Tax Compliance & Planning (TCP)

Basic Strategies & Income Types

Two Basic Tax Strategies

• Defer Taxable Income: Postpone income recognition to a later tax year.
• Accelerate Tax Deductions: Take deductions in the current tax year instead of a future one.

Income Types

• Active: Salaries and wages, materially participated business income/loss.
• Passive: Not materially participated business income/loss, rental real estate income/loss, income/loss from limited partnerships.
• Portfolio: Dividends, interest.

Individual Tax Credits

• Child Tax Credit: $2,000 per child < 17 ($1,600 refundable).
• Child & Dependent Care Credit: 20–35% of up to $3,000 expenses ($6,000 for 2+ dependents).
• American Opportunity Tax Credit (AOTC): Up to $2,500/student (40% refundable).
• Lifetime Learning Credit (LLC): 20% of up to $10,000 expenses (max $2,000/family).
• Savers Credit: Up to $1,000 ($2,000 MFJ) for low-income retirement contributions.
• Foreign Tax Credit: Lesser of foreign taxes paid or FTC limitation formula.

Comprehensive Individual Loss Limitations

Losses from flow-through entities are applied sequentially against these four limitations. The Tax Basis and At-Risk limitations are applied at the entity level, while the Passive Activity and Excess Business Loss limitations are applied at the individual taxpayer level.

1. Tax Basis Limitation:
   • Losses are deductible only to the extent of the owner's tax basis in the entity.
   • Excess loss is suspended and carried forward until tax basis is reinstated.
   • On Disposal: Any suspended losses remaining when the owner disposes of the interest are lost.
2. At-Risk Limitation:
   • Losses are deductible only to the extent of the owner's economic risk, which is the same as tax basis but excludes the owner's share of nonrecourse debt.
   • Excess loss is suspended until the at-risk amount is reinstated.
   • On Disposal: Any suspended losses remaining can be used to offset the gain on the sale of the interest.
3. Passive Activity Loss (PAL) Limitation:
   • A passive activity is one in which the taxpayer does not materially participate.
   • Passive losses can only offset passive income.
   • Excess loss is suspended and carried forward to offset future passive income.
   • On Disposal: Any suspended passive losses can be used as an active loss to offset other nonpassive sources of income.
4. Excess Business Loss Limitation:
   • Total business losses are limited to $305,000 for single filers or $610,000 for MFJ.
   • Any excess loss is carried forward as a Net Operating Loss (NOL).
   • The NOL carryforward is subject to the 80% of taxable income limitation.

Equity Compensation Awards

Includes Statutory/Nonstatutory Stock Options, Restricted Stock Awards, and Stock Appreciation Rights.

Statutory Stock Options (Not taxed as compensation income)

Nonstatutory Stock Options

Taxed as ordinary compensation income to the employee. The timing depends on whether the option's value is readily determinable.

Alternative Minimum Tax (AMT)

A separate tax calculation that adds back certain tax preference items and adjustments to regular taxable income.

Adjustments

• Passive activity losses added back.
• Accelerated depreciation adjustments.
• Net operating loss recalculated.
• Installment method adjustments.
• Long-term contract income adjustments.
• State and local taxes deducted added back.
• Standard deduction added back.

Tax Preferences

• Private activity bond interest (tax-exempt for regular tax, but added for AMT).
• Percentage depletion (excess over adjusted basis of property).
• Pre-1987 accelerated depreciation (excess over straight-line) on real property.

Gifts, Education, & Retirement

Gift Taxation

The donor is responsible for any gift tax. For 2025, the annual exclusion for gifts is $18,000 per donee ($36,000 for a married couple splitting gifts). The lifetime gift and estate tax exclusion for 2025 is $14,290,000.

• Recipient's Basis (Gift): Same as donor's basis (carryover basis).
• Recipient's Basis (Inheritance): FMV of property at date of death.
• Unlimited Exclusions: Direct to educational institutions, direct to healthcare, charity, spouse.
• Ineligible for Exclusion: Future interest gifts (still subject to gift tax), incomplete gifts (not eligible for gift tax).
• Imputed Interest: $$ \text{AFR interest} - \text{actual interest} $$. Limited to borrower's net investment income. If < $1,000 imputed interest=0.

Noncash property is valued at its Fair Market Value (FMV) on the date of the gift.

Education Plans

• 529 Plans: Tax-deferred savings for education, with two types: Prepaid Tuition (guaranteed against tuition inflation) and Educational Savings (invested, subject to market risk). Nontaxable options for unused funds: Save for future educational needs, Transfer money to family member, Withdraw up to $10,000 to pay for qualified education loans, Roll over to beneficiary's Roth IRA ($35,000 limit).
• Coverdell Accounts: Up to $2,000/year for K-12 and college expenses, tax-free if used for qualified expenses.
• Series EE Bonds: Interest is tax-free when used for education.
• Student Loans: Stafford (subsidized/unsubsidized) and PLUS loans for parents, with up to $2,500 in annual interest deductions.
• Grants and Scholarships: Non-repayable aid; tax-free if used for qualified expenses.

Retirement Plans

• Section 401(k) Plans: Employee Sponsored. Maximum employee contribution: $23,000 ($30,500 if age 50+). Maximum combined employer and employee contributions: $69,000 ($76,500 if age 50+). Traditional: distributions of principal and earnings are taxable as ordinary income, RMDs required at age 73 or if the employee is terminated. Roth: contributions are taxable when put in, distributions of principal are nontaxable; earnings are only taxable if nonqualified. Qualified: open for at least 5 yrs AND age 59½ or older.
• IRA Plans: Individual investment that grows tax-deferred. Maximum contribution: lesser of earned income or $7,000 (single), couple's earned income or $7,000 each (MFJ), $8,000 for age 50+.
• Traditional IRA: Contributions are deductible as adjustment toward AGI. Distributions of earnings are taxable. Distributions of principal as ordinary income if taxpayer took deduction for contributions.
• Roth IRA: Contributions are nondeductible. Distributions of principal never taxable. Distributions of earnings are taxable if nonqualified Roth distribution.
• Self Employed Retirement Plans: SEP IRA, SIMPLE IRA, Solo 401(k). Contributions to traditional self-employed plans are deductible as an adjustment toward AGI. Funds grow tax deferred. All plans have a maximum contribution based on self-employment income reduced by one half of self-employment tax deduction.

Other Individual Tax Topics

Kiddie Tax

Standard deduction is $$ \max(\$1,300, \text{Earned Income} + \$450) $$ up to the normal standard deduction amount. Net unearned income in excess of $2,600 is taxed at the parent's rate.

FSA vs. HSA

• Flexible Savings Account: Maximum annual contribution is $3,200. Funds forfeited if not used within plan year. Carryover $600 to following year.
• Health Savings Account: Maximum contribution: $4,150 for self, $8,300 for family plan. Increased by $1,000 if age 55+. Continue to accumulate.

Estimated Tax Payments

Must pay quarterly payments (or withhold from wages) throughout year if expected to owe $1,000+. Underpayment penalties avoided if owe less than $1,000, tax prepayments for year are at least 90% of CY taxes, 100% of PY taxes, or 110% if PY AGI > $150,000.

Foreign Earned Income Exclusion

Eligible exclusion for foreign-earned income: $126,500 if bona fide and physical presence test is met.

Charitable Contributions & AGI Limits

AGI Limits for Contributions

• Cash to Public or Private Charities: 60% of AGI
• Cash to Private Operating Foundations: 50% of AGI
• Ordinary Income Property to Public or Private Charities: 50% of AGI
• Ordinary Income Property to Private Operating Foundations: 30% of AGI
• LTCG Property to Public or Private Charities: 30% of AGI
• LTCG Property to Private Operating Foundations: 20% of AGI

Gifts of Noncash Property to Charity

• Ordinary Income Property: (inventory, assets held ST, investment that have depreciated) deduction is lesser of adjusted basis or FMV at time of donation.
• Long Term Capital Gain Property: Deduction is FMV at time of donation.
• Appreciated Personal Property: Deduction limited to adjusted basis if charity uses for unrelated purpose.
• Personal-Use Vehicle (Depreciated): Deduction is lesser of gross proceeds from sale or FMV at time of donation.

Risk Management & Investment

Risk Management Method

Types of Risk

• Nonsystematic: Unique to a certain industry; can protect from this risk by diversifying investments.
• Systematic: Affects entire system; can be mitigated through short selling stocks or investing in derivatives. Includes currency risk, inflation risk, sociopolitical risk.

Investment Formulas

C Corporation Formation & Distributions

Forming C Corps

Corporation: No gain/loss recognized. Basis = greater of shareholder's basis in property or debt assumed by corporation.

Shareholder: No gain/loss recognized if contributing property shareholders own at least 80%. Shareholder who contributes service recognize ordinary income in FMV of services provided.

Corporate Distributions

Taxable if classified as dividends. Distributions come out of: (1) current E&P and accumulated E&P as taxable dividend income, (2) then stock basis (nontaxable return of capital), (3) then excess over stock basis is taxable capital gain.

Property Distributions: Dividend = FMV of property or cash. Appreciated property distributed, corporation can recognize a gain if property sold. No loss for depreciated property.

Corporate Liquidation

Corp and shareholders recognize gain/loss. Corp recognizes gain if assets distributed were sold. Shareholder recognizes gain for FMV of assets distributed - SH basis in stock. SH basis in assets distributed = FMV of assets.

Section 1244 Small Business Stock

Ordinary loss up to $50,000 single, $100,000 MFJ for original shareholder if stock is sold or becomes worthless.

Qualified Small Business Stock

Noncorporate shareholder holds QSBS for > 5 years may exclude 100% of gain on sale or exchange of stock.

Corp/SH Loans

Imputed interest is dividend income to a SH if they are an employee. Imputed interest = AFR - actual rate on below market loan.

Corporate Losses & Planning

Capital Losses

Can only offset capital gains. Can carryback 3 years, carryforward 5 years.

Net Operating Losses

• NOL Generated Pre-2018: Carryback 2 years, carryforward 20 years. Able to offset 100% of taxable income.
• NOL Generated 2018-2020: Carryback 5 years, carryforward indefinitely. Able to offset 100% of taxable income, unless post 2020 tax year, 80% taxable income.
• NOL Generated 2021 and After: Carryback not allowed, carryforward indefinitely. Able to offset 80% of taxable income.

Section 382

Ownership change occurs when 1 or more 5% shareholders increase their ownership by more than 50% in testing period. Testing period is 3 years prior to and including date of ownership change.

Tax Planning

• Timing Strategy: Utilizes NOL carryovers, changes in tax legislation, or shifts in marginal tax rates.
• Income Shifting Strategy: Involves paying salaries to shareholder-employees or using noncash property transactions.
• Estimated Payments: Must be 100% of the lesser of: the prior year's (PY) tax liability, the current year's (CY) tax liability, or the CY tax liability using annualized taxable income.

Corporate Capital Losses & Reorganizations

Capital Loss Carryover Rules

• Corporate capital losses can only be used to offset capital gains.
• Losses can be carried back three years and carried forward five years to offset gains in those years.

Tax-Free Reorganizations

In a tax-free reorganization, a shareholder's basis in the stock received is typically the Net Book Value (NBV) of the property exchanged. The shareholder's basis is the same as the NBV.

International Corporate Tax

Sourcing of Income

• Interest: Sourced where the entity paying the interest is located.
• Dividends: Sourced where the dividend-paying company is located.
• Personal Services: Sourced where the services are performed.
• Rents & Royalties: Based on where the property is located (tangible) or used (intangible).
• Disposition of Real Property: Gains are sourced where the property is located.

Foreign Tax Credit

Categories of Income for Foreign Tax Credit limits: Passive category income, Foreign branch income, General category.

Key International Tax Provisions

• BEAT: Prevents large U.S. companies from eroding the tax base by making excessive deductible payments to foreign affiliates.
• GILTI Tax: The GILTI tax is a minimum tax imposed on U.S. shareholders of CFCs that earn low-taxed foreign income. It aims to reduce the incentive for U.S. companies to shift profits to low-tax jurisdictions.
• FDII: Provides a tax break for U.S. companies earning income from foreign sales of goods or services, especially intangible assets.
• IC-DISC: Offers a tax incentive for U.S. exporters by allowing commissions paid to a tax-exempt IC-DISC to reduce taxable income.
• Transfer Pricing: Ensures that intercompany transactions (sales of goods, services, loans, etc.) between related companies (called controlled taxpayers) are conducted as if they were between unrelated parties (arm's-length principle). IRS can adjust the taxable income reported from controlled transactions to ensure consistency with the arm's-length standard.

Foreign Operations & Consolidated Returns

Foreign Sub vs Branch

• Foreign Branch: An extension of the domestic corporation, not a separate legal entity. Income is taxed both by the foreign host country and the U.S.
• Foreign Subsidiary: A legally separate entity incorporated in the foreign country. Its profits are taxed in the host country, but the U.S. can tax the income when it's repatriated to the U.S.

US Activities on Foreign People

Inbound Transactions: Foreign individuals and businesses earning income in the U.S. are generally only taxed on their U.S.-source income, but they may be treated as U.S. residents (and taxed on worldwide income) if they meet the substantial presence test.

Consolidated Tax Return

Affiliated group of corps (80% ownership). Remove elims, intercompany sales, intercompany dividends, etc.

• Advantages: NOL carryovers can be used against other group income. Capital losses can offset other group capital gains.
• Disadvantages: Not all states allow. Tax credits may be limited.

Flow-Through Formation & Basis

Contribution of Property

Generally tax-free for both S Corps (if 80% control met) and Partnerships. For partnerships, pre-contribution built-in gains/losses on property are allocated to the contributing partner upon sale.

S Corporation Shareholder Basis

Basis Roll-Forward:

A shareholder has a separate debt basis. The loss deduction limit = Stock Basis + Debt Basis.

Partnership Basis & Debt

• Outside Basis: Partner's basis in their partnership interest.
• Inside Basis: Partnership's basis in its assets.
• Recourse Debt: Partner has personal liability.
• Nonrecourse Debt: Secured by property; creditor cannot go after personal assets.

Adjustments to Partnership Basis

• Increases: Additional contributions, share of income, share of partnership debt.
• Decreases: Distributions, share of losses, decrease in partnership debt.

S Corp Operations & Distributions

S Corp Accounts

• Accumulated Adjustments Account (AAA): Tracks undistributed earnings. Distributions from AAA are tax-free and reduce shareholder basis. The account balance may be negative from losses, but distributions cannot reduce the AAA below zero.
  • Increases: Ordinary Business Income; Separately Stated income/gain items.
  • Decreases: Ordinary Business Loss; Separately stated losses/deductions; Nondeductible expenses; and Distributions.
• Other Adjustments Account (OAA): A separate account for tax-exempt income, related expenses, and federal taxes paid by the S corp that relate to prior C corp years.

Distribution Order (with C Corp E&P)

1. Nontaxable from AAA (reduces stock basis).
2. Taxable dividend from C Corp E&P.
3. Nontaxable return of capital (reduces stock basis to zero).
4. Taxable capital gain.

Distribution Order (No C Corp E&P)

1. Nontaxable return of capital to the extent of stock basis.
2. Taxable capital gain for any excess distribution.

S Corp Taxes

• Built-in Gains (BIG) Tax: On appreciated assets if a C Corp converts to an S Corp and sells assets within 5 years.
• LIFO Recapture: C Corp must include LIFO reserve in income in its final year before S election.
• Passive Investment Income Tax: If S Corp has C Corp E&P and passive income > 25% of gross receipts.

S Corp: Separately Stated Items & Liquidation

Separately Stated Items

Certain items are not aggregated at the corporate level and must be passed through separately to shareholders. These include:

• Rental real estate income/loss
• Portfolio income (interest, dividends)
• Net Section 1231 gain/loss
• Charitable Contributions
• Section 179 expense deduction

S Corp Liquidation

An S Corp liquidation is treated similarly to a C Corp liquidation:

• Consequences to S Corp: The corporation recognizes a gain or loss on the distribution of property as if the property were sold at its Fair Market Value (FMV). This gain/loss flows through to the shareholders.
• Consequences to Shareholder: The shareholder treats the liquidating distribution as a payment in exchange for their stock. They will recognize a capital gain or loss equal to the difference between the FMV of property received and their stock basis. The shareholder's basis in the property received is its FMV.

Partnership: Formation & Sale of Interest

Formation Details

• Contribution of Property: No gain or loss is generally recognized by the partner or the partnership on the contribution of property.
• Contribution of Services: A partner must recognize ordinary income equal to the FMV of the partnership interest received in exchange for services.
• Property with Excess Liability: A partner recognizes a taxable gain if they contribute property subject to a liability, and the portion of the liability assumed by other partners exceeds the partner's basis in the contributed property.

Sale of Partnership Interest

The gain or loss on the sale of a partnership interest equals the amount realized minus the partner's adjusted basis.

• The amount realized includes cash, FMV of property, and any relief from the partner's share of partnership liabilities.
• The gain is generally a capital gain, but the portion attributable to "hot assets" (like inventory or A/R) is treated as ordinary income.
• Income/loss for the year of sale may be allocated based on the number of days the selling partner held the interest.

Partnership Operations & Distributions

Nonliquidating Distributions

Generally nontaxable. Distributions reduce the partner's outside basis (cash first, then property). Gain is only recognized if cash distributed exceeds the partner's basis.

Liquidating Distributions

Generally nontaxable. The partner's remaining outside basis is allocated to the assets received. Loss can be recognized only if the distribution consists solely of cash, unrealized receivables, and inventory, and the basis of those assets is less than the partner's outside basis.

Sale of Partnership Interest

Partnership Basis Allocation in Liquidation

In a liquidating distribution, the partner's remaining outside basis is allocated to the assets received. Special rules apply when the partner's outside basis does not equal the partnership's inside basis in the distributed assets.

When Partner's Outside Basis > Partnership's Inside Basis

1. Assign a basis to all distributed assets equal to the partnership's basis in those assets.
2. Adjust the basis of any assets that have appreciated in value up to their FMV.
3. Allocate any remaining outside basis among all assets based on their relative FMV.

When Partner's Outside Basis < Partnership's Inside Basis

1. Assign a basis to all distributed assets equal to the partnership's basis in those assets.
2. Adjust the basis of any assets that have depreciated in value down to their FMV.
3. Allocate any remaining outside basis among all assets based on their relative adjusted basis (after the step 2 adjustment).

Entity Choice: Taxation at a Glance

Entity Tax Comparison

Entity Choice: Comparative Analysis

Contribution of Property

To avoid gain recognition on the contribution of appreciated property, the most advantageous entities are generally a partnership or sole proprietorship. C and S Corps must meet the 80% control test to avoid recognizing a gain.

Deduction of Business Losses

• C Corp: NOLs are carried forward by the corporation and can offset up to 80% of future taxable income. Owners get no immediate deduction.
• Flow-Through Entities: If the owner has sufficient basis and is actively involved, they can immediately deduct business losses against other sources of income.
• Most Advantageous: Generally a partnership or S Corp, because the owner can deduct losses immediately.

Owner Compensation

• C and S Corps: Can pay and deduct salaries to owners.
• Partnerships: Cannot pay salaries, but can deduct guaranteed payments made to partners.
• Most Advantageous: Generally a C Corp or S Corp, as they can deduct the employer portion of payroll taxes.

Liquidating Distributions

• C Corp & S Corp: The corporation recognizes a gain/loss on the distribution of property as if sold for FMV. The shareholder also recognizes a capital gain/loss.
• Partnership: Generally, no gain or loss is recognized by the partnership or partner. A gain is recognized only if cash distributed exceeds the partner's basis, and a loss is recognized only in specific circumstances.
• Most Advantageous: Generally a partnership for appreciated property. C or S Corps are advantageous for depreciated property as the loss can be recognized.

Entity Choice: Most Advantageous Scenarios

Contribution of Property

To avoid gain recognition on the contribution of appreciated property, the most advantageous entities are generally a partnership or sole proprietorship.

Deduction of Business Losses

A partnership or S Corp is generally most advantageous because the owner can immediately deduct business losses against other sources of income, assuming sufficient basis and active involvement.

Owner Compensation

A C Corp or S Corp is generally most advantageous because they can deduct the employer portion of payroll taxes for owner-employees.

Liquidating Distributions

• For appreciated property, a partnership is generally most advantageous because no gain is typically recognized and the basis is adjusted rather than being the FMV.
• For depreciated property, a C Corp or S Corp is generally more advantageous because losses can be recognized at the time of distribution.

Character of Assets

Capital Assets

Assets held for investment or personal use (e.g., stocks, bonds, personal car, home).

Noncapital (Ordinary) Assets

• Inventory
• Accounts Receivable
• Depreciable property and real estate used in a trade or business held for one year or less.
• Treasury Stock
• Original use property

Section 1231 Assets

Depreciable property and real estate used in a trade or business held for more than one year.

Property Gains & Deferrals

Gain/Loss Calculation

Amount Realized: Cash received + FMV of property/services + Debt assumed by buyer.

Realized Gain/Loss: Amount Realized - Adjusted Basis.

Adjusted Basis: Original basis (cost, or rollover/FMV if a gift) - accumulated depreciation.

Homeowner's Exclusion

Exclude up to $250k (S) / $500k (MFJ) gain on sale of principal residence. Must own and use for 2 of the last 5 years. The exclusion may be reduced due to nonqualified use of the home.

Like-Kind Exchange (Sec. 1031)

For real property used in business or held for investment. No loss is ever recognized.

Other Deferrals/Exclusions

• Involuntary Conversion: Gain is deferred if insurance proceeds are reinvested in similar property within 2 years. Recognized gain is limited to unreinvested proceeds.
• Installment Sale: Gain is recognized as payments are received.
• Divorce Property Settlement: Nontaxable transfer. Basis is carryover.
• Treasury/Capital Stock: Corps don't recognize G/L on transactions in their own stock.

Depreciation Recapture

Related Party Transactions

Includes family (siblings, spouses, ancestors, lineal descendants), >50% owned entities, and controlled groups.

Losses & Subsequent Sales

Losses on sales between related parties are disallowed. The buyer can use the disallowed loss to offset a gain on a future sale to an unrelated party.

Constructive Ownership

Stock ownership can be attributed between entities and individuals:

1. Stock owned by a corp/partnership is treated as owned proportionately by its shareholders/partners.
2. An individual is considered to own the stock of their family members.
3. Stock constructively owned by a person under Rule 1 shall be treated as actually owned by that person for the purposes of applying Rule 1 or 2 in other situations.

Taxation of Estates & Trusts

Estates and trusts are separate tax-paying entities. Income is taxed at either the entity level (if retained) or the beneficiary level (if distributed), but not both.

Trust Classification & Exemptions

• Simple Trust: Must distribute all income currently, cannot make charitable contributions, and cannot distribute principal (corpus). Granted a $300 exemption.
• Complex Trust: Any trust that is not a simple trust. It may accumulate income, make charitable contributions, and distribute principal. Granted a $100 exemption.
• Grantor Trust: The grantor retains control, and all income is taxed to the grantor on their individual return. Not treated as a separate tax entity.

Distributable Net Income (DNI)

DNI is the maximum amount of income that can be taxed to beneficiaries and deducted by the trust. It establishes the character of the income (taxable, tax-exempt) for beneficiaries.

Income Distribution Deduction

The trust or estate can deduct the amount distributed to beneficiaries. The deduction is the lesser of:

1. Actual amount distributed to beneficiaries, OR
2. Distributable Net Income (DNI), less tax-exempt interest included in DNI.

Taxation of Beneficiaries

Beneficiaries are taxed on the lesser of the amount distributed to them or their share of DNI. The income they receive retains the same character (e.g., taxable interest, tax-exempt interest) as it had at the trust level.

Tax-Exempt Organizations

Section 501(c)(3)

Organizations operated for religious, charitable, scientific, or educational purposes. They must be a trust, corporation, or unincorporated association. They must not benefit private interests and may not participate in political campaigns.

Unrelated Business Income (UBI)

Income from a trade or business that is regularly carried on and not substantially related to the organization's tax-exempt purpose. UBI is subject to tax (UBIT).

• Exclusions from UBI: Dividends, interest, royalties, rents from real property, gains from property sales, income from research, bingo games, work done for member convenience, trade shows, and sale of merchandise received as gifts.
• Work done for the convenience of members
• Income from trade shows
• Proceeds from the sale of merchandise received as gifts