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Federal Income Tax Outline General Formula:
Gross Income-Above the Line (ABL) Deductions= Adjusted Gross Income AGI- Deductions (either standard or itemized) + Exemptions= Taxable Income Taxable Income x Tax Rate=Tax (before credits) Tax (before credits)-Credits= Tax Liability (tax after credits)
SS61 Gross Income - SS62 ABL deductions= AGI-SD SS63(c) or Itemized Ded SS63(d) (below-the-line) (s/t SSSS67, 68)= Taxable Income (TI) x rate schedule SS1=Tenative Taxcredits=Tax Liability
SS61 Defines Gross Income=
"all income from whatever source derived" Accessions to wealth, clearly realized, and over which TP have complete dominion will be recognized as part of income if not specifically excluded in the code. Cesarini Case- $ found in piano was income because it was something that could be separted from the piano. If have something that can be separated then it will usually be income.
SS61 (a)(3): gross income includes "gains derived from dealings in property" (only certain exceptions like sale of personal residence or like kind exchanges to a certain degree) Only Include the Gain amount in income
SS1001. Determines GainGain= Amt Realized - Adjusted Basis Amt Realized=FMV or amt of cash received Cost (Basis)= what paid for property decreased by such things as depreciations, cod, ect.
SS62 Defines Adjusted Gross Income "gross income minus the deductions listed in 62(a)" Deductions allowed to get to AGI (above the line) (1) Trade and Business (2) Certain Trade and Business deductions of Employees (3) Losses from sale or exchange of property (4) Rents and Royalties (5) Alimony (6) Interest on Education Loans (7) Higher Education Expenses
SS63 Defines Taxable Income If don't itemize your below the line deductions, then Taxable Income= AGIStandard Deduction and Personal Exemption Deductions SS151( s/t phaseouts).
If do itemize deductions, then Taxable Income= AGI-all below line itemized deductions
SS63 and the Personal Exemption Deductions SS151 (s/t phaseouts). YOU CANNOT CLAIM THE STANDARD DEDUCTION AND ITEMIZED DEDUCTIONS
SS67. 2% Floor on Misc. Itemized Deductions Misc. Itemized Ded only allowed to extent that when added together they exceed 2% of AGI)
SS68. Overall Limitation on Itemized Deductions If AGI exceeds the applicable amount, the amt of TP's itemized deductions that they could otherwise claim will be reduced by the lesser of (do this before floors)--(1) 3 % of the excess of AGI above the applicable amt, or (2) 80% of the amount of itemized deductions that they could otherwise take. But, medical expenses not reduced.
Watch out for phaseouts of such things as personal exemptions reduced by 2% for every $2500 the AGI exceeds the threshold amt; child care credit applicable amt is 35% reduced by 1% for every $2000 AGI is more than 15,000; lifetime and hope learning credits; child tax credit reduced by $50 for each $1000 the AGI exceeds a threshold amount; itemized deduction reductions, etc. STRATEGY Add up all itemized deductions (based on floors and ceilings and phaseouts) and see if larger than the Standard Deduction. Then claim the larger of the two!
If Cant figure out the answer in the code then look to the Regulations and if they don't help then look to case law.
SS151 Personal Exemptions
SS151(b) allows a deduction for "the TP" & Spouse if NOT filing jointly
SS151(c) allows an exemption for EACH dependent Reg 1.151-1(b) if 2 TPs then 2 exemptions
SS1 Gives the Applicable Tax Rates to apply to tax base (tax base =AGI after exemptions & deductions but before any credits) Different dollars of income may be taxed at different rates due to Progressive Marginal Tax Rates. The Higher rates apply only to the portion of income that falls w/in the higher brackets. Average Tax Rate=
Tax liability as a percentage of their taxable income
Formula (tax liability/income) Marginal Tax Rate=
Tax rate applied to their last dollars of income (most important for tax planning purposes)
SS1(a) determines any adjustments that can be made to the tax liability, ie Credits (child care credit, child tax credit, Hope Scholarship Credit, Lifetime Learning Credit) General Information Deductionsappear as entries on tax returns and they depend on the use of funds by the TP not on the source. Exclusionsare allowance that if qualify exclude certain amounts from income and they do not appear on tax returns. CreditsDirectly reduce tax liability, come into play after have determined AGI, Taxable Income, and Initial Tax Liability, Savings from credit is simply the amount of the credit Not usually a 100% credit, but some specified lower % of a qualifying expenditure Can get regardless of if itemize or take standard deduction DeferralValue of a deferral is a function of 2 things: (1) the length of the deferral period, and (2) the rate of return the TP can ear on investments during the deferral period. Concept important, always rather defer income reporting to a later time cause of the time value of money and if can have the income now and spend it or gain interest on it and pay tax at a later date would rather do this. If have long enough deferral period and a high enough return rate then the deferral can almost act as a permanent exlusion. Examples of deferrals (value of gain on a gift received from donor since don't have to pay tax on the gain until you sell it and realize the gain) Heirarchy of Tax Law
-Regs (Legislative have force of Law, Interpretive are generally upheld if reasonably consistent)
-Revenue Ruling (administrative announcement by IRS, can be persuasive in court, but individuals not bound)
-Revenue Procedures published by IRS (get private letter ruling from IRS if considering a major transaction and are unsure of the tax consequences, binds only that individual)
-Treasury will rely on House Ways and Means Committee and Senate Finance Committee records
-"Bluebooks" published after the statute/law is enacted and no authority but IRS and Treas will use to interpret the enacted law. Tax Litigation: 3 Judicial Forums:
-U.S. District Court for the district in which the TP resides (only time can have jury)( have to pay the disputed amt & then sue for refund)
-Fed Court of Claims (have pay disputed amt & sue for refund)
-U.S. Tax Court (Washington D.C.) must file petition w/in 90 days of date of notice of IRS delinquency. There are 19 judges that ride the circuit throughout US. Always bench trials and sometimes En Banc. (don't have to pay 1st). (if lose case begun in Tax Court, must pay deficiency and interest at the "Federal ShortTerm Rate" plus 3 percentage points) Tax Rates Generally: 1st several thousand tax dollars actually taxed at 0% due to standard deduction SS63 and Personal Exemptions SS151 Tax rates of SS1 apply only to income that is left over after the subtraction of standard deductions & personal exemptions. Entering a new tax rate bracket only affects the amt of income that pushes into the new bracket. "Cliff Effect"- tax rule under which a very small change in the TP Income results in a Huge change in liability. (Tax Savings from a Deduction= amt of deduction x marginal rate) Other General Concepts for Including IncomePayment In-Kind
-If do work for anybody but they don't pay you with cash but instead pay you in-kind, like exchange or charge account etc, the objective FMV (what charge other customers for same thing) of that item or service will be income to you. Example Case- Rooney v. Commish Constructive Income DoctrineA TP who has the right to receive a taxable item (trip won, or payment for services) cannot avoid the tax by "deliberately turning his back on the income" Example: if do services and person want to pay you now, can't tell them wait to pay you next year so don't have to take as income", must take it in the year entitled to it. Imputed IncomeIf exchange w/ someone there is a form of income for each person and it is taxable (ie you help paint my house, I will help you mow your lawn) BUT, if do the work for yourself it is not taxable, same with the imputed rental income when living in your own home.
Exclusions from Income:
SS102. Gifts and Inheritances
-Gross Income does not include the value of property acquired (even cash) by gift.
-Gift= proceeds from a "detached and disinterested generosity" "out of affection, respect, admiration, charity or like impulses"
-If give expecting some sort of benefit then likely not a gift, same ifdoing out of moral duty.
-Basis = the same as the basis of the donor at the time of transfer.
-Basis in gift from deceased person= FMV at time of transfer.
-If FMV at time of gift is less than the donors Basis then for determining gain Basis=
-SS274(b): denies transferor a business deduction for any business gift, to the extent that total value of gifts made to that person exceeds $25.
-SS102(c): 102(a) cant apply to "any amount transferred by or for an employer to, or for the benefit of, an employee". No Gifts to Employees so still include value in income
SS104: Compensation for Injuries or Sickness
SS104(a)(2) excludes from Gross Income "any damages (other than punitive) received (by suit or settlement and lump sum or periodic payments) on account of PERSONAL PHYSICAL INJURIES OR PHYSICAL SICKNESS"
-Emotional distress doesn't count even w/ physical manifestations
-Applies to All 3 Types of Compensatory Damages Non Pecuniary Damages for pain and suffering and loss of enjoyment Damages for Medical Expenses (past & future) Damages for Lost Wages (past & future) For Settlement to Count: (1) The underlying cause of action giving rise to recovery is "based upon tort or tort type rights" and (2) TP must show that the damages were received on account of personal physical injuries or sickness. Loss of Consortium also not taxed as income and same with wrongful death just not any punitive damages.
SS101: Life Insurance
SS101(a) gross income doesn't include "amts recvd under a life insurance policy, if the amts paid are by reason of death of the insured. There are no deductions for the premiums paid over life but the proceeds at death are not taxable as income.
-SS101(g) in cases of terminal illness, can exclude amts recvd before death and reasonably expect to die w/in 24 months. (SS101(g)(4)(A))
-SS101(a) & (g) may be able to exclude payments as death benefits for Chronic Illness if paid to defray certain long-term care expenses. "Chronic Illness=illness that leaves patient unable perform basic living activities (eating, bathing, etc) or which
leaves so supervision for own
cognitively impaired as to need substantial protection"
Term Life Insurance: For a certain term of years. Whole Life Insurance: Internal Earning w/in policy not usually taxed to TP or to Ins. Co. Internal Earning = amt earned by the ins. Co. that are credited to a policy reserve for the insured. But...if all or part of reserves are distributed to TP policyholder in event cancel then are taxed.
SS132 Certain Fringe BenefitsSS132(a) Exclusion from Gross Income- gross income shall not include any fringe benefit which qualifies as a.... amt
Make sure to track through the SS132 and Reg 1.132 for definitions and explanations and limitations of what is and is not excluded from income.
(Examples: no additional-cost service, qualified employee discount, de minimis fringe, qualified transportation fringe ie qualified parking, qualified retirement planning services, working condition fringe, etc)
SS105 & SS106 Employer-Provided Health Insurance- (above-the-line deduction)
SS106(a): excludes from gross income of an employee the value of employer-provided health insurance coverage.
SS105(b): excludes from gross income the value of benefits received under employer provided health insurance, to the extent the benefits constitute reimbursement of medical expenses. and
-Together SSSS105 and 106 remove employer provided health insurance-both premiums benefits- form the base of the income tax.
-This applies to employee, spouse or dependants Reg. 1.106-1
-Unmarried partner coverage cant be excluded from gross income unless rarely qualify
the employee under SS152(a)(9).
-For employee's that don't get covered ins.SS213 allows TP to deduct medical expenses (itemized only) including premiums- but only to the extent that they exceed 7.5% of AGI. (so usually ends up not deductible). Only get the amt that exceeds the 7.5% amt.
-SS162(c) : Self-employed individuals do better cause they can claim the health-ins cost for self, spouse, & dependants as an Above-the-Line deduction so don't have to itemize to get.
-Non-discrimination rules apply to employers who self-insure rather than purchasing ins from ins. Co (105(h)), and to cafeteria plans providing health benefits where pay a credit amt to employee which provides ins but never gets put into income (SS125(g)(2)). Except in those 2 situations: employer can provide unlimited amts of tax-favored health ins. to its execs w/o having to provide ins. to its lower employees.
SS79 Group-Term Life Insurance-Allows employees to exclude the value of group-term life insurance provided by employers, for up to $50K of insurance (death benefit)
-Larger amts of ins. can be provided but if goes above the 50K, then the employee has wage income in amt of the premium property ALLOCABLE to the EXCESS COVERAGE. Example: Policy= 100K and the premium is $100 then the cost of 50K is $50 and so
$50 would be included in wage income.
SS117. Scholarships and Other Tax Benefits for Higher Ed ExpensesSS117. Excludes from gross income "any amt recvd as a Qualified Scholarship by an individual who is a candidate for a degree at a college or university"
-applies to cash and in-kind scholarships (free or reduced tuition)
-Limited to cost of tuition & fees, cost of course-related books, supplies & equiptment
-No room & board
-Source can be university attending, a gov. agency, a business, a charitable org., or any other source even individuals.
-BUT SS117(c) exclusion doesn't apply to "any amt recvd that represents pymt for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship"
-source can't be a relative (but this could be a gift)
-SS117(d): college can provide its employee's w/ tax free "qualified tuition reduction" (employee , child or spouse) but is subject to nondiscrimination req.
-SS127: exclusion for employee whose tuition paid by employer under an "educational assistance program" but 2 limitations: (1) max amt to exclude $5,250 (2) subject to nondiscrimination req.
Rev Proc. 76-47. Where the scholarship is given as part of an employer-related grant program to employee or his child it must satisfy these guidelines: (1) The availability of the grants fall outside the pattern or employment, and (2) The grants don't otherwise represent compensation for past, present, or future services rendered or to be rendered the foundation or employer by the employee or kids, and (3) The grants are not for studies or research undertaken primarily for the benefit of the foundation or employer or other purpose not 117 sanctioned. Also Must Meet all 7 Guidelines:
.01 Inducement Must not be used by employer, foundation, or organizer, to recruit employees or to induce employees to continue employment
.02 Selection Committee
-Selection of grantees must be made by a committee with people totally independent &
separate from foundation, organizer, and employer
-Cant be former employee, grants must be awarded solely in order recommended, only committee can vary the # of grants given
.03 Elegibility Requirements
-Must impose identifiable minimum requirements
-Min. Period for employment may not exceed 3 years
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