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Tax Exam 1 Review

by: Ally Rose

Tax Exam 1 Review ACC 403

Marketplace > University of Miami > ACC 403 > Tax Exam 1 Review
Ally Rose
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Chapters 1-4
Fundamentals of Taxation
Mario Perez
Study Guide
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This 7 page Study Guide was uploaded by Ally Rose on Monday October 3, 2016. The Study Guide belongs to ACC 403 at University of Miami taught by Mario Perez in Fall 2016. Since its upload, it has received 2 views.

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Date Created: 10/03/16
Accounting 403: Exam 1 Review Chapter1:  Progressive Tax Rate System: our income system - Tax rates increases income increases - A tax that is a larger percent of rich income - Regressive Taxes: larger percent of poor income ie. Food tax  Capital Gains Rates: - Long Term: own for more than 1 year. The property/stock gets taxed at reduced rates - Short Term: use ordinary income rates - Corporation have no special capital gains rates  Average Tax Rate =Tax Liability  Taxable Income  Marginal Tax Rate: Rate to which the next dollar of taxable income is subject  C-Corporation: regular corporate form 1120 - Corporation pays tax on profits - Shareholders only pay tax on dividends received - NOT FLOW THROUGH - Basis = cash contributed + profit – withdrawals - Losses: carry back up to two years or carry forward up to 20 o Carry back: uses FIFO calculate tax paid starting at the earliest period. If only a portion of tax paid in year is added back use the highest percentage. o Corporation losses can only offset the corporation’s profits - Fiscal year  S-Corporation: unique entity separate and apart from those who own it. - No more than 100 shareholders - FLOW THROUGH entity: profits and losses flow to the owners/shareholders - Shareholders basis (prior to loss) = cash contributed + profit – withdrawals o Losses can be deducted up to this basis o Carry losses excess of basis to the following year - Calendar Year  Partnership: 2 or more individuals or entities who agree to carry business activities jointly. - Partners cannot be employees - Each partner files form 1065 - FLOW THROUGH entity: profits and losses flow to shareholders - Partner Basis: Cash contributions + Profit + Partner Share of Liability – Withdrawals o Losses can be reduced up to the basis o Basis can never be negative, carry forward excess loss  Sole Proprietorship: owner considered self employed - Form 1040 - Taxed at individual rates - Taxed on net profits regardless of how much is withdrawn - Loss can offset other income Chapter 2:  Filing Deadlines: - April 15 = individuals, C-Corps, and estate th - March 15 = partnerships and S-Corps  also the deadlines for a 6-month extension to file (not pay)  Filing Penalties: 1) Failure-to-Pay: ½ % of what you owe per month late (max 25%) 2) Failure-to-File: 5% of what you owe per month late (max 25%)  If both, 5% per month for first 5 months and then ½ % (max 47½ %)  Statute of Limitations: time in which legal action can be made- 1) If error is less than 25% of gross income: 3 years from date returned, filed or due. (whichever creates the latest deadline) 2) If error is greater than 25% of gross income: 6 years 3) No time limit if fraud can be proven in court Chapter 3:  Taxable Gross Income: IRS defines everything as income unless there is an exception.  Differences in GAAP and IRS Income: 1) Temporary Differences: arise when income is taxed either before or after it is accrued for accounting purposes. Ex: depreciation and prepaid rent will eventually correct itself 2) Permanent Differences: income not taxed but reported for accounting purposes. Ex: IRS only recognizes 50% of meals and entertainment expense, Life insurance cannot be deducted from IRS. will never correct itself  Basis: Book value/amount paid for an asset - Basis can be recovered tax free - Only pay tax on gain  Investment Alternatives: - Investments yielding appreciation: tax is not paid if value goes up, only when you sell it. - Investments yielding annual income: interest income is taxed annually  Accounting Methods: 1) Cash Method: income/expenses are determined when cash/cash equivalents are exchanged. (cash is in account or made available) 2) Accrual Basis: income is recognized based on completion of all events test. a. Required for large corporations receipts >5 million, or when businesses have inventory and sell merchandise 3) Hybrid Method: Sales Revenue -COGS = Gross Profit  Accrual basis for sales of inventory and COGS - Operating Expenses = Income Before Tax  Cash basis  Interest Income: mostly taxable - Municipal Bonds: gain on sale is taxed but the interest is tax free  Below Market Rate/Interest Free Loans: usually made between related parties - Imputed Interest: the interest income that is not actually received or accrued is treated as if it was, and taxed at the applicable federal rate of interest. o Gift Loans between $10,000 and $100,000: imputed interest cannot exceed the borrowers net investment.  If the net investment is <$1,000 there is no imputed interest o Gift Loans less than $10,000 are exempt 1) Loans from Corporation to Employees: Corporation: Interest Income X Compensation Expense X  no effect on taxable income Employee: The amount of interest not actually charged is treated as compensation income and is taxed. 2) Loans from Corporation to Shareholder: Corporation: Interest Income X makes income go up because dividends are not Dividend Paid X deductible. Shareholder: Interest is treated as dividend income and is taxed at reduced rates.  Dividend Income: - Dividends received must be paid out of accumulated earnings and profit (E&P) (retained earnings) o Any dividends in excess of E&P are considered return on investment and are not taxable, reduce stock basis. o Distributions in excess of the stock basis are taxed at capital gains rate.  Stock Dividends: only taxable if shareholder has the option of receiving cash or stock - Otherwise basis is just divided amongst the new total of stocks  MAGI: Modified Adjusted Gross Income (only used to determine how much of SS is taxed) MAGI = AGI before any SS benefits + tax exempt interest income + ½ SS benefits - If MAGI is <25,000 for single or <32,00 for married, then no SS is taxed - If MAGI is >34,000 for single or >33,000 for married, then 85% of SS is taxed - If in between 50% of SS is taxed  Divorce Payments: - Property settlement and Child Support: not income and not deductible - Alimony: taxable income and deductible  Tax Exclusions: - Gifts/Inheritances: if taken in lump sum are tax free o If inheritance is paid periodically, the excess received is taxed - Life Insurance Proceeds - Accident and Health Insurance Proceeds: tax free to extent for qualified medical expenses (excess is taxed) - Disability: if you pay its tax free if employer pays its taxed - Scholarships: includes tuition, fees, books, supplies o Room and board are taxable Chapter 4:  Employee Compensation: all forms (salaries, bonuses, tips and fringe benefits) are taxable as ordinary income unless specifically excluded.  W-4 : complete when you get hired so that employer can determine what to deduct from paycheck  W-2 : created by employer – shows salary and amount withheld in order for employee to file their tax return  Payroll Taxes: - FICA: Social Security and Medicare: paid by both employer and employee (7.65%) o SS: rate = 6.2% up to the first $118,500  Once annual paycheck hits $118,500 company no longer withholds SS from paycheck o Medicare: rate = 1.45% - Employer withholds your share of FICA based on W4 and adds its share of tax  govt. - Employer can deduct their share of tax from income  Self Employment Taxes: - Self employed individuals must pay both the employer and employee share of FICA - FICA = 15.3% o SS: 12.4% on income up to $118,500 for the year o Medicare: 2.9% Tax Computed: Start with profit from Schedule C: Income – Expenses = Income from being Self-Employed Step 1) Schedule C profit x 92.35% = amount subject to SE Tax Step 2) Calculate FICA: A) SS tax = 12.4% x (up to 118,500) = ______ B) Medicare tax = 2.9% x (total amount subject to SE tax) = ______ A + B = amount of self employment tax Step 3) Deduct half of the SE tax from income: ½ x SE Tax = deduction on page 1 of 1040 from your AGI  Other Payroll Taxes: for employers - Unemployment Tax: FUTA o Rate = 6% on first $7,000 o Max employer will pay for 1 year is $420 for 1 employee - Other Federal/state taxes - Deductible by employer  Timing of Compensation: - Cash Basis: employer deducts salaries/bonuses when paid - Accrual Basis: employer deducts salaries/bonuses when earned o Exception: compensation accrued but not paid within 2 ½ months of years-end is not deductible o If the related party uses a cash basis, compensation accrued is not deductible until paid  Reasonable Compensation: the amount a similar business would pay (given similar circumstances) for the same service. - If shareholders’ salary is considered unreasonable the excess can be reclassified by the IRS as a non-deductible dividend. (good for individual bad for corp)  Fringe Benefits: - Not taxable as income to employee - Are deductible from income of employer - Most are limited to a dollar amount - Excess of limit is taxable - Tax free fringe benefits: employee discounts up to 20%, meals/lodging, parking etc.  Discriminatory Plans: plan is in favor of key employees. These key employees must report GI to: 1) Employers actual premiums paid 2) Benefit determined from chart (w/o exclusion)  Whichever is greater  Restricted Stock: stock is given with a vesting period at which point you can keep the stock 2 Options: 1) No Compensation Income until stock vests: a. Employee recognizes ordinary income of stock when its vested. = FMV b. Corporation (employer) deducts when you vest 2) Elect to Accelerate the Income: (risky) a. The FMV at this point is ordinary income. b. If you never become vested you can’t reverse it (not eligible for tax refund) c. Corporation (employer) deducts when you sell - Any dividends prior to vesting are taxed as ordinary income  Stock Options: employee has the right to purchase a stock at a “strike price” - Grant date = date option is offered - Exercise date = date stock is purchased - Bargaining Element = difference between strike price and FMV on exercise date - Motivates the employee to work harder to get the price of stock to go up 1) Nonqualified Stock Options: (NQSO) o Employee recognizes income equal to bargain element on the date NQSO is exercised  Employees Basis = Cash Paid + Bargain Element o Employer deducts the same amount when it is exercised as compensation 2) Incentive Stock Options: (ISO) o Employee: (more favorable) no income on grant/exercise date  Income is not recognized until stock is sold  Stock cannot be sold before 1 year  No ordinary income only capital gain on sale o Employer: no deduction for compensation expense (no tax incentive)  Stock Appreciation Rights: (SARS) - Employees are given the right to receive cash payment equal to the appreciation in value of employer’s stock for a certain period. o If stock goes above X you multiple the # of SARS times the increase o Compensation income/expense o Employees recognize income when it is exercised  401(k): employees can elect to have employer contribute part of their salary to plan on pretax basis. (they may match certain %) - Flexible: can change yearly amount - Employer receives deduction when you recognize the income  Individual Retirement Accounts: (IRA) - Individuals can contribute up to $5,500 - Qualified contributions may be deductible for AGI - ROTH IRA: o Tax payers may make nondeductible contributions o Primary advantage: able to withdrawn earnings/contributions tax free o If you expect to be in a higher tax bracket you pick ROTH


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