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Advanced Individual Taxation

Advanced Individual Taxation. Advanced Individual Taxation. Advanced Individual Taxation. Chapter 1. Tax-Wise College Financing for Middle-Class Clients. Preface – Medicare Surtaxes. 0.9% on earned income Individuals with earned income > $ 200,000 or $ 250,000 for MFJ

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Advanced Individual Taxation

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  1. Advanced Individual Taxation

  2. Advanced Individual Taxation

  3. Advanced Individual Taxation

  4. Chapter 1 Tax-Wise College Financing for Middle-Class Clients

  5. Preface – Medicare Surtaxes • 0.9% on earned income • Individuals with earned income > $200,000 or $250,000 for MFJ • Applies to each dollar in excess of the threshold amounts. • MAGI is irrelevant • Includes W-2 wages and net self-employment income. • Additional tax will be withheld by employer when applicable or, if required, should be paid via estimated taxes.

  6. Preface – Medicare Surtaxes • 3.8% on unearned income • Applies to individuals, trusts, and estates. • For individuals, the unearned income tax is applied to the lesser of: • Net investment income (“NII”), or • The excess (if any) of their modified adjusted gross income (MAGI) over the threshold amounts - $200,000 for single filers and $250,000 for MFJ • For estates and trusts, the tax is applied to the lesser of: • Undistributed net investment income, or • The excess (if any) of the adjusted gross income over the dollar amount at which the highest tax bracket for trusts and estates begins ($11,950 in 2013).

  7. Preface – Medicare Surtaxes • Net investment income (“NII”) includes • Interest, dividends, capital gains, annuities, royalties, rents, and other gross income attributable to a passive activity. • NII excludes • Income from a business that the taxpayer actively participates in, rental income if the taxpayer qualifies as a real estate tax professional, tax-exempt interest, life insurance proceeds, Social Security benefits, veterans’ benefits, and distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans.

  8. Preface – Medicare Surtaxes • Example: • Jim, a single individual, has modified AGI of $220,000 and NII of $40,000. The tax applies to the lesser of (i) NII ($40,000) or (ii) MAGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8% of $20,000, or $760.

  9. Lifetime Learning Credit • The Lifetime Learning Credit equals 20% of qualified higher education expenses of up to $10,000. • The maximum Lifetime Credit is $2,000.

  10. Lifetime Learning Credit • The most common scenarios for claiming the Lifetime Learning Credit are for • Tuition paid for continuing undergraduate education after four years of work has been completed • Tuition paid by employees for work-related college courses (especially those taken at community colleges) • Tuition for graduate school courses

  11. Education Tax Credits Compared

  12. Deduction for College Tuition & Related Fees • The maximum deduction is $4,000 • Unmarried taxpayers with MAGI between $65,001 and $80,000 can deduct up to $2,000. Joint filers with MAGI between $130,001 and $160,000 can also deduct up to $2,000

  13. Chapter 2 Tax-Smart College Financing Maneuvers for High-Income Clients

  14. Splitting Investment Income with Children • Parent makes gifts to child under annual exclusion • Investment made in child’s name • Income and gains taxed at child’s lower tax rate • Beware of kiddie tax

  15. Kiddie Tax Rules • Applies to dependent child’s unearned income exceeding $2,000 • Age is key issue • Can apply to children • Ages 19 – 23 • Student • Earned income less than half of support

  16. Deductible Payments from Parent’s Business • Employ under age 18 child • Not subject to Social Security & Medicare taxes • No federal unemployment tax on under age 21 kids • Shelter up to $6,100 of wages in 2013 • Generally no income tax on wages • Child saves & invests the money

  17. Deductible Payments from Parent’s Business • Triple tax break available • Business deduction for wages • Lowers parent’s income, AGI, and self-employment tax • No federal payroll taxes • Child has minimal or no income tax on wages

  18. Suggestions for Procrastinators • Take out a home equity loan (if client has not exhausted $100K limit and is not subject to AMT) • Gift appreciated assets (up to the $14K limit, or $28K for joint gifts) • Tap into IRA funds (10% penalty tax does not apply, but traditional IRA withdrawals will usually be fully or partially taxable) • Make direct gifts to educational institution to pay tuition expenses

  19. Chapter 3 Tax Planning Opportunities with Vacation Homes, Timeshares, and Co-Ownership Arrangements

  20. “Regular” Vacation Homes • Category 1 - Rented more than 14 days (§280A) • Substantial personal use • Interest deductible up to $1.1 million • Property tax deductible • Category 2 - Rented more than 14 days • Personal use not substantial • Interest, property tax and operating expenses based on actual usage

  21. “Regular” Vacation Homes • Category 3 - Rented < 15 days and personal use > 14 days • Consider personal residence • No rental days – Schedule A deductions • Partial rental days – Schedule A deductions • No write-offs allowed for operating expenses

  22. Timeshares and Co-Ownership Arrangements • No rental days • Schedule A – property tax and mortgage interest • Some rental days • Usually falls into Category 1 rules of “Regular” vacation homes • 14-day/10% test applied to unit as whole for personal days • Allocate expenses based on actual usage

  23. Timeshares and Co-Ownership Arrangements • Owner right to only 1 or 2 weeks – more than 14 days or 10% test difficult to meet • Qualified residence rule

  24. Example: Timeshares and Co-ownership • Butch -- Unit #310, Sunny Shores Timeshare Resort • Owns weeks 29 and 30 • Rents week 29 and uses week 30 personally • Total cost of two weeks $30,000 • partly financed by a $20,000 mortgage loan • Interest expense: $2,400 • Annual maintenance fees for the two weeks: $1,300 • Property taxes: $450 • Week 29 rental income: $1,500

  25. Example: Timeshares and Co-ownership • Unit 310 • Owners • Rent approximately half the year • Use personally half the year • Category 1 vacation home rules apply to any unit owners who rent some of their time • Butch’s return should show $1,500 of rental income on Schedule E

  26. Example: Timeshares and Co-ownership • Allocable rental expenses ($1,500 limit) can be deducted on Schedule E • Allocation percentage: 50% • Before considering depreciation • Allocable rental expenses total $2,075 • Mortgage interest: $1,200 • Property taxes: $225 • Maintenance fees $650 • Schedule E: Butch can offset his rental income with these expenses ($1,500 limit)

  27. Example: Timeshares and Co-ownership • Next-year carryover: • Disallowed cash expenses ($2,075 - $1,500 = $575) plus • Disallowed depreciation expense • On Schedule A: Butch deducts $225 of property taxes • The 50% attributable to personal use • Personal use mortgage interest ($1,200): nondeductible • Butch does not own enough personal days to pass the more-than-14-days-or-10% test.

  28. Cancellation of Debt Income • Exclusion • Allows individuals to exclude up to $2M ($1M for MFS) of qualified principal residence indebtedness through 2013 • Qualifying amounts • Any proceeds not used for the principal residence cannot be excluded under§108(a)(1)(E). • Possible exclusion from income if the taxpayer is insolvent under §108(a)(1)(B) • Forms • Qualifying taxpayers should complete Form 982 using Form 1099-C

  29. Chapter 4 Tax Planning for Marital Splits

  30. State Law Aspects of Divorce • The following nine states are community property states: • California, Texas, Washington, Wisconsin, Arizona, Nevada, New Mexico, Louisiana, and Idaho • All other states, except Mississippi, are so-called equitable distribution states

  31. Section 66 Rule For the Section 66 rule to apply, all four conditions listed below must be met for the tax year in question: • Individuals are married at year end, but lived apart for the entire year • Joint return is not filed for the year • One or both of the individuals had earned income for the year that is community income (i.e., income that would be shared 50/50, under general rule) • There were no transfers of such earned community income between the individuals

  32. Abandoned Spouse Rule • HOH status is available to married individuals meeting all conditions listed below: • Separate returns filed • Taxpayer lived apart from spouse during the last six months of the year • Taxpayer's home served for more than half the year as principal home of taxpayer's child, stepchild, or adopted child for whom personal exemption deduction is allowed • Taxpayer paid more than half the cost of maintaining home for the year

  33. HOH Status in Year of Divorce • In year of divorce and later years, HOH status is available if both the following requirements are met: • Taxpayer is single at year-end and maintains a home that constitutes principal residence of his child, stepchild, or adopted child for more than half of the year • Child resides in same household as taxpayer during the "more than half the year" qualification period

  34. HOH Status in Year of Divorce • After couple is divorced – or legally separated under decree of separate maintenance – HOH eligibility rules are more liberal than those for individuals who are still married at year-end

  35. HOH Example Fred and Wilma are separated and soon to be divorced. • Fred, 2013: • $60,000 from employment • $7,000 FIT withheld • Separate residences from June 1 through year-end. • Wilma: primary custody of their two children kids after separate residences were established. • Fred: weekend visitation rights • Pays $1,000 temporary monthly child support.

  36. HOH Example • In Fred and Wilma’s state the spouse earning the larger income owes the taxes when separate returns are filed. • Standard deduction will be taken. • Wilma: HOH filing status for 2013 despite being legally married at year end. • Wilma’s home was the children’s primary home for more than half the preceding year • Children spent more than half the year under her custody. • See §152(c) and (e)

  37. HOH Example • Wilma: entitled to the personal exemption deductions for both children. • Despite Fred’s temporary child support payments • Wilma qualified as the custodial parent for the preceding year since the children spent more than half the year under her custody. • If Wilma chooses to file a separate return using HOH status, Fred would have to file using MFS status. • Alternatively, they could file a joint return.

  38. HOH Example Tax Results • Tax results of the filing status options (2011 rates):

  39. HOH Example Tax Results • Fred wants to file jointly • $1,842 refund ($13,000 in withholdings less $11,158 joint tax liability) • Would split refund 50/50 with Wilma. • Separate returns • Fred would owe $1,429 ($8,429 MFS liability less $7,000 withheld form his salary).

  40. HOH Example Tax Results • Wilma should file a separate HOH return. • Refund: $2,985 • Withholdings: $6,000 • HOH Tax Liability: ($3,015) • Protection from Fred’s tax liability • His failing to report income • Overstating preceding year deductions • Combined separate return liabilities versus joint return liability • Joint return liability: $11,158 • Combined separate return liabilities: $11,444

  41. HOH Example Tax Results • Wilma should give $1,842 of her refund to Fred • To convince him to file separately • To compensate Fred for the amount he will owe if filing separately • Alternatively, she could agree to release at least one personal exemption deduction for the children to Fred for the year. • Form 8332 • Would reduce or eliminate Fred’s unpaid tax liability • Would decrease Wilma’s refund.

  42. HOH Example Tax Results • Key Point: If Wilma and Fred each had primary custody of one child from June 1 through year-end, both spouses would qualify for HOH status under the abandoned spouse exception.

  43. Qualified Domestic Relations Order • QDRO is legal judgment, decree, or order (including one approving divorce property settlement agreement) that meets certain Tax Code guidelines • It can be a separate document or simply language included as part of another divorce-related document

  44. Qualified Domestic Relations Order • QDRO establishes that one spouse or ex-spouse has a legal right to receive all or part of other party's qualified retirement plan benefits without violating plan's benefit distribution rules

  45. Requirements for Deductible Alimony • In order for a payment or stream of payments to be deductible alimony for federal income tax purposes: • It must be made under a written divorce or separation instrument • The instrument cannot state the payment is not alimony • The payment cannot be made in a year when the payor and payee file a joint return together

  46. Requirements for Deductible Alimony • After divorce or legal separation occurs, the ex-spouses cannot be members of the same household • The payment must be to the spouse or ex-spouse or to a third party on behalf of the spouse or ex-spouse • Payment must be in cash or cash equivalent • The payor’s return must include the payee’s name and social security number

  47. Requirements for Deductible Alimony • There cannot be any legal obligation for payment after the payee’s death • The payment cannot be considered to be for child support

  48. Deemed Child Support-Related Contingencies • Attaining age 18, 21, or local age of majority • Death • Marriage • Completion of schooling • Leaving the household • Attaining a specified income level • Employment

  49. Chapter 5 All About Roth IRAs

  50. Two Big Roth IRA Advantages • Qualified withdrawals are federal-income-tax-free, and usually state-income-tax-free, too • Roth IRAs are exempt from the required minimum distribution rules, until the account owner dies

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