1.1.

Individual Income-tax Return = Form 1040

 An individual must file Schedule 3 of Form 1040 to claim both refundable

and non-refundable credits. Examples of refundable credits on Schedule 3
are credits for federal tax fuels and excess social security withheld.

 Organizations that are members of an affiliated service group or a

controlled group of corporations are treated as a single employer for tax
purposes and must aggregate their gross receipts to determine whether
the gross receipts test is met or not.

 Tax shelters are never allowed to use cash method of accounting

(excluded entities) or any combination of method that includes cash
method.

 Head of Household filing status is applicable to single individuals with

qualifying dependents. To qualify for this status, the taxpayer should also
have provided greater than 50% support to the dependents. Support
includes cost of maintaining household such as rents, repairs, property
tax, mortgage interest, property insurance, utilities and food consumed in
the house. As such, the value of services rendered in the home by
the taxpayer is not considered in determining whether taxpayer
contributed more than one-half the cost of maintaining the
household.

 The three-year statute of limitations applies for additional tax assessment

when there is error/ simple negligence or the gross income
understatement is less than 25%.

 A husband and wife can file a joint return even if the spouses have
different accounting methods (cash or accrual) in different parts of the tax
return.

1.2. Gross Income

 Passive activity loss and credit rules state that passive activity loss can be
offset only against passive income. Any excess is carried forward
indefinitely or until the activity is disposed of. From the given options,
passive activity loss rules apply only to Personal Service Corporations
(PSCs). A Personal Service Corp. is one whose income is primarily derived
from personal services and over 95% of the shares are held by specified
shareholders including employees. PSCs are subject to passive activity
loss limitations to prevent the shareholders from hiding personal service
income by creating a corporation and passing on the losses to the
corporation.

Other than PSCs, passive activity loss deductions apply to individuals,

estates, trusts, and closely held C-Corps.
  A cash basis taxpayer should recognize income the earlier of actual or
constructive receipt, whether in cash or in property. E.g., a Constructive
receipt is a check received at year-end but not deposited, rent/ royalties
received in advance are taxable when received.

 Dividend income from life insurance is not included in taxable income as

they are treated as a return on capital unless they exceed the aggregate
amount of premiums paid. Dividend income from S Corp is taxable in the
year it is reported on Sch K-1 irrespective of the actual date of its
distribution.

1.3. Adjustments (“Above the Line” Deductions)

 Self-employed individuals who work for themselves such as sole
proprietors and contractors, are subject to self-employment tax
computed on the net income. Also included in this list are
partners who receive guaranteed payments. These payments are
made to partners irrespective of whether a partnership makes
profit or not. Ordinary income to an S Corp. shareholder is
excluded from self-employment tax.

 Non-cash charitable contribution is not a deduction in arriving at AGI;

instead it is deductible from AGI as an itemized deduction subject to
certain limitations on schedule A (Mnemonic: Mike Takes Interest in Charity
& Casual Outings). The overall limitation on deduction of qualified non-
cash charitable contributions is 50% of AGI.

 A sole proprietor can normally adopt either cash method, accrual

method or hybrid method of accounting. An exception to this is
where taxpayers are required to follow accrual method of
accounting for tax purposes for purchases and sales of inventory,
irrespective of how the books are maintained.

1.4. Deductions from AGI

 Generally medical expenses are deductible in the year paid, even if it is for
services that were availed in the prior years. Qualified medical expenses
are deductible as itemized deductions on Schedule A subject to 7.5% AGI
limitation.

 Charitable contributions made during the year in cash or property are

deductible as itemized deductions on Schedule A subject to certain
limitations or as an adjustment ('above the line deduction') for
contribution made in cash only to public charity by the taxpayers who do
not itemize ($300/$600 MFJ - 2021). However, a deduction is not allowed
for the value of taxpayer’s time or services rendered to a charity

 The $20,000 loan secured by main home used to purchase an automobile,

is considered home equity indebtedness (Mnemonic: Mike Takes Interest in
 Charity & Casual Outings). Under pre-enactment law, this type of loan
could be used for any purpose and the interest on loan upto $100,000 was
deductible, provided the home equity debt is lower than the Fair Market
Value (FMV) of home. However, the Tax Cut and Jobs Act (TCJA) has
suspended the deduction of interest on home equity loans unless the
home equity loan is considered acquisition indebtedness. Proceeds from a
home equity loan are considered acquisition indebtedness if they are used
to buy, build or substantially improve the taxpayer's home provided all
mortgage loans combined do not exceed the applicable limitation on
acquisition indebtedness ($750,000 on loans acquired on or after
December 15,2017 and $1 million for grandfathered loans acquired prior
to such date).

Since the home equity loan secured by Brown of $20,000 was used to
purchase a car, it does not meet the requirements of acquisition
indebtedness and as such, any interest paid on the loan would be
considered nondeductble interest.

 Contribution to Traditional IRA is tax deductible. On distribution both the

Principal as well as Interest component of the distribution are taxable.

 The Tax Cuts and Jobs Act of 2017 (TCJA) allows taxpayers a deduction for
qualified business income (QBI) from a qualified trade or business
operated directly or through a pass-through entity.
Starting 2018, in addition to standard OR itemized deductions, taxpayers
are allowed to deduct from AGI:
20% of Qualified Business Income from Qualified trade / business.
(+) 20% of Qualified REIT (Real Estate Investment Trust) dividends.
(+) 20% of Qualified PTP (Publicly Traded Partnership) income.
Eligible taxpayers may be entitled to a deduction of up to 20 percent of
QBI from a domestic business operated as a sole proprietorship or through
a partnership, S corporation, trust or estate. Income earned through a C
corporation or by providing services as an employee is not eligible for the
deduction.
QBI is the net amount of qualified items of income, gain, deduction and
loss from any qualified trade or business and excludes: Investment items
such as capital gains or losses, dividends or interest income, wage income,
foreign income that is not effectively connected with the conduct of
business within the US, certain commodities transactions or foreign
currency gains or losses, reasonable compensation from an S corporation,
guaranteed payments from a partnership.
Thus, income received as guaranteed payments from S corporation are not
generally considered as wages and not allowable for the qualified business
deduction.

Common Notes

 Cafeteria plan, is like a non-taxable fringe benefit, which allows employees

to make contribution to a range of qualified benefits on a pre-tax basis.
 Some of the qualified benefits that can be included in a cafeteria plan are
adoption assistance, dependent care assistance, education assistance,
HSA, etc. The employer provided cafeteria plan need to meet certain
requirements to qualify as non-taxable:

1) All participants must be employees who must have at least one year
of service

2) The plan should allow the participants to carryover up to $500 of

unused contributions to the immediate following year

3) Participants are required to make elections among the benefits

4) The plan must be in writing and have certain specified information

5) The plan does not allow contribution towards benefits that defer pay,
except for 401(k) plans.

 Dependency exemptions have been suspended, as per the Tax Cuts and
Jobs Acts, from 2018. (Prior to TCJA, a taxpayer was able to claim
dependency exemption for self and for each dependent on the tax return
(subject to AGI limitations) which reduced the taxable income before
computation of tax.) Thus, a taxpayer cannot claim dependency
exemptions anymore.

 An individual is not required to file a return if income is less than then the
standard deduction.
Note: Even though the individual need not file a tax return, it is still
advised to do so to get a refund of any federal income tax withheld or if
there is any refundable credit (such as earned income credit, additional
child tax credit, american opportunity credit).

 Form 1040-X can be filed after an original tax return is filed to

correct/amend an original tax return, make certain elections after the
prescribed deadline, change amounts adjusted by the IRS or make claim
for a carryback due to loss or unused credit. However, cannot be used as
late filing return.

 The 12 month rule, which says that an expense is deducted immediately,

only if the following conditions are satisfied:

(i) Benefit does not extend beyond 12 months after the first date of receipt
of benefit
AND
(ii) Benefit does not extend beyond the end of the taxable year following
the taxable year in which the payment is made.

 The general rule is that a non-business debt must be totally worthless to

be tax deductible. There is no deduction available for a partially worthless
non-business debt. As at the end of year 2, the taxpayer has estimated to
 collect 20% of the principal which shows that the debt is not totally
worthless in Year 2 and therefore none of the losses can be claimed in Year
2.

 In case of multiple support agreements where more than 50% of support is

provided by two or more tax payers; only one of the taxpayer providing >
10% support can claim the relative as dependent

 Per currently applicable rules, worker's compensation benefits, damages

for physical injuries (or disability insurance) and any reimbursements from
a health plan for which no deductions were taken (itemized deductions),
are excluded from gross income.

2.1. Capital Gains and Losses

<< No Notes>>

2.2. Depreciation and Amortization

 Under Modified Accelerated Cost Recovery System (MACRS), there are
three types of conventions that are applied to depreciable property. These
conventions are applied both in the year of purchase and sale. They are
Half-Year (HY), Mid-Quarter (MQ) and Mid-Month (MM).

The HY convention applies to property (other than real estate), wherein a

property is treated to have been purchased or disposed of in the middle of
the year. The key word here is "treated", meaning irrespective of when a
property is actually purchased or sold, the convention allows for a half-
year's depreciation in the year of purchase or sale.

 Depreciation using MACRS (Modified Accelerated Cost Recovery System)

allows depreciation over a stated recovery period that is generally shorter
than the asset’s estimated useful life and salvage value is ignored.
Depreciation conventions are used for the first and last years'
depreciation. They are used to determine when and how depreciation is
calculated for both the year when the fixed asset is placed in service and
the year when the fixed asset is disposed off. The different conventions
followed to depreciate assets for tax purposes are half-year convention
(property is treated to have been purchased or disposed in the middle of
the year), mid-quarter convention (property is treated to have been
purchased or disposed in the middle of the quarter), or mid-month
convention (one half of the month in which the property is purchased or
disposed is taken). Thus, statement I is true.

Mid quarter convention is used for property other than real estate property
if more than 40% of the property placed during the year has been done in
the last quarter (and not 50%). Thus, statement II is untrue.
 Bonus (first year) depreciation of 100% is allowable as a deduction for new
/ used qualified property placed in the business during the year. As per the
law, a taxpayer is required to claim bonus depreciation unless they elect
out. The “election out” is made on an asset recovery class basis.
Taxpayers may have any number of reasons for electing out, including
avoiding the expiration of income tax credits or net operating losses.

3.1. C - Corp Income tax Return

 C Corporations are always subject to double taxation. The first level of

taxation occurs when corporations pay taxes on their earnings. The
second level of taxation occurs, when corporations pay dividends to
shareholders and those dividends are taxed again in the hands of the
shareholders.

 A C corporation is the only entity among the given list that has flexibility in
adopting an accounting period that it chooses. An accounting period or
taxable year can be:

(1) Calendar year with a December 31 year end

(2) Fiscal year ending on the last day of any month other than December
(3) 52-53 week year/period ending on the same day of a week (e.g., last
Friday of a month)

 Which is the common inventory identification method which is not used in

Tax? - Weighted Average method

3.2. Income

 Under the LIFO method the last of item inventory purchased is the first
one to be sold. Therefore, the ending inventory or the inventory on hand
will consist of goods that were acquired the earliest. In period of rising
prices if the cost of most recently acquired goods are included in the cost
of sales, the overall cost of sales would increase resulting in lower taxable
income under the LIFO method when compared to the FIFO method. Lower
taxable income means lower tax liability than the FIFO method.

 The Tax Cuts and Jobs Act of 2017 introduced 100% dividend received
deduction (DRD) on the foreign-source portion of dividends received from
a specified foreign corporation to encourage US MNC’s to repatriate
foreign-earned income back to the U.S. Thus, statement I is correct.
Dividend from domestic corporations were eligible for DRD even in under
the prior law. However, under the TCJA, the amount of deduction has been
revised as below:
 - 50% DRD for dividends from less-than-20%-owned domestic
corporations.
- 65% DRD for dividends from 20%-or-more-owned domestic corporations.
Thus, statement II is incorrect as the DRD on dividend from domestic
corporations is not 80%.
Global Intangible low taxed income (GILTI) is the pro-rata share of excess
CFC income over the CFC’s “net deemed tangible income return” {sort-of
penalty imposed by TCJA for generating excessive returns on foreign CFCs
which is generally achieved by migrating intangible assets offshore}. GILTI
is eligible for upto 50% deduction as per Section 250.
Thus, statement III is also incorrect because special deduction on GILTI is
50% and not 100%.

 The tax law allows cash basis of accounting for small businesses that have
average annual gross receipts of $29 million or less (Limit for the year)
during the preceding three years. Further, it allows the cash basis
taxpayers to not use accrual method for valuing inventories (unlike prior
law when even cash basis taxpayers were required to use accrual method
for inventories).

They may now use either of the options:

- Treat inventories as non-incidental materials and supplies, or
- Conform to the taxpayer’s financial accounting treatment of
inventories.

A taxpayer with gross receipts $28 million in the prior year and $47 million
for the two years prior will have total gross receipts of $75 million (and
average of $25 million) for the three preceding years. Such taxpayer can
use cash basis if the average gross receipts of the three preceding years is
less than or equal to $29 million (for the year).
 In general, when contribution of inventory is made to a qualified
organization, the amount of charitable contribution deduction is equal to
the lower of fair market value or tax basis of the property
donated. However, if the cost of donated inventory isn't included in the
corporation's opening inventory, the inventory's basis is zero and a
charitable contribution deduction cannot be claimed. Therefore, in order to
take a charitable deduction, corporations must include the purchase price
of the inventory bought and donated in the same year in the cost of goods
sold for that year.

3.3. Deductions
 C corporations are only allowed to amortize and deduct organizational
expenses such as state fees of incorporation, accounting and legal costs
incidental to incorporation, temporary director fees and organizational
meeting expenses. Stock issuance costs such as printing and underwriting
commissions are never deductible and must be capitalized.

 Covenant not to Compete is an acquired intangible asset under

Section 197 of the IRC. The cost incurred to acquire the asset is
 amortized over a period of 15 years or 180 months. Other Section
197 intangibles include acquired goodwill, patents, copyrights, franchise,
trademark, customer based intangibles and supplier based intangibles.
Note: In this case, even though the period of covenant is 7 years (extend
from 5 years), the cost must be amortized over a period of 15 years.

3.4. GAAP / Book Income vs. Taxable Income

No Notes

3.5. Tax Computation

 The accumulated earnings tax (AET) is a penalty tax imposed by the IRS
on corporations which unreasonably accumulate excessive retained
earnings instead of reinvesting them for business purposes or distributing
as dividends to its shareholders. This tax is imposed regardless of the
number of stockholders in a corporation.

 The Tax Cuts and Jobs Act of 2017 (TCJA) provides a 20% qualified business
income (QBI) deduction to individuals with respect to business income
from sole proprietorship as well as pass through income from
partnerships, limited liability companies (LLCs) and S corporations. This
deduction is not available for C Corporations.

 Corporations that file a short year tax return (taxable period of less than
12 months), must determine taxes for that period by annualizing the
income. The following are the steps involved:
1) Annualize the taxable income for the short period by multiplying by
12 and dividing by number of months in the short period.
2) Determine tax liability for the annualized income.
3) Compute the tax liability for the short period by multiplying the
annualized tax liability with the number of months in the short period and
dividing by 12.

4.1. S - Corporations
 An S-corporation has two types of income:

- Ordinary Business Income calculated as business net receipts less

deductions

- Separately Stated Items which are amounts that can hit a limit on the
shareholder's individual tax return

Charitable contributions are separately stated items that flow through to

the shareholder's individual income tax return and deductible subject to
gross income limitations.
 S corporations do not pay income taxes but are required to file annual
information returns reporting income and the allocation of that income to
the various shareholders. As the items will be reported on the tax returns
of the shareholders, the shareholders must segregate items that have
special treatment on their individual tax returns. For this purpose, the S
corporation prepares a Schedule K that summarizes ordinary income and
separately lists all items that are not ordinary. Additionally, a Schedule K-1
is prepared for each shareholder showing that shareholder’s allocated
share of all of the items on the Schedule K. In other words, separately
stated items [Schedule K] are those amounts that can hit a limit on the
shareholders’ individual tax return.

Charitable contribution deductibility is dependent on the status of the

taxpayer i.e. the allow ability of charitable deduction is different for an
individual tax payer as compared to a trust as compared to a C
corporation. Thus, the charitable contribution is a separately stated item.

 Income of S corporation is divided into two categories: (1) General

business income and loss and (2) separately stated income, loss,
deductions and credits. A schedule K is prepared which shows the net
business income and the separately stated items. Information from
Schedule K is allocated to various shareholders on schedule K-1 which is
then reported on their individual tax returns.
From the given choices, only gain or loss from the sale of collectibles is
separately stated on the S corp. K-1 because of their special treatment on
the individual tax returns of shareholders.

 Items which can alter the tax liability of shareholder, if taken into account
by them on their personal tax returns, are required to be states separately.
Item not required to be separately stated (e.g., amortization of
organizational expenditures), are combined at corporate level, and a net
amount of ordinary income or loss is passed through. So here,
amortization of organizational expenditure of $865 will be deducted as
ordinary expenses on Windmills tax return.

 A shareholder's at-risk basis is the sum of money and the adjusted basis of
property contributed, pro-rata share of pass-thru income and losses and
amount borrowed and lent to the corporation for which the shareholder is
personally liable for repayment. Any excess of shareholder’s pro-rata
share of pass-thru losses for the tax year over his/her amount at risk at
the close of the tax year is not deductible.

 When an S corporation has no Accumulated Earnings and Profits (AEP),

any distribution it makes would be from its Accumulated Adjustment
Account (AAA). Distribution to the extent of AAA is non-taxable return of
capital and would reduce the shareholder’s basis until it reaches zero.

 An S corporation's Accumulated Adjustment Account (AAA) represents the

cumulative total of undistributed non-separately stated and separately
 stated income (+) and expense (-) items. Further it is reduced for any
distributions made to the shareholder.

From the given choices, interest and dividend are separately stated
income items that increase the balance in the AAA account.

 A C corporation can be converted to an S corporation, provided a

valid S- election is made (Consent of 100% of shareholders and
election is made within the 15th day of the third month of the tax
year). One of the primary benefits of filing as S Corporation is the
elimination of double taxation. S corporation no longer pays any
taxes; all income, expenses, and losses are passed through to the
shareholders who pay tax at the individual level. Accordingly, as
given in choice (d), capital losses are passed through to the individual
shareholders who can claim the loss on their tax return subject to a $3,000
excess capital loss limitation against ordinary income on Form 1040.

4.2. Partnership
 A partnership distribution can either be liquidating or non-liquidating.
Liquidating partnership distributions imply that the partner is no longer
going to be associated with the partnership. Non-liquidating distributions
can either be current or partial distributions that do not terminate the
interest of the partner.

The fact pattern of this question does not indicate if the payment of
$12,500 proportionate to Brown's interest ($25,000 x 50%) is related to
partial or full liquidation. Therefore, it can be assumed as a current
distribution, i.e., non-taxable return of capital as partners pay tax on
partnership income when earned and not when distributed.

 The partnership’s holding period for contributed assets includes the

holding period of the assets in the hands of the contributing partner. If the
partnership interest is received in exchange for money or other property,
the partner's holding period in the partnership commences on the date the
interest is acquired, i.e., the contribution date. Generally, no gain or loss is
recognized on the contribution of property to a partnership in exchange for
a capital interest. Here, Since Jane owned property for 2 years before
contribution, the partnership JJR's holding period for equipment would
begin from the time Jane acquired the property.
 Guaranteed payments are payments made to partners for service or use
of capital, irrespective of the partnership's income/loss. These payments
are both (i) ordinary business expense to the partnership reported on page
1 of Form 1065 and (ii) a separately stated item on Schedule K and
included on Schedule K-1 of individual partner/s, to be taxed as ordinary
income to the partners, subject to self-employment tax.

 A partnership is a pass-through organization, where each partner is

allotted pro rata share of profit/losses as also share of separately stated
 items, e.g. rent, interest, capital gains etc. A partner's pro-rata share of
losses can be deducted, provided the loss limitations set by the following
are met in the order stated:

(1) Tax-Basis: Losses can be deducted only to the extent of partner's tax
basis.

(2) At-risk: A partner is at-risk to the extent of cash & property contributed
into the activity, amounts borrowed with respect to the activity and is
personally liable for and qualified non-recourse financing and the pro-rata
share of income each year.

(3) Passive Loss - A partner's share of partnership loss can be deducted to

the extent of passive income available from other activities.

Any losses that are not currently deducted, can be carried forward until
utilized in other years or complete disposition of partnership interest.

4.3. Limited Liability Companies

 Individuals who are members of single-member LLCs report the LLC's

income and expenses on Schedule C (Profit or Loss from Business) of the
individual's Form 1040, and they are subject to self-employment taxes on
the net earnings from the LLC. The single-member LLC is disregarded for
federal income tax purposes, meaning its activities are treated as directly
conducted by the individual member, making the member responsible for
self-employment taxes on the business's profits.

4.4. Tax Exempt Organizations

 In order to maintain the exempt status, the organizational test requires
that an organization satisfies the exempt status on paper. Therefore, the
articles of organization of a tax-exempt entity such as a public service
charitable organization must limit the purpose of the entity to the
charitable purpose.

 An exempt organization is a non-profit entity that operates for the benefit

of others. Organizations other than churches must apply with the
IRS for exempt status within 15 months from the end of the
month in which they were organized.

 Sec 501 of the Internal Revenue Code provides for certain organizations to
be exempt from federal income taxes. Sec 501(c) (3) describes the type of
organizations that are exempt and includes corporations, funds and
foundations that are organized and operated exclusively for charitable or
religious [not being political] purposes and whose net earnings do not
benefit any private shareholder or individual. Therefore, a partnership may
not qualify for federal tax exemption under Sec 501(c)(3).
5.1. Federal Taxation Recapitulation

<<No Notes>>

5.2. Tax Research (Internal Revenue Code or IRC)

 Tax regulations provide directions on how to apply the law outlined in the
IRC. There are three types of tax regulations—legislative, interpretive, and
procedural.

 Revenue procedures deal with the internal practice and procedures of the
IRS in the administration of the tax laws.

 Treasury regulations are the Treasury Department's official interpretation

of how a particular IRC section is to be administered and applied. There
are three types of Treasury Regulations— proposed, temporary and final.

5.3. Tax Planning

<<No Notes>>

5.4. Federal Tax Procedures and Legislative Process

 A financial account, such as a depository, custodial or retirement account
at a US branch of a foreign financial institution is an exception to the
general rule that a financial account maintained by a foreign financial
institution is a specified foreign financial asset and hence does not have to
be reported for the filing an FBAR (Foreign Bank and Financial Accounts
Report).

 The FBAR filing requirement applies to all U.S. persons who have a
financial interest in or signature authority over foreign financial accounts
AND if the aggregate value of those accounts exceeds $10,000 at any
time during the calendar year. This includes accounts held jointly with non-
U.S. persons. The requirement to file an FBAR does not differentiate based
on the nationality of the other account holders; instead, it focuses on the
aggregate value of the accounts and the U.S. person's relationship to
those accounts. Therefore, the total of $12,000 across all three accounts
necessitates FBAR reporting.

 FBAR (Foreign Bank and Financial Accounts Report) requirements

necessitate U.S. persons to report foreign financial accounts in which they
have a financial interest or over which they have signature authority if the
aggregate value of those accounts exceeds $10,000 at any point during
the calendar year. In this scenario, the individual has signature authority
 over an account that clearly exceeds the $10,000 threshold, thereby
requiring FBAR reporting.

5.5. State and Local Taxes (SALT)

<<No Notes>>

6.1. Professional and Legal Responsibilities

 When completing a return with the possibility of a taxpayer penalty being

assessed, a tax advisor should inform the taxpayer of potential penalties
and advise to disclose the position on the tax return. Note that the final
decision of whether or not the position is disclosed on the return rests with
the taxpayer and not the tax advisor.

 In an action brought under Section 11 of the Securities Act of 1933 there is

no privity requirement, and the plaintiff has no obligation to prove reliance
(since the receipt of the prospectus creates that presumption). Mnemonic:
Material L.

Most notably, the plaintiff need not demonstrate that the auditor’s work
was deficient; the law presumes that the audit must have been deficient
due to the material misstatements. Instead of the plaintiff having to prove
that he relied upon the information, the auditor needs to prove that the
plaintiff did not rely.

 When the IRS seeks client records from a CPA who is not in possession of
the same, the CPA can notify the IRS of the identity of any person who is
believed to have the records. Additionally, the CPA may make reasonable
inquiries with the client about the third party who may have the
information.

 Under the Treasury Department Circular 230 (10.21), a tax practitioner

who knows or identifies an error or omission on a previously filed tax
return must advise the client promptly of the error or omission and also
advise the consequences of such noncompliance, error, or omission.

 The IRS does not impose a penalty on a CPA for making an error in
calculating a tax return; unless the error resulted from the preparer's
negligence, there is no penalty for an honest mistake.

 When sued for negligence, a CPA will be liable to anyone in privity (client),
intended third party beneficiary or anyone known and foreseen by the CPA
(example a shareholder). Therefore, when a CPA negligently gives an
opinion on the financial statements, he would be liable to a third party that
he knows would rely on the opinion.
 Common law principles to establish negligence requires that there be
privity of contract between the accountant and the plaintiff. Generally, the
parties in privity are the client and the intended third party beneficiary. An
accountant can use lack of privity as a viable defence against a client's
creditor on the premise that the creditor was not the intended beneficiary
and was not specifically identified by the client.

 The Internal Revenue Code is the basic foundation of federal tax laws and
represents a codification of the federal tax laws of the United States. It is
the official "consolidation and codification of the general and permanent
laws of the United States," as the Code's preface explains. Since it is law,
it has the greatest authority.

 Negligence is the absence of due professional care. A CPA is considered to

be negligent when previously discussed errors are not corrected.
Additionally, a CPA is negligent when he fails to:

(1) Disclose information to client and

(2) Does not follow GAAP/GAAS standards

 According to Treasury Regulation 301.7701-15, a tax return preparer is

defined as "any person who prepares for compensation, or who employs
one or more persons to prepare for compensation, all or a substantial
portion of any return of tax or any claim for refund of tax under the
Internal Revenue Code (Code)." This can include a signing preparer and
any number of non-signing preparers.

 When a sole practitioner CPA prepares income tax returns, he is required

to retain documentation of the taxpayer's name and identification number
or a copy of the prepared tax return for a period of three years. The tax
preparer is not required to retain an unrelated party compliance
statement, work papers associated with the preparation of each tax
return, or a power of attorney.

 A single-member LLC is a disregarded entity for tax purposes, unless it

elects to be treated as a corporation. Therefore, there is no tax return to
file for federal tax purposes. Filing of a partnership tax return for Year 1,
was incorrect on behalf of the prior CPA. The AICPA Statement of
Standards for Tax Services provides that the current CPA engaged to
prepare tax return for Year 2 must prepare the correct tax return and
advice the client of the errors in the prior tax return. The decision to rectify
the error, however, remains with the taxpayer.

 The AICPA Statements on Responsibilities in tax practice includes

guidelines for the tax practitioners, that are merely advisory in nature and
do not include professional rules and ethics having formal administrative
authority.
 Under Treasury Department Circular 230, a CPA tax advisor's best practice
includes establishing relevant facts, evaluating the reasonableness of
assumptions and representations, and arriving at a conclusion supported
by the law and facts in a tax memorandum.

 A partner in a CPA partnership firm is an owner of the firm and not a third
party. Therefore, on the death of one of the partners, the CPA partnership
can provide its working papers to any surviving partner. This can be done
legally and without the client’s consent.

 According to IRC section 6695, a penalty of $600 per check is assessed on

tax return preparers who endorse or otherwise negotiate any check made
to taxpayers by the IRS.

 A CPA cannot accept contingent fees from clients in case of the following
services: audit or review of the financial statements, Compilation of
financial statements expected to be relied upon by a third party, or
examination of prospective financial information. In addition, a contingent
fee cannot be accepted for the preparation of an initial or amended tax
return. However, a contingent fee may be accepted if fixed by courts,
other public authorities, or in tax matters if based on the results of judicial
proceedings.
 The AICPA Code of Professional Conduct has very strict rules around the
acceptance of contingent fees, commissions, and referral fees. From the
given choices, only fees such as commission or referral fees paid to the
CPA for recommending a product or service such as a computer system
are allowed, provided the CPA does not provide audit or attest services.

 When considering whether to communicate in writing or orally, the AICPA

standards suggest that the CPA consider factors such as the importance of
the transaction, the technical complexity involved, the potential penalty
consequences of the tax return position, and the tax sophistication of the
client.

 Information obtained by the auditor during the audit is confidential but not
privileged. Hence in majority of the states, where common law prevails,
the auditor must comply with a subpoena from a court. However, some
states have enacted privilege statutes, which allow the accountant to
refuse to honor a court subpoena. Hence Silo will be able to prevent Pym
from testifying in such states where a statute has been enacted creating
such a privilege and provided Silo has not waived such privilege and the
purpose of privilege is to protect the accountant and not client.

 According to the Statements on Responsibilities in Tax Practice, preparers

may rely on information provided by the client without verification unless
it is clearly incorrect or incomplete. However, reasonable enquiries must
be made about the existence of the documentation for certain expenses
like business travel expenses. As the CPA has failed to make the inquiry
related to the documentation of the travel expenses, he may be assessed
a tax return preparer penalty.
  The proposed adjustment is improper because the statute of limitations for
a properly filed tax return is 3 years from the return due date or filing
date, whichever is later. The statute is extended to 6 years if the omission
is greater than 25% of gross income reported on the tax return and the
statute is unlimited in case of non-filing of tax return or fraud.
In this case, since the IRS agent did not find any fraud or errors substantial
in nature, therefore, the proposed adjustment can go back only up to 3
years of tax returns. The proposed assessments for year 1 and year 2
expired in year 5 and year 6 respectively.

 In a common law suit against CPA firm where a plaintiff asserts

that the CPA firm has committed actual fraud or is grossly
negligent (constructive fraud), the best defense that the CPA firm
can use is lack of scienter. Scienter indicates actual knowledge of
fraud. The CPA firm on the basis of good faith, can defend itself by
submitting that it lacks both actual and constructive knowledge of
falsity of the financial statements when providing the unqualified
opinion, i.e, Scienter. However, the CPA firm cannot escape a
negligence law suit based on this defense.

 A tax return preparer is any individual (not necessarily a CPA, or Enrolled

Agent) who prepares a tax return for compensation. Louis, in this case is
not a tax return preparer because he is not compensated for preparing the
annual tax return of the non-profit organization.

 In the states that follow the decision of Ultramares vs Touche, an

accountant is liable for negligence only to anyone in privity and
intended third party beneficiary. The accountant is never
responsible for negligence to a foreseen party or a third party. A
CPA is liable to foreseen parties only in states that follow 2nd
restatement of torts, which provides that a user or foreseen party
who relies on financial statements audited by CPA can sue for
negligence.

6.2. Federal Laws and Regulations

 A non-contributory pension plan is a pension plan that is fully funded by
the employer. Enrolment in a non-contributory pension plan typically
begins with employment and is often non-voluntary.

 The main purpose of antitrust laws is to promote production and

distribution of goods by ensuring free and fair competitive markets in an
open economy. A corporation attempting a takeover of a target
corporation may prevent it by either making a self-tender to the
shareholders or seek an injunction against the acquiring company.

 Worker's Compensation Act gives guaranteed compensation to employees

for job-related injury or illness that occurred while working within the
scope of employment.
  The Fair Labor Standards Act requires a minimum wage that must be paid
to all employees without exception, including hourly and salaried
employees. The pay bases used may be hourly, weekly or monthly and the
payment must be at least the minimum hourly wage.

 One of the primary purposes for enacting the workers' compensation

statutes was to guarantee an employee compensation for a job-related
injury or illness, even if the employee was negligent and without having to
prove the employer's fault.

 An individual is eligible to receive Social Security retirement or survivors

benefits and work at the same time. But if the individual is less than full
retirement age at the time of receiving the benefits and earns more than
certain amounts, then, the benefits will be reduced. However, this does
not apply to individuals who are of full retirement age or older, they may
receive full benefits, but a portion of it becomes taxable (based on AGI
limitations) depending on their other income.

 Worker's Compensation Act guarantees compensation to

employees from an employer on account of job-related injuries.
The employer is subject to strict liability and is due to pay even if
not at fault.

6.3. Business Structures

 Apparent authority of a partner creates an impression to a good faith third
party that a partner can enter into any contract that involves the business
of partnership, irrespective of what the partnership agreement provides
for. But, if there is a formal resolution limiting the authority of a partner
and the third parties are aware of the same, then the partnership and the
partner are bound by such resolution.

 A recommendation of dissolution by the board of directors and approval by

a majority of all shareholders entitled to vote is required to achieve a
successful voluntary dissolution.

 Pre-emptive right is a privilege extended to existing shareholders, the

right to subscribe to new issuance of shares up to the percentage they
own of existing shares, to prevent dilution if their interests. It is usually
available to shareholders of a startup company who commit large amounts
of capital.

 Mergers is one company absorbing another and becoming liable for all
obligations of the acquired corporation. A merger can be effected by
giving some parties cash or property. Receipt of voting stock by all
stockholders of the original corporations is not a necessity.
 A general partner of a limited partnership is responsible for the
management of the partnership and has unlimited liabilities. A general
partner can also be a creditor of the partnership, whether secured or
unsecured.

 An operating agreement is one of the most important documents of an LLC

as it outlines the business financial and functional decisions. The purpose
of this document is to spell out the internal operations of the business in a
way that it is suited to its members and forestall and resolve dispute
among members.

 Limited Liability Company (LLC) is unique in the sense that it enjoys both
the benefits if a partnership as well as a Corporation. It is created formally
like a Corporation where members have limited liability and functions like
a partnership where taxes are paid at member level via pass-through
income instead of the corporation paying taxes. An added benefit when
compared to S Corporation is that, unlike S Corp. which pays tax on
distribution of appreciated property, the distribution of appreciated
property to members of LLC is tax-free.

 A stock dividend is a dividend paid out in proportion to the exisiting shares

held by the shareholders. Unlike cash dividends, generally stock dividends
are non-taxable to the shareholders.

 Partnership agreement is required to be in writing only when the

partnership term exceeds one year. This is as per the statute of frauds.

 Mergers and combinations require support of a majority of both boards

and both sets of shareholders unless the change in ownership is not
significant such as the merger of a subsidiary that is already 90% owned
by the parent.

 A shareholder must repay illegal distributions from Corporation that was

insolvent at the time of distribution, even though the shareholder was
unaware of the illegality of the distribution. This is based on the premise
that creditors have superior claim over shareholders on the assets of a
Corporation in the event of insolvency.

 Distribution of property to the owners is not taxable, if the distributing

entity is a partnership. This is irrespective of whether the partnership is a
general partnership or a limited liability partnership. Partners, who receive
appreciated property will,
(i) receive the property at the inside basis of the partnership (i.e, FMV of
property is ignored) and
(ii) in case, the partner's basis is insufficient to receive the appreciated
property, the distributing property's basis is adjusted such that, the
partner/partnership recognizes no gain or loss.
 Therefore, the individuals may be advised to form a general partnership or
a limited liability partnership, to defer recognition of gain on appreciated
property.

 Assignment is typically made to secure a loan. Assignee is not substituted

as a partner without the consent of all other partners and does not receive
right to manage partnership, to have access to accounting records, to
inspect books, to possess and own any individual partnership property.

 Partnership at will is a form of partnership where no fixed term has been

agreed for the duration of the partnership or the partnership has been
entered into for an undefined term. A partnership at will may be dissolved
at any time by a partner serving notice on the other partner(s).

 A partnership by estoppel is a legally binding partnership that may arise

where, in fact, no formal partnership agreement is in effect.

7.1. Contracts

 In common law contract both the parties to the contract must provide
some consideration for it to be valid. If only one side has obligations, the
contract is not valid. Additionally, consideration must be “of value” (or
legally sufficient), and be “bargained for”. It is assumed that the
consideration is fair because it resulted from a bargain between two
parties.

 Under the personal services contract, the party's duty will be discharged if
there is illegality of the services to be performed.

 Under the parol evidence rule, any prior or contemporaneous oral or

written evidences that contradict the terms of a written agreement will be
excluded.

 The statute of limitation provides time period within which the aggrieved
party can bring an action against defaulting party for breach of contract.
Upon expiration of the stipulated period, the defaulting party may demand
performance, however the right to judicial remedies of the aggrieved party
extinguishes.

 The statute of limitations for an action for breach of contract begins after
the date of breach and is generally four to six years.

 An offer must be accepted before it terminates. Under common law, an

offer is automatically terminated by operation of law such as death or
incapacity of party performing the contract, impossibility or destruction of
subject matter, illegality of the services performed or bankruptcy
discharge.
 Once a contract has been formed, right and duties may be assigned
and/or delegated. However, there are certain exceptions to assignment
and includes assignment of a contract which materially alters the rights or
responsibilities of the other party. As such, option contract rights are
assignable but a malpractice insurance policy rights cannot be assigned as
it would materially alter the rights and responsibilities of the contract.

 Assignment is the transfer of a right under a contract by one person to

another. The right to receive a sum of money is an assignable right.

 In case of written contracts, parol evidence rule precludes parties to

provide external evidence from prior or contemporaneous oral agreement,
that contradicts the written contract. In other words, the parol evidence
rule provides that any contradictory oral agreements made between the
parties prior to the written agreement are not admissible.

 A court will generally grant remedy of specific performance which is

available for unique property or patents.

 The Statute of Frauds requires written evidence for certain type of

contracts. The statute of frauds may be stated in more than one
document.

 Assignment of contract to a third party involves the assignment of all

rights and delegation of all duties. It does not however, allow for material
alteration of rights and responsibilities of other party or increase the other
party's risk or duty.

Additionally, assignment is not allowed if (1) the contract specifically

prohibits it and (2) duty is personal in nature.

 Rescission is the method by which the parties to a contract are restored to

their original position.

 The main objective of parol evidence rule is to protect the terms of a

written contract by not allowing alteration to the terms already finalized
between the parties through use of any prior or contemporaneous oral or
written declaration that were not actually part of the written contract.
However, it permits the admission of any subsequent oral or written
modifications.
7.2. Sale of Goods (UCC Article 2)
 A reasonable method of acceptance is a valid acceptance unless an offer
states a specific means of acceptance to be effective. As the written offer
was made without specifying a means of acceptance but provides that the
offer will remain open for ten days, both sending acceptance by regular
mail and by fax before the expiry of ten-day period are valid acceptances.

 A firm offer is an irrevocable written offer, made and signed by merchant

seller, regarding the sale/purchase of specified goods, at a specified time
and normally considered to be enforceable for a specified period of time
mentioned in writing or for reasonable time generally up to 3 months.

 The warehouse would be liable for ordinary negligence as it takes on the

burden of being responsible to return the goods to their owner.

 A common carrier undertakes the transport of goods for a particular party

and is responsible for any possible loss of the goods during the transport
(strict liability). If the good being carried are subject to a negotiable,
bearer bill of lading, it implies that any holder of the bill can claim delivery
of the goods and may be neogtiated by a simple delivery, without
endorsement. Additionally, a carrier who delivers goods without/missing
negotiable bill of lading, is liable to any person injured by the misdelivery.

 Under the Documents of Title Article 7 of the UCC, the common carrier
may limit the liability or add a provision in the contract to cap the liability
to a specific fixed dollar amount, provided it is reasonable and agreed to
by the parties

 In a shipment contract the title and risk of loss transfers to the buyer when
goods have been properly transferred to the carrier (usually a trucking) at
the seller’s [Link] that the references to F.O.B. (free on board) and
F.A.S. (free along side) are to indicate that the transfer of ownership occurs
when the goods are loaded onto the truck or placed on the loading dock
next to the [Link], the title to the radios passes to Lazur at the
time they are delivered to the carrier, even if the goods are
nonconforming.

 A bailment is created when the owner of goods (bailor), temporarily

delivers them to the possession of another party (bailee), for an intended
purpose upon which the parties have agreed. The bailee has the
responsibility to return to the bailor the good entrusted to him or dispose
as instructed by the bailor.

 Where the provision for liquidated damages is not explicitly stated in the
contract, the injured party may recover only the reasonable amount of the
anticipated loss. The seller may retain the lesser of $500 or 20% of the
contract price.
7.3. Secured Transactions (UCC Article 9)
 Attachment to the collateral can happen when all three conditions are
satisfied (Mnemonic: PIC): (1) Property is owned by debtor i.e. debtor has
rights to the property; (2) Interest is created either through a signed
agreement or by creditor taking possession and (3) Creditor has given
value to the debtor.

 Under UCC Article 9 for secured transactions, security interest for

consumer goods can be automatically perfected (Mnemonic: File @ APP)
by those creditors who have Purchase Money Security Interest (PMSI).
PMSI is created by creditors who sell the consumer good to the debtor
retaining a security interest for the purchase price. This option is however,
only available for sales made to consumers and not to retailers or
wholesalers.

 Under the Secured Transaction Article of the UCC, a debtor must sign a
written agreement for the security interest to be enforceable (Mnemonic:
PIC). However such written security agreement is not required if the
collateral is in the possession of the secured party.

 Creditors need to protect their interest from several different parties.

Attachment gives a secured creditor the right to repossess collateral when
the borrower/debtor does not pay the secured debt (Mnemonic: BOTS).
Perfection gives the creditor legally enforceable rights against the
borrower (Mnemonic: BOTS) and all other parties (Mnemonic: BOTS)
claiming an interest in the same collateral. If a security interest is not
attached, it will not be effective against either the borrower or the third
parties.

7.4. Bankruptcy
 A chapter 11 reorganization pal must make provision to pay for the
administrative expenses to the court. This amount may be paid in
installments. The debtors must be aware that failure to pay for the
administrative fees may result in dismissal of the case.

 Chapter 7 of the Federal Bankruptcy Code will deny a debt discharge when
the debtor is artificial persons such as corporations and partnerships,
though they can participate in the Chapter 7 liquidation process.

 The trustee is given the power to maximize the property included in the
debtor’s estate by avoiding or setting aside certain transfers to maximize
the corpus available to the creditors. (Mnemonic: FAST). Statutory liens
that become effective after the bankruptcy petition is filed, can be set
aside by the trustee. However, a trustee may not set aside liens that were
effective before the bankruptcy petition was filed.
 A debtor need not be insolvent to file for voluntary petition under Chapter
7 bankruptcy proceedings. Hence, there is no requirement to show that
the debtor’s liabilities exceed the fair value of assets while filing such a
[Link], under the Bankruptcy Abuse and Protection Act of 2005,
“means test” is used to determine if individual debtors may file under
Chapter 7. If the debtor has income above certain thresholds, petition may
be dismissed or the debtor may proceed under Chapter 11 or 13
(applicable to individuals only).

 A judgement creditor is one, who by ruling of court, is entitled to

enforcement through liens, execution and levy. A debtor, who is
discharged under Chapter 7 bankruptcy proceedings, need not pay any
remaining outstanding debt those creditors who have not been paid due to
insufficient bankruptcy estate. The debtor is also relieved of any personal
liability to the judgement creditor.

7.5. Suretyship & Creditor’s Rights

 The Federal Fair Debt Collection Practices Act restricts how creditors may
collect debts and prevents a debt collector from directly contacting a
debtor who is represented by an attorney.

 An official bond is a type of surety bond that insures the performance of

the issuer in compliance with laws and regulations.

 Surety's personal defenses relating to surety’s incapacity (e.g., minor,

insane, etc.) or bankruptcy, can be used as a successful defense to limit
the surety's liability to a creditor.

7.6. Agency
 Generally, an employer-employee relationship is an agency relationship
where, the employee acts on behalf of the employer and has certain
express and fiduciary duties (loyalty, obedience, reasonable care, duty to
account). Respondent Superior is a common-law doctrine that makes an
employer liable for the actions (torts) of an employee when the actions
take place within the scope of the employment.

 Ratification is when an agent acts without actual or apparent authority,

but the principal decides after the contract is made to still honor the
agent's actions or commitments.

 In the absence of a contractual principal-agent relationship and where the

principal is guilty of violating a duty owed to the agent, the agent can
obtain remedy for past services, or recovery of future damages and
protect himself from further performance. But he will not be able to obtain
specific performance from the principal.


Important sums

QBID

Haden Kacin (aged 32) is married and files a joint tax return with his wife
María Guadalupe. Haden is a shareholder in an S Corp. S Corp holds no
qualified property. Haden's share of S Corp’s QBI is $300,000 in the current
year and his share of W-2 wages from S Corp is $40,000. Maria earns
wages from employment by an unrelated company. After allowable
deductions unrelated to the S Corp, Haden and Maria’s taxable income for
the current year is $424,200. What is the amount of qualified business
income deduction that the couple can claim on their Form 1040?
Assume that the threshold limit are as follows:

Lower Limits - $182,100 for single & others / $364,200 for MFJ

Upper Limits - $232,100 for single & others / $464,200 for MFJ

Answer:
Haden and Maria are eligible for Qualified Business Income Deduction
(QBID) based on their income from the S Corporation (Note: Assume
income from S Corp is from Qualified Trade or Business, unless otherwise
specified).

Generally, when taxable income is below the threshold, QBID is computed

as the lesser of
(i) 20% of Qualified Business or Income or (ii) 20% x (Taxable Income –
Capital Gains)

The deduction, however, will be subject to limitations if taxable income

exceeds the lower threshold, or is within the phase-in range or exceeds
the phase-in range.

In this case, for MFJ status, as the taxable income of $424,200 exceeds the
threshold of $364,200 but is within $464,200 ( the upper limit for MFJ filing
status), the QBID deduction is limited.

The QBID deduction is computed as follows in this scenario:

20% of QBI less an amount equal to “reduction ratio” multiplied by an

“excess amount”, where:

(i) Reduction ratio = (Taxable Income – Lower Threshold for MFJ) >(ii)
Excess amount = 20% of QBI less the wage and property limitation. The
wage and property limitation is computed as the greater of:

(a) 50% of wages from qualified trade or business or (b) 25% of wages
plus 2.5% of the unadjusted basis qualified property from the qualified
trade or business
Step 1: Calculate Reduction Ratio:

$424,200 taxable income - $364,200 Lower Threshold =

$60,000/$100,000 = 60%

Step 2: Calculate Wage limitation, greater of:

50% of taxpayer’s share of W-2 wages = $40,000 x 50% = $20,000 or
25% of wages + 2.5% of unadjusted basis of qualified property = ($40,000
x 25%) +$0 = $10,000

Step 3: Compute 20% of QBI = 20% of $300,000 S Corp Income = $60,000

Step 4: Calculate Excess: 20% of QBI $60,000 - W-2 limit $20,000 =

$40,000
(Note: Under circumstances, where the W2>20% of QBI, then the
deduction is equal to 20% of QBI)

Step 5: QBID = (20% of QBI) – (Excess x Reduction Ratio)

$60,000 – ($40,000 x 60%) = $36,000

Charitable deductions - Corporation

Triage Corporation has total income of $550,000 during year 2018. In the
same year, ordinary deductions are $400,000. It also has a net operating
loss of $30,000 carried forward from year 2016 and it accrued qualified
charitable contributions of $4,000. It also had $15,000 disallowed carried
forward charitable contribution from year 2013. What is the amount of
charitable contribution that can be carried forward to year 2019?

Answer:
Charitable contributions made by corporations are allowable upto a
maximum deduction of 10% of income less ordinary deductions (before
deduction of the charitable contribution, capital loss or net operating loss
(NOL) “carryback” and special deductions). Capital loss carry forward and
net operating loss carry forward are deducted for calculating the 10%
income limit. However, accrued charitable contributions are deductible
only if paid by the due date for filing the corporation’s tax return.
Any amount not allowed due to the 10% limit is allowed to carry forward
for 5 years.
Amoun
Particulars
t
$550,0
Total income
00
400,00
Less: Ordinary deductions
0
150,00
0
Less: Net operating loss carried forward 30,000
Base to calculate 10% of limit for $120,0
 charitable deduction 00
Charitable deduction is allowable upto $12,000 (i.e. $120,000 x 10%).
In case of prior year, charity contribution carried forward, first the current
year charity contribution is deducted then the carried forward is deducted.
Amou
Particulars
nt
$12,0
Maximum 10% limit
00
Less: Deduction for 2018
-
(only accrued)
Less: Charity deduction $12,0
carried forward 00
Balance $0
$4,000 for the year 2018 is not eligible for deduction as it is accrued and
no information is provided if paid or not by the tax return filing date.
$3,000 balance from 2013 is not allowed for carry over as the maximum
carry forward limit is only 5 years for charitable deduction.

Limitation period

Jackson Corp., a calendar year corporation, mailed its year 3 tax return to
the Internal Revenue Service by certified mail on Friday, April 8, year
2018. The return, postmarked April 8, 2018, was delivered to the Internal
Revenue Service on April 12, 2018. The statute of limitations on Jackson's
corporate tax return begins on (Note: April 15th was a Sunday and April
16th was a legal holiday)

Answer:

According to the IRS statute of limitations, taxes, if any, can be levied on a

corporation for up to 3 years after later of due date or filing date of the
original tax return. The statute of limitation expires after that time period.

Since Jackson Corp., is a calendar year corporation, the tax return is due
on April 17 of 2018 (Note: If the due falls on a legal holiday or weekend,
the tax return is due on the next business day). Accordingly, the statute of
limitations for examining Jackson Corp's return begins on April 17, 2018,
which is the later of filing date of April 8, 2018.

Carry forward of losses for a single taxpayer

Victor, a single taxpayer has the following in the current year:

Particulars Amount

Taxable salary $400,000

 Net loss from trades or businesses:

($100,00
Net passive losses
0)

Pass through losses from S Corporation in which taxpayer ($750,00

materially participates 0)

($850,00
0)

Assume that the Excess Business Loss limitation as $289k for single
taxpayers and $578k for MFJ.

What is the total amount of loss that Victor can carry forward to later tax
years?

Answer
Non-corporate taxpayers are allowed to offset business losses up to
$289,000/$578,000 for joint filers in the tax year from other sources of taxable
income. The remaining are ‘excess business losses’ that can be carried forward
to the future years indefinitely [carry back not allowed] and are subject to the 80
percent taxable income limitation of the carry forward year [Exception: Farming
losses are allowed a 2-year carry back].
Passive losses can be offset only with passive income and unadjusted losses can
be carried forward indefinitely.
In the given case, Victor's pass thru loss from S Corp would be an ordinary loss
and therefore can be used to offset salary income. As a single filer, Victor, would
be able to offset $289,000 of S Corp losses from salary income and will carry
forward the remaining $461,000 to the future years for indefinite period. His
taxable salary income after the offset will be $111,000 ($400,000 - $289,000).
Also, in absence of passive income, net passive losses of $100,000 will be
suspended and carried forward to the future years. Therefore, a total of $561,000
of losses will be carried forward to the later tax years.

Carry forward of losses to taxpayers married filing jointly

Frank, a married (filing jointly) taxpayer income and loss details for the
current year are as follows:

Particulars Amount
 Taxable salary $900,000

Net loss from trades or

($400,000)
businesses

Pass through losses from S ($1,350,00

Corporation 0)

($1,750,00
0)

What is the amount of loss that Frank must carry forward to future tax
years?

Non-corporate taxpayers are allowed to offset business losses up to $262,000

($524,000 for joint filers) – 2021 limits from other sources of taxable income, the
remaining are ‘excess business losses’ that can be carried forward to the future
years indefinitely [carry back not allowed] and are subject to the 80 percent
taxable income limitation [exception is NOL created from farming losses that can
still be carried back 2 years].

Before calculating the excess business loss, the at-risk limitations and passive
activity limits are applied. The at-risk rules relate to the investments in an
activity while passive rules relate to the taxpayer’s participation in the activity. To
determine the maximum amount of loss allowed for a year, an at-risk limitation
is applied first to each activity and then passive loss limitation is applied to all
losses from all passive activities to determine the amount of loss deductible for
the year.

In the given case, net business losses are $400,000 and pass-thru losses from S
Corp are $1,350,000. Unless indicated otherwise, losses from S Corp are passive.
Further, as no information is provided with respect to the taxpayer’s basis in an S
Corp, we assume the basis is large enough to cover the losses, however, as there
is no other passive income, the entire $1,350,000 loss from S Corp would be
carried forward to the future years to be offset against the passive income only.
$400,000 (<$524,000 limit for MFJ for 2021) of business losses on the other hand
can offset taxable salary leaving the taxable income as $500,000 ($900,000 -
$400,000).
Accordingly, the total amount of loss that Frank will carry forward to the future
years would be $1,350,000.

AAA / AEP
Smart Corp., a calendar-year corporation, was formed in 20X1 and made an S
corporation election in 20X3 that is still in effect. Its books and records for Year
20X6 reflect the following information:
Accumulated earnings and profits at 1/1/X6 $90,000
Accumulated adjustments account at 1/1/X6 $50,000
Ordinary income for Year 20X6 $200,000

Smart Corp. is solely owned by Roget, whose basis in Smart’s stock was
$100,000 on January 1, 20X6. During 20X6, Smart distributed $310,000 to Roger.
What is the amount of the $310,000 distribution that Roger must report as
dividend income for 20X6 assuming no special elections were made with regard
to the distribution?
AEP / AAA
Benny Corporation, a calendar year S corporation, voluntarily terminates its S
corporation status on June 30, 2018. Its accumulated adjustment account on that
date was $45,000. During the rest of the year the Company earned $45,000. In
year 2019, Benny Corporation earned $60,000. It distributed $30,000 in
December 2018 and $60,000 on December 1, 2019. What is the amount of
distribution that is not taxable to Benny’s shareholders for both the years?
Answer
A distribution from S Corporation to its shareholders are made either from AAA
and/or AEP. Accumulated Adjustments Account (AAA) is the S corporation income
that has already been taxed to shareholders but not yet distributed; so AAA
distribution is non-taxable. Accumulated earnings and profits (AEP) is the earning
and profits (E&P) accumulated in C corporation years that have never been taxed
to shareholders, so AEP distribution is taxable as dividend income.
The internal revenue code provides that when a S corporation is converted into a
C corporation, any distributions within the post transition termination period
(PTTP) are considered to be from the AAA of the S corporation (and will not be
taxable).
PTTP begins on the day of termination and ends on the later of (1) one year after
the termination date, or (2) the due date for filing the final S Corporation tax
return (including extensions).
The general rule is that if the company cannot distribute all AAA during the PTTP,
remaining AAA essentially [Link], post the TCJA Act an exception
applies wherein, certain S Corporations can treat distributions following the PTTP
as proportionally paid from AAA and from Accumulated E&P.
The above exception applies only to S Corporations that revoke S Corporation
status within 2 years of enactment of this new law i.e. December 22, 2017 and
share ownership on date of revocation that is identical to that on the date of the
law’s enacment.
Benny terminated S corporation on June 30, 2018 which is within 2 years of the
enactment of the new law and as no information is provided regarding change of
ownership, we can assume that tje ownership on the date of revocation is
identical to the ownership on the date of the law's enactment.
The Post Transition Termination Period (PTTP) begins from July 1, 2018 and ends
later of June 30, 2019 or September 15, 2019 (filing due date including
extensions) i.e. September 15, 2019. Therefore,
(i) distribution of $30,000 in December 2018 is within PTTP and is considered to
be from AAA and not taxable.
(ii) distribution of $60,000 in December 2019 is after PTTP and is considered to
be proportionately from AAA and AEP.
AAA balance on December 31, 2019 = $45,000- $30,000 (distribution on
December 2018) = $15,000.
AEP balance on December 31, 2019 = Earnings of 2018 $45,000 + earnings of
2019 $60,000 = $105,000.
Non-taxable portion of the $60,000 distribution in 2019 =$60,000 x
$15,000/$120,000 = $7,500.
(iii) the total amount of $37,500 (i.e. $30,000 + $7,500) is not taxable.
(Remaining $52,500 of $60,000 distribution is made from AEP. and is taxable to
the shareholder as dividend income)

Determination of whether trade is in US

Lauren, a non-resident alien individual, is employed by London office of a

domestic partnership and uses calendar year as her taxable year. During
Year 1, she is temporarily present in the United States for 60 days
performing personal services for the London office of the partnership.

For each of the following two situations, determine if Lauren's performance

of personal services in the U.S. will constitute a U.S. trade or business
during Year 1:

1. Lauren is paid by that office a total gross salary of $3,000 for such
services.
2. Lauren's total gross salary during Year 1 amounts to $3,250, of which
$2,625 is received in Year 1 and $625, is received in Year 2.
Answer
A non-resident alien who performs personal services in the US, is
considered to be engaged in trade or business in the US (The term trade
or business within the United States includes the performance of
personal services within a taxable year). A non-resident alien who
performs personal services within the U.S. is considered to be engaged in
a U.S. trade or business, except:

(1) when the individual's stay in the U.S. is for 90 days or less during the
tax year,

(2) the amount of compensation received for U.S. services is $3,000 or

less, and

(3) the non-resident alien works for either a foreign personal who is not
engaged in a U.S trade or business, or the foreign office of a U.S. person
(called foreign employer).

However, if all three conditions are not met then the income would be
considered U.S source income and taxed.

In situation I, all three conditions are met, Lauren's presence in the U.S
was not for more than 90 days; she was working with a foreign employer
(London office of the U.S. partnership); and Lauren's total gross salary did
not exceed $3,000. Therefore, she will not be considered as engaged in
U.S trade or business for Year 1.

In situation 2, since Lauren's total gross salary exceeded $3,000 in

aggregate for Year 1, she will be considered as engaged in U.S trade or
business.
Hierarchy

With respect to the federal tax law, list the following tax authorities as per
weight of their authority from highest to lowest:

Judicial Authorities
Revenue Rulings
U.S. Treasury Regulations
Revenue Procedures
U.S. Internal Revenue Code

The Internal Revenue Code (IRC) holds the most authoritative value in the
federal tax law followed by Treasury Regulations, Judicial decisions on tax
matters, Revenue Rulings and Revenue Procedures.

Treasury regulations (IRS/ federal tax regulations) are the Treasury

Department's official interpretation of how a particular IRC section is to be
administered and applied.

Judicial authorities’ decisions also interpret the IRC but do not have similar
authority as IRC. Generally, the decision of the higher court is accorded
more weight.

Revenue rulings are official interpretations by the IRS of the IRC of how the
code and regulations apply to a specific fact/ situation and can be relied
upon by a taxpayer and guide the taxpayer in a similar situation. Revenue
rulings may be cited as authority.

Revenue procedures outline procedures for complying with the tax law.
They are official statement of procedures relating to the sections of the
IRC, its related statutes, tax treaties and regulations and generally guide
the taxpayers on the tax procedures.