occurs within 60 days of the IERA distribution.Keogh deductions. the annual contribution is limited to the lesser of (1) 49. Maximum annual contribution is subject to reduction if the AGI exceeds certain thresholds. The contribution must be made by the due date of the taxpayer’s tax return (not including the extension) Self-employed retirement accounts Congress created a number of retirement saving plans targeted toward self-employed taxpayers. A self-employed individual may contribute to a qualified retirement plan called a Keogh plan.5 3. Net earnings from self-employment = net earnings from self-employment . Two of the more popular plans for the self-employed are SEP IRAs and individual (or solo) 401k plans. These are defined contribution plans that generally work the same as employer-provided plans (same tax treatment). Maximum annual contribution The lesser of (1) 49. Contributions can be made even after the taxpayer reaches age 70. the sole proprietor must contribute to their respective SEP IRAs based on their compensation. 4.000.000 or (2) 20% of the sole proprietor’s net earnings from self-employment. This rollover can occur if the AGI < =100. Individual 401k 80 Regulation Notes By Tomato . Simplified employee pension (SEP) IRA A Simplified employee pension (SEP) can be administered through IRA called a SEP IRA.One-half self-employment tax . This transfer of funds is called a rollover.000 or (2) 100% net earnings from self-employment 5. 25% net earnings from self-employment = 20% of self-employment income before after one-half of the self-employment tax.

81 Regulation Notes By Tomato .Individual 401k plans are strictly for sole proprietors (and the spouse of the sole proprietor) who do not have employees. she may contribute an additional 5. The sole proprietor can contribute the lesser of (1) (1) 49.000 or (2) 20% of the sole proprietor’s net earnings from self-employment+16.500. If the sole proprietor is over 50 years old at end of the tax year.500.

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