CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning Module 8Tax Law Research & Special Income Tax Considerations

Learning Objectives 8–1: Identify the purpose of a given provision of the federal tax law. 8–2: Identify characteristics of the audit process. 8–3: Identify the sources of authority for reliance on tax-related issues. 8–4: Identify the steps necessary to research a tax problem properly. 8–5: Identify tax preference items or adjustments for the alternative minimum tax for noncorporate taxpayers. 8–6: Analyze a situation to calculate the alternative minimum tax for noncorporate taxpayers. 8–7: Analyze a situation to calculate the self-employment tax. 8–8: Identify characteristics or consequences of tax traps or tax penalties. 8–9: Analyze a situation to calculate tax penalties or penalty taxes. 8–10: Analyze a situation to identify tax traps present. 8–11: Analyze a situation to identify the potential for the imposition of a tax penalty. 8–12: Identify ethical considerations in tax planning.

Questions to Get Us Warmed Up

Learning Objectives 8–1: Identify the purpose of a given provision of the federal tax law. 8–2: Identify characteristics of the audit process. 8–3: Identify the sources of authority for reliance on tax-related issues. 8–4: Identify the steps necessary to research a tax problem properly. 8–5: Identify tax preference items or adjustments for the alternative minimum tax for noncorporate taxpayers. 8–6: Analyze a situation to calculate the alternative minimum tax, or Medicare contribution tax, for individual taxpayers. 8–7: Analyze a situation to calculate the self-employment tax. 8–8: Identify characteristics or consequences of tax traps or tax penalties. 8–9: Analyze a situation to calculate tax penalties or penalty taxes. 8–10: Analyze a situation to identify tax traps present. 8–11: Analyze a situation to identify the potential for the imposition of a tax penalty. 8–12: Identify ethical considerations in tax planning.

Purposes of the Federal Tax Law

IRS Audit Systems • Discriminant Function Systems Program (DIF) • Taxpayer Compliance Measurement Program (TCMP) • Targeted Programs Audit • Document Matching Program • National Research Program (NRP)

Research of a Tax Problem • Assemble the facts • Identify the problem • Locate authority on the issue • Evaluate authority in terms of the issue • Develop one or more solutions • Communicate the solutions

Authority for Reliance on Tax-Related Issues • The Internal Revenue Code and Regulations: source of all federal tax law and highest statutory authority • Treasury Department Decisions: authorized by law and having the full force and effect of law • Revenue Rulings and Revenue Procedures: may be cited as precedents but do not have the force and effect of Treasury Department Regulations • Congressional Committee Reports: indicates congressional intent when a law is enacted • not precedential • IRS Private Letter Rulings: indicate the probable approach of the IRS in a particular situation • Court Decisions: judicial decisions interpret tax law or facts related to a particular case

Alternative Minimum Tax • Enacted in 1969 • Parallel tax system • Designed to ensure that “high-income” taxpayers pay at least a minimum amount of taxes • Good news—ATRA indexes exemption and phaseout numbers, and start of 28% bracket

Alternative Minimum Tax Items of Tax Preference & Adjustments of the AMT for Noncorporate Taxpayers Accelerated cost recovery deductions • on real property in excess of the straight-line method • on leased property in excess of the straight-line method • for personalty placed in service after 1986 to the extent the deductions exceed the 150% declining-balance method

Alternative Minimum Tax Items of Tax Preference & Adjustments of the AMT for Noncorporate Taxpayers • Excess intangible drilling costs (IDC) • Percentage depletion in excess of adjusted basis • The bargain element on the exercise of an incentive stock option • Rapid amortization of a certified pollution control facility in excess of the alternative depreciation method

Alternative Minimum Tax Items of Tax Preference & Adjustments of the AMT for Noncorporate Taxpayers • Tax-exempt interest on qualified private-activity municipal bonds (but not for bonds issued in 2009 and 2010) • Passive farm losses are treated as a preference item • A portion (generally 7%) of the gain excluded from sale of some qualified small business stock • Research and experimental costs, circulation expenses, and mining exploration and development costs

Alternative Minimum Tax Calculation for Noncorporate Taxpayers

AMT & Itemized Deductions Many itemized deductions disallowed: • state and local income taxes • property taxes • Tier-II miscellaneous itemized deductions Itemized deductions treated differently: • medical expenses exceeding 10% of AGI • qualified housing interest

Self-Employment Tax • Self-employment income—from trade or business as sole proprietorship, general partner or independent contractor, or rental of personalty • Self-employment income reduced by 7.65% prior to computation of self-employment tax • 15.3% up to wage base of $113,700 (2013) • 2.9% Medicare with no ceiling • One-half of the self-employment tax deductible as adjustment to income • Additional Medicare tax of 0.9% on self-employment income over $200,000 for single taxpayers, or $250,000 (combined self-employment income) for joint returns - no adjustment to income for this portion of S/E tax

Medicare Contribution Tax • The tax is 3.8% of the lesser of the • net investment income, or • the excess of the modified AGI (MAGI) over the specified threshold amount • Net investment income • investment income reduced by • penalty on the early withdrawal of savings • investment interest expense • Tier II investment expenses after 2% of AGI

Medicare Contribution Tax Investment income includes gross income from: • interest, substitute interest • dividends, substitute dividends • annuities • net capital gains, net royalties, net rental income • passive business income Specifically not included in investment income: • muni bond interest • income from active trades or businesses • income from qualified plans—including 401(k)s, 403(b)s, IRAs, Roth IRAs, and 457 plans.

Tax Traps

Tax Penalties

Accumulated Earnings Tax • $150,000 accumulation limit for PSC • $250,000 accumulation limit for non-PSC • Must prove valid business purpose for additional accumulations: • bond sinking fund • expansion of business • other reasonable need of the business

Accumulated Earnings Tax Computation • C Corporation taxable income • MINUS: • federal income tax paid • dividends paid • accumulated earnings credit* • EQUALS: • excess accumulations (taxed at 20%) *$250,000/$150,000 minus the prior accumulations

Estimated Taxes • To avoid underpayment penalty, pay the lesser of: • 90% of the current year’s tax liability, or • 100% of the prior year’s tax liability. • If prior year AGI exceeded $150,000, then pay • 90% of the current year’s tax liability, or • 110% of the prior year’s tax liability. • Safe harbor of $1,000

Review Question 1 Assume a taxpayer is faced with a tax deficiency of $15,000, along with interest on the deficiency of $2,200. The entire deficiency resulted from an honest error in applying the tax law from the taxpayer’s 2011 return. What is the amount of the penalty? • $1,500 • $3,000 • $4,100 • $11,250

Review Question 2 Which one of the following is not a step in the tax research process? • obtaining all the facts • diagnosing the problem from the facts • obtaining a letter ruling from the IRS if the issue is novel • communicating the answer

Review Question 3 Which one of the following is not a step in the calculation of the alternative minimum tax? • Adjusted gross income is decreased by any net operating losses and tax preference and adjustment items. • Adjusted gross income is increased by any net operating losses and tax preference items and increased or decreased by the adjustment items. • The net amount of alternative minimum taxable income is reduced by an appropriate exemption amount to arrive at the AMT base. • The AMT payable is reduced by any refundable credits.

Review Question 4 Which one of the following is not an allowable itemized deduction against alternative minimum taxable income? • medical expenses in excess of 10% of adjusted gross income • charitable contributions • qualified housing interest • state and local income taxes

Review Question 5 Which one of the following statements is true with regard to self-employment taxes? • A taxpayer is allowed to deduct a portion of his or her self-employment tax liability as an adjustment to income. • The wage base is not adjusted annually for cost of living increases. • Net earnings from self-employment must be calculated under the accrual method of accounting. • Self-employed taxpayers are subject to employer withholding.

Review Question 6 Which one of the following rules or doctrines deals with determining whether or not a taxpayer retains control over the “tree” and is thus taxed or not taxed on its “fruit”? • the constructive receipt doctrine • the tax benefit rule doctrine • the assignment of income doctrine • the sham transaction doctrine

Review Question 7 Which one of the following statements correctly defines negligence as it applies to imposition of the penalty? • Negligence is bad faith conduct by a taxpayer who has an intent to evade paying income tax. • Negligence is intentional conduct by a taxpayer to avoid paying income tax. • Negligence is a failure to make a reasonable attempt to comply with provisions of the Internal Revenue Code. • Negligence is an intentional disregard of the provisions of the Internal Revenue Code that results in a substantial underpayment.

Review Question 8 Which one of the following is not a primary objective of the federal tax law system? • raising revenue • economic growth and development • social objectives • political stability

Review Question 9 A Treasury regulation is • a general administrative interpretation of statutory tax law. • the source of statutory tax law. • an administrative interpretation of statutory tax law that is generally related to specific circumstances of fact. • an administrative interpretation of statutory tax law that is generally related to compliance issues.

Review Question 10 All of the following are preference items for purposes of the individual alternative minimum tax except • interest on qualified private-activity municipal bonds issued in 2008. • the bargain element on exercise of an incentive stock option. • the excess of percentage depletion over the property’s adjusted basis. • investment interest in excess of net investment income. • excess intangible drilling costs.

Review Question 11 Sandy McVey has Schedule C net income of $40,000. Sandy also has a general partnership interest from which she received a flow-through of operating income of $5,858. She also has a flow-through from an S corporation of $15,000. What is the amount of self-employment tax that Sandy must pay for the current tax year? • $6,480 • $7,016 • $8,599 • $9,311

Review Question 12 ABC Corporation has the following items of income and expense: Assume ABC is not a personal service corporation and cannot establish a valid business purpose for its excess accumulations. What is the amount, if any, of accumulated earnings tax payable? • $0 • $16,200 • $28,000 • $28,200

Review Question 13 Which one of the following is not a relief provision that applies to federal income taxation? • exclusion for life insurance proceeds • Section 179 expense election • child care credit • additional standard deduction for the elderly or blind

Review Question 14 Jerry Nelson has Schedule C net income of $150,000. He also has a flow-through from an S corporation of $10,000. What is the amount of self-employment tax that he must pay for the current tax year? • $17,396 • $18,116 • $18,384 • $22,607

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning Module 8End of Slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning