CPA Becker Review Regulation 2 Class Notes REGULATION 2 CLASS NOTES This lecture covers the taxation of individuals with an emphasis on adjustments, the standard deduction, itemized deductions, tax calculations, tax credits and the alternative minimum tax. According to the AICPA's Content Specification Outline these items and the items listed in lecture R1 should make up between 28% and 34% of your Regulation examination. ADJUSTMENTS, STANDARD DEDUCTION AND ITEMIZED DEDUCTIONS I. ADJUSTMENTS A. B. Very Important! The examiners can use many terms for the same amounts - Adjustments to Gross Income; adjustments to Arrive at AGI; Deductions to Arrive at AGI; deductions for AGI; above the line deductions. Adjustments are available to anyone regardless of taking the standard deduction or itemized deductions. Educator Expenses, IRA, Student Loan Interest, Tuition & Fees, Health Savings Account, Moving Expenses, self-employment Taxes, Self-employed Health Insurance, Self-employed Retirement, Early Interest Withdrawal Penalty, Alimony. Educator Expenses (K-12th Grade, up to $250 qualified expenses). This expired on 12/31/07, but it is expected to be extended. Individual Retirement Accounts (4 types of IRAs) Deductible IRAs are tested often. Know rules regarding deductibility $5,000 in 2008. A non-working spouse can also contribute and claim full amount even if no earned income (based on working spouse's earnings). Alimony counts as "earned income." Limits apply to excessive AGI and active participation in a retirement plan (amounts do not have to be memorized but be familiar with approximate levels). Additional catch-up retirement contribution (Age 50 plus $1,000 in 2008). Roth IRAs are non-deductible, distributions are tax-free, $5,000 contribution limits apply, no plan participation limitations. Phase out = Single $101,000 $116,000; MFJ $159,000 - $169,000 and MFS $0 - $10,000. Non Deductible IRAs $5,000 contribution limits, only earnings are taxable upon distribution, return of capital is tax-free, proration is necessary. Note the $5,000 contribution limit is aggregated so the maximum IRA contribution for any taxpayer is $5,000 or $10,000 MFJ. Coverdale Education Savings Accounts are not deductible; distributions are tax-free if used for qualified education. Know contribution requirements, $2,000 maximum contribution per beneficiary and phase out for higher AGIs Single $95,000 - $110,000 and MFJ $190,000 - $220,000. Student Loan Interest limited to $2,500 and phased out Single $55,000 - $70,000; MFJ $115,000 - $145,000 (MFJ); dependant cannot claim this adjustment. Tuition & Fee Deduction $4,000, not allowed for expenses also claimed as Hope Credit, Lifetime Learning Credit or Non-taxable Savings Accounts, eliminated at higher AGI levels Single $65,000 - $80,000; MFJ $130,000 - $160,000. This expired on 12/31/07, but it is expected to be extended. Health Savings Accounts must be combined with high-deductible health insurance, make pre-tax contributions of up to $2,900 for 2008 ($5,800 for family), money to be used on health care costs...few definitions or limitations on "health care". Moving Expenses new workplace 50 miles farther from old house than old workplace, 39 week stay (first 24 months), self-employed 78 week stay (first 24 months), direct moving costs of self and family only; travel, lodging, transportation (people and household goods), personal auto, tolls, parking. No deduction for; pre-move "house hunting", expense of breaking a lease, or cost of temporary living expenses. Self-employment FICA Tax. 1
2009 DeVry/Becker Educational Development Corp. All rights reserved.
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Becker CPA Review Regulation 2 Class Notes K. L. M. N. Self-employed Health Insurance Expense. Self-Employment Retirement. Early Interest Withdrawal Penalty (forfeited interest on CDs). Alimony deductible if paid pursuant to divorce or legal separation, is income to receiving spouse, child support portion "not" deductible, if parent is behind on payments, the payments first apply to child support. Keogh (Profit Sharing) Plans The maximum annual "deduction" is limited to the lesser of 25% net (Keogh/self-employed) earnings or $46,000 (2008). The maximum annual "additions (contributions)" that are non-deductible are limited to the lesser of $46,000 or 100% net earnings. HINT just use 20% of self employment net income.
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STANDARD DEDUCTION A. Standard deduction for non-itemizers (1040EZ always uses standard; do not need to know amounts), know there is additional deduction for blind and/or elderly (65 and older) taxpayers; no additional dependent exemption.
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ITEMIZED DEDUCTIONS (SCHEDULE A) A. Know there is a limitation based on AGI and to what deductions the phase out does not apply; GIMC mnemonic (Gambling, Investment Interest, Medical expenses, Casualty & Theft losses). Medical Expenses who is eligible you, your spouse and your dependents, special dependent rule for medical purposes, no gross income test and no joint return test. Use cash basis to determine deduction and 7.5% of AGI limitation. Types of expenses deductible include medicines, prescriptions, doctors, medical/accident insurance, physically handicapped costs, etc, after insurance reimbursement (out of pocket). State, Local and Foreign Taxes real estate obligation to pay and taxes paid under protest, income tax payments follow strict cash basis rules, non-deductible taxes (FIB mnemonic). Interest Expense 1. Home Mortgage first and second home, acquisition indebtedness maximum $1,000,000, points rules (deductible on original purchase and must be amortized on re-finances of same home), home equity indebtedness maximum $100,000 and for any purpose, must be secured by home and technically, deduction is limited to the difference between the FMV and original debt (computed each year). Investment Interest Expense deduction limited to net taxable investment income, indefinite carry-forward of unused amounts (or until the investment is disposed of), tax free bond investment interest never deductible. Personal Interest not deductible. Prepaid Interest must be allocated over period of loan.
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Charitable Contributions limited to 50% AGI for cash and 30% AGI for long-term capital gain property, services not deductible except for out-of-pocket expenses, substantiation rules must have written acknowledgement from the charity, 5 year carryover, reduced deduction for value of consideration received. Casualty and Theft Losses 10% AGI limit, plus $100 per occurrence, lesser of FMV or adjusted basis, sudden, swift and unexpected.
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2009 DeVry/Becker Educational Development Corp. All rights reserved.
Becker CPA Review Regulation 2 Class Notes G. H. Miscellaneous Itemized Deductions 2% AGI limit, unreimbursed business expenses, investor expenses, education expenses, tax preparation. Other Miscellaneous Deductions no 2% limit, remember that gambling losses cannot exceed income and can only be deducted by those who itemize, otherwise no deduction allowed even though income is claimed.
TAX CALCULATIONS AND CREDITS I. TAX CALCULATIONS A. Tax Calculations do not need to know brackets, examiners will give candidate rates if needed, examiners focus on correct calculation of taxable income.
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TAX CREDITS A. B. Tax Credits - most are tested on a candidate's ability to recognize which credits apply to individuals, businesses, etc. Issues that are tested more frequently are listed below. Know which credits are refundable (child tax credit, earned income, withholdings, W-2 excess social security withheld by 2 or more employers, and long-term unused minimum tax credits). Child and dependent care credit minimum and maximum credit (20% to 35%) and amount of eligible expenses for child and dependent care credit (1 - $3,000, 2 or more $6,000). Educational Tax Credits Hope per student = $1,800 100% of first $1,200 and 50% of next $1,200. Lifetime not per student - $2,000 - 20% of first $10,000 expenses. Can use both together but not for same expenses. Both are phased out Single $48,000 $58,000 and MFJ $96,000 - $116,000. Qualified Tuition Programs (QTP) Program established & maintained by a state (or state agency or eligible educational institution), taxpayer may purchased tuition credits or make cash contributions to an account on behalf of a beneficiary, distributions used for qualified education expenses (tuition, fees, books, supplies, equipment) are exempt from federal income taxation. Adoption Credit maximum amount per child $11,650. Phased-out AGI of $174,730 $214,730. Carry-forward of 5 years. Retirement Savings Contribution Credit (non-refundable) is available for contributions by taxpayers over 17 who are not full-time students and not dependants, paid into a traditional or ROTH IRA, maximum amount $2,000 completely phased out at $50,000 of income. Foreign Tax Credit can be used as itemized deduction in lieu of credit. General Business Credit (GBC) made up of many credits, limitation formula sometimes tested (note, only first $25,000 may be eliminated completely, remaining income can only be 75% eliminated by the GBC. Child Tax Credit of $1,000 per "qualifying child" (dependent son or daughter or descendent of either or stepchild or eligible foster child of taxpayer), not 17 by end of tax year, phase out by $50 per $1,000 for AGI over MFJ $100,000, MFS $55,000, Unmarried $75,000. Portion may be refundable. Earned Income Credit, refundable credit (most common question), taxpayer must have earned income and 1 or more qualifying children to maximize; a lesser credit available if TP or spouse is over 25 and less than 65 years of age.
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2009 DeVry/Becker Educational Development Corp. All rights reserved.
Becker CPA Review Regulation 2 Class Notes L. Excess FICA (Social Security Tax Withheld) must have two or more employers (if only 1 employer, employer must refund excess) each withheld Social Security, normally limited after a certain wage, each acted independent of the other, treat the excess as a "withholding credit" when filing the tax return. Long-Term Unused Minimum Tax Credits through 2012, these credits that are at least 3 years old may be refundable, generally at the greater of $5,000 or 20% of the unused amount per year against regular tax.
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ALTERNATIVE MINIMUM TAX (AMT) AND OTHER ITEMS I. AMT A. Calculation of AMT is complex and examiners have focused on a candidate's knowledge of what does and does not go into the calculation of Alternative Minimum Taxable Income (AMTI), along with the exemption formula, the AMT credit and credits available against AMT. AMT exemption amount Single $33,750, MFJ $45,000; MFS $22,500 and is reduced by 25% of excess AMTI over Single $112,500, MFJ $150,000, MFS $75,000. Pending 2008 legislation exists to increase these exemption amounts. Adjustments PANICTIMME mnemonic (note the TIMME items do not generate Alt Min Tax Credit for future years, only PANIC items do). Tax preferences PPP mnemonic (always add backs), only "P"re-1987 accelerated depreciation generates Alt Min Tax Credit, "Private" activity bond interest and "Percentage" depletion excess over adjusted basis does not. Credit For Prior Year Alt Min Tax (AMT Credit) carry-forward forever, offsets only regular tax (cannot offset additional AMT), results when there was prior Alt Min Tax paid and a subsequent year's regular tax exceeds the Alt Min Tax Computation, that excess is a potential credit if that amount was paid in Alt Min Tax before (note exceptions for TIMME Adjustment items and first 2 Preferences). AMTI Calculation Regular Taxable income adjust for PANICTIMME and PPP. AMT Credits Foreign tax credit, adoption credit, child tax credit, contribution to retirement plans credit and earned income credit are permitted to reduce the Alt Min Tax.
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INDIVIDUAL TAXATION OTHER ITEMS A. Social Security Tax (FICA and Medicare) is computed on "net Schedule C" income at 15.3% combined and is reported and paid on the Federal 1040 in the "Other Taxes" section. Remember that of this computed tax is deducted on the face of the return as an "adjustment to income" in arriving at AGI. Statute of Limitations for additional assessments of tax is later of 3 years from the "due date" of the return (including extensions) or "date return is filed" if late filed. A six-year Statute exists when there is a 25% or more understatement of gross income if it is the result of a "good faith" mistake. If the "understatement" of income or "overstatement" of expense was intentional, fraud exists and there is no statute of limitation on assessment/collection...the Service can come anytime! Refunds (Form 1040X) can be filed the later of three years from the time the return was due (including extensions) or two years from the time the tax was paid. Bad Debts and/or Worthless Securities can generate Refund claims up to seven years from the later of "due date" of return (including extensions) or date return was filed if later.
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Becker CPA Review Regulation 2 Class Notes D. Tax Payments Taxpayers typically make pre-payments of tax during the year, which consist of quarterly estimated payments by the taxpayer or withholdings from W-2 wages by employer. Also, remember the excess FICA tax Credit if "two or more" employers. At year end, on the Tax Return, these pre-payments of tax and the various "credits" mentioned above are compared to "total taxes" to determine if tax is overpaid (refunded) or underpaid (owed). Estimated Tax Payments Taxpayers are expected to make estimated quarterly tax payments to avoid "owing" more than $1,000 at year end unless current withholding is 90% or more of this year's tax or 100% of last year's tax (even if last year's liability was $0). Use 110% of prior year's liability when AGI exceeds $75,000 (MFS) or $150,000. Consequently, whenever you see MFJ amounts, for anything, are double the Single amounts, this is an example of no "marriage penalty." Failure to achieve the necessary "pre-payments" or "estimated quarterly payments" as mentioned in "E" above result in an "estimated tax penalty" unless due to casualty, disaster, illness, or death of the taxpayer or immediate family member. Remember that the underpayment must be $1,000 or more before any penalty is applicable.
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Simulations quite often the examiners will ask candidates to complete a tax form other than the ones we have included in the review material. Don't panic! Read the form to determine what information is needed in order to complete the form. Most forms are self explanatory since they need to be used by all taxpayers. So relax, read the form and fill in the necessary information. I hope you find these tips helpful. Work hard and you will succeed.
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2009 DeVry/Becker Educational Development Corp. All rights reserved.