Chapter 1 of 430–40% of exam

Area I: Tax Compliance and Planning for Individuals and Personal Financial Planning

This area covers nonroutine individual compliance and planning: equity compensation, AMT items, loss limits, gifts and personal financial planning. Most items give a client's facts and ask for the tax effect of a choice, such as timing, the asset to give or sell, or the account to fund. Inflation-indexed amounts, such as the annual gift exclusion or the standard deduction, are supplied in the question and are not recalled from memory.

Income, AMT and estimated tax

Equity awards are taxed on different schedules. An incentive stock option creates no regular-tax income at exercise but does create an AMT adjustment. A nonstatutory option without a readily ascertainable value is taxed at exercise. Restricted stock is taxed when it vests unless the employee elects to be taxed at grant. Other planning items in this group are the kiddie tax, below-market loans between family members, and income earned abroad. Estimated tax planning turns on the prior-year safe harbor.

ISO holding periods

A sale is a qualifying disposition only if the shares are held at least two years from grant and one year from exercise. Otherwise the spread at exercise becomes compensation, capped at the gain realized.

IRC §422(a)(1), (c)(2)

ISO spread under the AMT

Section 421 does not apply for AMT purposes, so the spread at exercise is an AMT adjustment when the shares are held past the end of the year of exercise.

IRC §56(b)(3)

Section 83(b) election

An election filed within 30 days of the transfer taxes restricted property at its value when received. Later appreciation is then capital, and no deduction is allowed if the property is forfeited.

IRC §83(b)

Gift loans of $100,000 or less

Imputed interest is limited to the borrower's net investment income, and it is treated as zero if that income is $1,000 or less.

IRC §7872(d)(1)

Individual estimated tax safe harbor

Required payments are the lesser of 90% of the current-year tax or 100% of the prior-year tax. The prior-year figure rises to 110% when prior-year AGI exceeds $150,000.

IRC §6654(d)(1)

Deductions, charitable gifts and year-end planning

Planning compares itemized deductions with the standard deduction and often bunches deductible payments into alternate years. A gift of appreciated long-term property to a public charity gives a deduction at value and avoids the gain. A gift of loss property wastes the loss. When tax rates are expected to change, income and deductions are shifted toward the year where they do the most good.

Long-term capital gain property

A gift to a public charity is deductible at fair market value, limited to 30% of the contribution base, and the excess carries forward five years.

IRC §170(b)(1)(C)

Reduction for short-term property

The deduction is reduced by the gain that would not be long-term capital gain if the property were sold, which limits short-term property to basis.

IRC §170(e)(1)(A)

Health savings accounts

A distribution not used for qualified medical expenses is included in income and incurs a 20% additional tax unless the holder is 65 or older, disabled or deceased.

IRC §223(f)(2), (f)(4)

Wash sales

A loss is disallowed when substantially identical stock is bought within 30 days before or after the sale, and the disallowed loss is added to the basis of the new shares.

IRC §1091(a), (d)

Passive activity and at-risk limits

A loss from a pass-through entity passes through three limits in order: basis, the amount at risk, and the passive activity rules. Passive losses offset only passive income, with a limited allowance for rental real estate where the owner actively participates. Suspended passive losses are released when the whole interest is sold in a fully taxable sale to an unrelated party.

Amount at risk

Cash, the basis of property contributed and debt the taxpayer is personally liable for count as at risk. Nonrecourse debt counts only if it is qualified nonrecourse financing secured by real property.

IRC §465(b)

Rental real estate allowance

Up to $25,000 of losses from actively managed rentals may offset other income. The allowance is reduced by 50% of modified AGI above $100,000.

IRC §469(i)

Material participation

One test is participating in the activity for more than 500 hours during the year.

Temp. Treas. Reg. §1.469-5T(a)(1)

Disposition of the entire interest

A fully taxable sale to an unrelated person frees the suspended losses. A sale to a related person defers the release until that person sells to an outsider.

IRC §469(g)(1)

Gifts, retirement plans and personal financial planning

The gift and estate taxes form one unified system. The annual exclusion, direct payments of tuition and medical costs, and the marital deduction keep gifts out of the tax base. Taxable gifts use up the credit that would otherwise shelter the estate. Retirement accounts differ in when contributions and growth are taxed and in distribution rules. Education funding, insurance and the way assets are titled also shape the plan.

Present-interest annual exclusion

The annual exclusion applies only to gifts of present interests. Tuition paid directly to a school and medical costs paid directly to a provider are not gifts.

IRC §2503(b), (e)

Gift splitting

Spouses who are U.S. citizens or residents may elect to treat a gift to a third party as made one-half by each.

IRC §2513(a)

Roth IRA qualified distributions

A distribution is tax-free if it comes after age 59½, death or disability, and after the five-taxable-year period. Distributions come first from regular contributions.

IRC §408A(d)(2), (d)(4)

Early distribution exceptions

The age-55 separation-from-service exception applies to qualified plans but not to IRAs. Higher education expenses and first-time home purchases are exceptions only for IRAs.

IRC §72(t)(2)-(3)

Life insurance and the estate

Proceeds are included in the insured's gross estate if the insured held any incident of ownership at death.

IRC §2042(2)

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