Taxable Entities; Tax Formula; Introduction to Property Transctions

CHAPTER 3: TAXABLE ENTITIES; TAX FORMULA; INTRODUCTION TO PROPERTY TRANSCTIONS        

1. Introduction:

Types of Entities: (p3-2, 3-3)

1. Taxpaying entities: Individuals, C corporation (regular corporations), Trusts, Estates. -> paying tax
2. Flow-through entities or conduits: Sole proprietorships, Partnerships and limited liability companies, S corporations (Small corporations). -> are not required to pay tax on any taxable income they might have. Instead, the taxable income of these entitles is passed through or allocated to their owners, who bear the responsibility for paying any tax that may be due.

• Note:

Entity: something exits

Conduit: s.o or s.t is used as a way of sending s.t (information, money…) from one place/ person to another

Ex: R and S are equal partners in a partnership that had taxable income of $50,000 in the current year. The partnership does not pay tax on the $50,000. Rather, the income is allocated equally between R and S. Thus, both R and S will report $25,000 of partnership income on their individual returns and pay the required tax regardless of whether they received distributions from the partnership.

1. Taxable Entities

1. Individual Taxpayers (form 1040, 1040A, and 1040 EZ)

1. Citizens and Residents of the United States:

• U.S citizens
• Resident aliens: persons who are not U.S citizens but who are considered residents.

1. Foreign taxpayers (nonresidents)

• Individual who are not U.S. citizens and do not qualify as residents may be subject to U.S. tax. -> nonresident aliens. They are taxed on certain types of income that are received from U.S. sources.
• If the income is derived from a trade or business carried on in the U.S, that income is taxed in the same way as it is for a citizen or resident.
• Most other income earned in the US is taxed at a flat rate of 30%.

1. Age

• Your age has nothing to do with whether you are taxed or not (although it can have an effect on how you are taxed)

1. Worldwide income

• A US citizen who works and lives in a foreign country may exclude from his or her US income certain amounts of income earned abroad.
• The foreign earned income exclusion is adjusted annually for inflation and for 2016 is $101,300.
• An individual qualifies for the exclusion if he/ she maintains his/ her tax home in a foreign country and he/ she is either a bona fide resident of a foreign country or physically present in a foreign country for 330 das in any 12 consecutive months.    

• Ex: R earned $113,300 in 2016, he meets requirement for exclusive; therefore $101,300 is excluded from his $113,300 salaries. The remaining $10,000 plus any other income are subject to tax.

1. State income taxes

• 7 states do not have income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
• 2 states have income tax extend only to interest and dividends: New Hampshire and Tennessee
• Others states have Federal income tax; state and local income taxes.

1. Corporate taxpayers

• Tax is imposed on all corporations.  The corporate income tax applies to both domestic corporations and foreign corporations that operate a trade or business in the US.
• The difference between C and S is made only for tax purposes: C corporations, like individuals, are treated as separate taxable entities. S corporations normally are not separate taxable entities but are treated as conduits, passing their income and losses through to their shareholders.

1. Fiduciary taxpayers

• A fiduciary is a person who is entrusted with property for the benefit of another, the beneficiary.
• 2 types of fiduciary relationships: trust and estate (both are treated as taxpaying entities)
• Trust: is a legal entity created when the title of property is transferred by a person (grantor) to the fiduciary (the trustee). The trustee is required to implement the instructions of the grantor as specified in the trust agreement. Typically, the property is held in trust for a minor or some other person until he/ she reaches a certain age or until some specified event occurs.
• Estate: is recognized as a legal entity, established by law when a person dies. Upon the herson’s death, his/ she property generally passes to the estate, where it is administered by the fiduciary until it is distributed to the beneficiaries.

1. Flow-Through Entities

1. Sole proprietorships

• Sole proprietorship is an unincorporated business owned by 1 individual -> all individuals who are in business for themselves (self-employed) or independent contractors.

1. Partnerships

• The partnership itself is not subject to Federal income tax and that all items of partnership income, expense, gain, loss or credit pass through to the partners and are given their tax effect at the partner level.
• Partners pay taxes on their shares of the partnership income regardless of whether it is distributed, distributions made by the partnership generally are not taxable to the partners.

• Ex: EG Partnership had taxable income of $18,000. During the year, each of its 2 equal partners received cash distribution of $4,000. The partnership is not subject to tax, and each partner mus include $9,000 in his annual income tax return, despite the fact that each partner actually received less than this amount in cash.

1. Electing small business corporations: "S" corporations

1. Limited liability companies

1. Tax-Exempt Organizations (and the Unrelated Business Income Tax [UBIT])

• Charitable and religious organizations; non-profit associations.

1. Tax Formula

Analyzing the tax formula

1. Income

• The income that is taxable.
• Exhibit 3-4: partial list of items included in Gross Income.

1. Exclusions

• Exclusions referred the income exempt from taxable and thus not included in a taxpayer’s gross income.
• Exhibit 3-5:  partial list of exclusions in Gross Income.

1. Gross Income

• The amount of income remaining after the excludable items have been removed.

1. Deductions

• Deductions: are those items that are subtracted from gross income to arrive at taxable income.
• 2 major groups:

+ Business and Production-of-income expenses: deductions for expenses related to carrying on a business or an income-producing activity, such as an investment.

+ Certain Personal Expenses: deductions for a few expenses of individual that are primarily personal in nature (charitable contribution, medical expenses…)

1. Classifying Deductions

• A corporate taxpayer, all deductions are subtracted directly from gross income to arrive at taxable income.
• Individual has 2 deductible groups:

+  Deduction is allowed to reduce gross income, resulting in Adjusted gross income (AGI). Ex: business expenses and other special items.

+  Deduction is subtracted from AGI. Including: 1. Deductions from AGI (itemized deductions and standard deduction) and 2. Deductions for personal and dependency exemptions.