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Exam 1 Study Guide

by: Merritt Notetaker

Exam 1 Study Guide ACCT 4350

Merritt Notetaker


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This study guide covers the material that will be on Exam 1.
Advanced Federal Taxation
Dr. Ellen Best
Study Guide
Advanced, taxation, Corporation, property, transfers
50 ?




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This 11 page Study Guide was uploaded by Merritt Notetaker on Saturday October 1, 2016. The Study Guide belongs to ACCT 4350 at University of North Georgia taught by Dr. Ellen Best in Fall 2016. Since its upload, it has received 19 views. For similar materials see Advanced Federal Taxation in Accounting at University of North Georgia.


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Date Created: 10/01/16
Advanced Taxation EXAM 1 STUDY GUIDE 1. CHAPTER 14 – PROPERTY TRANSACTIONS This chapter essentially breaks down to gains and losses. A. Three things determine the character of a gain or loss. i. Tax Status 1. Capital 2. § 1231 3. Ordinary ii. Manner of Disposition 1. Sale 2. Exchange 3. Casualty 4. Theft 5. Condemnation iii. Holding Period 1. Short Term – less than 1 year 2. Long Term – longer than 1 year B. § 1231 Assets i. Depreciable and real property, used in the business, and owned for more than 1 year. (Long term) ii. For the creator of a patent, the patent is a long term capital asset. If the patent is sold, it becomes either a § 1231 asset or an ordinary asset, depending on the use of the asset. iii. The alternative tax rates for capital gains are not very beneficial for corporations. iv. Does Not Include: 1. Depreciable and real property, used in the business, and owned for LESS than 1 year. 2. Casualty losses that exceed casualty gains. 3. Held-for-Sale investments. 4. Copyrights and artistic creations. 5. Accounts and Notes Receivables. v. § 1231 gains are long term capital gains. vi. § 1231 losses are ordinary losses. vii. Special Rule: Casualty Gains and Losses are netted together and then netted with § 1231 C. Depreciation Recapture i. Assets subject to depreciation or cost recovery and disposed of at a gain are subject to depreciation recapture. ii. Losses are not subject to recapture. Losses are treated as ordinary. iii. 2 Recapture Provisions: 1. § 1245 a. 100% of the deprecation can be recaptured as ordinary gain instead of capital gain. i. Only applies to gains. We don’t care about losses. b. The method of depreciation does not matter. c. If the gain is greater than depreciation, the amount equal to the accumulated depreciation is treated as ordinary gain and the rest is capital gain. i. Easy Trick: The only time there will be a capital gain is if the asset is sold for more than the purchase price. 2. § 1250 – Real Estate and Leaseholds a. MACRS is the standard depreciation method so, we don’t see § 1250 very often. i. We do see it when you take bonus depreciation. Such as, 1. § 168 (k) – When depreciation exceeds Straight Line depreciation. 2. § 179 (media) – When depreciation exceeds Straight Line depreciation. b. Only applies to additional depreciation. c. Only applies to gains. d. § 291 – a corporation must take the lesser of 20% of recognized gain or 20% of depreciation taken. 3. Recapture provision override everything else except: a. When all the gain is not recognized at once. i. Such as, like kind exchanges and involuntary conversions. b. When gain is not recognized at all. i. Such as, gifts and inheritances. * Capital assets are capital, non-depreciable, assets. Such as, investments. D. Netting Capital Gains and Losses – For individuals i. First, determine short vs. long term gains and losses. ii. Second, net short items together. Then, net long items together. 1. If you have a net short term loss and a net long term loss, keep both items separate. DO NOT net them together. a. You can take up to $3000 in deductions. Use short term first. b. Can carry any leftover loss indefinitely c. They keep their character. (Short stays short, long stays long) 2. If you have a net short term gain and a net long term gain, keep both items separate. DO NOT net them together. 3. If you have a net short term loss and a net long term gain, net them together. 2 a. You will have either a net short term loss or a net long term gain. 4. If you have a net short term gain and a net long term loss, net them together. a. You will have either a net short term gain or a net long term loss. E. Netting Capital Gains and Losses – For corporations i. First, determine short vs. long term gains and losses. ii. Second, net short items together. Then, net long items together. 1. If you have a net short term loss and a net long term loss, keep them separate. DO NOT net them together. a. They cannot be used in the current year. b. They can be carried back 3 years. c. They can be carried forward 5 years. d. Always carries as short term, in which case, combine short and long. 2. If you have a net short term gain and a net long term gain, keep them separate. DO NOT net them together. 3. If you have a net short term loss and a net long term gain, net them together. a. You will have either a net short term loss or a net long term gain. 4. If you have a net short term gain and a net long term loss, net them together. a. You will have either a net short term gain and a net long term loss, which will be carried as short term. F. § 1231 Gain and Loss Netting i. Combine gains and losses 1. Net Losses – always ordinary 2. Net Gains – consider lookback for 5 years 2. CHAPTER 17 – CORPORATE STRUCTURES A. Different Corporate Structures i. Partnerships 1. Two people 2. Separate entity, but does not pay taxes 3. Income and taxes are aggregated a. Some items are reportedly separately to each partner 4. Schedule K-1 form is used ii. S Corporation 1. Separate entity, only pay special taxes 2. Previously a C Corporation 3. Certain items are reported separately to shareholders iii. C Corporation 1. Subject to entity level federal income tax 2. Double taxation 3 a. The corporation is taxed when dividends are paid and shareholders are taxed when they receive dividends. b. Dividends are not deductible by corporations. c. Taxed at a capital gains level for individuals. iv. Limited Liability Company 1. Owners avoid unlimited liability 2. Business can be treated as a partnership v. Non-Tax Issues in Selecting an Entity Form 1. Liability a. Ex, a sole proprietor has unlimited liability. 2. Capital Raising a. Ex, a corporation can sell stock to raise capital. 3. Transferability a. Ex, a corporation can transfer stock in order to transfer ownership of the company. 4. Continuity of Life a. Corporations live forever, until dissolution. 5. Centralized Management a. Corporations have board of directors, etc. vi. Check the Box Regulation 1. Allows a taxpayer to choose tax status 2. If you don’t choose, the default: a. For 1 person, a sole proprietorship b. For more than 1 person, a partnership. B. Corporate and Individual Tax Comparisons i. Similarities 1. Gross Income 2. Business Deductions ii. Differences 1. Corporations do not have Adjusted Gross Income 2. Corporations do not have itemized deductions 3. Corporations do not reduce casualty losses by $100 or 10% iii. Specific Provisions 1. Accounting Methods and Periods a. Most C Corporations can use a calendar year. b. S Corporations are limited in available year ends. c. C Corporations cannot use Cash method unless: i. They are in the farming or lumber industry ii. They are a Qualified Personal Service Company. iii. They’re average annual gross receipts are less than $5,000,000. C. Other Topics 4 i. Passive Income – dividends, interest, etc. 1. Individuals cannot offset passive losses. 2. Corporations do not have passive income. ii. Charitable Contributions 1. Must take the deduction in the same year the contribution is made. a. Unless it was approved at year end and paid by March 15 thof the next year. 2. If contributing Long Term Capital Gain property; a. You can deduct the Fair Market Value b. Except: i. If you contribute tangible personal property and it is used in the intended purpose, you can deduct the basis of the property. ii. If you contribute to a Private Non-Operating Foundation. 3. If you are contributing inventory; a. You can deduct the cost of the inventory. i. Except: 1. If the inventory is used in the intended function, you can deduct the cost of the inventory + 50%. 4. Limit for Charitable Contribution Deductions a. 10% of taxable income b. Can be carried forward 5 years iii. Domestic Production Activities Deduction - DPAD 1. 9% times the lesser of: a. Qualified Production Activities Income or b. Taxable (or Adjusted Gross) Income 2. Deduction cannot exceed 50% of an employer’s W2 wages related to qualified production activities income. iv. NOL – Net Operating Loss 1. Can be carried back 2 years. 2. Unused portion can be carried forward 20 years. 3. Corporation does not a. Adjust tax loss because of capital loss. b. Adjust for non-business expenses. 4. Corporation can use Dividends Received Deduction. v. DRD – Dividends Received Deduction 1. Allows a corporation to deduct portions of dividends received from other corporations that the initial corporation has ownership in. a. If the initial corporation owns less than 20% of the other corporation, they can deduct 70% of dividends received. b. If the initial corporation owns between 20% and 80% of the other corporation, they can deduct 80% of dividends received. 5 c. If the initial corporation owns more than 80% of the other corporation, they can deduct 100% of dividends received. 2. Deduction is limited to a percentage of taxable income. a. Taxable income is computed without: i. NOL Deduction ii. DRD iii. DPAD iv. Any capital loss carry back 3. Calculating DRD a. First, take the dividend received and times it by the corporation’s tax rate. b. Second, take the taxable income and times it by the corporation’s tax rate. c. Third, subtract the answer in (a) from taxable income. i. If the answer in (c) creates an NOL, the DRD is equal to the answer in (a). ii. If the answer in (c) does not create an NOL, the DRD is equal to the lesser of the answer in (a) or the answer in (b). vi. Organizational Expenditure § 248 1. A corporation may elect to amortize the organizational expenditures over an 18 month period. 2. A special exception allows a corporation to immediately expense the first $5,000. a. However, there is a dollar for dollar phase-out that begins when the expenditures equal or exceed $50,000. b. If the expenditures equal or exceed $55,000, the corporation cannot claim the $5,000 immediate expense. 3. Valid expenditures include: a. Legal expenses related to the organization b. Necessary accounting services c. Expenses of temporary directors d. Fees paid to the state of incorporation 4. It doesn’t matter so much when the expenses are paid, as long as they are incurred in the current year. vii. Start Up Expenditures 1. Various investigation expenses involved in entering a new business. 2. Also includes operating expense that are incurred before the business makes income. 3. At the election of the tax payer, such expenses can be treated as organizational expenditures. a. Still get the $5,000 immediate expense and the same phase-out. b. Any remaining amount amortized over 180 months. viii. Tax Liability of Related Corporations 6 1. If you have related companies and there is sufficient ownership, all of the corporations may have to come together and file one huge entity. ix. Corporate Filing Requirements th rd 1. Form 1120 on or before the 15 day of the 3 month that following year. a. Automatic 6 month extension is available by filing Form 7004 b. The extension is for filing your taxes, not an extension for paying them. 2. Must make estimated tax payments equal to the lesser of: a. 100% of the corporation’s taxes for the current year or b. 100% of the corporation’s taxes for the previous year. 3. Schedule M-1 a. Must reconcile accounting income to taxable income. b. Common items: i. Federal Income Tax ii. Net Capital Losses iii. Income reported for tax but not for book income. (and vice versa) iv. Expenses for book income but not taxable income. (and vice versa) 4. Schedule M-2 a. AKA Retained Earnings Statement 5. Schedule M-3 a. Massive M-1 for corporations with more than $10 million in assets. i. More in depth ii. Identifies more questionable tax practices * High income individuals can take advantage of lower marginal tax rates as a corporation. 3. CHAPTER 18 – CORPORATIONS A. What is § 351? i. A § 351 transaction is when a person transfers property to a corporation in exchange for stock or other assets, typically when the company is first formed. ii. § 351 allows this transaction to be tax free for the person giving the property and the corporation accepting the property. iii. § 351 transactions can occur at any time. However, it’s a lot harder to meet the 80% ownership requirement in later transactions. B. Consequences of § 351 i. In general, there is no gain or loss to the transferors (those giving) when 1. They give the property 2. In exchange for stock 3. If immediately after the transfer, the transferors own 80% of the outstanding share of stock. ii. If boot (property other than stock) is received by the transferors 1. Gain recognized up to the lesser of 7 a. Root received b. Realized Gain 2. No loss is recognized C. What is property? i. Cash ii. Secret Processes and formulas iii. Unrealized Accounts Receivable iv. Installment payments * § 351 specifically EXCLUDES services from the definition of property. D. What stock is transferred? i. Can be common or preferred 1. However, if preferred, any debt features will cause the preferred stock to be considered debt. ii. Does not include stock rights or warrants. They would be considered boot if included. iii. Does not include bonds. They would be considered boot if included. E. What does control mean? i. After a § 351 transfer, the transferors must own 80% of the outstanding shares of stock AND ii. The transferors must have 80% of the voting rights. F. How soon is immediately after? i. For § 351, the transfers do not need to be simultaneous. ii. Rights of parties should be outlined before the transfer. iii. Must be reasonably close together. G. Transfers of Property AND Services i. A person who transfers property and also performs a service may be to be a part of the 80% controlling group and, therefore, be covered under § 351. 1. Must put in property worth more than 10% of the value of the property the other shareholders are putting in. 2. The person performing services will be taxed on the value of the stock received in exchange for services. a. However, they will not be taxed on the stock received in exchange for the property contributed. 3. ALL of the shares received are counted towards the 80% control requirement. H. Assumption of Liabilities in § 351 i. When a building with a mortgage is contributed to a corporation, the corporation takes up the mortgage payments, assuming the liability of the mortgage. ii. Assumption of liabilities does not typically result in boot for gain recognition purposes. iii. Unless: 1. § 357 (b) – Liabilities incurred for no business purpose or for tax avoidance. In this case, the entire amount of the liability becomes boot. 8 a. One bad liability taints any and all liabilities in the same transfer. 2. § 357 (c) – Liabilities are greater than the basis of the property. In this case, boot is equal to the excess of liability over basis. 3. If both are present, (b) trumps (c). iv. For the shareholder, their basis in the stock received is decreased by the amount of the liability assumed. I. Stock Basis Formula i. Adjusted Basis of Property Transferred ii. + Recognized Gain iii. – Loss Property iv. – Boot v. Basis vi. The stock basis should be equal to the Fair Market Value of the property transferred. J. Corporation’s Basis in Property i. Adjusted Basis of Property ii. + Recognized Gain by Shareholder iii. – Loss Property Adjustment iv. Basis K. Adjustment for Loss Property i. Property that is transferred when the fair market value is less than the basis is considered a loss property. ii. Aggregate basis may have to be stepped down so basis doesn’t exceed the Fair Market Value iii. Necessary to prevent parties from obtaining a double benefit. iv. A step down has to be allocated among assets (See example 23 in text book) v. The step down has to happen with either the corporation or the shareholder but, not both. vi. The step down usually happens on the corporation’s side but, the shareholder can elect to do it on their side. L. Stock Issued for Services i. May be able to deduct the Fair Market value of stock issued for service. ii. If it is a normal service that would typically be expensed, the stock can be expensed. iii. If it is a service that would normally be capitalized, then the Fair Market Value will be capitalized. iv. If not enough information is given, assume it is a normal expenditure and expense off. M. Holding Period i. Corporation picks up the holding period where the transferor left off. ii. Ex. The corporation receives property that has been owned by the transferor for 30 years. The holding period for the corporation then becomes 30 years. N. Recapture 9 i. § 1245 and § 1250 are not considered under § 351. O. Capital Contributions i. No gain or loss is recognized by the corporation on receipt of money or property in exchange for stock. ii. If you get a capital contribution from a non-shareholder, it is not taxable and its basis will be 0. P. Cash Capital Contribution i. If cash is contributed by a non-shareholder, not in exchange for stock, you must reduce any assets purchased in the following 12 months by the amount of the cash received. Q. Debt vs. Equity i. Debt 1. Interest Expense is deductible by corporation. 2. Interest received is taxed as ordinary income. 3. Loan repayments are not taxable. ii. Equity 1. Corporations pay dividends, which are not deductible. 2. Individuals may be taxed at a lower rate on dividends received. 3. Corporation may be able to use the Dividends Received Deduction. iii. Reclassification of Debt as Equity 1. Thinly Capitalized – you have too much debt and not enough equity 2. IRS argues that debt is really equity. 3. Debt may be treated as a dividend. iv. Losses on Investment in Corporation 1. Stock and Security Losses a. If stocks and bonds are capital assets, losses from worthlessness are capital losses. i. Loss is treated as occurring on the last day of the tax year. ii. No loss if it simply declines in value. iii. If the stocks and bonds are not capital, then it is any ordinary loss. b. If you gave the company a loan: i. If you are an individual: 1. It is a non-business bad debt. 2. It is a short term capital loss. 3. Only deductible when fully worthless. ii. If you are a corporation: 1. It is an ordinary loss. 2. Business bad debt. 3. Can deduct partial worthlessness. v. §1244 Stock 10 1. Ordinary loss treatment for loss of “small business corporation.” 2. Gain is a capital gain. 3. Applies to the first $ 1 million of corporation’s stock. a. If there are more than 1 million shares, the corporation determines which shares are §1244. 4. Loss Limit a. $50,000 if single b. $100,000 is married filing jointly c. Any remaining is capital 5. Only §1244 stock in the hands of the original owner. 6. Only individuals or partnerships can own §1244 stock. 7. If §1244 stock is issued for loss property, stock basis is reduced to fair market value on date of exchange. R. Selecting Assets to Transfer i. When going from a sole proprietorship to a corporation, you can pick can choose which assets you transfer in. ii. For example, a cash basis accounts receivable has a basis of 0 so, when they are paid, the company will have to recognize a gain of $50,000. If you didn’t transfer, the owner can collect them and the transfer in cash. MAKE SURE TO REVIEW HOMEWORK PROBLEMS POSTED IN D2L 11


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