EA Exam Prep Part 1 All

EA Exam Prep – Part 1 • All audio is streamed through your computer speakers. • There will be several attendance verification questions during the LIVE webinar that must be answered via the online quiz at the conclusion to qualify for CPE. • Today’s webinar will begin at 2: 00 pm EDT • Please note: You will not hear any sound until the webinar begins. 1

EA Exam Prep – Part 1 John O. Everett, Phd. , CPA Cherie J. Hennig, Phd. , CPA

Learning Objectives After attending this seminar, you should be able to: • Identify the main components of the individual tax formula • Recognize the key tax rules related to itemized deductions, • • individual credits, and travel & entertainment expenses Determine the appropriate tax reporting for capital gain and loss transactions Apply the special tax limitations associated with vacation rental homes Determine the correct contribution and deduction for payments to an Individual Retirement Account Recognize the key components of gift & estate taxes 3

Two Rules for Studying for the EA Exam • Rule 1 – There absolutely NO shortcuts in studying for the EA Exam • Rule 2 – Refer to Rule 1 4

Topic 1 Individual Tax Computation Format

1 A Individual Taxation Format Basic Components of Individual Formula: Gross Receipts (Statutory Exclusions) Gross Income (Deductions for Adjusted Gross Income) Adjusted Gross Income (Personal Exemption Deductions - $3, 950 each) (Larger of Itemized or Standard Deduction) Taxable Income 6

1 B The Standard Deduction • 2014 Inflation-Adjusted Amounts: $6, 200 (S), $12, 400 (MJ or SS), $6, 200 (MS), and $9, 100 (HH) • Additional Amounts for Blindness and Age 65 - $1, 200 for MJ or MS, $1, 550 for all others • Limits on Full Standard Deduction – Married – Separately - Consistency requirement – Eligible Dependent – Larger of (1) $1, 000 or (2) Earned Inc. + $350 • Question 1 7

Question 1 Mary Allen, age 12, earned $800 from a paper route and received $1, 200 of taxable interest during 2014. Mary is claimed as an exemption by her parents. Mary’s standard deduction for 2014 is: a. $800 b. $1, 000 c. $1, 150 d. $6, 200 8

1 C Requirements to File • General Rule – Gross income > (standard deduction + exemption deduction of TP and spouse) • Additional Amounts - ($1, 200 or $1, 550) added to the total, but only for taxpayer and spouse • Social Security – generally excludable if gross income plus ½ SS less than $25, 000 S ($32, 000 M) • Question 2 9

Question 2 Mr. Todd, who is 43 years old, has lived apart from his wife since May 2014. For 2014, his two children, whom he can claim as dependents, lived with him the entire year, and he paid the entire cost of maintaining the household. Assuming that Mr. Todd cannot quality to file a joint return for 2014, he must, nevertheless, file a return if his gross income is at least: a. $3, 950 b. $6, 200 c. $10, 000 d. $13, 050 10

1 D Filing Req. - Exceptions • Married – Separate - > $3, 950 requirement • Eligible Dependents - > $1, 000 unearned income • Self-Employed - > $400 net self-employment income (but don’t forget gross income rule) • Others – Tip income, special taxes, refunds • Question 3 11

Question 3 In 2014, Mr. Oak quit his job to start his own sole proprietorship. Prior to quitting his job, he had earned $5, 000 in wages. At the end of the year, his sole proprietorship showed $50, 000 in sales. Mr. Oak will not have to file a return if his sole proprietorship expenses are at least: a. $49, 601 b. $50, 000 c. $50, 400 d. a return will be required in any case 12

1 E Exemptions – General • Exemption Deductions - Available for taxpayer, spouse, and any dependent meeting 5 tests (discussed below) • $3, 950 Deduction - For each exemption • Year of Death – Full deductions allowed • Dependents – Cannot take deduction on their own return if eligible as a dependent of another • Special Cases – – Divorced Parents – Custody claims, unless waived in writing – Multiple Support Rule – 10% minimum support, others waive 13

1 F Exemptions – Five Tests of Dependency 1. Relationship (family, including half- & step-, other than cousins, nonrelative living with TP entire year qualifies) 2. Gross income (limited to amount of exemption, unless child under age 19 or full-time student) 3. Support (>50% living necessities, include all, taxable and nontaxable, except scholarships) 4. Filing Status (not MJ, unless no gross tax due) 5. Citizenship (US, and part-time resident of Mexico or Canada) 14

Question 4(a) Mr. and Mrs. White filed a joint return. During the year they provided more than 50% support for the following individuals, all of whom are U. S. citizens: • The Whites’ single daughter, age 22, was a full-time student for eight months. During the summer she earned $4, 200, which was spent on her support. • Mr. White’s cousin, age 15, lived with them from May to December. • Mr. White’s widowed mother, age 70, lived with them and had no income. • The Whites’ single daughter, age 20, lived with them the full year. She had gross income of $4, 300. 15

Question 4(b) • Mrs. White’s widowed father, age 64, lived alone, and his sole source of income was Social Security of $3, 000. • The Whites’ legally adopted son, age 10, lived with them from February to December. How many total exemptions may Mr. and Mrs. White claim on their return? a. 5 b. 6 c. 7 d. 8 16

Question 5 Ada lived with her son Robert and his wife Barbara. Ada’s only income was a $1, 500 fully taxable pension, which she spent on clothes and recreation. Robert and Barbara paid Ada’s medical and drug expenses of $600 for the year. Robert and Barbara’s total food expense for the household was $6, 000. The fair rental value of the lodging provided Ada was $1, 200 for the year, based on the cost of similar room facilities. What was Ada’s total support for the year for purposes of determining whether Robert and Barbara can claim Ada as a dependent? a. $1, 800 b. $3, 330 c. $5, 300 d. none of the above 17

Topic 2 Itemized Deductions: A Broad Brush

2 A Medical Expenses - Family • Deduction – Those of TP, spouse, dependent (10% of AGI floor, 7. 5% if age 65 or older through 2016) • Dependent – Ignore gross income & filing status tests • Expense – Must be for specific disease/illness • Nonqualified – Over the counter drugs, cosmetic surgery (unless deformity), health club dues, meals Capital Expenditures Increasing Value of Property – Deduct only to extent of not increasing the value of the property (e. g. , elevator, swimming pool, etc. ) • Question 6 19

Question 6 Billy had bypass heart surgery in February. At the advice of his doctor, he had an elevator installed in his home so that he would not have to climb stairs. The costs associated with this capital improvement are as follows: • Cost of elevator installed $5, 000 • Increase in value of home due to elevator 2, 500 • Cost of decorative lattice work over elevator 500 • Increase in value of home due to lattice work 0 • Maintenance and repair of elevator 500 None of the expenses were covered by insurance. How much would qualify as deductible medical expenses, before any limitation? a. $3, 000 b. $2, 500 c. $3, 500 d. $5, 500 20

2 B State, Local & Foreign Taxes • Personal Property Taxes – Deduct if based on value • Taxes on Realty – Deductible only by owner, always based on actual period of ownership (not payment; allocate deduction, adjust selling price and basis) • Assessments – Not deductible if add to value (e. g. , sidewalks, streetlights, etc. ) • Sales Tax Option – May elect to deduct state & local sales taxes rather than state & local income taxes (increase table amount by taxes on large purchases) • Question 7 21

Question 7 Humberto purchased a new home on March 15, 2014 in a county that assesses real estate property taxes in the succeeding year (i. e. , 2013 taxes assessed in 2014). At the closing on his new home, Humberto received the following credits against the purchase price of the home: – 2013 real estate property taxes $2, 000 – 2014 real estate property taxes pro-rated 420 In 2013, when the property tax bill for 2012 came in, Humberto had to pay $2, 000. The property tax bill for 2013 rose to a total of $2, 350 which he paid when received in 2014. What are his tax deductions? 2013 2014 a. $2, 220 $2, 350 b. $ 200 $1, 930 c. $ 0 $1, 930 d. $ 0 $1, 880 22

2 C Interest Expense • Interest Expense on Investments – Deduction is limited to net investment income; excess is carryover • Qualified Acquisition Indebtedness – Interest on 1 st $1, 000 loans secured by home (two homes) and spent on home; pre-10/14/87 debt qualifies, reduces $1, 000 • Home Equity Indebtedness – Interest on 1 st $100, 000 of loans secured by home (two homes qualify) but NOT spent on home; no limit on pre-10/14/87 debt • Points – On a primary residence are deductible • Question 8 23

Question 8 Earl took out a mortgage on his home for $250, 000 in 1996. He filed as single for the current year. In April, when the home had a fair market value of $430, 000, Earl took out a home equity loan for $140, 000. He used the proceeds as follows: • $90, 000 for home improvements • $30, 000 for payment of credit card debt • $20, 000 for purchase of securities which produce tax-free income How much of the $140, 000 loan would produce deductible interest? a. $0 b. $90, 000 c. $120, 000 d. $140, 000 24

2 D Charitable Deductions • Deductible – Cash, property, & credit card to listed orgs. (not needy individuals); services not deductible • Out-of-Pocket Exp – Deduct ($. 14 per mile for auto) • Overall Limit – 50% of AGI for both (5 year carryover) • Public Limit – 50% of AGI (deduct first) • Private Limit – 30% of AGI (deduct last) • Special Rules – Property (FMV, limited to 30%AGI, or 50% AGI if TP reduces FMV by gain not recognized), and stringent dollar limit documentation rules • Question 9 25

Question 9 Jerry’s adjusted gross income for the year is $40, 000. How much of the following contributions after limitations, if any, can he deduct on Schedule A? • $1, 000 paid at a charity auction for a week at a fishing resort. The trip is valued at $1, 000. • $500 to the local Chamber of Commerce. • Land adjacent to his church for use as a parking lot. The fair market value of the land is $35, 000. Jerry paid $20, 000 for the land. He doesn’t elect to reduce the fair market value to qualify for a different AGI limit. a. $20, 000 b. $12, 000 c. $10, 500 d. $8, 000 26

2 E Casualty & Theft Losses • Casualty – Fire, storm, shipwreck or other sudden destruction • Temporary Living Expenses – Taxable, reduce by excess cost • Initial Deduction – Lesser of (1) cost or (2) decrease in FMV of property (could be repairs); reduce by insurance • Personal Loss Floors - $100 per casualty/theft, and 10% AGI on total net personal C&T loss • Business Losses – No floors, and if completely destroyed, deduct adjusted basis of property • Casualty in Federally Declared Disaster Area – May elect to deduct on prior-year return • Question 10 27

Question 10 A flood damaged a personal auto owned by Mr. and Mrs. Montez. The area of the flood was a federally-declared disaster area. Based on the following facts, what is the amount of the Montez’s casualty deduction for the year (assume election was not made to file an amended return for prior year)? • Fair market value before the flood $ 7, 000 • Fair market value after the flood 1, 300 • Cost basis 9, 500 • Insurance proceeds 2, 000 • Replacement thru disaster relief 1, 100 • Adjusted gross income for the year 18, 000 a. $700 b. $2, 500 c. $3, 600 d. $4, 500 28

2 F Miscellaneous Itemized • Miscellaneous Itemized Not Subject to 2% Floor– – Impairment-related work expense – Deductions against Income in Respect of a Decedent – Unrecovered annuity or pension costs of decedent – Gambling losses of amateur, to extent of winnings – Limited expenses of certain performing artists • Miscellaneous Itemized Subject to 2% Floor: – Investment expenses for other than rent or royalty income – Allocated investment fees of nonpublic mutual funds (public funds net these on Form 1099 -DIV) – Tax return preparation and litigation fees – Legal fees related specifically to tax advice – Certain hobby expenses • Question 11 29

Question 11 Mr. G, a construction worker, had adjusted gross income of $20, 000. He incurred the following employment- and investment-related expenses: • Safety shoes $ 100 • Union initiation fees 2, 000 • Union dues 300 • Life insurance 800 • Jeans and flannel shirts used for work 200 • Management fees on taxable income-producing investments 1, 200 • Legal expenses for drafting a will 100 He was not reimbursed for any expenses. What is the amount of his miscellaneous expense deduction after any limitations? a. $3, 200 c. $3, 600 b. $3, 400 d. $4, 600 30

Topic 3 Travel & Entertainment Expenses 31

3 A Meals and Entertainment • Deductible Entertainment – Either directly related (bus. discussion during entertain) or associated with (before or after) • Tickets - Treat as entertainment if TP present, and either as gift or entertainment if TP is not present) • 50% Disallowance – On M&E to ultimate payor • Entertainment Facilities – Maintenance cost not deductible • Country Club Memberships – Not deductible, but any direct costs incurred at facility (e. g. , lunch) may be • Gifts - $25 limit per donee per year ($400/$1, 600 for service awards); related party rules apply • Question 12 32

Question 12 Mr. Banks incurred the following unreimbursed business expenses for which he has adequate proof for amounts & purpose: • Business meals $2, 000 • Business entertainment 1, 000 • Business gifts (10 @ $30 each to 10 different people) 300 Based on the above, what is the amount Mr. Banks can deduct before the percentage of adjusted gross income limitation? a. $1, 625 b. $1, 650 c. $1, 750 d. $2, 650 33

3 B Transportation and Auto Exp. • Deductible Commuting Costs – Office to client, or between two jobs, incremental costs for tools/equip. • Auto – Deduct larger of actual or standard mileage • Actual Costs – All actual operating costs (gas, oil, insurance, depreciation), prorate for business usage • 2014 Std. Mileage Rates - $. 56 per business mile Parking & Fees – If business, add to either method • Actual Costs & Accelerated Depreciation – May not switch to Standard Mileage Method 34

3 C Travel Expenses • Travel Expenses – Includes transportation, meals, lodging, incidentals while “away from home” on bus. • Tax Home – Workplace, determined by time spent, activity, & total income; may be personal residence Temporary Location – In travel status unless (1) more than one year, or (2) indefinite; in both cases, tax home has moved to new location • Transportation Costs – For domestic travel, deductible if trip is “primarily business” (bus. days > personal days); travel days are business days 35

Topic 4 Tax Credits for Individuals: A Broad Brush 36

4 A Child & Depend. Care Credit • Credit – Qualified amount x Qualified percentage Qualified Amount – Smallest of: – Actual qualifying child care expenses – $3, 000 (one dependent), $6, 000 (two or more) – Earned income of lesser earning spouse (impute at $250/ $500 mo. for each month spouse is disabled or full-time student) • Qualified Percentage – – 35% if AGI <= $15, 000 – decreases 1% for each additional $2, 000 AGI – constant at 20% once AGI > $43, 000 • Question 13 37

Question 13 Ed and Sue both work and their daughter attends day care. The cost of day care is $300 per month. Ed’s earned income for the year was $10, 000; Sue’s earned income was $40, 000. They had no other income or adjustments. What amount of child care credit can they claim? a. $480 b. $600 c. $720 d. $900 38

4 B Credit for Elderly & Disabled • Credit – For (1) taxpayers age 65 or older with limited social security, or (2) permanently disabled individuals of any age • Formula for Credit – 15% of: – Initial Amount*=$5, 000 S, $7, 500 MJ, $3, 750 MS – Less any social security payments received – Less ½ AGI > $7, 500 S, $10, 000 MJ, $5, 000 MS * Disabled substitute disability pay, if smaller • Question 14 39

Question 14 Dan and Marge filed a joint return for 2014. Dan was 67 years old and Marge’s 65 th birthday was January 1, 2015; neither of them is disabled. During 2014, they received total nontaxable income of $3, 800 from Social Security. Their adjusted gross income was $15, 000. How much can they claim as a credit for the elderly? a. $0 b. $120 c. $180 d. $375 40

4 C Earned Income Tax Credit • E/I Credit – Refundable if no tax due (up to 60%) • Married – Must file MJ; if divorced, custody parent • Claimant – May not be a “qualifying child” • Investment Income Limit for Credit - $3, 350 (2014) • Qualifying Child –Natural/step/foster/adopted, if < 19 or F/T student < age 24, lived w/ TP > ½ yr. • Qualifying Earned Income – Deferred comp, meals & lodging, excluded fringes (but not alimony, unemployment compensation) • Computation – Max for >1; phaseouts apply • Question 15 41

Question 15 Which taxpayer may claim an earned income credit for 2014? a. Ginger, 50 years of age, who has a qualifying child for whom she provides sole support. She received $15, 000 in Social Security and $500 in interest income in 2014. b. Cinnamon, 42 years old, was divorced the entire year. She had investment income of $2, 800 and wages of $7, 000. c. Woody, age 51, is single and lived in a homeless shelter during 2014, and received retirement benefits of $5, 000. d. Cherie, age 35, who is single and has one qualifying child. She had $48, 000 wages and AGI of $50, 000. 42

4 D Child Tax Credit • Child Tax Credit - $1, 000 for qualifying child < age 17 (natural/step/foster, brother/sister & step, or direct descendant of any of these); limited to tax liability • Phaseout of Credit - $. 50 for each $1, 000 AGI > $110, 000 (MJ), $75, 000 (S or HH), $55, 000 (MS) • Refundable Portion – 15% of taxpayer’s earned income (+ combat pay) > $3, 000 43

4 E Education Credits • Credits – For higher education expenses other than room & board; claimed by person eligible to take exemption (even if paid by dependent) • American Opportunity Scholarship Credit – Up to $2, 500 per student for first 2 years of postsecondary education expenses (100% of first $2, 000, 25% of next $2, 000); $2, 500 max • Lifelong Learning Credit – 20% per TP for first $10, 000 expenses for all courses ($2, 000 max) • AGI Phaseouts – $160, 000 -$180, 000 MJ & $80, 000 -$90, 000 S for AOS, $100, 000 -$120, 000 MJ & $50, 000 -$60, 000 S for LLC • Question 16 44

Question 16 Jerry has two dependent children, Greg and Mandy, who are attending an accredited college in 2014. Greg is a graduate student (fifth year of education) who spent $12, 000 for tuition and fees. Mandy, a freshman with no prior post-secondary education, had tuition expenses of $4, 000. Jerry meets all the income and filing status requirements for the education credits. There is no tax-free assistance to pay these expenses. Jerry’s tax liability before credits equals $12, 000. What is the maximum credit that Jerry may claim on his 2014 tax return? a. $2, 500 Lifetime Learning Credit (LLC) b. $3, 000 American Opportunity Credit (AOC) c. $2, 500 AOC and $2, 000 LLC d. $2, 500 AOC and $1, 800 LLC 45

4 F Other Individual Credits • Residential Energy Credits – $500 maximum, reduced by any previous year RE credits • Adoption Credit – Up to $13, 190 for qualified expenses (automatically use maximum amount for special needs child, even if cost is less) • Excess FICA Taxes Paid – If more than one employer and total wages exceed $117, 000 • Elective Deferrals and IRA Contributions – 50%, up to $2, 000, depending on income limits 46

Topic 5 Determining the Adjusted Basis of Property 47

5 A Basis of Purchased Property • Adjusted Basis = Cost + Installation + Capital Improvements – Depreciation/Cost Recovery • Taxes & Closing Costs – Add to basis • Above-Mkt. Price – If business, excess is goodwill • Liabilities Assumed – Always in basis • Property as Compensation – FMV of property received is taxable, and that becomes basis • Securities – Use specific ID; otherwise, FIFO flow; if stock split, reallocate cost to all 48

5 B Stock Dividends & Securities • Stock Dividends – Nontaxable; spread original cost over old & new shares (tack holding periods); if blocks of securities, allocate within each block • Fractional Shares – Allocate basis (relative FMVs) • Stock Dividends – Different Class – if nontaxable, allocate old cost by relative FMVs of both stocks • Proportionate Stock Rights – If nontaxable, allocation required if FMV rights > 15% FMV of stock • Question 17 49

Question 17 On January 3 rd of the current year, Wilson purchased 300 shares of common stock in Corporation Why for $120 per share. Four months later he purchased 100 additional shares at $180 per share. On December 10 th of the current year, Wilson received a 20% nontaxable stock dividend. The new and the old stock are identical. What is the amount of Wilson’s basis in each share of Corporation Why stock after the stock dividend? a. 480 shares at $112. 50 a share b. 360 shares at $120 a share and 120 shares at $180 a share c. 360 shares at $120 a share and 120 shares at $150 a share d. 360 shares at $100 a share and 120 shares at $150 a share 50

5 C Basis – Gift Property • Gift Basis – Gain – Always use donor’s basis • Gift Basis – Loss – Use lesser of (1) donor’s basis or (2) FMV of gift at date of gift • If FMV < Donor’s Basis – And amount realized is between the two possible bases, no gain or loss • Gift-Tax Add-On – To donor’s basis, portion of gift tax related to appreciation in value (100% for pre 77) • Donor Holding Period – Tacks if donor basis used • Figure 1(a) and 1(b) • Questions 18 and 19 51

Figure 1(a) Facts: Taxpayer receives 100 shares of stock as a gift on 4/1/2014, cost of stock to donor on 1/1/2011 was $10, 000, and donor paid a gift tax of $1, 200. FMV of stock on date of gift was $15, 000. Results assuming various sales prices are: a. $18, 000 - $7, 600 LT gain [$18, 000 – ($10, 000 + ($1, 200 x 5/15))] b. $6, 000 - $4, 400 LT loss [$6, 000 – ($10, 000 + ($1, 200 x 5/15))] c. $12, 000 - $1, 600 LT gain [($18, 000 – ($10, 000 + ($1, 200 x 5/15))] Note – In all three cases, gain or loss was long-term because the donor’s basis was used; therefore, holding periods tack 52

Figure 1(b) Facts: Taxpayer receives 100 shares of stock as a gift on 4/1/2014, cost of stock to donor on 1/1/2011 was $10, 000, donor paid a gift tax of $1, 200. FMV of stock on date of gift was $8, 000. Results assuming various sales prices are: a. $18, 000 - $8, 000 LT gain ($18, 000 – $10, 000; no addon) b. $6, 000 - $2, 000 ST loss ($6, 000 – $8, 000; no add-on) c. $8, 500 - $0 gain or loss (SP between basis for gain and loss) Note – In case (b), loss was short-term because the donor’s basis was not used; therefore, holding periods do not tack (4/1/2014) 53

Question 18 In 2008, Paul received a boat as a gift from his father. At the time of the gift, the boat had a fair market value of $60, 000 and an adjusted basis of $80, 000 to Paul’s father. After Paul received the boat, nothing occurred affecting Paul’s basis in the boat. In 2013, Paul sold the boat for $75, 000. What is the amount and character of Paul’s gain? a. ordinary income of $15, 000 b. long-term capital gain of $15, 000 c. long-term capital loss of $5, 000 d. neither a gain or a loss 54

Question 19 Juan received a gift of property from his uncle. At the time of the gift, the property had a fair market value of $100, 000 and an adjusted basis to his uncle of $40, 000. Juan’s uncle paid a gift tax on this transfer of $18, 000. What is Juan’s basis in the property? a. $40, 000 b. $50, 800 c. $60, 000 d. $128, 000 55

5 D Basis – Inherited Property • General Rule – FMV at date of death (state valuation if no federal estate tax return) • Jointly –Held – FMV on inherited portion • Alternate Valuation Date (AVD) – 6 months after date of death; may elect only if (1) value of adjusted gross estate decreases, and (2) estate tax decreases • Distributed Prior to AVD – Use FMV @ distribution • Holding Period – Automatically long-term for all • Question 20 56

Question 20 Mr. Hill inherited 1, 000 shares of Pro Corporation stock from his father who died on March 8, 2013. His father paid $10 per share for the stock on September 1, 1990. The fair market value of the stock on the date of death was $50 per share. On September 8, 2013, the fair market value of the stock was $60 per share. Mr. Hill sold the stock for $75 a share on December 5, 2013. The estate qualified for, and the executor elected, the alternate valuation method. A federal estate tax return was filed. What was Mr. Hill’s basis in the stock on the date of sale? a. $50, 000 b. $60, 000 c. $75, 000 d. $150, 000 57

5 E Basis of Personal Property Converted to Business Use • Basis for Gain – Always cost of property • Basis for Loss – Lesser of (1) cost or (2) FMV of property on date of conversion • Loss Basis – Is always the depreciation basis • Date of Conversion – Determines the cost recovery method (e. g. , ACRS, MACRS, etc. ) • Question 21 58

Question 21 Mary converted her personal residence ($200, 000 cost) to rental property at a time its fair market value was $170, 000. Mary sold the property for $100, 000, after properly deducting $40, 000 of depreciation. Mary’s loss on the sale is: a. $0 b. $30, 000 c. $70, 000 d. $100, 000 59

Topic 6 Netting Capital Gains & Losses of Individuals 60

6 A Capital Asset Definition • Capital Asset Definition – NEVER includes: – Property held for resale (e. g. , inventory) – Property used productively in a trade or business – Copy, literary or artistic composition (c/o basis) – Ordinary accounts or notes receivable – U. S. Government. publications issued at a discount – Commodities and derivatives, hedges, business supplies • What is a Capital Asset? – Purely personal assets and Investment properties • Question 22 61

Question 22 Yang and May Ling owned a fashionable handbag sole proprietorship in New York. They had the following transactions in 2014: • $600, 000 on sale of a rare coin collection May inherited in May 2010 • $100, 000 in accounts receivable from sales of 500 bags in May 2014 • $50, 000 from sale of stocks held in their personal account that were purchased in 2010 • $5, 000 for the purchase of supplies such as computer paper, invoices, etc. used in the business What is the proper gross amount and characterization of capital transactions that Yang and May Ling should report for 2014? a. $650, 000 as long-term capital gain b. $695, 000 as ordinary income c. $50, 000 as long-term capital gain d. $95, 000 as short-term capital gain 62

6 B Capital Gain & Loss Netting • 3 -Step Process – (1) Net all S/Ts, (2) Net all L/Ts (held > 1 yr. ), (3) if same sign, add separately to income under four basic rules below; if opposite signs, add net difference to income under four basic rules below. • Final Result – 4 Basic Rules (for final net result): – S/T Capital Gain – Treat as ordinary income – S/T Capital Loss - $3, 000 offset against ordinary income – L/T Capital Gain – 15% max. rate (0% if 10%/15% bracket, 20% if 39. 6% bracket) – L/T Capital Loss - $3, 000 offset against ordinary income • Figure 2 63

Figure 2 2010 2011 2012 Current-Year Capital Transactions (Before c/o): ST Gain $16, 000 $18, 000 $ 3, 000 ST Loss (18, 000) (26, 000) ( 2, 000) LT Gain 24, 000 2, 000 8, 000 LT Loss (12, 000) ( 1, 000) ( 2, 000) Net Result: Net ST ( 2, 000) ( 8, 000) ( 3, 000) Net LT 12, 000 1, 000 6, 000 Adjusted Gross Income: Salary $70, 000 Capital 10, 000* ( 3, 000) 3, 000* AGI $80, 000 $67, 000 $73, 000 Capital Loss Carryovers (c/o): ST Loss c/o 0 ( 4, 000) 0 LT Loss c/o 0 * Qualifies for 15% maximum rate 2013 2014 $ 2, 000 ( 6, 000) 4, 000 ( 8, 000) $ 9, 000 ( 1, 000) 8, 000 ( 6, 000) ( 4, 000) 7, 000 ( 2, 000) $70, 000 ( 3, 000) $67, 000 $70, 000 5, 000 $75, 000 ( 1, 000) ( 4, 000) 0 64

6 C Preferential Tax Rates for Long-term Capital Gains • If Net L/T Gain – Sort by appropriate rates (ST, 15/20, 25, 28) • 15% (or 0% or 20%) - Basic rate for most L/T capital gains • 25% - For “unrecaptured Sec. 1250 gain” on realty • 28% - For collectibles, Sec. 1202 stock gain, all c/o’s • Netting Process – Four columns for 4 rates: – If 15/20% Nets to a Loss – Net against 28% result first – If S/Ts Net to a Loss – Net against 28% result first – If 28% Nets to a Loss – Net against 25% result first – If 25% Nets to a Loss – Net against any 15% gain result • Figure 3 • Question 22 65

Figure 3 All 28% 25% 15% Short-Term Long-Term* Long-Term (4, 000) (5, 000) 14, 000 (10, 000) 9, 000 4, 000 6, 000 (9, 000) 12, 000 1, 000 (3, 000) (4, 000) 8, 000 14, 000 ** (3, 000) | (3, 000) <-------------v v----- (4, 000) 1, 000 ** * Includes any long-term capital loss carryover ** Result - $1, 000 taxed at a 28% rate, and $14, 000 taxed at a 25% rate 66

Question 23 In December, Emily sold an antique rug for $4, 100. She bought the rug two years ago for $1, 100. What is her taxable gain and at what maximum rate will it be taxed? a. $3, 000 long-term capital gain, taxed at regular rate b. $3, 000 long-term capital gain, taxed at 28% rate c. $1, 500 long-term capital gain, taxed at regular rate d. $1, 500 long-term capital gain, taxed at 28% rate 67

6 D Reporting Net Capital Losses • $3, 000 – Maximum total ordinary income offset for net S/T and net L/T losses each yr. (use S/T first) • $1, 500 – Married – filing separately limit • If Taxable Income < Capital Loss – Full limit (up to $3, 000) still assumed utilized in computing carryover • Capital Loss Carryover – Indefinite (retain character) • Decedent’s Return – No carryovers possible • Question 24 68

Question 24 During the current year, Nancy had the following transactions: – Short-term capital loss $(2, 400) – Short-term capital gain 2, 000 – Short-term capital loss carryover from 2013 (1, 400) – Long-term capital gain 3, 800 – Long-term capital loss (8, 000) What is the amount of her capital loss deduction, and what is the amount and character of her capital loss carryover to the next year? • Deduction Carryover a. $0 $6, 000 long-term b. $3, 000 long-term c. $6, 000 $-0 d. $3, 000 short-term 69

Topic 7 Vacation Home Rentals Under Sec. 280 A 70

7 A Sec. 280 A Classifications • Sec. 280 A – 3 Basic Vacation Home Rules: – De Minimis – Ignore income and expenses if rental days < 15 – Insignificant Personal Usage – If <= larger of 14 days or 10% days rented, deduct loss (passive? ) – Significant Personal Use – If > larger of 14 days or 10% days rented, deductions limited to income (carryover any unused losses to future years) • If Limit Applies – Deduct (1) interest/taxes/casualty & theft losses first, then (2) non-depreciation expenses, then (3) depreciation, up to the point of $0 net income 71

7 B Sec. 280 A Loss Limitations • Allocations of Expenses to Rental & /Personal – IRS (days actually used), Bolton decision (365 days for int. /taxes) • Co-owner Use & Swaps – Count as personal days • Repair Days (substantial) – Not personal days • Figure 4 • Questions 25 and 26 72

Figure 4 J owns a cabin by the beach that was held out for rent for the entire year of 2014. J actually rented the cabin for 120 days and used the cabin for 30 days of personal vacation. J received $2, 850 gross rents for the 120 -day period and incurred the following expenses in 2014: interest, $1, 600; taxes, $1, 200; repairs, $500; utilities, $800; and depreciation, $1, 500. Since her personal usage (30 days) exceeds the greater of 14 days or 10% of the days rented (12 days), her expense deductions under the two methods would be as follows: IRS Method Bolton Method Gross rents $2, 850 Less expenses otherwise deductible: Interest ($1, 600) (*120/150 & **120/365) (1, 280)* ( 526)** Taxes ($1, 200) (*120/150 & **120/365) ( 960)* ( 394)** Limit on Remaining Rental Expenses $ 610 $1, 930 73

Question 25 Peter owned a cottage on the lake that he bought in 2013. In 2014, he rented the cottage for 10 days to a stranger and used the cottage for 20 days for his own personal use. The cottage was not used the rest of the year. Peter had rental income of $1, 000 and he paid $600 for repairs. How should he report these activities on his 2014 return? a. $1, 000 income, $600 expense b. $333 income, $200 expense c. $-0 - income, $-0 - expense d. $667 income, $400 expense 74

Question 26 Mr. Lee rents his vacation home. Given the following information, determine the correct treatment of the rental income and expenses on his 2014 return. • Days rented in 2014 to unrelated parties at a fair rental price 56 • Days used for personal purposes in 2014 18 • Total income and (expenses) during 2014: Gross rental income $ 5, 000 Allocated interest and taxes (4, 000) Other allocated expenses (1, 500) Net rental loss (500) a. $500 loss should be shown on Schedule E, Form 1040 b. interest & taxes deducted on 1040 Schedule A, as itemized deductions c. Mr. Lee should include none of the income or expenses from beach house d. rental expenses (other than interest & taxes) limited to the gross rental income in excess of deductions for interest & taxes allocated to rental use 75

Topic 8 Individual Retirement Accounts 76

8 A IRAs – Qualifications • Required – Earned comp. , < age 70½ at year end • Spouses – Each has account (total comp. limit) • Contributions – Up to due date (no extension); owner cannot be trustee (bank or fiduciary is OK) • Investments in IRA – Not allowed in saving bonds or collectibles (except U. S. gold or silver coins OK) • Rollovers – If w/d, redeposit w/i 60 days; no loans • Death – IRA included in estate, can only be rolled over by spouse, can combine with spouse, basis carryover 77

8 B IRAs – Earned Compensation • “Earned” – Limits IRA contribution/deduction • Does Not Include - Deferred comp, unearned sources (interest, dividends, pension income, etc. ), or a limited partner’s share of income • Includes – Wages/salary/commissions, S/E income (less ½ SE tax & other retirement contributions), taxable alimony & separate maintenance payments • S/E Loss – Does not offset salary for limit • Question 27 78

Question 27 Which of the following is compensation for the purpose of contributions to individual retirement accounts? a. deferred compensation received b. foreign earned income excluded from income c. pension or annuity income d. taxable alimony and separate maintenance 79

8 C IRAs: Prohibited Transaction • Prohibited Transactions – Plan and D/Q Person: – Transfer income/assets to “disqualified” person – Fiduciary acting in its own self-interest – Consideration to fiduciary from plan party – Any acts between plan/disqualified Person (sell, lending) • IRA Rule – If prohibited transaction, lose IRA status as of 1 st day of year, treated as distribution of cash (FMV of account) as of first of year 80

8 D Maximum Contrib. & Deduct. • Maximum Contribution – Lesser of $5, 500 per spouse ($6, 500 if 50 or older), or TPs’ combined earned income • Maximum Deduction – Depends on other plan participation: • Neither Spouse Participates – Maximum $5, 500/$6, 500 each • Both Spouses Participates – Reduce $5, 000/$6, 000 proportionately for AGI between $60, 000 and $70, 000 ($96, 000 and $116, 000 if married filing jointly) • One Spouse Participates – If covered, same as both; if not covered, AGI phaseout over $181, 000 -$191, 000 [$200 minimum contribution allowed] • Question 28 81

Question 28 Lenny and Norma file a joint return for tax year 2014. Lenny is covered by a retirement plan but Norma is not. Norma wishes to make a contribution to a traditional IRA, and her earnings alone are $1, 500. The combined earnings on the joint return are $163, 000 (the same as the modified AGI). Which of the following is correct? a. Norma may make a nondeductible contribution of $2, 000 b. Norma may make a deductible contribution of $5, 500 c. Norma may not make any contribution d. Norma may make a deductible contribution of $3, 000 and a nondeductible contribution of $2, 500 82

8 E Roth IRAs • Roth IRA – No age limit for contributions, contribute up to $5, 500/$6, 500; nondeductible, but no tax on withdrawals after 5 -year period; reduce $5, 500/$6, 500 by contributions to regular IRA • Phaseout – MJ($181, 000 -$191, 000), S($114, 000 -$129, 000) • Tax-Free Distributions – After 5 yrs. if age 59½, disabled, or first-time home buying • Regular IRA – May be converted to Roth, but must recognize deferred income at conversion Recharacterizations – Possible if trustee to trustee • Question 29 83

Question 29 Which of the following is correct regarding contributions to a Roth IRA? a. contributions may be made regardless of age provided other requirements are met b. contributions may be deducted if you are within certain income limits c. contributions may be deducted if you are not covered under a retirement plan d. contributions may not be deducted, but earnings are taxable when distributed 84

8 F Educational (Coverdell) IRA • Educational IRA – Designate as such, for education expenses of beneficiary (child < 18) • Contributions - $2, 000 maximum total per child, no deduct; AGI phaseouts begin at @$95, 000 (single, over $15, 000 range) or $190, 000 (MJ, over $30, 000 range) • Amounts Spent – Nontax. if for qualified education exp; any excess taxed @ regular tax rate + 10% • Req. Withdrawal – Within 30 days of beneficiary reaching age 30, or date of death if before • Exceptions – Special needs, military advanced ed. • Question 30 85

Question 30 Which of the following is correct regarding a Coverdell (education) IRA? a. contributions are deductible b. contributions other than cash may be made c. contributions may be made until age 30 d. the annual contribution limit is $2, 000 for each child, no matter how many education IRAs are set up for that child 86

8 G Sec. 401(k) Plans • CODA – Employee choice - cash or deferred annuity • Contributions – Excluded, 100% vested, deferred taxes, tax-free accumulations • Nondiscrimination - Tests for highly comp. • Sec. 403(b) Plan – Similar plan for educators • Maximum Contribution - $17, 500 per year ($23, 000 if age 50 or older) – not excluded from payroll tax • Overall Limit on Contribution – Lesser of 25% comp or $51, 000, less all contributions to qualified plans 87

Topic 9 Federal Gift Tax – A Quick and Dirty Overview 88

9 A Filing Requirements • Certain “Gifts” Are Not Gifts for Gift Tax Purposes: – Tuition ore medical expenses paid for someone else – Political contributions – Gifts to spouse or charity – Gifts to 3 rd party <= $14, 000 (if present interest) • Spouses – No “joint return, ” but may elect to split gifts • Generation-Skipping Transfer Tax – Any gift to “skip” (2 generations younger), taxed at maximum rate, $5, 340, 000 exemption • Unified Credit (below) – Means no tax on first $5, 340, 000 of taxable transfers. • Question 31 89

Question 31 Donald is a tax return preparer. His client, Jody Black, told him that she had made several gifts during 2013 and asked if she should file a gift tax return, and if so, how much tax she would owe. Jody has never given a taxable gift before. Donald reviewed Jody’s gift transactions as follows: • Paid medical bills, of $15, 000 for her father and $8, 000 for her mother • Bought a sports car for her son; cost was $37, 000 • Gave $15, 000 cash to her church • Prepared her will leaving her $75, 000 vacation cabin to her sister • Sent a wedding gift of $1, 000 to her niece What is Donald’s best answer to Jody’s questions? a. no return is due because gifts to family are excluded b. must file gift tax return and will owe tax on $37, 000 c. must file gift tax return but no tax owed due to the unified credit d. none of the above 90

9 B Types of Gifts • Types of Gifts – Include bargain sales, release of general power of appointment, forgiveness of debt (family), below-market loans, beneficiary assignment, property settlements in divorce, exchanging single annuity for joint annuity • Donee Disclaimer – Donor must receive from donee within 9 months of gift; if so, no gift has been made • Due Date – By April 15 th after year end (penalties exist for late filing and/or payment) • Deceased Donor – Due date is earlier of (1) gift tax due date (2) estate tax due date (plus extensions) 91

9 C Computing Taxable Gifts • Gift-Splitting – By married couple, splits gifts in half; (must file 709 with signature agreements) • Annual Exclusion - $14, 000 per donee per year for gifts of present interest (can currently enjoy) • Marital Deduction – Unlimited for any gift to (U. S. citizen) spouse that is not a terminable interest Charitable Deduction – Unlimited for gifts of present interests to recognized charities • Credits - $2, 081, 800 unified credit (UC), prior gift taxes paid (UC was $2, 045, 800 in 2013) • Figures 5, 6, 7 and 8 (note – uses 2013 UC) • Question 32 92

Figure 5 No Gift-Splitting 93

Figure 6 Gift Splitting – Tom 94

Figure 7 Gift Splitting – Jan 95

Figure 8 Unified Transfer Tax 96

Question 32 Mr. Fred Wall bought a house that cost $50, 000 for an unrelated friend, Gloria Wilson, in 2014. Mrs. Wall made no gifts in 2014. In filing their gift tax returns for 2014, Mr. and Mrs. Wall should file Form 709, United States Gift Tax Return, as follows: a. Mr. Wall should file a gift tax return reporting the $50, 000 gift and taking a $14, 000 annual exclusion. b. File one joint gift tax return reporting the $50, 000 gift and taking a $14, 000 annual exclusion for each spouse, or $28, 000 total. c. File two gift tax returns, one for Mr. Wall and one for Mrs. Wall, with each spouse signing the consent section of the other’s gift tax return signifying that the spouse agrees to treat all gifts as made one-half by each spouse. A $14, 000 annual exclusion may be taken on each return. d. Either a. or c. 97

Topic 10 Federal Estate Tax – A Quick and Dirty Overview 98

10 A Estate Tax – Requirements • Form 706 – Due 9 months after date of death • Gross Estate – FMV of all properties owned by decedent at death • Required Filing – If sum of gross estate and lifetime gifts > $5, 340, 000 (the exemption equivalent of unified credit for the estate tax) • Unified Credit – $2, 081, 800 in 2014 (equals the unified transfer tax on an estate of $5, 340, 000) • Questions 33 and 34 99

Question 33 What amount of a decedent’s taxable estate is effectively tax-free in 2014 if the maximum unified estate and gift tax credit is taken? a. $12, 000 b. $345, 800 c. $1, 000 d. $5, 340, 000 100

Question 34 Mr. Alexis died April 30, 2014. His gross estate totaled $6. 8 million dollars. Assuming no extension is granted, the executor must file Form 706, United States Estate Tax Return, on or before: a. April 15, 2014 b. August 15, 2014 c. January 31, 2015 d. October 31, 2015 101

10 B Gross Estate – Inclusions • Gross Estate – FMV of all property at death, including any outstanding loans and notes • Incomplete Transfer Inclusions – Life insurance proceeds (if payable to estate or retained incidents of ownership, e. g. , loans, etc. ) – Life insurance proceeds (if transfer within 3 years) – Any transfers within 3 yrs. with reversionary int. – Gift taxes paid on gifts within 3 yrs. of death 102

10 C Gross Estate Deductions • Marital Deduction – Unlimited deduction for bequests of non-terminable interest prop. (also for QTIP election terminable interest property) • Charitable Deduction – Unlimited for contributions to recognized charities • Administrative Exp. – Legal & accounting fees • Others – Liabilities against property, casualty or theft loss funeral costs, , last illness expenses (latter two may be on 1040 or 1041 instead) 103

10 D Computation of Estate Tax • Estate Tax – Computed on a cumulative basis: – Add lifetime gifts to gross estate, – Compute tax on total, then – offset total tax with any gift taxes paid and unified credit • Extensions to File/Pay – Are available • Some Credits – Are available (see next slide) 104

10 E Credits Against Estate Tax • $2, 081, 800 Unified Credit - Available to each estate to offset tax in 2014; $2, 045, 800 in 2013) • Prior Gift Taxes Paid Credit – Allowed because total tax includes lifetime gifts in base • Prior Transfer Taxes Credit – Mitigates multiple estate inclusions within 10 years; sliding % inclusion depending on interval between the two deaths(100% within 2 years, 20% drop for each 2 years, 0% for 10) • Foreign Death Tax Credit – For amounts paid • Figure 9 (uses 2013 UC) 105

Figure 9(a) – Example Facts 106

Figure 9(b) (Estate Tax) 107

Bonus Topic Individual Shared Responsibility Payments

Affordable Care Act—Individual Mandate • Since January, 2014, each taxpayer and member of the taxpayer’s household must: – have health insurance coverage throughout the year, – qualify for an exemption from coverage, or – make a payment when filing their tax return. • Qualifying coverage includes: – Coverage provided by an employer, • employer’s share is reported on W-2, line 12 d, code DD – Purchased by the taxpayer through the Health Insurance Marketplace or a private carrier – Government-sponsored coverage (Medicare, Medicaid) 109

Individual Shared Responsibility Payment • ISRP payment is required for each month that the taxpayer or taxpayer’s dependents do not have coverage and do not qualify for an exemption. • The 2015 payment is 2% of household income or a flat dollar amount, whichever is greater, limited to the cost of the average national premium for a bronze level health plan available through the Marketplace. – The flat annual dollar amount is $325 per adult and $162. 50 per child limited with a per household limit of $975. – The bronze level premium is $207 per individual per month, with a maximum monthly premium of $1, 035 for a family with 5 or more members. – Divide annual payment divided by 12 to get monthly payment 110

• Examples • Single – Baylor, single with no dependents, has income of $50, 000 before the household exemption. – His ISRP is $794, the greater of (1) $325 or (2) $794 ($50, 000 - $10, 300) x 2%. – The ISRP may not exceed $2, 484 (the national average for bronze coverage for singles). • MFJ – Harold and Maude are married with three children, one under the age of 18, have income of $62, 000 before the household exemption. – Their ISRP is $975, the greater of (1) $975— family maximum, or (2) $828 ($62, 000 - $20, 600) x 2%. – The ISRP may not exceed $12, 420 (the national average for bronze coverage for a family of five or more individuals).

Computation of ISRP—Single • Jim, is not married and has no dependents. He does not have minimum essential coverage for any month during 2015 and does not qualify for an exemption. His household income of $40, 000 reduced by the filing threshold of $10, 300 is $29, 700. • What is Jim’s ISRP? • $0 • $325 • $594 • $2, 484 112

Computation of ISRP—MFJ • Eduardo and Julia are married and have two children under 18. They do not have minimum essential coverage for any family member for any month during 2015 and no one in the family qualifies for an exemption. Their household income is $70, 000 reduced by their filing threshold of $20, 600 is $49, 400. • What is their ISRP? a. $0 b. $975 c. $988 d. $9, 936 ($204 x 12) 113

2016 and beyond • In 2016, the 2. 0% penalty on household income increases to 2. 5% and the flat dollar amount increases to $695 per adult ($347. 50 per child under 18) with a maximum of $2, 085. • Maximum flat dollar amount may apply to families with household income <$83, 400 ($2, 085/2. 5%) • After 2016, the percentage increase is based upon the inflation adjusted increase in health care costs. 114

Questions? As Time Permits Or contact: NSA EA Review Blog 115

Question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Answer c d d b c a c c b a a c b c d d b Explanation Earned income + $350 exceeds $1, 000 minimum S/D Filing requirement is $3, 950 exemption + $9, 150 S/D (HH status) Careful - <$400 net, but gross income is $50, 000 (no deductions) Exclude daughter (not F/T student), and cousin (not whole year) $1, 500 own + $600 medical + $2, 000 food (1/3) + $1, 200 lodging The elevator cost less increase in value is deductible, as is upkeep None of 2013 is deducted, $2, 350 -$420 credit deductible in 2014 $90, 000 is acquisition debt, and the $30, 000 is home equity debt The land donation, FMV, is limited in one year to 30% of AGI) $5, 700 decline in FMV-$3, 100 ins-$100 floor– 10% AGI Deduction = $100 + $2, 000 +$300 + $1, 200 – ($20, 000 x. 02) 50% of $3, 000 M& E deductible, plus $25 max. per gift x 10 gifts $3, 000 maximum costs for one dependent x. 20 [$7, 500 -$3, 800 -(($15, 000 -$10, 000)x. 50)]x. 15 (age 65 on 12/31) < $3, 350 invest. income (a & c no earned income; d too much) Am. Op ($2, 500 maximum for Mandy), LL ($10, 000 x. 20 for Greg) Basis of each block is allocated over the larger number of sh. Selling price between two possible bases (FMV < donor basis) Donor’s $40, 000 basis inc. by (60, 000/100, 000 x $18, 000 gift tax) 116

20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 b b a b b c d d b a d c d d c FMV at 6 months after date of death - alternate valuation date Basis for loss is lesser of FMV at conv. or cost, reduced by depr. Accounts receivable and supplies never qualify as capital assets The antique rug is a collectible, taxed at a 28% rate ST nets to $1, 800 loss, LT nets to $4, 200 loss ($1, 200 deduct. ) Property was rented for less than 15 days, no reporting required Significant personal usage, limits apply (int. & taxes deduct first) Alimony qualifies as compensation for IRA qualification purposes Earnings limit based on combined earnings of both spouses There are no age restrictions on Roth contributions Contributions in one year for a child are limited to $2, 000 total Gift to son necessitates filing a return (> $14, 000), no tax due Taxpayer has a choice of gift-splitting or not Threshold is the unified exemption equiv. of $5, 340, 000 in 2014 The filing deadline is nine months following the date of death 117

Thank you for participating in this webinar. Below is the link to the online survey and CPE quiz: http: //webinars. nsacct. org/postevent. php? id=15782 Use your password for this webinar that is in your email confirmation. You must complete this survey and the quiz or final exam (for the recorded version) to qualify to receive CPE credit. National Society of Accountants 1010 North Fairfax Street Alexandria, VA 22314 -1574 Phone: (800) 966 -6679 members@nsacct. org 118