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Consider these scenarios:
- Father has a large savings account, and daughter is 18 years old. Daughter is enrolled at Private University and in need of tuition money. Father and mother have planned for many years
for this day and saved an ample amount to pay for Daughter’s tuition. They now have $1M saved, and the annual interest income on this amount is $80,000. Father and mother are in the 39.6%
marginal income tax bracket. Daughter is in the 0% marginal income tax bracket. An income of $80,000 would place Daughter in the 25% marginal tax bracket – although some of that income would
not be subject to any tax, some would be subject to 10% tax, and some would be subject to 15% tax. Father and mother decide to loan Daughter $1M interest free. Daughter would deposit the
money in an interest bearing account and use the interest income to pay her tuition and other expenses for four years. With diploma in hand, Daughter will repay the loan.
- Are there any income tax problems with this?
- Read § 7872(a)(1), (c)(1)(A), (e), (f)(2), (f)(3).
- [By the way, § 7872 applies both to the income tax and to the gift tax.]
- What result under these provisions.
- Corporation very much wants to hire Star Employee and has made a generous salary offer. To sweeten the deal, Corporation offers to loan $1M to Star Employee interest free so that Star
Employee can purchase a house in an otherwise expensive housing market. Star Employee will repay the loan at the rate of $40,000 per year for the next 25 years.
- Are there any income tax problems with this?
- Read § 7872(b), (c)(1)(B), (e), (f)(2), (f)(5), (f)(6).
- What result under these provisions?
- Closely-held Corporation is owned by four shareholders. If the corporation pays dividends to shareholders, the dividend income is subject to income tax for the shareholders. The payments
are not deductible to Corporation. Corporation loans each shareholder $100,000 interest free. Shareholders will repay the loans at the rate of $1000 per year for the next 100 years.
- Are there any income tax problems with this?
- Read § 7872(b), (c)(1)(C), (e), (f)(1), (f)(2).
- What result under these provisions?
- Alpha owns a vacant piece of land (capital asset). Alpha’s AB in the land is $700,000. Alpha wanted to sell the land, but bank financing is very tight. In order to sell the land, Alpha
entered a contract with Beta whereby Beta would pay $1M for the property exactly four years from taking possession.
- Are there any income tax problems with this?
- Read § 7872(b), (c)(1)(E), (e), (f)(1), (f)(2).
- What is the likely result under these provisions?
Father and Mother are the proud parents of a 1-year old. Knowing that a college education costs a lot, they place $100,000 in the child’s e-Trade account that he entirely manages from his crib. The account earned $9000 this year. This is unearned income. Child is of course the dependent of Mother and Father.
- Tax consequences to Father, Mother, and Child?
- Assume Father and Mother are in the 30% tax bracket. Assume Child is in the 10% tax bracket.
- Read § 1(g) very carefully and § 63(c)(5).
- Check the latest revenue procedure to determine the standard deduction “for an individual who may be claimed as a dependent by another taxpayer.” For tax year 2013, it is $1000 or the sum of $350 and the individual’s earned income. Rev. Proc. 2012-41, § 3.01.
- How do we determine the amount that is subject to the parents’ tax rate? How do we determine the amount that is subject to the child’s tax rate?
Do:
CALI Lesson, Basic Federal Income Taxation: Deductions: Below Market Loans
CALI Lesson, Basic Federal Income Taxation: Taxable Income and Tax Computation: Taxation of Minor Children’s Income
- Note: the § 63(c)(5)(A) amount is indexed. Assume for purposes of this Lesson that the amount is $900, not $500.
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