Gleim CPA Review Updates to Regulation 2013 Edition, 1st Printing September 2013

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1 Page 1 of 11 Gleim CPA Review Updates to Regulation 2013 Edition, 1st Printing September 2013 NOTE: Text that should be deleted is displayed with a line through the text. New text is shown with a blue background. Study Unit 4 Self-Employment, Farming, and Adjustments Page 149, Subunit 4.2, new items 3. and 4.: This update is a result of the increased Medicare tax rate for b) The minister and/or clergyman requests and is granted an exemption from selfemployment tax by the IRS. c) The minister and/or clergyman is subject only to the Social Security laws of a foreign country under the provisions of a Social Security agreement between the United States and that country. 3. Increased Medicare Tax Rate Beginning 2013 a. Beginning in 2013, an Additional Medicare Tax (employee increase) of.9% is applied, for a total employee and employer rate of 3.8% (1.45% % +.9%). The additional.9% applies to an individual s wages, Railroad Retirement Tax Act compensation, and selfemployment income that exceeds the applicable threshold amount based on the individual s filing status. Threshold Amounts MFJ $250,000 MFS 125,000 Others 200,000 b. The employer is responsible for withholding the Additional Medicare Tax from wages or compensation paid to an employee in excess of $200,000. c. Individuals with wages and self-employment income calculate their liabilities in three steps: 1) Calculate the tax on any wages in excess of the applicable threshold without regard to any withholding; 2) Reduce the applicable threshold by the total amount of Medicare wages received, but not below zero; and 3) Calculate the tax on any self-employment income in excess of the reduced threshold. EXAMPLE C, a single filer, has $130,000 in wages and $145,000 in self-employment income. C s wages are not in excess of the $200,000 threshold for single filers, so C is not liable for the surtax on these wages. Before calculating the tax on selfemployment income, the $200,000 threshold for single filers is reduced by C s $130,000 in wages, resulting in a reduced self-employment threshold of $70,000. C is liable to pay the tax on $75,000 of self-employment income ($145,000 $70,000).

2 Page 2 of Net Investment Tax a. Beginning in 2013, there is a Net Investment Income Tax (NIIT) of 3.8%. The tax subjects investment income to the same Medicare tax treatment as wages. The tax applies to individuals, estates, and trusts that have certain investment income above specified threshold amounts. Individual MAGI Threshold Amounts MFJ, SS $250,000 MFS 125,000 Single, HH 200,000 NOTE: The surviving spouse threshold is $200,000 for the Additional Medicare Tax and $250,000 for the NIIT. b. Estates and trusts will be subject to the NIIT if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins ($11,950 for 2013). c. Net investment income includes interest, dividends, capital gains, rental and royalty income, nonqualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. d. For individuals, NIIT is reported on and paid with Form For estates and trusts, the tax is reported on and paid with Form EXAMPLE Taxpayer, a single filer, has $180,000 of wages. Taxpayer also received $90,000 from a passive partnership interest, which is considered NII. Taxpayer s modified adjusted gross income is $270,000. Taxpayer s modified AGI exceeds the threshold of $200,000 for single taxpayers by $70,000. Taxpayer s NII is $90,000. The NIIT is based on the lesser of $70,000 or $90,000. Taxpayer owes NIIT of $2,660 ($70, %). e. Taxpayers with income subject to the.9% Additional Medicare Tax and income subject to the 3.8% NIIT will have to pay both, but not on the same income Federal Unemployment Taxes (FUTA) a. This tax is imposed on employers. The tax is 6.0% of the first $7,000 of wages paid to each employee. The employee does not pay any portion of FUTA. b. If state unemployment tax is paid, a credit is available, which reduces the applicable tax rate up to 5.4%.

3 Page 158, Subunit 4.5, item 3.a.2): This update is a result of changes related to the Archer MSA deduction for Health Savings Account Deduction a. Archer MSAs Page 3 of 11 1) Archer MSAs (previously called Medical Savings Accounts) allow individuals who are self-employed or employed by a small employer and covered by a high deductible health insurance plan to make tax-deductible contributions to pay medical expenses. 2) The deduction for an Archer MSA is not included with other medical expenses and is not subject to the % (7.5% if 65 or older) limitation. 3) The following are nontaxable: a) Earnings generated by the plan b) Distributions from an Archer MSA used to pay medical expenses c) Distributions made after the age of 65 d) Distribution made upon death or disability 4) Distributions that do not meet any criteria [under 3) above] are subject to a 15% penalty tax. 5) Contributions are limited to a percentage of the deductible of the required highdeductible health plan (i.e., varies per health plan). 6) An Archer MSA can be rolled into a Health Savings Account tax-free. Page 161, Subunit 4.5, item 8.a.8)b): This update is a result of changes related to IRA deductions for IRA Deduction a. Individual Retirement Arrangement (IRA) Contributions 1) For 2012, contributions are fully deductible (subject to certain qualifying rules and limitations) up to the lesser of $5,000 ($6,000 for taxpayers age 50 and over) or 100% of includible compensation. 2) To qualify for the return year, contributions must be made by the due date of the return without regard to extensions. 3) Compensation includes alimony and earned income but not pensions, annuities, or other deferred compensation distributions. 4) An additional $5,000 ($6,000 for taxpayers age 50 and over) may be contributed to the IRA for the taxpayer s nonworking spouse if a joint return is filed. a) The combined IRA contributions by both spouses cannot exceed their combined compensation for the year.

4 Page 4 of 11 5) If the taxpayer is an active participant in an employer-sponsored retirement plan and has earned income of over $92,000 [married filing jointly or qualifying widow(er)] in 2012 ($58,000 in 2012 for head of household or single taxpayers, and $0 for married filing separate), the IRA deduction is proportionately reduced over a phaseout range. a) An individual is not labeled an active plan participant due to the status of that individual s spouse. b) If an individual s spouse is an active plan participant, that individual s deductible contribution will be phased out when AGI is between $173,000 and $183,000. 6) Excessive contributions may be subject to a 6% excise tax. 7) The owner of an IRA must begin receiving distributions by April 1 of the calendar year following the later of the calendar year in which the employee attains age 70 1/2 or the calendar year in which the employee retires. 8) IRA distributions made before age 59 1/2 are subject to regulation taxation plus a 10% penalty tax. Exceptions to the penalty include distributions for a) Death or disability b) Medical expenses in excess of 10% (7.5% if 65 or older) of AGI for 2013 c) Qualified higher education expenses d) The purchase of a first home (up to $10,000) Page 171, Subunit 4.5, question 27: This update is a result of changes related to IRA deductions for A 33-year-old taxpayer withdrew $30,000 (pretax) from a traditional IRA. The taxpayer has a 33% effective tax rate and a 35% marginal tax rate. What is the total tax liability associated with the withdrawal? A. $10,000 B. $10,500 C. $13,000 D. $13,500 Answer (D) is correct. REQUIRED: The tax liability associated with an early distribution from a traditional IRA. DISCUSSION: IRA distributions made before age 59 1/2 are subject to taxation as well as a 10% penalty. Each amount is calculated based on the distribution. No penalty is applied if it is for reason of death or disability, use of medical expenses in excess of 7.5% the applicable percentage limitation, or up to $10,000 use of purchase of a first home. None of these circumstances are applicable; therefore, tax and penalty apply to the entire $30,000. The applicable tax rate is 35% for a tax liability of $10,500 ($30,000 35%), which is added to the penalty of $3,000 ($30,000 10%), for a total of $13,500. Answer (A) is incorrect. Early distributions from a traditional IRA must be taxed as well as penalized. Answer (B) is incorrect. In addition to the tax at a rate of 35%, a 10% penalty is also applicable. Answer (C) is incorrect. The tax rate used should be the marginal rate, not the effective rate.

5 Page 5 of 11 Page 174, Simulation Question Tab 1: This update is a result of changes related to the Archer MSA deduction for David, a newly licensed CPA, opened an office in 2012 as a sole practitioner engaged in the practice of public accountancy. David reports on the cash basis and has adopted the calendar year for income tax reporting purposes. David has many items for both business and personal matters that can be included in income and as deductions. For each of David s transactions, select from the list provided the appropriate tax treatment. Each choice may be used once, more than once, or not at all. Transaction 1. Fee for the biennial permit to practice as a CPA 2. Alimony paid to former spouse who reports the alimony as taxable income 3. Personal medical expenses charged on a credit card in December 2012 but not paid until January Personal casualty loss sustained 5. Insurance premiums paid on David s life 6. Penalty paid to bank on early withdrawal of savings 7. Interest income on mortgage loan receivable 8. Write-offs of uncollectible accounts receivable from accounting practice 9. Foreign income tax withheld at source on dividend received 10. Employer s portion of self-employment tax paid with 2012 return filed in April 2013 Answer A) Not taxable Choices B) Deductible on page 1 of Form 1040 to arrive at adjusted gross income C) Deductible in full in Schedule A -- Itemized Deductions, 100% deductible D) Deductible in Schedule A -- subject to threshold of 7.5% applicable percentage of adjusted gross income threshold E) Deductible in Schedule A -- subject to threshold of 10% of adjusted gross income and threshold of $100 F) Deductible in Schedule B -- Interest and Dividend Income G) Deductible in Schedule C -- Profit or Loss from Business H) Deductible in Schedule D -- Capital Gains or Losses I) Deductible in Schedule E -- Supplemental Income and Loss J) Deductible in Form Sales of Business Property K) Claimed in Form Foreign Tax Credit, or in Schedule A -- Itemized Deductions L) Based on gross self-employment income M) Based on net earnings from selfemployment N) Not deductible O) Taxable as interest income in Schedule B -- Interest and Dividend Income P) Taxable as other income on page 1 of Form 1040

6 Page 6 of 11 Page 175, Simulation Question Tab 3: This update is a result of the American Taxpayer Relief Act of A taxpayer employing both full-time and seasonal employees must determine the appropriate amounts of FICA and FUTA taxes to pay for (or withhold from) the employees. For each situation given, calculate the correct amount to be paid or withheld based on the current year 2012 rates. Situation 1. FICA tax withheld by employer on wages of $60,000 paid to an employee. 2. Taxpayer s employer s share of FICA for self-employment income of $120, FUTA tax on $5,000 of wages for seasonal employee who only worked during the third quarter of the year. No SUTA tax was paid. 4. FUTA taxes on $6,000 of wages for seasonal employee for the first quarter of the year. No SUTA tax was paid. 5. FUTA taxes on $60,000 of wages for full-time employee from Jan-Dec, when a 5.40% state unemployment rate was paid. Amount Paid or Withheld Page 177, Simulation Question Tab 1 Unofficial Answers: This update is a result of changes related to the Archer MSA deduction for Tax Treatment (10 Gradable Items) 1. G) Deductible in Schedule C -- Profit or Loss from Business. Professionals can deduct expenses peculiar to their profession, such as dues to professional organizations. These are to be distinguished from costs of entering the profession. 2. B) Deductible on page 1 of Form 1040 to arrive at adjusted gross income. Payments included in the recipient s income as alimony are deductible by the payor in computing adjusted gross income. 3. D) Deductible in Schedule A -- subject to threshold of 7.5% applicable percentage of adjusted gross income threshold. A deduction for expenses paid for the medical care of the taxpayer, spouse, or dependent is allowed. It is treated as paid when charged on the credit card. The medical expenses are an itemized deduction only to the extent they exceed 7.5% of the taxpayer s adjusted gross income. 4. E) Deductible in Schedule A -- subject to threshold of 10% of adjusted gross income and threshold of $100. An itemized deduction is allowed for personal casualty losses to the extent that the loss from each casualty exceeds $100 and the aggregate of all such losses during the tax year exceeds 10% of the taxpayer s adjusted gross income. 5. N) Not deductible. Proceeds of an insurance policy paid by reason of the death of the insured are excludable. The premiums paid are a personal expense of the taxpayer, and Sec. 262(a) generally disallows deduction of personal, living, or family expenses. 6. B) Deductible on page 1 of Form 1040 to arrive at adjusted gross income. Penalties for premature withdrawal from a time savings account, certificate of deposit, or similar class of deposit may be deducted from gross income to arrive at adjusted gross income. 7. O) Taxable as interest income in Schedule B -- Interest and Dividend Income. Interest on a receivable is gross income. Interest income is reported on Schedule B. 8. N) Not deductible. David reports income on the cash basis. Therefore, the accounts receivable have not been included in income, and no deduction will arise from writing them off as uncollectible. 9. K) Claimed in Form Foreign Tax Credit, or in Schedule A -- Itemized Deductions. A deduction for foreign income taxes paid or accrued during the tax year is allowed. A foreign tax credit on income earned and subject to tax in a foreign country is also available. The deduction is an alternative to the credit. 10. B) Deductible on page 1 of Form 1040 to arrive at adjusted gross income. A self-employed person may deduct onehalf of his/her self-employment taxes. It is treated as a trade or business expense deductible to arrive at adjusted gross income.

7 Study Unit 5 Deductions from AGI, Credits, and Limitations Page 7 of 11 Page 183, Subunit 5.1, item 6.a.: This update is a result of the American Taxpayer Relief Act of Medical and Dental Expenses a. For 2013, Aamounts paid for qualified medical expenses that exceed 10% (7.5% if 65 or older or the spouse of an individual 65 or older) of AGI may be deducted. b. To qualify for a deduction, an expense must be paid during the taxable year for the taxpayer, the taxpayer s spouse, or a dependent and must not be compensated for by insurance or otherwise during the taxable year. c. Deductible medical expenses are amounts paid for 1) Diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body 2) Transportation primarily for and essential to medical care 3) Medical insurance 4) Qualified long-term care premiums and services Page 202, Subunit 5.4, item 3.b.: This update is a result of the American Taxpayer Relief Act of AMT adjustments represent either a limitation on itemized deductions or timing differences. a. Only certain itemized deductions are allowed in calculating the AMT. The following are not allowed: 1) Miscellaneous itemized deductions 2) State, local, and foreign income taxes 3) Real and personal property taxe b. For 2013, Mmedical expense deduction is allowed, but only for the amount that exceeds 10% of AGI (as opposed to 7.5% for regular tax for those 65 or older). c. The standard deduction and personal exemptions are not allowed. d. Timing differences may permit the taxpayer to defer income temporarily or to accelerate deductions. Appropriate adjustments are made, taking into account the timing of different accounting methods. 1) For example, the installment method is not allowed for sales of dealer property. Another example is when depreciation is taken under MACRS using the 200%- declining-balance method, and 150%-declining-balance method for AMT. e. Interest from home equity refinancing in excess of the acquisition amount is not allowed (i.e., interest on loan amount qualified for regular itemized tax deduction, in excess of acquisition amount).

8 Page 8 of 11 Pages ; Subunit 5.1; questions 2, 5, 12, and 13: This update is a result of the American Taxpayer Relief Act of Poole, 45 years old and single, is in the 15% tax bracket. He had adjusted gross income of $20,000. The following information applies to Poole: Medical expenses $8,150 $9,000 Standard deduction 5,950 6,100 Personal exemption 3,800 3,900 The relevant tax brackets are below: Income Tax $8,700 $8,925 10% $8,701 $8,926 to $35,350 $36,250 15% Poole wishes to minimize his income tax. What is Poole s total income tax rounded to the nearest dollar? A. $2,565 $2,554 B. $1,125 $1,054 C. $1,000 $919 D. $805 $710 Answer (C) is correct. REQUIRED: The income tax of an unmarried individual. DISCUSSION: Taxable income is defined as adjusted gross income minus the standard deduction (or total itemized deductions, if greater) and the deduction for personal exemptions. For a single taxpayer in , the basic standard deduction is $5,950 $6,100. Qualifying medical expenses in excess of 10% (7.5% if 65 or older) of AGI may be deducted as an itemized deduction. Poole s income tax is computed as follows: Medical expenses $8,150 $9,000 Less: 7.5% 10% of AGI ($20, ) (1,500) (2,000) Allowable medical expenses $6,650 $7,000 Use the greater of Allowable itemized deductions or $6,650 $ Standard deduction 5,950 6,100 AGI $20,000 Itemized deductions (6,650) (7,000) Personal exemption (3,800) (3,900) Taxable income $9,800 $ 9,100 Tax Computation: First: $8,700 $8, $870 $ 893 Balance: $850 $ $ Income tax $1,000 $ 919 Answer (A) is incorrect. The AGI must be reduced by the $3,800 $3,900 personal exemption and $6,650 $7,000, the greater of the standard deduction or itemized deductions, before calculating the tax. Answer (B) is incorrect. The itemized deductions of $6,650 $7,000 should be used because they exceed the standard deduction. The itemized deductions consist of the allowable medical expenses [$8,150 $9,000 ($20, % 10%)]. Answer (D) is incorrect. The medical expenses must be reduced by 7.5% 10% of AGI to find the allowable itemized deductions. 5. In 2012, Welch paid the following expenses: Premiums on an insurance policy against loss of earnings due to sickness or accident $3,000 Physical therapy after spinal surgery 2,000 Premium on an insurance policy that covers reimbursement for the cost of prescription drugs 500 In 2012, Welch recovered $1,500 of the $2,000 that she paid for physical therapy through insurance reimbursement from a group medical policy paid for by her employer. Disregarding the adjusted gross income percentage threshold, what amount could be claimed on Welch s 2012 income tax return for medical expenses? A. $4,000 B. $3,500 C. $1,000 D. $500 Answer (C) is correct. REQUIRED: The amount of deductible medical expenses. DISCUSSION: Medical expenses are deductible to the extent they exceed 7.5% an applicable percentage of AGI threshold. Medical care expenses include amounts paid for the diagnosis, cure, medication, treatment, or prevention of a disease or physical handicap or for the purpose of affecting any structure or function of the body. The term medical care also includes amounts paid for insurance covering medical care. However, the amount deductible for expenses incurred for medical care is reduced by the amount of reimbursements. The cost of insurance against loss of earnings is not deductible. Therefore, deductible medical expenses are $1,000 [($2,000 $1,500 reimbursement) + $500]. Answer (A) is incorrect. The cost of insurance against loss of earnings is not deductible. Answer (B) is incorrect. The cost of insurance against loss of earnings is not deductible. The cost of insurance for medical care, which includes the cost of prescription drugs, is deductible. Answer (D) is incorrect. The cost of insurance covering medical expenses is deductible.

9 Page 9 of In the current year, Drake, a disabled taxpayer, made the following home improvements: Cost Pool installation, which qualified as a medical expense and increased the value of the home by $25,000 $100,000 Widening doorways to accommodate Drake s wheelchair. The improvement did not increase the value of his home 10,000 For regular income tax purposes and without regard to the adjusted gross income percentage threshold limitation, what maximum amount would be allowable as a medical expense deduction in the current year? A. $110,000 B. $85,000 C. $75,000 D. $10, Smith paid the following unreimbursed medical expenses: Dentist and eye doctor fees $ 5,500 Contact lenses 500 Facial cosmetic surgery to improve Smith s personal appearance (surgery is unrelated to personal injury or congenital deformity) 10,000 Premium on disability insurance policy to pay him if he is injured and unable to work 2,000 What is the total amount of Smith s tax-deductible medical expenses before the adjusted gross income limitation? A. $17,500 B. $15,500 C. $7,500 D. $5,500 Answer (B) is correct. REQUIRED: The maximum allowable medical deduction. DISCUSSION: Amounts paid for qualified medical expenses that exceed 7.5% an applicable percentage of AGI threshold may be deducted. The deduction must be paid during the taxable year for the taxpayer, the taxpayer s spouse, or a dependent and must not be compensated for by insurance or otherwise during the taxable year. Deductible medical expenses are amounts paid for (1) diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body; (2) transportation primarily for and essential to medical care; (3) medical insurance; and (4) qualified long-term care premiums and services. Expenditures for new building construction or for permanent improvements to existing structures may also be deductible in part. The excess of the cost of a permanent improvement over the increase in value of the property is a deductible medical expense. Therefore, $75,000 ($100,000 $25,000 increase in FMV) is deductible. Construction of handicap entrance/exit ramps, installation of elevators, or widening of doorways also qualify. Answer (A) is incorrect. Only the excess of the cost of the pool installation over the increase in value of the property is a deductible medical expense. Answer (C) is incorrect. Widening the doorways also qualifies as a medical expense. Answer (D) is incorrect. The excess of the cost of the pool over the increase in value of the property is also deductible as a medical expense. Answer (D) is correct. REQUIRED: The amount of deductible medical expenses. DISCUSSION: Medical expenses are deductible to the extent they exceed 7.5% an applicable percentage of AGI threshold. Medical care expenses include amounts paid for the diagnosis, cure, medication, treatment, or prevention of a disease or physical handicap or for the purpose of affecting any structure or function of the body. Therefore, $5,500 ($5,000 dentist and eye doctor fees + $500 contact lenses) qualifies for the deduction before the AGI limitation. Answer (A) is incorrect. Cosmetic surgery is not deductible unless it corrects a congenital deformity. Furthermore, only premiums paid for medical insurance that provides for reimbursement of medical care expenses is deductible. Answer (B) is incorrect. Cosmetic surgery is not deductible unless it corrects a congenital deformity. Answer (C) is incorrect. Only premiums paid for medical insurance that provides for reimbursement of medical care expenses is deductible.

10 Page 10 of 11 Page 214, Subunit 5.2, question 19: This update is a result of the American Taxpayer Relief Act of Which of the following is a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor? A. Gambling losses up to the amount of gambling winnings. B. Medical expenses. C. Real estate tax. D. Employee business expenses. Answer (D) is correct. REQUIRED: Identify the itemized deduction subject to the 2% of AGI floor. DISCUSSION: Miscellaneous itemized deductions are subject to a 2%-of-AGI exclusion. Only that portion of the aggregate amount of allowable second-tier itemized deductions that exceeds the threshold amount of 2% of AGI may be deducted from AGI. Any surplus cannot be carried forward to a succeeding year. The three categories of miscellaneous itemized deductions are employee expenses, tax determination expenses, and other expenses. Answer (A) is incorrect. Gambling losses up the amount of gambling winnings are reported on Schedule A after itemized deductions subject to the 2% of AGI floor. Answer (B) is incorrect. Medical expenses are subject to a 10% (7.5% if 65 or older) of AGI floor and not part of the deductions subject to the 2% of AGI floor. Answer (C) is incorrect. Real estate taxes are itemized deductions but are reported above those subject to the 2% of AGI floor. Study Unit 16 Agency and Regulation Page 606, Subunit 16.6, item 1.c. and new item 1.d.: This update is a result of the increased Medicare tax rate for EMPLOYMENT LAW 1. Federal Insurance Contributions Act (FICA) a. FICA provides programs for disabled employees and families of retired, disabled, and deceased workers, including, in some cases, divorced spouses. Employers and employees contribute under this program. b. Employers must contribute (pay tax) based on the employee s pay. c. The employer must pay 6.20% of the first $110,100 of wages paid plus 1.45% of all wages for the Medicare portion. The employer must withhold from the employee 4.20% of the first $110,100 of wages paid plus 1.45% for Medicare from the employee s wages. For 2013, the employee adds.9% if income exceeds the applicable threshold. d. Also beginning in 2013, there is a Net Investment Income Tax (NIIT) of 3.8%. The tax subjects investment income to the same Medicare Tax treatment as wages above applicable threshold amounts. d. e. Wages are all forms of consideration paid for employment, including cash and the cash value of compensation in any medium other than cash. They include wages and salaries, commissions (including contingent fees), bonuses, productivity awards, tips, vacation and sick pay, severance allowances, and fringe benefits. 1) Wages exclude (a) payments for moving expenses to the extent that it is reasonable to believe a corresponding deduction is allowable and (b) medical care reimbursements under a self-insured plan. e. f. Group term life insurance. Payments for such insurance for retirees are treated as wages insofar as they constitute gross income and are for periods during which the employee status no longer exists.

11 Page 11 of 11 f. g. Withholding. The employer must withhold FICA tax from the employee s wages. The employee s contribution (tax) must be withheld upon each payment of wages, up to the maximum bases and at the same rates. g. h. Deductions. Contributions made by the employee are not tax deductible by the employee. Those made by the employer are deductible by the employer. h. i. Self-employed persons are required to report their own taxable income and pay FICA taxes. FICA is calculated based on net income.

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