8 TAX RETURN PREPARER ISSUES

1. Treasury department circular 230

1) Information to be furnished

2) Assistance from or to disbarred or suspended persons and former IRS employees

3) Fees: never charge an unconscionable fee
A practitioner may only charge a contingent fee in the following situations:
(1) IRS tax audit or examination
(2) Claim solely for a refund of interest and/or penalties, or
(3) A judicial proceeding arising under IRC

4) Conflict of interest

5) Advertising and fee information

6) Best practices for tax advisors

7) Reasonably likely penalties

8) Practitioner's reliance upon client-furnished information

9) Knowledge of omission by a client

10) Diligence as to accuracy

11) Return of client records

12) Tax shelter and reportable transactions
(1) Listed transactions
(2) Confidential transactions
(3) Transactions with contractual protection
(4) Loss transactions
(5) Transactions of interest

13) Requirements for written advice

14) Reliance on the advice of others

15) Compliance with circular 230

16) Sanctions for violation of the regulations

2. IRC Penalty Imposed on Tax Return Preparer

The internal revenue code penalty provisions apply to all federal tax return preparation and not to the preparation of other tax returns (such as payroll, estate, gift).

1) Understatement of taxpayer's liability due to an unreasonable position by the tax return preparer (IRC Sec. 6694 a)

2) Understatement of taxpayer's liability due to willful or reckless conduct of the tax return preparer (IRC Sec. 6694 b)

3) Failure to sign tax return or refund claim (IRC Sec. 6695)

4) Failure to furnish (indicate on return or claim) the tax identification number of the tax return preparer (IRC Sec. 6695)

5) Failure to provide a completed copy of tax return (IRC Sec. 6695, 6701)

6) Failure to properly retain records: 3 years (IRC Sec. 6695, 6107, 6060)

7) Failure to file correct information returns (IRC Sec. 6695, 6060)

8) Negotiation of IRS refund check (IRC Sec. 6695)

9) Failure to be diligent in determining a client's eligibility for the earned income credit, child tax credit, American opportunity credit  (IRC Sec. 6695-2b)

10) Aiding and abetting the understatement of tax liability (IRC Sec. 6702, 6703 a)

11) Wrongful disclosure and/or use of taxpayer's information  (IRC Sec. 6713, 7216)

7.3 Federal Estate Tax

1. Form 706: Estate Tax Return

Gross Estate
 - Deductions
= Taxable Estate
 + (Adjusted) Taxable Gifts
= Tentative Tax Base
 x Uniform Tax Rates
= Tentative Estate Tax
 - Gift Taxes paid
= Gross Estate Tax
 - Unified Tax Credit
= Net Estate Tax Due

2. Gross Estate

1) Alternate valuation date: 6 months after the date of death

2) Jointly-held property
(a) Spouse joint tenancy - split 50/50
(b) Other joint tenancy - 100% less other owner's contribution
(c) Tenancy in common - decedent's interest %

3) Life insurance proceeds

4) Revocable transfers (i.e., revocable trusts)

5) Income in respect of a decedent

3. Deductions

1) Administrative expenses: Form 706 or 1041

2) Medical Expenses: Form 706 or 1040

4. Deceased Spouse's Unused Unified Credit

5. Generation-Skipping Transfer Tax

7.2 Federal Gift Tax

1. Form 709: Gift Tax Return

Gross Gifts
 - Deductions
= Taxable Gift for the Current Year
 + Taxable Gift for the Prior Year
= Total Taxable Gift
 x Uniform Tax Rates
= Tax on Total Taxable Gift
 - Taxes Previously Paid
 - Unified Tax Credit
= Net Gift Tax Due

2. Gross Gifts

1) FMV at date of the gift
2) Joint ownership (extent the contribution exceeds the retained interest)
3) Joint bank account (when the noncontributing tenant withdraws funds)

3. Exclusion and Deduction

1) Annual exclusion
The first $15,000 per donee per year (2019, 2020)

2) Gift Splitting
One half of a gift is considered to be given by each spouse if spouse elect gift splitting.

3) Tuition and medical expenses paid on behalf of the donee (paid directly)

4) Charitable gift

5) Marital deduction

4. Complete vs. Incomplete Gifts

1) Complete vs. Incomplete Gifts
(2) Incomplete gift
a) Conditional gift
b) Revocable gift

2) Present interest vs. Future interest gift
(1) Present interest gift: qualified for the annual exclusion
(2) Future interest gift: NOT qualified

7.1 Unified Transfer Tax System

1. Unified Transfer Tax System

Lifetime taxable gifts and death time transfers are taxed on a cumulative basis.

2. Unified Transfer Tax Credit

Exclusion $11,400,000 - Unified Credit $4,505,800 (2019)

6 Trust and Estate

1. Income Taxation Rules for Estates and Trust

No double taxation of income earned by an estate or trust (i.e. fiduciary income) occurs.

2. Form 1041: Income Tax Return of Estate and Trusts

1) Filing requirement and the due date
GI: more than $600
Due: 15th day of the fourth month

2) Taxable year
Trust: calendar year
Estates: calendar year or fiscal year

3) Estimated tax payment
Generally the same as individuals
Estates are exempted for 2 years

4) Gross Income
Generally the same as individuals

5) Deductions
(1) Deductions for expenses
- Trustee fees
- Executor's fees
- Interest
- Taxes
- Investment advice fees
- Tax return preparation fees
- Expenses to produce income
- Business expenses to carry on a trade or business

(2) Charitable Contribution: unlimited

(3) Personal exemption
- Simple trust: $300
- Complex trust: $100
- Estate $600

(4) Income distribution deduction
Lesser of (a) actual distribution to beneficiaries or (b) Distributable Net Income (DNI)

(5) Distributable Net Income (DNI)
Estate / Trust Gross Income
 - Estate / Trust Deductions
= Adjusted Total Income
 + Adjusted Tax-Exempt Interest
 - Capital Gains
=Distributable Net Income (DNI)

(6) Tax rate schedule (progressive tax rate)

(7) tax credit

5 Exempt Organizations

1. Exempt Organizations

1) Sec. 501 (c) (3) Organization
(1) Organization test: the articles of organization must limit to sec. 501 (c) (3)
- Religious
- Charitable
- Scientific
- Literary
- Educational
- Testing for public safety
(2) Operational test
No part of the net earnings may inure to the benefit of any private shareholders or individual.
No substantial part of the activities may be non-exempt activities (e.g., influence legislation).
The organizations may not directly participate or intervene in any political campaign.

* To obtain exempt status, the organization must apply and approved by the IRS
* Tax-exempt organizations may be in the form of a corporation, trust, fund, foundation.

2) Public charity vs. private foundation
(1) Public charity
The following four distinct categories are NOT private foundation:
a) Maximum (50% type) charitable deduction donees
b) Broadly publicly-supported organizations receiving more than 1/3 of their annual support form members and the public and less than 1/3 from investment income and unrelated business income.
c) Public safety testing organizations
(2) Private foundation

3) Filing requirement
An annual information return, Form 990/990-EZ (or 990 PF) by May 15

2. Unrelated Business Income

UBI in excess of $1,000 is subject to tax

UBI is:
a) Derived from an activity that constitutes a trade or business,
b) Regularly carried on, and
c) Not substantially related to the organization's tax-exempt purposes.

Exceptions to UBI tax
(1) Any activity where all of the work is performed by unpaid workers (volunteers).
(2) The sale or exchange of property not held primarily for sale to customers in the ordinary course of trade or business.
(3) The business carried on for the convenience of students, patients, members of 501 (c) (3) organizations.
(4) Income from the research of a college or hospital.
(5) Dividends, interest, and royalties (except income from debt-financed investments)
(6) Activity limited to exempt organizations by state law (e.g., bingo)
(7) Rents from real property, rents from personal property leased with real property (if less than 50% is attributable to the personal property), other than income from debt-financed property.

4.9 S Corporation and LLC

1. Eligibility Requirements

1) Domestic corporation
2) Only one class of stock
3) Shareholders must individual, estate and qualified trust can be shareholders
4) No nonresident alien individual shareholders
5) 100 shareholders or less (family members are counted as one)

2. Election of S Corporation Status

All shareholders (voting and nonvoting) must consent to a valid election.
If the election is made at any time on or before the 15th day of the third month (March 15) of the election year, the election is effective on the first day of the tax year.

3. Effect of S Corporation Election on Corporation

1) No tax on S corporation
However, S corporation is subject to special taxes: the built-in gain tax, excessive passive investment income tax, and LIFO recapture tax.

2) A taxable year and the due date
S corporations file Form 1120S and must adopt the calendar year unless a valid business purpose for a different taxable year(fiscal year) is established.
The return is due by the 15th day of the third month (March 15) after the close of the tax year.

3) Pass-thru & Form 1120S
S corporations report both separately and non-separately stated items of income and/or loss. (see 3.3 Partnership Information Return)

(1) Fringe benefits
a) Deductible fringe benefits: employee owning 2% or less of the share
b) Non-deductible fringe benefits: for a more than 2% employee shareholder

(2) Mid-year change of ownership
Allocations to shareholders are per day, per-share basis

4. Effect of S Corporation Election on Shareholders

1) Loss limitation
At-risk: adjusted basis in stock + direct loans to the corporation

2) Shareholder's basis of stock
Original basis
+ Additional investment
+ All income
- All loss
- Distributions received
= Shareholder's adjusted basis

5. Taxability of Distributions to Shareholders

1) With NO C corporation earnings and profits
(a) Return of capital - nontaxable and reduces shareholder's stock basis
(b) Capital gain - taxable to extent distribution exceeds stock basis

2) With C corporation earnings and profits
(a) AAA (accumulated adjustment account) - nontaxable and reduces shareholder's stock basis
(b) AEP - taxable as a dividend and does NOT reduce shareholder's stock basis
(c) Return of capital - nontaxable and reduces shareholder's stock basis
(d) Capital gain - taxable to extent distribution exceeds stock basis

6. Termination of S Corporation

1) When S corporation status terminates
(1) The corporation fails to meet any eligibility requirements for S corporation status
(2) Greater than 50% of the shareholder consent to a revocation
(3) More than 25% of the corporation's gross receipts come from passive investment income for 3 consecutive years and the corporation had C corporation earnings and profits at the end of each year.

2) Re-electing: 5 years

7. Limited Liability Company

A single-member LLC: sole proprietorship
At least two owners: partnership or C corporation (Form 8832 Entity Classification Election)

4.8 Corporate Reorganization

1. Tax-Free Reorganization

A) Statutory mergers and consolidations

B) Stock for stock exchange

C) Stock for asset exchange

D) Corporation divisions

E) Recapitalization

F) Change in identity, form or place of organization

G) Bankruptcy

4.7 Distributions from Corporation

1. Ordinary (Current/Nonliquidating) Distribution

1) Dividends defined
Current earnings and profits, accumulated  earnings and profits

2) Amount of distributions (to the shareholder): FMV

3) Three categories of distributions
(a)  earnings and profits: dividend - taxable
(b) Stock basis: the return of capital - nontaxable (reduces stock basis)
(c) Capital gain distribution - taxable

4) Order of distribution allocation
Current earnings and profits first and then accumulated earnings and profits

5) Matching cash dividends to source
(1) Current earnings and profits are allocated on a pro-rata basis for each distribution.
(2) Accumulated earnings and profits are applied in chronological order

6) Shareholder's Taxable Amount: FMV
* Corporation shareholder: DRD

7) Stock dividends: generally not taxable

8) Constructive dividends
(a) Excessive salary paid to shareholder-employees
(b) Sale of assets below fair market value
(c) Interest-free loans or "loans" to shareholders where no intent to repay

9) Distribution of appreciated property (taxable on the corporation)
The corporation recognizes gain (but not loss) as if the property had been sold for its FMV

2. Stock Redemptions

1) Exchange (sale): capital gain or loss
(2) The redemption is substantially disproportionate or
(3) All of the shareholder's stock is redeemed.

2) Dividend: ordinary income

3. Complete (Liquidating) Distribution

Shareholder: taxable - capital gain/loss

Corporation recognize gain or loss as if the distributed property were sold to the distributee for FMV (taxable event)

4. Liquidation of Subsidiary

No gain/loss is recognized when the parent owns at least 80%

4.6 International Tax Issues

1. The U.S. Taxation of Foreign Transactions

1) Worldwide tax system

2) Territorial tax system (after 2018)
Foreign-source portion of dividends received: 100% DRD (owns 10% or more)

3) Transition tax (one-time deemed repatriation tax)

2. Subpart F Income

Controlled foreign corporation (CFC)
Subpart F income: passive investment income or active income tied to are "related party".
(1) Foreign personal holding company (PHC) income
(2) Foreign base company sales income
(3) Foreign base company service income

3. Global Intangible Low-Taxed Income (GILTI) Tax

4. Foreign-Derived Intangible Income (FDII) Deduction

5. Base Erosion and Anti-abuse Tax (BEAT)

4.5 Consolidated Tax Return

1. Affiliated Group

1) Affiliated group defined

More than 80% of the combined voting power of all outstanding stock AND 80% of the total value of all outstanding stock

2) Controlled group defined

(1) Parent-Subsidiary: 80% of combined voting power OR total value of stock

(2) Brother-Sister

(3) Combined

2. Consolidated Tax Returns

1) Intercompany Dividends

2) Advantage of filing consolidated return

3) Disadvantages of filing consolidated return

3. Transfer Pricing Taxation

4.4 Other Taxes

1. Personal Holding Company Tax

Personal Holding Company (PHC)
(1) Stock ownership: more than 50% owned by 5 or fewer individuals
(2) Gross income: more than 60% of adjusted ordinary gross income as PHC income consisting of dividends, taxable interest, royalties, and net rent.

1) Additional tax assessed
2) PHC tax calculation
Taxable income
- Dividend payments (includes payment within 3.5 months and consent dividend)
= Undistributed income x 20%

3) Consent dividend: not actually distributed, but shareholders include it in gross income

4) Self-assessed tax: Schedule PH

2. Accumulated Earnings Tax (AET)

1) Additional tax assessed
2) Not self-assessed tax
3) AET calculation
Taxable income
- Dividend payments (includes payment within 3.5 months and consent dividend)
- Accumulated earnings credit
= current accumulated taxable income x 20%

(!) Accumulated earnings credit
Greater of (a) $250,000 ($150,000 PSC) or (b) reasonable needs of the business

4.3 Schedule M-1/M-2/M-3

1. Schedule M-1

The reconciliation of the corporation's income per books and its taxable income

1) Income subject to tax - not recorded on books this year
Interest,  rental, and royalty income received in advance

2) Expenses recorded on books - not deducted on this return
(1) Charitable contributions in the excess of 10% of taxable income
(2) 50% of business meals
(3) Estimated liabilities for contingency
(4) Fines and penalties for a violation of a law
(5) Insurance premium on officers' lives where the corporation is the beneficiary
(6) Interest expense incurred to carry tax-exempt municipal and state obligations

3) Income recorded on books - not included on this return
(1) Interest income from municipal or state obligations
(2) Proceeds from life insurance on officers' lives where the corporation is the beneficiary

4) Deductions on this return - not charged against book income
(1) Tax depreciation expense in the excess of books (if any)
(2) Charitable contribution carryover
(3) Sec.179 expense deduction

2. Schedule M-2

"Analysis of Unappropriated Retained Earnings per Book"

3. Schedule M-3

"Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More"

4.2 Corporate Income Tax Return

1. Filing and Payment of Tax

1) Filing requirements: (C corporation) Form 1120 every year

2) Due date and Extension: (C corporation) by 15th day of the fourth month
Automatic six-month extension by filing Form 7004

3) Taxable year: Form 1128 (application to change a tax year)

4) Accrual Basis: for C corporations, partnerships having a C corporation as a partner, or tax shelters

5) Estimated payments of corporate tax: $500 or more and smaller of
(a) 100% of current year's tax (actual or annualized income basis) or
(b) 100% of prior year's tax (if full 12 months and showed tax liability)
*A large corporation must pay 100% of the tax due for the current year

2. Form 1120 Page 1

Gross income - Deductions = Taxable income

3. Gross Income

Gross profit = Gross sales - Cost of goods sold
+ Dividends
+ Interest
+ Gross rent
+ Gross royalties
+ Net capital gains/other gains
+ Other income

1) Prepaid income (include in GI when received)
(1) Interest Income
(2) Rental Income (nonrefundable deposits, cancellation)
(3) Royalty income

2) Tax-exempt income
(1) Interest from municipal or State obligations/bonds
(2) Proceeds from life insurance on officers

4. Deductions

1) Ordinary, necessary, and reasonable expenses

2) Executive compensation

$1,000,000 to CEO, CFO, and three other most-highly officers in a year (publicly held corporation)

3) Bonus accrual

Accrual basis and paid within 2.5 months after the year-end deductible in the taxable year

4) Taxes

Federal income taxes are not deductible.

5) Penalties and illegal activities: not deductible

6) Lobbying and political expenditures: not deductible

7) Interest Expense

30% of EBITDA: Earnings Before Interest Taxes Depreciation and Amortization (carry forward indefinitely)
* Not apply average annual gross receipts are less than $25 million for the prior three years

8) Charitable contributions

10% of taxable income before the dividends received deduction (carry forward for five years)
Accrual basis and paid within 3.5 months after the year-end deductible in the taxable year

9) Depreciation and depletion: the same rules as individuals

10) Organizational expenditure

The first $5,000 to be expensed and the remainder amortized over 180 months (same as individuals)
(1) Include: drafting the corporate charter, bylaws, minutes of organizational meetings, and terms of original stock certificates
(2) Exclude: issuing or selling shares of stock, commissions, underwriter's fees, and the cost incurred in the transfer of assets (syndication cost)

11) Research and development expense

(1) Deducted currently (before 2022)
(2) Amortized over 60 months or more
(3) Capitalized and written off when the project is abandoned

12) Amortization expense

Straight-line basis over a 15-years
Intangibles: goodwill, franchises, licenses, trademark, and covenants not to compete

13) Life insurance premium

(1) The corporation is the beneficiary: not deductible
(2) The insured employee is beneficiary: deductible (employee fringe benefit)

14) Business meals and gifts

Business meals: 50% deductible
Business gifts: $25 per recipient per year

15) Losses

(1) Related party loss: disallowed between more than 50% share

(2) Capital loss
a) Deductible only to the extent of capital gains
b) Carried back 3 years and then carried forward 5 years (as a short-term capital loss)
c) Regular tax rate (add to ordinary income)

(3) Bad debt loss: ordinary loss (direct write-off method, specific charge-off method)

(4) Casualty loss: any loss is deductible (no limitation)

(5) Net operation loss
After 12/31/2017: indefinite carryforward, 80% deduction of taxable income
Before 12/31/2017: 20 years carryforward, 100% deduction of taxable income

16) Dividends received deduction (DRD)

To partially mitigate the effects of triple (multiple) taxations, corporations are allowed DRD.

(1) Entities for which the DRD does not apply
a) Personal service corporations
b) Personal holding companies
c) S corporation

(2) Holding period: more than 45 days

(3) Percentage
a) 100% DRD: received from affiliated (at least 80% owned) corporations
b) 65% DRD: domestic unaffiliated corporations that are at least 20% owned
c) 50% DRD: domestic corporations that are less than 20% owned

<Taxable income limitation>

65%/50% of taxable income before the DRD, NOL, and capital loss carryback
* Exception: if the full 65%/50% DRD creates or increases NOL

5. Corporate Tax Rate

A corporation's taxable income is subject to a flat tax of 21%.
Personal service corporations are also subject to a flat tax of 21%.

6. Tax Credits

1) Foreign tax credit: same as individual

2) General business credit
(1) Combination credit
(2) Limit: not exceed "net income tax" less 25% of regular tax liability above $25,000

4.1 Corporation Formation

1. Shareholder's Tax Consequences

1) General rule
(a) Cash
(b) Service (taxable event)
(c) Property (taxable event)

(!) Sec.351: property (nontaxable event)
No gain or loss is recognized (deferred) by the shareholders if the property is transferred to a corporation solely in exchange for stock and immediately after the exchange those shareholders control the corporation.
(1) Property: everything but services
(2) Control: at least 80% of the total combined voting power and 80% of each class of nonvoting stock
(3) Solely: no receipt of a boot (a receipt of boot will cause recognition of gain) but not loss

2. Shareholder's Basis of Stock

a. Cash - Amount contributed
b. Service - Fair market value (taxable to the shareholder)
c. Property - Adjusted basis (NBV)

1) Property subject to liability (C.O.D.)
(1) Under Sec.351: no gain
(2) The basis is reduced by the amount of liability

2) Excess liability: gain recognized by the shareholder

3) Shareholder's holding period for stock
Include the holding period of property contributed, if that was a capital asset or Sec.1231 assets

3. Corporation Tax Consequences

No gain or loss is recognized in:
a. Formation - issuance of common stock
b. Reacquisition- purchase of treasury stock
c. Resale - sale of treasury stock

4. Corporation's Basis of Property Received

Generally, the same basis as the contributing shareholder's hands (carryover basis)

1) Corporation's holding period for contributed property
Include the period that was held by the shareholders

3.6 Distribution from Partnership

1. Nonliquidating (Current) Distribution

1) General rule: nontaxable

2) Basis of property distributed by the partnership: NBV

3) Reduction in the partner's basis for the partnership interest

4) The assigned basis may not exceed the partner's basis for the partnership interest
(!) Gain recognized by the partner

2. Liquidating (Complete) Distribution

1) Complete withdrawal (liquidation)
(!) Loss recognized by the partner

2) Retirement or death of the partner
(1) Payment for a partnership interest
(2) Other payments: ordinary income

3) Sale of the partnership interest
(1) General rule: capital gain/loss
(2) Hot assets (appreciated inventory or unrealized receivable): ordinary income
(3) Mid-year change of ownership

3.5 Termination of Partnership

1. Termination of Partnership

1) As there are less than two partners
2) As the partnership's business and financial operations are discontinued

3.4 Transaction Between Partner & Controlled Partnership

1. Related Party Loss

1) Related party loss is disallowed (directly or indirectly over 50% of interest)
2) Constructive ownership rule

2. Related Party Gain

1) Ordinary income:
(1) Depreciable asset (2.3 Loss not recognized 2. Related Party Transaction) or
(2) Not capital assets in the hands of the transferee

3.3 Partnership Information Return

1. Pass-thru & Form 1065

1) Separate line items: Schedule K -> K-1
(1) Charitable contributions
(2) Capital/Sec.1231 gain and loss
(3) Net income (loss) from rental activity
(4) Interest and dividend income
(5) Sec179 expense deduction
(6) Investment interest expense
(7) Partner's health insurance premiums
(8) Keogh (retirement) plan contribution for partners
(9) Tax credits
(10) Foreign income tax
* Guaranteed payments to partners
* Ordinary business income/loss

2) Other: Form 1065 Page 1

2. Guaranteed Payments

(1) Partnership: tax deduction
(2) Partner: taxable income - Form 1040 Schedule E (Schedule SE)

1) Payments not guaranteed: distribution
2) Fringe benefits: partnership: tax deduction, partner: taxable income

3. Organizational Expenditures

Organizational expenditure: first $5,000 to be expensed and the remainder is amortized over 180 months

(1) Included costs
The filing fee, accounting fees for establishing the initial accounting system, and legal fees for negotiating and preparing partnership agreements

(2) Excluded costs
Expenditures connected with issuing and marketing of interests in the partnership (e.g. offering materials) (syndication cost)

4. Distributive Share

1) Distributive share: the partnership agreement

2) Special allocation - Sec. 704
Precontribution gain or loss must be allocated to the contributed partner

5. Partners' Tax Reporting

1) K-1 to Form 1040
K-1 line 1: ordinary business income (loss) -> Schedule E (passive or nonpassive)
K-1 line 5&6: Interest and dividends -> Schedule B
K-1 line 8&9: Capital gain (loss) -> Schedule D
K-1 line 13: Other deductions: charitable contribution -> Schedule A

2) Reporting partnership losses: loss limitation
(1) Limited to basis / "At-Risk" basis
(2) Carryforward of losses indefinitely
(3) Passive activity loss limitation (if not materially participate)
(4) Excess business loss limitation: $250,000/$500,000

6. Taxable Year of Partnership

1) Calendar year (Generally required)
2) Fiscal year: maximum three-month deferral

3.2 Partner's Basis of Partnership Interest

1. Original Basis

1) Property subject to liability
The basis is reduced by the resulting decrease in the partner's individual liability.

2) Excess Liability: Gain recognized by the partner
The basis is zero

2. Partnership Operation: Partner Basis Formula

1) Effect of subsequent transactions
(1) Subsequent contribution: increase a partner's basis
(2) Subsequent withdrawal: decrease a partner's basis

2) Effect of partnership income/loss (pass thru)
(1) Distributive share of income/gain: the partner's basis increase by ALL INCOME
(2) Distributive share of loss/Expense: the partner's basis decrease by ALL LOSSES

3) Effect of partnership's liability
(1) Increase in the partnership liability: increases each partner's basis
(2) Decrease in the partnership liability: decreases each partner's basis

3.1 Partnership Formation

1. General Rule

No gain or loss is recognized by the partner

2. Exceptions to Non-recognition of Gain

(1) Capital Interest acquired for services rendered: FMV
(2) Property subject to (excess) liability: NBV

3. Original Basis

1) Partner's basis of the partnership interest (outside basis)
Cash: amount contributed
Service: FMV (taxable)
Property: adjusted basis (NBV)

2) Partnership's basis of contributed property (inside basis)
Partner's adjusted basis (NBV)

4. Holding Period

1) Partner's holding period for the partnership interest
The contributed property was a -
(a) capital asset or Sec. 1231 asset: include the holding period of the property contributed
(b) ordinary income assets: begin on the date the property is contributed

2) Partnership's holding period for contributed property
It includes the period of time the property was held by the partner.

2.4 Section 1231 and Recapture

1. Section 1231 Assets

Sec. 1231 assets are real or depreciable business property held for more than one year.

2. Tax Treatment for Sec. 1231 Assets

1) Sec. 1231 gains
Lower capital gain tax rate (15% for most taxpayers)

2) Sec. 1231 losses
Ordinary loss

3) Netting procedures of Sec. 1231 gains and losses

3. Recapture Provision of Sec. 1245

1) Section 1245 asset
Sec. 1245 assets are generally depreciable personal property.

2) Section 1245 recapture
All accumulated depreciation is recaptured as ordinary income.

4. Recapture Provision of Sec. 1250

1) Section 1250 asset
Section 1250 assets are depreciable real property.

2) Section 1250 recapture

3) Section 291 recapture (for C corporations)

2.3 Loss Not Recognized (Nondeductible)

1. Wash Sales

Within 30 days before or after the sale date

(1) Basis of new security
 = Purchase price of new security + Loss not recognized

(2) Holding period of new security

(3) Gain recognized

2. Related Party Transaction

1) Related parties defined
(a) Husband and wife
(b) Brothers and sisters
(c) Lineal descendants (father, son, grandfather)
(d) Entities that are more than 50% owned
(e) Personal service corporation and any of its owner-employee

2) Related party loss: disallowed
Any gain recognized on related-party sales transactions is ordinary income if the property is a depreciable asset in the hands of the transferee

3) Basis of buying relative: cost basis
However, future gain on the disposition of the property is reduced by the amount of the disallowed loss.

3. Personal Losses (Not Bussiness or Investment)

No deduction is allowed

2.2 Gain Not Recognized (Nontaxable)

1. Like-Kind Exchange

1) "Like-Kind" property defined
Real property held for investment or used for trade or business

2) Boot
(1) Boot: cash, unlike-kind property, C.O.D
(2) Receipt boot
Gain recognized lesser than realized gain or FMV of boot received
* Giving boot: no gain/loss

(3) Basis of property received
= Adjusted basis of the property given up (carryover basis)
 + Gain recognized
 - FMV of boot received
 - Loss recognized
 + Basis of boot given

(4) Holding period of property received

2. Involuntary Conversions

(condemnation, theft, seizure or fire)

1) Replacement property defined: similar or related
2) Time limitation of replacement
Personal use property: two years from year-end
Business property: three years from year-end

3. Homeowner's Exclusion

Sale of Personal Residence ($250,000)

(1) To qualify for the full exclusion: Two years or more during the five-year period

(2) Nonqualified use provision
The exclusion amount is not adjusted, but the portion of the gain attributable to the nonqualified use is not eligible for the exclusion.
Exclusion = period of nonqualified use / total period x gain

(3) Partial (on a prorated basis) exclusion

(4) Multiple-use of exclusion
(5) No age and replacement residence

4. Divorce Property Settlement

5. Installment Sales

2.1 Property Transactions - Realized Gain / Loss

1. Amount Realized

(1) Cash received
(2) FMV property received
(3) FMV Service received
(4) Cancellation of debt (C.O.D)

2. Adjusted Basis of the Property

1) Purchased property: cost basis

<Include>
brokerage commission, sales tax, title transfer tax, a recording fee, legal fee,
appraisal fee, the survey fee, freight, installation & testing, zoning cost,
new roof, new gutters, demolition costs, installation of lifelines
<Exclude>
fire insurance, mortgage insurance, points, refinancing points, real property tax
* Points related acquisition indebtedness: immediately
* Refinancing points: amortized
(1.10 Below The Line Deductions)

2) Gift property: roll-over cost basis (donor's basis)

(1) FMV > donor's basis: donor's basis + gift tax adjustments

(2) FMV < donor's basis: dual basis
a) gain basis: donor's basis
b) loss basis: FMV at the date of the gift
c) middle selling: no gain/loss recognized

(3) Holding period
a) Donor's basis: donor's period
b) FMV: date of the gift

3) Inherited property: Step-up FMV basis

(1) Alternate valuation date (6month after death)
(2) Holding period: long-term

4) Property received as compensation for service: FMV

5) Allocation of basis

(1) Basket purchase: allocated on their FMV

(2) Stock split: allocate the original basis over the total number

(3) Stock dividends
a) Identical: allocated equally to all shares
b) Different: allocated based on the FMV of each

(4) Employee stock option

6) Property converted into business use

Lower of the basis or the FMV

1.13 Tax Procedures

1. Assessments

Three years from later of
(a) original due date of the return or
(b) date of return is filed.

2. Claims for Refund

Later of
(a) three years from the return was filed or
(b) two years from the tax was paid
*Bad debts, worthless securities: seven years

3. IRS Audit and Appeal Process

1) Selection of return for audit
(1) Statistical models (DIF)
(2) Random (manual) selection

2) Types of audits
(1) Direct correspondence audit
(2) Office or field audit (formal examination)

3) Appeals process
(1) Preliminary notice (30-Day Letter) and administrative appeal request
(2) Notice of deficiency (90-Day Letter)

4. Federal Judicial Process

(1) U.S. Tax Court
(2) U.S. District Court
(3) U.S. Court of Federal Claims
(4) U.S. Court of Appeal
(5) U.S. Supreme Court

5. Penalties Imposed on Taxpayers

1) Failure-to-file (Late filing) penalty: 5%
2) Failure-to-pay (Late payment) penalty (tax delinquency penalty): 0.5%
* Interest on penalties: federal short-term interest rate

3) Accuracy-Related Penalty: 20%
i) Negligence penalty with respect to an understatement of tax
ii) Penalty for substantial understatement of tax
iii) Penalty for a substantial valuation misstatement

4) Fraud Penalty: 75%

5) Taxpayer's Defense
(1) Reasonable basis standard: 20% chance of succeeding (Form 8275)
(2) Substantial authority standard: a one-in-three chance of succeeding
(3) More likely than not standard

1.12 Tax Credits

1. Overview of Tax Credit

2. Personal Tax Credit

1) Credit for other dependents

$500 for each dependent who is not a qualifying child under age 17.

2) Foreign tax credit <Form 1116>

Computation of allowable credit

3) Child and dependent care credit <Form 2441>

Babysitter, daycare, nursery school (not grammar school) for a child under age 13.

4) American opportunity credit ($2,500 max. per year)

For a student's first four years of post-secondary (college) education
100% of first $2,000 and 25% of the next $2,000 credit, 40% refundable per student (2019)

5) Lifetime learning credit ($2,000 max. per year)

20% of qualified expenses up to $10,000 (2019) at the taxpayer

6) Retirement savings contribution credit

Available for contributions to either a traditional IRA or Roth IRA

7) Elderly and/or permanently disabled credit

$5,000/$7,500 - SS Benefit - 50% (AGI - $5,000/$7,500) x 15%

8) Adoption credit

$14,080 (2019)

9) General business credit (combination)

10) Credit for prior year AMT

3. Refundable Credit

11) Withholding taxes / estimated taxes paid

12) Excess social security taxes withheld

13) Earned income credit (EIC)

14) Child tax credit
$ 2,000 credit for each qualifying child age under 17, refundable up to $1,400

1.11 Other Taxes

1. Alternative Minimum Tax (AMT) <Form 6251>

1) Computation of tentative minimum tax

Regular taxable income
+ AMT adjustments
+ Tax preference items
= AMTI
- AMT exemption
= AMT base
x 26% or 28%
= Tentative AMT Tax
- AMT tax credits
= Tentative minimum tax
- Regular income tax
= AMT


2) AMT adjustments
(1) Timing differences
a) Passive activity losses
b) Accelerated depreciation: 40-year SL / 150% declining balance
c) Net operating loss
d) Installment method
e) Contracts (long-term)
(2) Itemized deduction (adds back)
a) Taxes
b) Standard deduction

3) Tax preference items (adds)
a) Private activity bond (Tax-exempt interest)
b) Pre-1987 accelerated depreciation on real property
c) Percentage depletion deduction

4) AMT exemption

5) AMT tax credit

6) Credit for prior year minimum tax
(1) Offsets the regular tax (excess tentative minimum tax)
(2) Forever carryforward
(3) Limitation on credit

2. Employee FICA Tax (Medicare and Social Security Tax)

Employer & Employee: (6.2% Social Security Tax + 1.45% Medicare Tax ) x 2 = 15.3%

3. Self-Employment Tax <Schedule SE>

15.3% (50% above the line deduction)

4. Additional 0.9% Medicare Tax

More than $125,000 (MFS), $250,000 (MFJ), $200,000 (Other) of medicare wages (box 5)

5. 3.8% Medicare Tax on Certain Unearned Income

High-income taxpayers to Net Investment Income Tax (NIIT)

1.10 Below The Line Deductions

I. Standard Deduction

Single $12,200 / HoH $18,350 / MFJ $24,400 (2019)

(1) Additional standard deduction for elderly and/or blind: single $1,650 / MFJ $1,300 (2019)
(2) Dependent's standard deduction: (a) $1,100 or (b) earned income +$350 (2019)

II. Itemized Deduction

1. Medical Expenses

1) Qualified individuals: spouse and dependent (no limitation to GI)

2) Timing of deduction: paid or charged

3) Amount of deduction: 10% of AGI (2019)

4) Types of deductible medical expenses
- Doctors
- Required surgery (reconstructive cosmetic surgery)
- Prescribed (Prescription) medicine and drugs
- Medical insurance premium
- Certain capital expenditures (exceeds the increase in FMV)
- Transportation to a medical facility
- Physically handicapped costs

5) Nondeductible Medical Expenses
- Elective cosmetic surgery, hair transplant surgery
- Over-the-counter drugs
- Life insurance premium
- Disability insurance premium
- Loss earning policy premium
- Capital expenditures
- Health club membership
- Funeral expenses and cemetery lots

2. Taxes

1) Deductible taxes
(1) Real property taxes (state, local taxes)
(2) Personal property taxes (state and local taxes)
(3) Income taxes (state, local and foreign taxes)
(4) Sales taxes (state, local general sales taxes)

2) Nondeductible taxes
- Federal taxes
- Business taxes (Schedule C), Rental real property taxes (Schedule E)
- Inheritance and gift taxes for states

3) Timing of deduction: cash/accrual method

4) Deduction limit: $10,000

3. Interest Expenses

1) Classification of Interest expenses
(1) Business/Rental Interest (Schedule C/E)
(2) Personal Interest (Nondeductible)
(3) Home mortgage interest
a) Buying, constructing, or substantially improving and secured by home
b) Points related acquisition indebtedness: immediately
c) Refinancing points: amortized

(4) Investment interest: net (taxable) investment income
a) Include as (taxable) investment income
- Interest and dividends
- Rents
- Royalties
- Net capital gain
(b) Exclude as (taxable) income
- Interest on a municipal bond
(c) Investment interest expenses used to purchase tax-free bonds: nondeductible

(5) Education (student) loan interest expense (Above the line deduction)

2) Timing of deduction
- Prepaid interest expenses must be allocated over the period
- Prepaid interest income is fully taxable in the year received

4. Charitable contributions

1) Qualifying organization
- Nondeductible: Bingo, raffle, gifts (individuals), political contributions

2) Contributed property: lesser of basis/FMV
- Appreciated LT capital gain property: FMV

3) Maximum allowable deduction
(1) Cash 60% / LT capital gain property 30% of AGI
(2) Combination rules (overall limit): 60% of AGI

4) Carryover of excess charitable contributions: five years carryforward

5) Consideration for contribution

6) Contribution of services: not deduct

7) Students living: $50 per month

8) Timing of deduction: paid/charged

9) Substantiation requirement: Form 8283 (more than $5,000)

5. (Personal) Casualty and theft losses

- Federally declared disaster area

1) Casualty loss defined
2) Theft loss defined
3) Amount of casualty loss: reduction in FMV/basis
4) Amount of deduction: each exceeds $500 (2019)

6. Miscellaneous deductions

1) Gambling losses: only to the extent of gambling winning
2) Federal estate tax paid on income in respect of a decedent

III. Qualified Business Income Deduction

(Sec. 199A Deduction)

1) Qualified business income (QBI)

2) Limitations to the QBI deduction
(1) Qualified trade or business (QTB)
(2) Specified service trade or business (SSTB)

<Taxable income limitation>
Below $160,700 (2019): 20% of QBI
Above $210,700 (2019): QBT: w-2 wage and property limitation, SSTB: no deduction

<w-2 wage and property limitation>
a) 50% of W-2 wages for the business
b) 25% of W-2 wages for the business plus the unadjusted basis of qualified property

<overall limitation>
20% of the taxable income in excess of net capital gains

1.9 Above the Line Deductions (Adjustments)

1. Alimony paid (before 12/31/2018)

2. Retirement plan contribution

(1) Traditional (regular/deductible) IRA

a) Contribution: deductible
b) Tax-free accumulation of earnings (deferred)
c) Withdrawals (distributions): taxable
d) Amount of deduction (deduction limit) - $6,000 (2019) or earned income (compensation)
e) Earned income (compensation) defined - salary, wages, commissions

f) Deductibility requirements
(i) Full deductions: not participants in an employer retirement plan or AGI is less than $64,000 (2019)
(ii) Partial deductions: AGI is less than $74,000 (2019)
(iii) A spouse is not a participant and MFJ AGI is less than $193,000 (2019): full deductions

g) Premature (early) distribution (before age of 591/2) - 10% penalty tax
  1. Home purchase (1st time)
  2. Insurance (medical)
  3. Medical expense in excess of 7.5% of AGI
  4. Disability
  5. Education
  6. Death

* Excess contribution: 6% penalty (under age 59.5)
* Excess accumulation: 50% penalty (over age 70.5)

h) Additional catch-up contribution (age 50 or over): $1,000

(2) Roth IRA

a) Contribution: nondeductible
b) Tax-free accumulation of earnings
c) Withdrawals (distributions): tax-free
d) Contribution limits: $6,000 (2019)
e) Phase-out income limits: AGI is less than $122,000 (2019)
f) Qualified nontaxable distributions of Roth IRA: least five years
g) Rollovers from traditional (deductible) IRAs to Roth IRAs

(3) Nondeductible IRA

a) Contribution: nondeductible
b) Tax-free accumulation of earnings (deferred)
c) Withdrawals (distributions): previously accumulated untaxed earnings - taxable

(4) Education IRA (Coverdell Education Saving Accounts: CESAs)

a) Contribution: nondeductible
b) Tax-free accumulation of earnings
c) Withdrawals (distributions): tax-free (before the beneficiary reaches 30)
d) Contribution requirements - under 18,  $2,000 per child (2019), AGI is less than $95,000 (2019)

(5) Keogh (profit sharing) plans

Deductible $56,000 (2019), $57,000 (2020) or 25% of net self-employment earnings for Keogh

Other

*SEP (Simplified employee pension) plan
*SIMPLE (Savings incentive match plans for employees) plan

	Traditional IRA	Roth IRA	Education IRA (Coverdell ESAs)
Contribution	Deductible	Nondeductible	Nondeductible
Distribution	Taxable	Tax-free	Tax-free**
Limit (2019)	$6,000	$6,000	$2,000/child
AGI limit for full contribution (2019)	$64,000 (Single) $103,000 (MFJ)*	$122,000 (Single) $193,000 (MFJ)	$95,000 (Single) $190,000 (MFJ)

3. Penalty on early withdrawal of savings

4. Self-employed health insurance

 - 100% deductible

5. Self-employed taxes

 - 50% deductible

6. Education (student) loan interest expense

 - $2,500 (2019)

7. Educator expense

 - $250 (2019) per year each taxpayer

8. Moving expense

9. Health (medical) savings account contribution

10. Jury duty pay remitted to an individual's employer

11. Attorney fees paid in certain discrimination cases

* Higher Education Deduction

Tuition and fees deduction - $4,000

1.8 Losses: Deductions and Limitations

1. Net capital losses

1) Definition of capital assets

2) Netting procedures of capital gains and losses
Form 8949: Sales and Dispositions of Capital Assets - Schedule D

3) Net capital gains rules
(a) Long term: more than one year, 15% tax rate
(b) Short term: one year or less, ordinary income

4) Net capital losses rules
(1) Offset against capital gains (Schedule D)
(2) Offset ordinary income to a $3,000 maximum (Schedule 1)
(3) Carry forward an unlimited period

2. Sale or exchange of securities

1) Worthless securities: as if they were sold on the last day of the taxable year

2) Small business stock
(1) Sec. 1244 stock: losses as ordinary losses (up to $50,000)
(2) Sec. 1202 stock (more than 5 years): gain 100% exclude from GI

3. Net passive activity losses

1) Definition of passive activity - any rental activity / not materially participate

2) Passive activity loss rule (PAL rule) - only offset passive income
Nondeductible PALs carryforward - carry forward without any limit

3) Taxpayers subject to PAL rule - individuals, personal service corporations, closely-held C corporations

4) PAL (disallowed net loss) exceptions
(1) Mom and pop exception - $25,000 deduct is the individuals are actively participating
The $250,000 is reduced by 50% of the amount by which adjusted gross income exceeds $100,000.

(2) real estate professional (not passive activity)

1.7 Depreciation, Amortization, and Depletion

1. Depreciation

1) MACRS (1987 and beyond)

(1) Salvage value: zero

(2) Property other than real property (personal property)
 - 5-year 200% class: automobiles, light trucks, computers
 - 7-year 200% class: office furniture and fixtures, equipment
a) Half-year convention
b) Mid-quarter convention (more than 40% placed in the last quarter)

(3) Real property (subtract land cost)
a) Residential rental real property (27.5-year straight-line)
b) Non-residential real property (39-year straight-line)
c) Mid-month convention

2) Bonus depreciation

For qualified property (new or used personal property with a recovery period of 20 years or less) placed in service after Sept. 27, 2017, and before Dec. 31, 2022, the first-year bonus depreciation percentage increases to 100%.

3) Straight-line in lieu of accelerated depreciation

4) Expense election in lieu of depreciation (Section 179)

The limit is $1,020,000 (2019) on new or used properties that are acquired by purchase from an unrelated party.

2. Amortization

1) Sec. 197 Intangible asset

Intangibles such as goodwill, franchises, licenses, trademarks, and covenant not to compete may be amortized using a straight-line basis over a period of 15 years (180 months), starting with the month of acquisition.

2) Others

(1) Organizational expenditure: first $5,000 to be expensed and the remainder is amortized over 180 months
(2) Research and development expenses: deducted currently or amortized over 60 months.

3. Depletion

1) Cost depletion (GAAP)
2) Percentage depletion (Non-GAAP)

1.6 Gross Income - Exclusion

1. Items that are NOT Income

1) Return of Capital
2) Amounts Obtained by a Loan
3) Unrealized Income

2. Major Statutory Exclusions

1) Scholarships and Fellowships

Excludable only spent on tuition, fees, books, and supplies (not room and board)
(a) The grant is made to a degree-seeking student.
(b) No services are to be performed as a condition of receiving the grant.
(c) The grant is not made in consideration for past, present, or future services of the grantee.

2) Employee Fringe Benefit

(1) Taxable Fringe Benefits (Non-Statutory)

(2) Partially Taxable Fringe Benefits
a) Group term life insurance premiums (employer-paid): $50,000 of coverage

(3) Non-Taxable Fringe Benefits
a) Accident, medical, and health insurance premiums (employer-paid)
b) De minimis fringe benefits
c) Meal and lodging
d) Employer payment of employee's educational expenses
e) Qualified tuition reductions
f) Qualified transportation
g) Flexible spending arrangements (FSAs)
h) Qualified profit-sharing, and stock bonus plans

(4) Cafeteria plans

3) Insurance Proceeds

(1) Life insurance proceeds (nontaxable)
(2) Accidents insurance proceeds (nontaxable)
(3) Recoveries of lost profit (taxable)
(4) Personal (physical) injury award (nontaxable)
(5) Punitive damages (taxable)
(6) Workers' compensation (nontaxable)
(7) Medicare benefits (nontaxable)

4) Gift and Inheritances

5) Foreign Earned Income Exclusion

1.5 Gross Income - Inclusions

1. Gross Income Defined 

Code Sec.61

2. Timing of Recognition 

1) Overall Accounting Methods

(1) Cash receipts and disbursements method
(Exception) prepaid interest expenses

(2) Accrual method
(Exception) prepaid rental income, prepaid interest income

(3) Hybrid method

2) Special Accounting Methods

(1) Long-term contract

(2) Installment method <Form 6252>
a) Recognize when cash is received
b) Gross profit percentage

3. Specific Items of Gross Income 

1) Salaries, Wages, Tip (Compensation for Services)

2) Interest Income <Schedule B>

(1) Taxable interest
a) Federal bonds (U.S. obligations)
b) Industrial development bonds
c) Corporate bonds
d) Premiums received for opening a savings account (e.g., prize and awards) are included at FMV
e) Part of the proceeds from an installment sale is taxable as interest.
f) Interest paid by federal or state government for late payment of tax refund is taxable.

(2) Tax-exempt interest (Reportable but not taxable)
a) State and local government bonds (municipal bonds)
b) Bonds of a U.S. possession
c) Series EE (U.S. government savings) bounds

(3) Amortization of bond premium

(4) Unearned income of a child under 18 ("Kiddie Tax")

3) Dividend Income <Schedule B>

(a) Dividends = return on investments (earnings & profits) *lower tax rate

(b) Return of capital = return of investments *nontaxable

(c) Capital gain distribution

4) IRA Distributions (Traditional IRA Income)

5) Pensions and Annuities

6) Social Security Benefits (Social Security Income)

0 - 85% taxable
Provisional income = AGI + Tax-exempt interest + 50% of SS benefits

7) Tax Refund

(1) Tax Refund of State & Local Taxes
a) Prior year itemized deduction: taxable
b) Prior year used standard deduction: nontaxable

(2) Tax Refund of Federal Income Taxes: nontaxable

8) Payment Pursuant to a Divorce

(1) Alimony and spousal support: taxable (before 12/31/2018)
(2) Child support: nontaxable
(3) Property settlement pursuant to divorce: nontaxable

9) Business Income or (Loss) <Schedule C>

(1) Gross Business Income

Uniform Capitalization (UNICAP) Rules
a) Produced for use
b) Produced for sale
c) Acquired for resale

(2) Business Expenses

a) Deductible business expenses
  1 Salaries and commissions paid to others
  2 State and local business taxes paid
  3 Office expenses and rent expenses
  4 Business travel expenses
  5 Business meal expenses at 50% (directly related or associated with)
  6 Depreciation, repair, and maintenance of business assets
  7 Interest expense on business loans
  8 Insurance expense for business
  9 Employee fringe benefits
10 Legal and professional services
11 Bad debts (accrual basis taxpayer only)
12 Business gift ($25 per donee per year)
b) Nondeductible expenses
  1 Personal (Non-business) expenses
  2 Salaries paid to a sole proprietor
  3 Federal income taxes (above the line deduction)
  4 Business entertainment expenses
  5 Bad debt loss of a cash basis taxpayer
  6 Bribes, kickbacks, fines, penalties, and other payments
  7 Political contributions and state/federal lobbying expenses
  8 Charitable contributions (itemized deductions)
c) Expenses of an office in the home

(!) Nonbusiness (personal) bad debts: short-term capital loss (Schedule D)

(3) Federal Self-Employment Tax <Schedule SE>

(4) Net business losses - Net operating losses (NOL)

10) Gains (Losses) on Disposition of Property

Capital assets: capital gain - Schedule D
Business property: ordinary gain - Form 4797

11) Rental Income or (Loss) <Schedule E>

(1) Security deposit (refundable or non-refundable)
(2) Prepaid rental income
(3) Leasehold improvements made by lessees (FMV)
(4) Lease cancellation payment (taxable)
(5) Rental of a vacation home
a) Less than 15 days: personal residence
b) 15 or more days: Schedule E

12) Income From Partnership, S Corporation, Estates, Trust <Schedule E>

13) Farm Income or (Loss) <Schedule F>

14) Unemployment Compensation (Unemployment Benefits)

4. Other Items of Gross Income

1) Prizes and Awards

2) Gambling Winnings

3) Illegal Income

4) Income from Discharge of Indebtedness (Cancellation of Debt: C.O.D)
Generally, all debts canceled are included in gross income (other income.)
Business loan - Schedule C

5) Income in Respect of a Decedent
IRD is gross income that the decedent earned before death was not includible on the decedent's income tax return.

6) Jury Duty Pay

1.4 Dependency Requirements

1. Taxpayer and Spouse Information

Form 1040 page 1

2. Dependent's Information

1) Qualifying Child

(a) Close relationship - taxpayer's son, daughter, stepson, stepdaughter

(b) Age limit - under age 19 or age 24 in the case of a full-time student

(c) Residency requirement - the child must have the same principal place of abode as the taxpayer for more than half of the tax year.

(d) Eliminate gross income

(e) Support (modified) - The support test has modified to determine if the child did not contribute more than one-half of his or her own support.

(f) Joint return

(g) Citizenship

2) Qualifying Relative

(a) Support test - more than one-half (>50%) of the support of a person
*Multiple support agreements, Child of a divorced parent

(b) Gross income test - the dependent's (taxable) gross income is less than $4,200 (2019).

(c) Joint return test - unless the joint return is filed solely for a refund of all taxes paid or withheld for the taxable year (i.e., the tax is zero).

(d) Citizenship

(e) Relationship test - closer than a cousin, OR resided with the taxpayer for the whole year

1.3 Filing Status

1. Tax Rate Schedule and Tax Calculation

There are seven tax brackets applicable to individual taxpayers:
10%, 12%, 22%, 24%, 32%, 35%, and 37% (2019).

2. Filing Status

1) MFJ: Married Filing Jointly (Joint Return)

Not divorced or legally separated
(!) If one spouse dies during the taxable year, a joint return may be filed.

2) MFS: Married Filing Separately (Separate Return)

3) Single

4) Qualifying Widow(er) (Surviving Spouse)

Two taxable years following the year of death of the spouse
(a) Has not remarried at year-end
(b) Was qualified to file a joint return in the year of death
(c) Maintain principal residence for a dependent child for the whole year

5) Head of Household

(a) The individual is not married, is legally separated, or is married and has lived apart from the spouse for the last six months
(b) U.S. citizen or resident
(c) Maintain as a household for more than half-year is the principal residence of a dependent relative, child, or parent.

1.2 Payment of Tax

1. Tax Payments

A taxpayer typically makes "pre-payments" of tax during the year. These payments reduce the amount shown as "total tax" on the tax return and result in the calculation of tax due to the IRS or refund due to the taxpayer at the bottom of Form 1040.

2. Withholding of Taxes

An employer is required to withhold income taxes and FICA tax (Social Security and Medical tax) from employee compensation. This procedure is not necessary for independent contractors.

Form W-4: Employee's Withholding Allowance Certificate
(Income Tax Withholding Table)

Generally, compensation for withholding purposes include salaries, tips, bonuses, termination payments, vacation pay, and taxable fringe benefits. Taxes may also be withheld from certain other income including pensions and annuities, commissions, gambling winnings, unemployment compensation, and certain federal payments, such as social security.

3. Estimated Tax Payments

(1) $1,000 or more tax liability and
(2) Inadequate withholding - less than the smaller of:
a) 90% of current year's tax
b) 100% of prior Year's tax

1) Underpayment Penalty

2) Withholding Tax Treated as Estimated Tax Payments

1.1 Overview of Individual Income Tax

1. The Formula for Individual Income Tax

1) Taxable Income

2) Gross Income (GI) - inclusions / Nontaxable Income - exclusions

3) Deductions

2. Form 1040: Individual Income Tax Return

1) Above the Line Deductions (Adjustments)

2) Below the Line Deductions
(1) Itemized Deductions or Standard Deduction
(2) Qualified Business Income Deductions

3. Filing

1) Filing Requirements

(1) General Rule
A taxpayer must file a return if his or her gross income is equal to or greater than the sum of:
a) The regular standard deduction (except for married filing separately) plus
b) The additional standard deduction for taxpayers age 65 or over or blind (except for married filing separately).

If a taxpayer has a gross income of less than the standard deductions and has withholding tax taken out of his/her pay, he/she needs to file a return in order to receive a tax refund, but there are no filing requirements.

(2) Exceptions
Certain individuals must file income tax returns even if their gross income is lower than the "general rule" requirement.
a) Individuals whose net earnings from self-employment are $400 or more must file.
b) Individuals who can be claimed as dependents on another taxpayer's return, have unearned income, and gross income of $1,100 (2019) or more must file.

2) Taxable Year

Annual accounting periods are used to measure taxable income. The taxable year maybe a calendar year or a fiscal year under certain restrictions.

3) When to File?

(1) Due Date: April 15
Individual taxpayers must file on or before the fifteenth day of the fourth month following the close of the taxpayer's taxable year which is April 15.

(2) Extension
An automatic six-month extension (until October 15) is available for those taxpayers who are unable to file on the April 15 due date. Although granted automatically, the six-month extension must be requested by the taxpayer by filing Form 4868 by April 15.
(!) The automatic six-month extension is not an extension for the payment of any taxes owed. The due date for payment of the taxes remains April 15. If the tax liability is not paid by this date, penalties will be imposed for late payment (failure-to-pay penalty).

4. Penalties Imposed on Taxpayer

(1) Failure-to-File (Late Filing) Penalty
The Penalty is 5% of the amount of tax due for each month (or any fraction thereof) the return is not filed. The penalty cannot exceed a maximum of 25% of the amount of tax due.

(2) Failure-to-Pay (Late Payment) Penalty
The penalty is 0.5% per month (or fraction of month) up to a maximum of 25% of the unpaid tax. (tax delinquency penalty)

* Interest on Penalties
Interest, compounded daily, is charged on any unpaid tax from the tax return due date until the date of payment (federal short-term interest).