Accounting 6160First Class Slides

Howard Godfrey, Ph.D., CPAProfessor of Accounting ©Howard Godfrey-2012

3. Planning Strategies, Limits1. Objectives of tax planning.2. Timing strategy: applications, limits. Apply present value.3. Income shifting, examples, limits.4. Conversion strategy, examples, limits

5. Judicial doctrines that limit tax planning.6. Tax avoidance vs. tax evasion

4. Indiv. Income Tax Overview1. Formula for calculating an individual taxpayer's taxes payable or refund, explain each formula component.2. Requirements for taxpayer's personal & dependency exemptions.3. Taxpayer's filing status.

6. Individual Deductions1. Common deductions for adj. gross income (AGI).2. Types of itemized deductions, compute itemized deductions3. Standard deduction, 4. personal and dependency exemptions, 5. compute taxable income.

Identify (on Form 1040 and related schedules) location (line number) of:1.Gross income2.Deductions for AGI3.AGI4.Exemptions5.Standard deduction6.Itemized deductions7.Taxable income8.Income tax before credits9.Credits10.Income tax due or refund

For example, Union Dues are:A. Not deductible on Form 1040.

B. Deductible in full in Schedule A-Itemized Deductions.

C. Deductible in Schedule A-Itemized Deductions,

subject to a threshold of 7.5% of adj. gross income.

D. Deductible in Sched. A-Itemized Deductions,

subject to a limit of 50% of adjusted gross income.

E. Deductible in Sched. A-Itemized Deductions, subject to

a $100 floor & a threshold of 10% of adj. gross income.

F. Deductible in Sched. A-Itemized Deductions, subject

to a threshold of 2% of adjusted gross income

Old CPA questions about Form 1040.

Taxes

1 0 to 60 Credits

Taxes-AMT

Income-defined, AGI etc.

2 61 to 160 Income-Included

Income-Excl&Exempt

Deduct.-Corp. & Indiv.

3 161 to 260 Deductions-Individuals

Deductions-Corporations

4 261 to 300 Limits on deductions

Approx. Ranges for K ey Code Sections

1-15 Taxes

1 0 to 60 21-50 Credits

55-59 Taxes-AMT

61-70 Income-definitions

2 61 to 160 71-100 Income-Included

100-160 Income-Exclusions

161-210 Deduct.-corp & indiv.

3 161 to 260 211-240 Deductions-Individuals

241=260 Deductions-Corp.

4 261 to 300 Limits on deductions

Approximate Ranges for K ey Code Sections

5 401 to 440 Retire. plans, options

6 441 to 500 Accounting Methods

7 1,000 to 1,100 Basis, Gain or Loss

8 1,200 to 1,250 Capital Gains/Losses

9 300 to 400 C Corporations

10 700 to 800 Partners

11 1,361 to 1,400 S Corporations

12 1,401 Self-Employment Tax

Approximate Ranges for K ey Code Sections

Code Amount

61 Gross Salary $50,000

FICA Withheld ($3,825)

Fed. Income Tax W/H ($5,000)

164, 31 N.C. Income Tax W/H ($2,000)

Take-Home Pay $38,175

Gross Deduct. Deduct.

Amount Income For AGI from AGI

Gross Salary $50,000 $50,000

FICA Withheld ($3,825)

Fed. Income Tax W/H ($5,000)

N.C. Income Tax W/H ($2,000) $2,000

Take-Home Pay $38,175

Gross Deduct. Deduct.

Income & exp.Amount Income For AGI from AGI

Gross Salary 50,000 50,000(61, 1.61-2 )

FICA Withheld (3,825)

Fed. In. Tax W/H (5,000)(31)

N.C. In. Tax W/H (2,000) 2,000(164, 62, 63, 67)

Take-Home Pay 38,175

Study the Individual Tax Model on the next slide.Can you find the support for that model in the following code sections?

161626367

Gross income- Less Excl.

Less: Deductions for adj. gross income

Equals: Adjusted Gross Income (AGI)

Less: Deductions from AGI (greater of

itemized or standard deduction)

Less: Exemptions (personal & dependency)

Equals: Taxable income (loss)

Individual Tax Model

Gross Deduct. Deduct.

Part 1. Income & expenses Amount Income For AGI from AGI

Gross Salary (61, 1.61-2 ) 50,000 50,000FICA Withheld (3,825)Fed. Income Tax W/H (31) (5,000)N.C. Inc. Tax W/H (165, 67) (2,000) 2,000Take-Home Pay 38,175Jane's interest income:Wells Fargo (1.61-7) 4,000 4,000City of Concord bonds (103) 3,000

Gift from parents (102) 2,000PaymentsAlimony (215, 71, 67) 9,000 9,000Gift-United Way (170) 2,000 2,000Hospital Ins. Prem (213) 4,000 4,000

Gross Income 54,000Deductions for AGI 9,000Deductions from AGI (Gross) 4,000

B C D E F

Gross Deduct. Deduct.

Part 1. Income & expensesAmount Income For AGI from AGI

Lines omitted XXXX XXXX

Jane's interest income:

Wells Fargo (1.61-7) 4,000 4,000

City of Concord bonds (103) 3,000

Gift from parents (102) 2,000

Payments

Alimony (215, 71, 67) 9,000 9,000

Gift-United Way (170, 67) 2,000 2,000

Hospital Ins. Prem (213) 4,000 4,000

Gross Income 54,000

Jan-Single-No dependent Single

Gross income (61-90) 54,000

Deduct. for Adj. Gross Income (9,000)

Adjusted Gross Income (62) 45,000

Part 2. Compute income tax (1 of 2)

Medical (213) 6,000Less 7.5% of Adj. Gross Income (3,375)Net Medical 2,625State Income Tax (164(a)(3)) 2,000Charitable contribution (170(a)) 2,000Total Itemized Deductions 6,625Standard Deduction (63( c)) 5,800Greater of item. Deduct. or Std 6,625Exemption (151, 152) 3,700Taxable Income 34,675

Part 2. Compute income tax (2 of 2)

Taxable Income 34,675

Tax before credits 4,794

Withholding (31) (5,000)

Tax due (refund) (206)

Compute income tax

Single, 2011 Base Rate Tax

Top full layer 34,500 4,750

Above layer 175 25% 44

Total Income 34,675

Total Tax 4,794

Rate Start End

10% $0 $8,50015% $8,500.01 $34,50025% $34,500.01 $83,60028% $83,600.01 $174,40033% $174,400.01 $379,15035% $379,150.01 No limit

Income Tax Rates -2011-Single

2011 Tax Rates - Single - Schedule XIf taxable Income is Of Taxable

Over Not over Tax is Income Over

$0 $8,500 $0.00 + 10% $0

$8,500 $34,500 $850.00 15% $8,500

$34,500 $83,600 $4,750.00 + 25% $34,500

$83,600 $174,400 $17,025.00 + 28% $83,600

$174,400 $379,150 $42,449.00 + 33% $174,400

$379,150 No limit $110,016.50 + 35% $379,150

Rate Start End

10% $0 $17,00015% $17,000.01 $69,00025% $69,000.01 $139,35028% $139,350.01 $212,30033% $212,300.01 $379,15035% $379,150.01 No limit

Income Tax Rates -2011-Joint

Rate Start End

10% $0 $17,40015% $17,400.01 $70,70025% $70,700.01 $142,70028% $142,700.01 $217,45033% $217,450.01 $388,35035% $388,350.01 No limit

Income Tax Rates-2012-Joint

Sec. Sb.

Gains & Losses - Stock Transactions.Monica works for Big Corp.- salary: 120,000 61

Single, no dependent. Exemption (3,800) 151 b

State income tax (6,200) 164 a

Property tax on home (4,000) 164 a

Home mortgage interest (6,000) 163 h

Taxable income [before stock trans] 100,000 63

What is marginal income tax rate? 1

If she paid interest on a loan to buy corp stock,

would interest exp. be deductible? 163 d

Is there a limit on that deduction?

Monica's Stock Transaction - sale for cashBought Bank of Am. stock in 2008 for 240,000 1012

Sold stock (12-31-2012) at a net price of 540,000 1001 b

4 Is gain of $300,000 included in income? 61

5 Suppose she traded stock for $540,000 home. 1001 b

6 How does she compute the gain? 1001 a

7 Is this a capital asset? 1221

8 Is this a long-term capital gain? 1222 3

9 What is special tax rate for this gain? 1 h

What if asset were a stamp collecton? 1 h 4

10 What is marginal tax rate if she bought Bank of Am stock in February, 2012? 1222 2

Explain.11 Can she use installment sales method for 453 k

gain on sale of Bank of America Stock?12 Does she report gain if it is traded for Duke Stock? 1031 a 2 B

[Rule for stock-for-stock corporate reorganzations.] 354, 368

Monica's Stock Transaction - sale for cashBought Bank of Am. stock in 2008 for 240,000 1012

Sold stock (12-31-2012) at a net price of 540,000 1001 b

4 Is gain of $300,000 included in income? Yes 61

5 Suppose she traded stock for $540,000 home. Yes 1001 b

6 How does she compute the gain? 1001 a

7 Is this a capital asset? Yes 1221

8 Is this a long-term capital gain? Yes 1222 3

9 What is special tax rate for this gain? 15% 1 h

What if asset were a stamp collecton? 28% 1 h 4

10 What is marginal tax rate if she bought Bank of Am stock in February, 2012? 28% 1222 2

Explain.11 Can she use installment sales method for 453 k

gain on sale of Bank of Am. Stock? No12 Does she report gain if it is traded for Duke Stock? Yes 1031 a 2 B

[Rule for stock-for-stock corporate reorganzations.] 354, 368

Change facts (ignore stock sale above):Bought Bank of Am. stock in 2008 for 240,000Sold stock this year at a net price of 40,000

14 Is she able to deduct a loss? 165 a & c

15 If so, how is the loss computed? 165 b

16 Is the loss deduction limited? 165 f

17 How much loss deducted in 2012? 1211 b

(This is only asset sale in 2012.)

18 Carry excess loss to another year? 1212 b

[Sec. 165-gateway for loss ded.]

[Rules- stock becomes worthless?] 165 g

[Rules different for corporations?] 1211 a

Change facts (ignore stock sale above):Bought Bank of Am. stock in 2008 for 240,000Sold stock this year at a net price of 40,000

14 Is she able to deduct a loss? Yes 165 a & c

15 If so, how is the loss computed? 165 b

16 Is the loss deduction limited? Yes 165 f

17 How much loss deducted in 2012? 3,000 1211 b

(This is only asset sale in 2012.)

18 Carry excess loss to another year? Yes 1212 b

[Sec. 165-gateway for loss ded.]

[Rules- stock becomes worthless?] Yes 165 g

[Rules different for corporations?] Yes 1211 a

Part 3. Loss on Small Business StockCorp. in Part 2 is Sec. 1244 corp.19 How much "ordinary"

loss deducted in 2012? 1244

20 How much capitalloss deducted in 2012? 1211 b

Part 4. Gain- Small Business Stock21 Is it possible to exclude gain from

sale of stock if requirements

of Sec. 1202 are met? 1202

Part 3. Loss on Small Business StockCorp. in Part 2 is Sec. 1244 corp.19 How much "ordinary"

loss deducted in 2012? 50,000 1244

20 How much capital loss deducted in 2012? 3,000 1211 b

Part 4. Gain- Small Business Stock21 Is it possible to exclude gain from

sale of stock if requirements

of Sec. 1202 are met? Yes 1202

Sec. 165. LOSSES(a) General Rule.There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.(b) Amount of Deduction.For purposes of subsection (a), the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.(c) Limitation on Losses of Individuals.

Sec. 165 LOSSES(c) Limitation on Losses of Individuals.In the case of an individual, the deduction under subsection (a) shall be limited to(1) losses incurred in a trade or business;(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and(3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

Sec. 165. LOSSES(d) Wagering Losses. Losses from wagering transactions shall be allowed only to the extent of gains from such transactions.(e) Theft Losses. For purposes of subsection (a), any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.(f) Capital Losses. Losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212.

165(g) Worthless Securities.(1) General rule.If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.(2) Security defined. For purposes of this subsection, the term “security” means(A) a share of stock in a corporation;(B) a right to subscribe for, or to receive, a share of stock in a corporation; or(C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.

165(h) Treatment of Casualty Gains and Losses.(1) $100 limitation per casualty.Any loss of an individual described in subsection (c)(3) shall be allowed only to the extent that the amount of the loss to such individual arising from each casualty, or from each theft, exceeds $500 ($100 for taxable years beginning after December 31, 2009).(2) Net casualty loss allowed only to the extent it exceeds 10 percent of adjusted gross income.(A) In general. If the personal casualty losses for any taxable year exceed the personal casualty gains for such taxable year, such losses shall be allowed for the taxable year only to the extent of the sum of—(i) the amount of the personal casualty gains for the taxable year, plus(ii) so much of such excess as exceeds 10 percent

SEC. 166. BAD DEBTS.(a) General Rule.(1) Wholly worthless debts.There shall be allowed as a deduction any debt which becomes worthless within the taxable year.(2) Partially worthless debts.When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.(b) Amount of Deduction.For purposes of subsection (a), the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.

166(d) Nonbusiness Debts.(1) General rule. In the case of a taxpayer other than a corporation-(A) subsection (a) shall not apply to any nonbusiness debt; and(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year.

166(d) Nonbusiness Debts.(2) Nonbusiness debt defined. For purposes of paragraph (1), the term “nonbusiness debt” means a debt other than(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.(e) Worthless Securities. This section shall not apply to a debt which is evidenced by a security as defined in section 165(g)(2)(C).

Sec. 1221. CAPITAL ASSET DEFINED (Slide 1 of 3)(a) In General. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include.

•(1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;

Sec. 1221.CAPITAL ASSET DEFINED (Slide 2 of 3)(a) In General. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include.

•(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;

Sec. 1221.CAPITAL ASSET DEFINED (Slide 3 of 3)(a) In General. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include. (3) a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, held by(A) a taxpayer whose personal efforts created such property,(B) in the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced …

Sec. 1211 LIMIT-CAPITAL LOSSES

(a) Corporations.In the case of a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges.

Sec. 1211 LIMIT ON CAPITAL LOSSES(b) Other Taxpayers.In the case of a taxpayer other than a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus (if such losses exceed such gains) the lower of((1)  $3,000 ($1,500 in the case of a married individual filing a separate return), or(2) the excess of such losses over such gains..01 Amended by P.L. 99-514, P.L. 95-30, P.L. 94-455 and P.L. 91-172. For details, see the Code Volumes.

Sec. 1212.CAPITAL LOSS CARRYBACKS, CARRYOVERS

(a) Corporations. (1) In general.If a corporation has a net capital loss for any taxable year (hereinafter in this paragraph referred to as the "loss year"), the amount thereof shall be —(A) a capital loss carryback to each of the 3 taxable years preceding the loss year, but only to the extent—(i) such loss is not attributable to a foreign expropriation capital loss, and(ii) the carryback of such loss does not increase or produce a net operating loss (as defined in section 172(c)) for the taxable year to which it is being carried back;(B) except as provided in subparagraph (C), a capital loss carryover to each of the 5 taxable years succeeding the loss year; and…

Sec. 1212 .CAPITAL LOSS CARRYBACKS, CARRYOVERS(a) Corporations.

(b) Other Taxpayers.(1)In general. If a taxpayer other than a corporation has a net capital loss for any taxable year—

(A) the excess of the net short-term capital loss over the net long-term capital gain for such year shall be a short-term capital loss in the succeeding taxable year, and(B) the excess of the net long-term capital loss over the net short-term capital gain for such year shall be a long-term capital loss in the succeeding taxable year.

Mary’s salary is $120,000 per year. Her federal income tax withheld is $20,000. There is no state income tax. What is her take-home pay for the year? See following slide.

Salary $120,000Federal income tax withheld: (20,000) Maximum for Soc. Sec. $106,800Social Security base 106,800

Rate-Social Security 6.20%Social Security Tax 6,622

Medicare base 120,000

Rate-Medicare Tax 1.45%Medicare Tax 1,740FICA (Soc. Security & Medicare) (8,362) Take-home pay 91,638$

Mary-2011

Gross income- Less Excl.

Less: Deductions for adjusted gross income

Equals: Adjusted Gross Income (AGI)

Less: Deductions from AGI (greater of

itemized or standard deduction)

Less: Exemptions (personal & dependency)

Equals: Taxable income (loss)

Individual Tax Model-1.

Taxable income

Times: Tax rates

Equals: Gross income tax liability

Plus: Additions to tax

Less: Tax credits or prepayments

Equals: Tax owed or refund due

Individual Tax Model-2

General Tax FormulaGross Income - Form 1040-Pg 1 $110

Deductions For A.G.I. (10) Adjusted Gross Income (AGI) 100 Exemptions (6) Regular Itemized Ded. (15) Misc. Itemized Ded. (5)

Less 2% of AGI 2 Deductible Amount (3)

Total Deductions From AGI (24) Taxable Income $76

Compute income taxfor married couplewith this information.See next two slidesSalaries $125,000 Deductions ($25,000)Taxable Income on Joint Return $100,000

End