2009 R-4 Class Notes

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Becker CPA Review Regulation 4 Class Notes

1 2009 DeVry/Becker Educational Development Corp. All rights reserved.

REGULATION 4 CLASS NOTES

This lecture covers partnership taxation, estate/trust/gift tax, tax return preparer issues, the Sarbanes-Oxley Act of 2002 and ethics and professional responsibilities. According to the AICPA's ContentSpecification Outline, these items and the items included in R3 should make up between 37% and 48%of the Regulation examination.

PARTNERSHIP TAX

I. PARTNERSHIPS - FORMATION

A. Partner General Rule No gain or loss recognized on a contribution of property inreturn for a partnership interest. Exceptions Capital interest for services rendered =ordinary income. Property subject to excess liability when the decrease in thepartner's individual liability exceeds his partnership basis, the excess amount is taxable(a taxable gain similar to boot).

Cash (amount contributed)

+ Property (adjusted basis (NBV))

(incoming partner's liabilities assumed by the other partners)+ Services (FMV and taxable to partner)

+ % Liabilities (other partner's liabilities assumed by the incoming partner)

Initial basis in partnership interest

B. Partnership No Gain or Loss Recognized. Partnership's basis is the contributingpartner's basis in the contributed property.

II. PARTNERSHIPS - OPERATIONS

A. Partner's Basis Formula

B: Beginning Capital Account

A: + % All income (including tax-free)

S: (including non-deductible expenses)

(property distribution reduced by NBV)

E: Ending Capital Account

+ % of Recourse liabilities

Year-End Basis

B. Partnership Tax Returns A partnership should be thought of as a collection of soleproprietors. Because of this, the income is taxed only once in a partnership, unlike a

corporation, where it is taxed twice. Form 1065 is an information return because it is usedto calculate partnership income. No tax is paid on this return. Income is shown on thisreturn and it "flows through" to the partner's individual tax returns on theirK-1.

C. Transactions between Partner and Partnership Generally, if a partner enters into atransaction with his partnership, the transaction is deemed to have occurred between thepartnership and an outsider, unless the partner is a controlling partner (over a 50% interestin the partnership, in which case the losses are related party (WRaP) and not permitted.

Any gains are always treated as ordinary gains.

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D. Partner's share of income, credits, and deductions. A partner must include his distributiveshare of partnership income (even if not received) on his individual tax return. Partner's taxloss deductions are limited by his basis in the partnership ("at-risk" provision). Any unusedloss can be carried forward to future years. Note that losses may be subject to the passiveactivity loss limitation rules.

E. Guaranteed Payments are compensation paid to partners for services or use of capital.

They are tax deductions to the partnership and income to the receiving partner.

F. Organizational/Start-Up Costs Partnership can deduct $5,000 (each) immediately andamortize any excess over 180 months. Syndication costs are not deductible.

G. Nonliquidating Distributions No gain recognized unless cash distributed exceeds thepartner's basis in the partnership. Partner's basis in the partnership is reduced by the cashor NBV or the property received. The partner's basis in the property received will be thesame as the basis in the hands of the partnership immediately prior to the distribution.

H. Liquidating distribution 3 ways a partner may terminate his interest:

1. Complete Withdrawal The partner's basis for the distributed property is the same asthe adjusted basis of his partnership interest reduced by any cash received. Gain isrecognized only if the cash received exceeds the partner's basis in the partnership.

2. Sale of Partnership Interest The partner has a capital gain or loss when transferringa partnership interest. The gain or loss is measured by the difference between theamount realized for the sale and the adjusted basis of the partnership interest. Ifpartnership liabilities are transferred to the buyer, they are considered part of theamount realized.

3. Retirement (Death) Payments are made for both the partner's interest in thepartnership (capital gain or loss) assets and the partner's share of partnershipincome (ordinary income).

ESTATE, TRUST, AND GIFT TAX

I. INCOME TAXATION FOR ESTATES AND TRUSTS

A. Fiduciary accounting is used in estates and trusts and it is centered on the classification ofall receipts and disbursements as either principle or income. These rules are generally thesame as GAAP.

B. Distributable Net Income (DNI) Includes Capital Gains

Estate (Trust) Gross Income

(ordinary and necessary)

Adjusted Total Income

+ Tax Exempt Income

DNI

C. Income Distributed to the Beneficiaries Income distributed to the beneficiaries onSchedule K-1 (Form 1041) retains the same character as it had at the fiduciary level.

D. Income Distribution Deduction is the lesser of the actual distribution to the beneficiary orDNI (less tax-exempt income).

E. Annual Estate or Trust Income Tax Return Form 1041

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F. Estates must file a return when annual income exceeds $600. Estates can elect either acalendar year (return is due on 4/15) or a fiscal year (return is due the 15 th day of fourthmonth after the year-end).

G. Trusts eitherSimple orComplex. A Simple Trust may only make distributions out ofcurrent income, is required to distribute all of its income currently, is not allowed acharitable deduction, and has a $300 exemption. All other trusts are complex. Complex

trusts allowed a $100 exemption.

II. THE ESTATE TAX

A. The estate tax is a transfer tax imposed on the value of property transferred by a decedentat death. If the gross estate exceeds $2,000,000, a Form 706 must be filed.

B. Estate Transfer Tax

Gross Estate FMV Property, Insurance Proceeds, etc.

Medical, administrative, etc.

Adjusted Gross Estate

Charity, marital both unlimited

Taxable Estate

Adjusted taxable Gifts Post-1976 gifts that were taxed

Tentative Tax Base

x Uniform Tax Rates

Tentative Estate Tax

on Post 1976 Gifts

Gross Estate Tax

$780,800 Credit = $2,000,000 Deduction

Estate Tax Due

C. Gross Estate FMV of property, insurance proceeds, incomplete gifts, revocable transfers,and income in respect of a decedent.

D. Estate Deductions Medical expenses (can be deducted instead on the final individualincome tax return); administrative expenses; outstanding debts; claims; funeral costs;taxes. Also discretionary expenses charity and marital which are both unlimited.

III. THE GIFT TAX

A. The gift tax is a transfer tax paid by certain donors of gifts. A Form 706 must be filed by a

donor who has made a taxable gift (more than $12,000 or $24,000 married with giftsplitting)

B. Taxable Gifts Every transfer of money or property for less that adequate consideration isa gift. The annual exclusion is $12,000 (or $24,000 with gift-splitting) per donee. Thereare unlimited exclusions for payments made directly to an education institution on behalfof a donee; made directly to a health care provideron behalf of a donee; made to acharity, or made to a spouse.

C. Calculating Taxable Gifts The total amount of gifts equals the aggregate value of all giftsmade during the calendar year less the annual exclusion.

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D. The Generation-Skipping Transfer Tax is a separate tax that applies in addition to thefederal estate and gift tax on any transfer that is two or more generations younger than thedonor or transferor. It applies to all lifetime transfers in excess of $2,000,000.

TAX RETURN PREPARER ISSUES

I. TAX RETURN PENALTIES

A. Failure to File a tax return by the due date (with extensions): 5% per month (or fraction ofa month) on the amount of tax computed on the return as "due" up to a maximum penaltyof 25%.

B. Failure to Pay tax due: .5% per month (or fraction of a month) up to 25% maximum. Ifboth the Failure to File and the Failure to Pay penalties are applied, they are not stacked,(i.e., Failure to Pay is .5% and Failure to File drops to 4.5% per month). Combined, theycannot exceed 25%.

C. Accuracy Related Penalty is 20% of the understatement of taxes when it is due to asubstantial understatement of income, negligence, or disregard of the rules or regulations.

D. Fraud Penalty is 75% of the portion of any underpayment of tax due to willful evasion.

E. Earned Income Credit Penalties cause a taxpayer to lose his/her ability to claim the EITCfor two years if incorrectly claimed due to "negligence" and three years if incorrectlyclaimed due to "fraud." Also, tax return preparers who fail to exercise "due diligence" arefined $100 per failure.

F. Preparer ResponsibilitiesIf the tax return preparer received compensation (i.e., "paidpreparer") he/she is subject to the following requirements: preparer must sign the return,preparer must include identification number and employer, preparer must provide a copy ofthe return to the taxpayer by or at the time taxpayer signs the original, employer of preparermust keep specified information on all employees, and preparer must keep a list oftaxpayers for whom returns were filed (or copies of the returns) for three years.

SARBANES-OXLEY ACT OF 2002I. SARBANES-OXLEY ACT OF 2002

A. This is a hot topic!

B. The Public Accounting Oversight Board (PCAOB) consisting of five members (two mustbe CPAs and three cannot be CPAs).

C. Auditorindependence concernsprohibit most other "services" with the exception of taxservices (if pre-approved by the audit committee).

D. Corporate responsibility through an audit committee appointed by the Board of Directorswho must oversee the accounting and financial reporting processes of the issuer and auditsof the issuer's financial statements.

E. Financial disclosures require that all financial reports be prepared in accordance withGAAP and must reflect all material adjustments that have been identified by a registeredfirm. Items include off-balance sheet transactions; transactions with officers, directors, or10% or greater shareholders; management assessment of internal controls; code of ethicsfor senior financial officers; disclosure of audit committee financial expert; and real-timeissuer disclosures.

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F. Corporate and criminal fraud for destruction of corporate audit records is a crimepunishable by fine and imprisonment for auditors who fail to keep all workpapers related tothe audit for at least seven years. The statute of limitations for private cases for securitiesfraud is the later of two years after discovery of the fraud or five years after the actionoccurred. Whistleblowers are protected from discharge for lawfully providing information totheir supervisors or the federal government regarding conduct believed to be a violation ofthe securities laws. If discharged, they may sue the employer.

G. SEC authority now provides for the censure of any person or denies any person theprivilege of practicing before the SEC in any way. This results if the person is found to nothave the requisite qualifications, to be lacking in character of integrity, to have engaged inunethical or improper professional conduct, or to have willfully violated or aided and abettedin the violation of any securities law.

ETHICS AND PROFESSIONAL RESPONSIBILITIES

I. ETHICS AND PROFESSIONAL RESPONSIBILITIES

A. The Code of Professional Conduct governs any service that a member of the AICPAperforms including; audits, special reports, compilations, reviews, and services performed

on financial forecasts and projections, as well as attestation engagements. If an AICPAmember is not in public practice, then only Rule 102 (Integrity and Objectivity) and Rule501 (Discreditable Acts) must be observed. Key rules are:

1. 101 Independence in fact and appearance

2. 102 Integrity and objectivity

3. 201 General standards

4. 203 GAAP

5. 301 Confidentiality of client information

6. 302 Contingent fees (not OK for "results")

7. 501 Acts "discreditable to the profession"

8. 502 Advertising and solicitation

9. 503 Commissions and referrals, and

10. 505 Form of practice and name

Watch for M/Cs on these topics. Also covered here are standards for managementconsulting. Making decisions for a client is not allowed when "consulting."

There is a lot ofREQUIRED HW READING after the lecture text. Topics covered are:

1. Responsibilities fortax practice,

2. Licensing and disciplinary systems within the profession,

3. Responsibilities inpersonal financial planning, and

4. Anti-trust laws.

Documents

2009 R-4 Class Notes