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CONTENTS
Preface
About the Author
About the Contributors
Professional and Legal Responsibilities — Module 23
Accountants’ Liability
Federal Securities Acts — Module 24
Federal Securities Regulations
Business Structure — Module 25
Partnership
Corporations
Contracts — Module 26
Contracts
Sales — Module 27
Sales
Commercial Paper — Module 28
Negotiable Instruments
Secured Transactions — Module 29
Secured Transactions
Bankruptcy — Module 30
Bankruptcy
Debtor - Creditor Relationships — Module 31
Suretyship
Agency — Module 32
Agency
Regulation of Business Employment, Environment, and Antitrust — Module 33
Environmental Law
Employment
Antitrust
Property — Module 34
Property
Individual Taxation — Module 35
Individual Income Tax
Transactions in Property — Module 36
Property Transactions
Partnership Taxation — Module 37
Partnership Taxation
Corporate Taxation — Module 38
Corporate Income Tax
S Corporations
Other Taxation Topics — Module 39
Taxation of Estates & Trusts
Income Tax Return Preparers
Index
Copyright © 2013 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada.
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ISBN: 978-1-118-41062-2 (paperback); 978-1-118-60750-3 (ebk); 978-1-118-60763-3 (ebk); 978-1-118-60766-4 (ebk)
Preface
This publication is a comprehensive, yet simplified study program. It provides a review of all the basic skills and concepts tested on the CPA exam, and teaches important strategies to take the exam faster and more accurately. This tool allows you to take control of the CPA exam.
This simplified and focused approach to studying for the CPA exam can be used:
As a handy and convenient reference manual
To solve exam questions
To reinforce material being studied
Included is all of the information necessary to obtain a passing score on the CPA exam in a concise and easy-to-use format. Due to the wide variety of information covered on the exam, a number of techniques are included:
Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists
Formulas and equations that simplify complex calculations required on the exam
Simplified outlines of key concepts without the details that encumber or distract from learning the essential elements
Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal conflict, or developing an audit program
Pro forma statements, reports, and schedules that make it easy to prepare these items by simply filling in the blanks
Proven techniques to help you become a smarter, sharper, and more accurate test taker
This publication may also be useful to university students enrolled in Intermediate, Advanced and Cost Accounting; Auditing, Business Law, and Federal Income Tax classes; Economics, and Finance classes.
Good Luck on the Exam, Ray Whittington, PhD, CPA
ABOUT THE AUTHOR
Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University. Prior to joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University. From 1989 through 1991, he was the Director of Auditing Research for the American Institute of Certified Public Accountants (AICPA), and he previously was on the audit staff of KPMG. He previously served as a member of the Auditing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Regents of the Institute of Internal Auditors. Professor Whittington has published numerous textbooks, articles, monographs, and continuing education courses.
ABOUT THE CONTRIBUTORS
Edward C. Foth, PhD, CPA, Administrator of the Master of Science in Taxation Program at DePaul University. Professor Foth is the author of CCH Incorporated’s Study Guide for Federal Tax Course, Study Guide for CCH Federal Taxation: Comprehensive Topics, and coauthor of their S Corporation Guide. Professor Foth prepared the answer explanations to the multiple-choice and task-based simulation questions in Income Taxes, wrote new questions, selected the mix of questions, and updated items to reflect revisions in the tax law.
Brad McDonald, JD, is an instructor of Business Law and Statistics at Northern Illinois University. He has taught business law since 1987 and has taught the Business Law section of the Northern Illinois CPA review course since 1998. He wrote and revised most of the Business Law modules. He prepared and revised answer explanations for the multiple-choice and simulation questions.
Professional and Legal Responsibilities — Module 23
ACCOUNTANTS’ LIABILITY
Liability under Common Law
An accountant may be liable under common law due to negligence or fraud.
Negligence
A loss due to negligence occurs when an accountant violates the duty to perform professional services in a competent manner. NEGligence may consist of
Nondisclosure of information to a client
Errors previously discovered not being corrected
GAAP not being followed
Best defense to common law negligence is that appropriate professional standards were followed.
Simple negligence
Careless mistakes
Defense of lack of privity may be available But client and intended third-party beneficiaries have privity Foreseen third parties have privity in majority of states under tort law Foreseen third parties lack privity in states conforming to Ultramares case
Gross negligence
Reckless disregard for the truth
Lack of privity not valid as defense
Fraud
Fraud refers to conduct that involves all of the following:
Material false representation of fact
Justifiable reliance on the information
Awareness of the false information by the accountant
The falsity was made with the ultimate intent to deceive
The party must have suffered damages
Scienter refers to the accountant’s knowledge of a false representation or material omission of fact with the intent to deceive.
Potential defenses against fraud include
Lack of intent to deceive
Immateriality
Lack of privity is not a valid defense
Liability under Federal Securities Regulations
Auditors are liable under both the Securities Act of 1933 (33 Act) and the Securities Exchange Act of 1934 (34 Act).
Liability under 33 Act
Accountants are liable under Section 11 of the 33 Act
Liable if financial statements contain untrue statement or material omission
Liable to anyone acquiring security without knowledge of error
To be successful, the plaintiff need not prove
Privity
Scienter
Reliance
Defenses the accountant may use include
Plaintiff’s knowledge of the error
Due diligence in performance of services
Liability under 34 Act
Accountants are liable under Rule 10b-5 of the 34 Act
Liable for oral or written misrepresentations of fact
Liable for wrongful act committed through mail, interstate commerce, or a national securities exchange
To be successful, the plaintiff must prove
Scienter
Reliance
Defenses the accountant may use include
Plaintiff’s knowledge of the error
Lack of reliance by plaintiff
Summary of Auditor Liability
Elements in action taken against an accountant
1) There is a misstatement or omission of a material fact 2) Plaintiff has reasonably relied upon the information 3) Plaintiff suffered a loss 4) Accountant was in error Auditor Common Law Liability
Auditor Liability under Federal Securities Laws
1933 Act Section 11 1934 Act Rule 10b-5 Who may bring action Any purchaser Any purchaser Accountant’s error resulting in action Lack
of due diligence Recklessness or intentional misconduct (scienter) Plaintiff must prove Elements 1 & 3 only All 4 elements Private Securities Litigation Reform Act of 1995
Requires auditor of publicly held company to include specific substantive procedures designed to
Identify illegal acts, including management fraud, having a direct and material effect on the financial statements
Identify significant related-party transactions
Determine if there is substantial doubt related to the entity’s ability to continue as a going concern
Illegal acts must be reported to management and board of directors must be notified
Board of directors must
Notify the SEC within 1 business day
Provide auditor with copy of report to SEC
If auditor not notified
Resign from engagement
Notify SEC within 1 business day of board’s failure to meet deadline
Responsibilities under the Sarbanes-Oxley Act
CPAs and CPA firms may be criminally prosecuted for destroying or falsifying records
Created the Public Company Accounting Oversight Board (PCAOB) Registers CPA firms that audit public (issuer) companies Sets standards on auditing, quality control, independence for registered CPA firms Restricts the types of services that a CPA firm may perform for an issuer audit client Requires rotation of audit partner every 5 years Requires audits of internal control over financial reporting
Public companies must disclose whether they have adopted code of ethics for company’s officers
For audit committees of the board of directors All members must be independent Must have at least one financial expert
Requires the CEO and CFO to certify to company’s financial statements
Liability as a Tax Preparer
Penalties
Actions by an accountant preparing a client’s tax return can result in penalties
Not providing client with copy of return
Failing to sign return as a preparer
Endorsing & cashing client’s refund check
Liability to Client
Other actions may create a liability to a tax client
Failing to file a return timely
Not advising client of tax elections
Neglecting evaluation of joint versus separate returns
Regulation of Accountants
State boards of accountancy issue licenses to practice in a state Investigate violations of professional standards and ethics May revoke license to practice
AICPA and state societies of CPAs Investigate violations of professional ethics through Joint Ethics Enforcement Program (JEEP) May admonish, sanction, suspend, or expel a member
The AICPA Uniform Accountancy Act (UAA) Provides guidance to states in establishing accountancy laws Contains rules for education, reciprocity, continuing education, etc.
The Securities Exchange Commission Investigates CPAs and CPA firms that violate SEC rules May disbar an accountant or firm from auditing public (issuer) companies
The Public Company Accounting Oversight Board (PCAOB) Registers and performs inspections of firms that audit public (issuer) companies Firms that audit more than 100 issuers are inspected every year Firms that audit 100 or less issuers are inspected every three years For substandard performance the PCAOB may: Prescribe remedial actions such as improvements in quality control Suspend an individual or firm from auditing issuers
Standards for Consulting Services
When performing consulting services, a CPA must adhere to certain general standards
Professional competence
Due professional care
Planning & supervision
Obtaining sufficient relevant data
Specific standards related to consulting services include
Serving the client
Establishing an understanding with the client as to the nature, scope, & limitation of services
Communicate with the client about conflicts of interest, scope of services, or benefits to be derived
Standards for Tax Practice
A CPA performing tax services
May not recommend a tax position that lacks merit
Must make a reasonable effort to answer applicable questions on the return
May rely on client information when preparing the return
Must make reasonable inquiries about questionable or incomplete information
May use estimates
Federal Securities Acts — Module 24
FEDERAL SECURITIES REGULATIONS
Securities Act of 1933 (33 Act)
The 33 Act requires
Registration of securities offered for sale to the public
Information be provided as part of that registration
Nonexempt securities must be registered before being offered to sale to the public
Through the mails
In interstate commerce
Registration consists of a registration statement, which includes the prospectus
The registration statement describes the use of proceeds & contains audited financial statements
The prospectus describes the securities, the company, & the risk
Once registration statement is filed
1) Oral offers to sell shares may be made 2) 20 day waiting period before registration is effective 3) During waiting period company may obtain an underwriter & issue a “red herring” (preliminary prospectus) 4) After waiting period, securities can be bought & sold 5) After waiting period, a tombstone ad informs investors about obtaining prospectus In addition to federal registration laws, states require registration under “blue-sky laws”
Securities Exempt from Registration
Certain securities are exempt from registration. The 1933 Act doesn’t apply to these securities at all.
Exempt securities include
Government securities
Regulated by federal agency (banks and railroads)
Insurance policy
Nonprofit organization
Debt maturing within 9 months (known as commercial paper)
Transactions Exempt from Registration
Certain transactions may qualify for exemption from registration. The securities themselves remain subject to the 1933 Act for other purposes or subsequent transactions that aren’t exempt.
Exempt transactions include
Splits, dividends, and other exchanges with existing shareholders without charge
Casual sales by parties other than issuers, underwriters, dealers, directors, officers, or 10% or greater shareholders
Intrastate offers (as long as shares aren’t resold to nonresidents for 9 months)
Private placements under Regulation D
Small issues under Regulation A
Securities Exchange Act of 1934 (34 Act)
The 34 Act established the SEC & made it responsible for
Requiring disclosures concerning offerings on national securities exchanges
Regulating activities of securities brokers
Investigating securities fraud
Companies are required to file periodic reports if
Company’s securities are traded on securities exchanges
Company’s assets > $10,000,000 & more than 500 unaccredited shareholders or 2,000 or more total shareholders (This does not include shares obtained from a qualified employee compensation plan)
Registration
Information required upon registration
Financial structure & nature of business
Names of officers & directors
Disclosure of bonus & profit-sharing arrangements
Reporting
Required reports include
10-K (annual report)—includes audited financial statements
10-Q & 8-K (periodic reports)—update information in original registration
Proxies
Shareholders may sign proxies authorizing the company to vote their shares. The company must file a preliminary copy of the proxy statement with the SEC at least 10 days before it is sent to shareholders.
Insider Trading
Insider trading must be reported to the SEC.
Insiders include agents of the issuer, such as attorneys, or directors, officers, and owners of 10% or more of any class of stock
Short swing profits must be returned to the company
Sarbanes-Oxley Act of 2002
Expands powers of SEC to regulate financial reporting
CEO and CFO must certify in writing that financial reports are accurate
Management is responsible for internal control
Officers must disclose knowledge of internal control deficiencies to auditor and audit committee
Must also disclose evidence of fraud, even if immaterial, by employees involved in internal control
Prohibits most personal loans by company to officers
Requires insiders to report trades within 2 business days
The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010
Designed “to promote the financial stability of the United States by improving accountability and transparency in the financial system”
Created the Financial Stability Oversight Council to identify and react to emerging risks
Increased the types of financial companies that could be seized and liquidated by the FDIC
Created the Federal Insurance Office to regulate insurance companies
Prohibits any “banking entity” from engaging in proprietary trading
Gives authority to the Commodity Futures Trading Commission and the SEC to regulate the derivatives (swaps) markets
The act includes broad changes in executive compensation policies for public companies including requiring The national exchanges to issue rules requiring companies to develop compensation-recovery arrangements (clawback policies) That all members of the compensation committee of the board of directors be independent A shareholder nonbinding vote on executive compensation at least every three years A nonbinding vote by shareholders on “golden parachutes” that result from major transactions
Provides that the SEC will increase its compliance activities regarding securities trading, and will pay awards to whistle-blowers
The Act requires mortgages securitizers or originators to retain an economic interest in a portion of the credit risk of any securitized asset they sell
Business Structure — Module 25
PARTNERSHIP
Partnership Characteristics
Partners’ Rights
1) Participation in management 2) Sharing of profits & losses Percentages may be specified in partnership agreement
Equal sharing of profits and losses when not specified
3) Property rights Partners’ Property Rights
Partner’s interest; this is only a partner’s right to profits
Right to share of profits & capital upon termination
May be sold or assigned
Buyer or assignee does not have same rights as partner
Right to specific property
Partnership purposes only
Individual partners may not sell or assign
Partners’ Authority
Authority to bind partnership & other partners
Actual authority – express or implied
Apparent authority – reasonable third party would believe partner has authority
Individual partner does not have apparent authority to
Admit a new partner
Guarantee debts of a third party
Admit a claim in court or submit a legal claim to binding arbitration
Sell or pledge partnership property (other than ordinary sales of inventory)
Partner has apparent authority for any other action that appears to be in the course of partnership business unless both of the following occur:
Partners mutually agree on a limit to the authority
Third parties are notified of this limit
Partners’ Liability
Jointly & severally liable
Liable for debts of partnership & torts committed by other partners engaged in partnership business
Right of contribution from other partners
Creditor must attempt to collect from partnership before partners unless partnership in bankruptcy
Notice is required after a partner dissociates from the partnership to avoid liability for later actions
Personal notice to third parties who dealt with the partner (actual notice)
Public notice for all others (constructive notice)
A statement of dissociation, filed with the state’s secretary of state, will provide notice 90 days after it is filed
Liability of Entering and Exiting Partners
Entering partner:
Not personally liable for debts created before entering, but may lose capital contributed to partnership
Personally liable for all debts created after entering
Exiting partner:
Liable for all debts created prior to exiting unless creditors perform a novation to release the exiting partner
Not liable for debts created after exiting as long as proper notice has been given to third parties of the exit
Formation of Partnership
Creation of partnership does not require government approval, and is created by agreement
Written – When a partnership falls within the Statute of Frauds (such as when partners agree that the term of the partnership will exceed one year), the partnership agreement must be in writing and signed by all parties
Oral – In other circumstances, an oral agreement will be sufficient
Implied – Even in the absence of a written or oral agreement, if two or more people are sharing the profits from a venture, there is legal presumption that they are partners unless they can demonstrate otherwise.
Partnership Dissolution
Partnership does not automatically dissolve upon
Withdrawal of a partner
Death or bankruptcy of a partner
Remaining partners with majority vote may continue partnership
Individual partners have right to withdraw
Withdrawing partner may be in breach of contract
Distributions upon liquidation
1st to creditors for loans
2nd to partners for capital contributions
3rd any remainder is given to partners as profits
Limited Liability Arrangements
Limited Partnerships
Basic requirements
At least one general partner with unlimited liability
At least one limited partner
Must file certificate with the state that contains the names of all general partners
Status of limited partners
Have right to profits but not to participation in management or use of property
Limited partner who participates in management or uses property loses limited liability protection
Limited Liability Partnerships (LLPs)
Partners have unique status under this arrangement
All partners may participate in management
Partners are personally liable for own negligence, malpractice, or fraud
Partners are liable for negligence, malpractice by employees/partners under their immediate supervision
Partners are not liable for negligence, malpractice, or fraud committed by other partners
Taxed as partnership (income and losses passed through to individual returns of partners)
Form of organization common in many licensed professions (accountants, attorneys)
Limited Liability Companies (LLCs)
Characteristics of corporations & partnerships
Limited liability to all members
All members may participate in management
Multiple member LLC taxed as partnership (unless members elect to be taxed as corporation)
Single member LLC taxed as sole proprietorship
CORPORATIONS
Characteristics of Corporations
Corporations are legal entities, separate from their owners.
They are generally taxed on their own income
Shareholders are taxed only on distributed income
Shareholders are not liable for corporate obligations
Corporations are incorporated by the various states
Domestic – A corporation that is operating within the state of incorporation
Foreign – A corporation when it is operating in a different state
Alien – A corporation when it is operating in a different country
Foreign and alien corporations must obtain approval to operate in the other state, or they will not have the protection of its courts and be subject to fines (as well as the normal taxes and fees that would have been owed had they qualified to operate in that state)
S Corporations
S corporations provide liability protection to shareholders, but are not taxed on their own income.
Corporate income passes through and is taxed to the shareholders
Shareholders are not taxed on distributions
Requirements for S corporations
Domestic corporation
Not member of affiliated group
100 or fewer shareholders
Only one class of stock
Shareholders generally need to be individuals and United States residents
Articles of Incorporation
Primary document in process of incorporation. Includes
Name of corporation
Capital structure
Name & address of registered agent
Name & address of each incorporator
Corporate purpose
State issues certificate of incorporation or corporate charter.
Incorporators elect board of directors
Board of directors adopts initial bylaws
Promoters
Prior to formation of corporation, promoters may act on behalf of proposed corporation
They do not have status of agents, as no principal exists to give them authority
Contracts made on behalf of corporation bind promoter instead
Promoter still has fiduciary duty to proposed corporation to act loyally and in good faith
Board of directors may adopt or reject contracts previously made by promoter
Promoters remains liable to other party to contract unless granted a novation by them
Promoters have no special right to compensation for services rendered before corporation has been formed
Directors & Officers
Shareholders elect directors, who
Set corporate policy
Select officers
May terminate officers
Rights of Directors
Directors’ rights include
Notification of meetings
Participation in oversight of company
Access to books and records
In addition, directors may receive
Compensation
Indemnification in the form of reimbursement of losses incurred in corporation-related lawsuits
Powers of the Board of Directors
Board, not individual directors, is an agent of the corporation
Acts as a single body – individual directors are not agents and may not act alone
Hires, fires, and sets salaries of officers
Issues stock to buyers at mutually agreed prices
Board may also repurchase shares and retire them or hold them as treasury shares
Board sets dividend policy, determining if there are sufficient resources to pay a dividend that year and setting the amount of the dividend
Dividends may not be declared if the corporation is insolvent or will be made so by dividend
Dividends that exceed retained earnings require shareholder approval
Rights of Officers
Officers are selected & supervised by directors who also set their compensation. Officers are responsible for the day to day operations of the corporation. An officer
May be a director & may be a stockholder
Is an agent of the corporation as an officer
May be entitled to indemnification
Duties of Directors & Officers
Directors & officers have a fiduciary responsibility to the corporation and owe it the duties of care & loyalty.
Care – They must act honestly & prudently when conducting corporate affairs
Loyalty – They must subordinate personal interests to those of the corporation
The duty of loyalty prohibits
Competing with the corporation
Using corporate opportunities for personal gain
Having interests in conflict with the corporation’s
Trading based on inside information
Authorizing transactions detrimental to minority shareholders
Selling control over the corporation
Shareholders
Shareholders also have certain rights & obligations.
Dividends
Dividends are declared at the discretion of the directors and may be paid in cash, property, or stock.
Undeclared dividends do not carry forward to future periods
Undeclared dividends on cumulative preferred stock do carry forward. These dividends in arrears
Are not a liability of the corporation until declared
Must be paid prior to payment of current dividends in subsequent periods
Dividends may not be declared if they threaten the corporation’s solvency.
Other Rights of Shareholders
Shareholders may reasonably inspect & copy corporate books & records
May designate a CPA or attorney as an agent
Must have legitimate reason for inspection such as investigation of management misconduct or commencing a derivative suit
A derivative suit is brought by stockholders
Against an officer or director of the corporation who has breached a fiduciary duty
On behalf of the corporation; thus any proceeds from such an action belong to the corporation, not the shareholder who brought the derivative suit
Shareholders may vote on fundamental changes to the corporation. These include
Consolidation or merger with other corporations
Voluntary dissolution of the corporation
Shareholders may have the right of appraisal
Applies when they dissent to amendments that materially and adversely affect shareholder rights
Gives shareholder the right to the fair value for shares held
Shareholders may have preemptive rights
Must be provided for in articles of incorporation or charter
Give shareholder the right to purchase proportionate amount of newly issued shares
Shareholders have right to transfer shares
Corporation must not hinder transfers
Close corporations may require stock to be offered first to other shareholders before being sold to outsiders
Limited Liability
Shareholders are entitled to limited liability, indicating they will not be liable
beyond their investment. Shareholders are not personally liable, even when
The corporation is an S corporation
The corporation has performed an ultra vires act, beyond its authority
The corporation was formed solely for the purpose of limited liability
The shareholder is a director, officer, or employee of the corporation
The courts will “pierce the corporate veil” and shareholders will be personally liable when
The corporation was undercapitalized upon formation
The corporation’s resources are commingled with those of the shareholders
Business Combinations
Combinations may be in the form of a merger or a consolidation
Merger – one or more companies are absorbed by another
Consolidation – two or more corporations form a new entity
Requirements for Combinations
Certain conditions must be met before a combination can occur
Directors of each combining corporation must approve
A merger plan must be given to all shareholders of all combining corporations
A majority of shareholders of each combining company must approve the plan
Dissenting shareholders have an appraisal right to be paid a fair amount for shares held on the date of the combination. To qualify, they must
File an objection to the merger
Not vote in favor of the proposal
Make a written demand that the stock be purchased at an appraised price
Dissolution
A corporation can be dissolved as a result of an action by the shareholders or by the directors.
1) Directors may pass a resolution to dissolve the corporation The resolution is submitted to the shareholders
It must be approved by a majority
Upon dissolution, the corporation is liquidated.
Contracts — Module 26
CONTRACTS
Formation of Contracts
Elements
In order to form a valid contract, there are 3 required elements
Offer
Acceptance
Consideration With all 3 elements, a contract is as sturdy as an oac (okay, so it should be oak) tree
Offer
Expresses intent to enter into contract
To be effective, the offer must be definite as to terms and received by the offeree
To be definite, an offer generally includes
Price
Subject matter
Time for performance
Terms considered definite if reasonable person could determine them
An offer may be revoked at any time until accepted
A promise to hold an offer open for a specified time is not binding unless supported by consideration
A revocation is effective when received by the offeree
Acceptance
Acceptance is generally effective when dispatched (mailbox rule)
Not effective until received when
Offer so specifies
Accepted by unauthorized means
Sent by means not equal to or better than that used to communicate offer
Acceptance must be the same terms as offer (mirror image rule)
A modification represents a counteroffer
Initial offer is rejected and offeree makes a new offer
Rejection
Rejection of an offer is effective when received by the offeror
Terminates original offer
If rejection is followed by acceptance, whichever is received first is effective
Consideration
Given in exchange for promise to form contract
Must be legally sufficient
Bargained for
Legal value: Party agrees to do something that s/he is otherwise not obligated to do, or refraining from an action that the party has a legal right to do
Does not have to be of equal value
Consideration may take various forms
May involve forfeiting a legal right
May be performed by a third party
May not consist of past performance or preexisting obligation
Validity & Enforceability
In certain circumstances, no valid contract exists. Even if a contract exists, it may not be enforceable.
A condition precedent is a condition that must be met before a contract becomes enforceable
A condition subsequent is a condition that, upon being met, releases a party from obligation
Validity
Certain factors may indicate that there is no valid contract
Fraud—A party entering into a contract due to a fraudulent misrepresentation will not be held to it. The contract is
Void due to fraud in the execution (Deceived into thinking it isn’t a contract)
Voidable due to fraud in the inducement
Ability—A party that does not have the capacity to enter into a contract will not be held to it
The contract is generally voidable.
The party may ratify or disaffirm the contract upon obtaining capacity.
Influence—A party entering a contract due to being improperly influenced (undue influence) may not be held to it. The contract is voidable.
Legality—A party entering into an illegal contract will generally not be held to it. The contract is void.
Violation of a licensing statute designed to raise revenues does not make the contract illegal.
Violation of a licensing statute designed to protect the public does make the contract illegal.
Error—A party entering into a contract by mistake will generally not be held to it. The contract is
Voidable in the case of mutual mistake (both parties were in error)
Unenforceable when the other party should have recognized the mistake or when
there is a material clerical error
Duress or force—A party forced to sign a contract will not be held to it. The contract is
Void if the duress is extreme, such as a threat of physical harm
Voidable if the duress is simple, such as a threat of breaching a contract These are the reasons the contract failed.
Enforceability
Under the Statute of Frauds, executory must be in writing, or have written evidence, to be enforceable. These include
A guarantee of the debt of another
A sale of goods for $500 or more
A contract that cannot be completed within one year
A contract involving an interest in land
LEGGY, Executory promises for Land, Goods, Guaranteeing another’s debts, and that cannot be completed within one Year need a writing.
If the contract itself is not in writing, then a sufficient writing is a writing or combination of writings that
Identifies the parties to the contract,
Identifies the terms of the contract, and
Contains the signature of the party to be charged (sued)
Parol Evidence Rule
Oral evidence generally cannot be used to contradict a written contract. The Rule excludes
Negotiations and agreements prior to the written contract
Oral agreements occurring at the same time as the written agreement
The Rule allows
Oral agreements occurring after the written agreement
Clarification of ambiguous terms in the written agreement
Evidence that the contract was void or voidable
Rights & Obligations
Unless otherwise specified
A party may assign their rights in a contract to a third party
A contract may delegate their obligations under a contract to a third party
A third party obtaining rights in a contract is a third party beneficiary
An intended beneficiary has rights under the contract
An unintended or incidental beneficiary has no rights under the contract
Assignment
When a party with rights to a contract assigns those rights, the assignor warrants
The assignor will not impair the assignment
The rights being assigned do exist
The assignor is not aware of information adverse to the assignment
Delegation
When a party delegates their obligations under a contract, they remain obligated to the other party to the contract.
Discharge
A party may also be released from obligations by being discharged. Discharge can result from a variety of circumstances.
Satisfactory performance
A condition precedent was not met
The contract was rescinded
An accord and satisfaction—different performance is accepted in place of the contracted for performance
Discharge may also occur as an operation of law.
Performance becomes impossible
Death or incapacity of the obligated party when personal services are required by that party under the contract
Discharge in bankruptcy
Illegality of the obligation
Breach of Contract
Nonperformance, resulting in a breach of contract, changes the relationship between the parties.
1) A material breach by one party releases the other. 2) Most breaches are nonmaterial; the remedy is normally compensatory damages. 3) One may inform the other that they will not perform resulting in an anticipatory breach of contract. The other party could Cancel the contract
Sue for compensatory damages immediately
Damages
An injured party may seek damages.
Money damages may include
Compensatory damages to recover losses
Consequential damages cover indirect costs & anticipated losses, but are only available if they are foreseeable to the breaching party.
Punitive damages are not available for breach of contract
Nominal damages ($1) are awarded when the nonbreaching party fails to prove damages.
Liquidated damage clauses specify the amount an injured party will received; such clauses are enforceable if the specified damages are reasonable.
Specific performance, requiring the other party to perform their obligations, may be appropriate when the subject of the contract is unique, such as real estate.
An action resulting from breach must be brought within the time period specified
in the relevant statute of limitations.
Sales — Module 27
SALES
Contracts involving the sale or lease of goods are covered by the Uniform Commercial Code and are subject to special rules.
Offer, Acceptance, & Enforceability
Like other contracts, elements of a sales contract include offer, acceptance, and consideration.
Offer
An offer under sales law may be incomplete as to terms provided the parties intend to enter into a contract.
A firm offer cannot be revoked for a specified time of up to 3 months, regardless of a lack of consideration. A firm offer must be
Made by a merchant
In a signed writing
Acceptance
Acceptance of a sales contract does not have to mirror the offer. A timely and definite indication of acceptance with different or additional terms is valid.
1) The different or additional terms are generally considered proposals. 2) If the contract is between merchants, the different or additional terms are part of the contract unless The offer required acceptance of the specified terms
The changes materially change the offer
The other party objects on a timely basis
An offer to buy goods for prompt or current shipment
May be accepted by a promise to ship promptly
May be accepted by prompt shipment of conforming goods
Enforceability
Modifications of existing contracts are enforceable, even if or not supported by additional consideration.
Under the Statute of Frauds, sales contracts in the amount of $500 or more, including modifications, must be in writing to be enforceable.
An oral contract between merchants for $500 or more will be enforceable if: There is a written confirmation signed by one party, and The other party fails to make a timely written objection.
Other oral contracts for $500 or more that will be enforceable include
A contract for specially manufactured goods
A contracted admitted to by the party
Portions of a contract that have already been performed
Goods in Transit
Title
Contract may specify when title passes to buyer.
When goods are not delivered
Title passes when document of title is delivered
In absence of document of title, title passes when goods have been identified to the contract
Title transfers to the buyer for both conforming and nonconforming goods. Title reverts back to seller if when goods are rejected by the buyer.
Risk of Loss
Risk of loss may pass with title or at the time specified by the contract. Risk remains with the seller
When nonconforming goods are sent
Until delivery when the shipper’s vessel is used for shipment
Until delivered to a common carrier in a shipment contract
Until delivered to their destination by a common carrier in a destination contract
When goods are not delivered
A merchant seller retains the risk of loss until the buyer has possession of the goods
A nonmerchant seller transfers the risk of loss when tendering delivery to the buyer
Obligations of Common Carriers
In shipment contract, common carrier is a bailee in a mutual-benefit bailment. Standard of care is based on strict liability
Responsible for loss regardless of negligence
Amount of loss is limited by law
Special Sales
Sale on Approval
Seller is actually making offer to sell goods
Buyer takes possession
Risk of loss remains with seller
Buyer is bailee owing duty of reasonable care
Title & risk of loss transfer to buyer upon acceptance or after grace period
Sale or Return
Goods are sold & delivered to buyer
Title & risk of loss transfer to buyer
Buyer may return goods to seller at buyer’s risk & cost
Title & risk revert back to seller upon return
COD
Buyer generally has right to inspect goods before making payment
Buyer gives up right to inspect before payment in contract specifying COD shipment
Seller’s Warranties
Warranty of Title
Automatic warranty of any seller. Warrants
Seller is transferring good & valid title
Goods are free from liens other than those that buyer is aware of
Goods are free from claims of third parties
May be disclaimed with specific language in contract only
Warranty of Merchantability
Implied warranty of merchant seller. Warrants
Goods are reasonably fit for ordinary use
May be disclaimed with specific mention of merchantability in disclaimer
May be disclaimed by use of recognizable phrases such as “as is”
Warranty of Fitness for a Particular Purpose
Implied warranty of any seller.
Seller must know purpose for which buyer will use goods and that buyer is relying on seller’s knowledge in selecting goods for the purpose
May be disclaimed in writing with specific mention of fitness in disclaimer
May also be disclaimed by use of recognizable phrases such as “as is”
Express Warranties
Created by the words or actions of seller
Product Liability
Manufacturer and seller of defective product may be liable to injured party under theory of strict liability, protecting consumers from unsafe products. To hold a manufacturer/seller liable the following elements are required:
Defendant is in the business of selling/manufacturing the product
The product was in an unreasonably dangerous condition (defective) when it left the seller’s control
The unreasonably dangerous condition caused the plaintiff’s injury/damages
Manufacturers/sellers are liable despite
No privity of contract with injured party
Ignorance of defect & lack of negligence
Lack of due care exercised by injured party
Liability for injury from defective product may not be disclaimed.
Breach of Contract
Different remedies are available to buyer & seller for the other party’s breach of a sales contract.
Seller’s Remedies
When a buyer is in breach, the seller may
Cancel the contract
Recover damages
Damages may include
The contract price of the goods if they cannot be resold
The difference between the contract price and the sales price if they can be resold
Incidental damages for costs incurred as a result of the buyer’s breach
Punitive damages are not available
Buyer’s Remedies
A seller is in breach by not shipping goods or by shipping nonconforming goods. Nonconforming goods include a combination of conforming & nonconforming goods.
When goods are not shipped, the buyer may
Obtain specific performance if the goods are unique
Cover the contract by acquiring goods elsewhere and recovering the excess cost from the seller
When nonconforming goods are shipped, the buyer may void the contract. The buyer
May reject all, some, or none of the goods shipped
Must notify the seller of the rejection
Give the seller an opportunity to cure the defect on a timely basis
Must follow reasonable instructions from the seller in disposing of rejected goods
May avoid costs incurred in relation to the rejected goods
When partial payment is made to an insolvent seller, the buyer may recover or capture goods identified to the contract that are in the possession of the seller under the
right of replevin.
Special Circumstances
Remedies available to the parties may be modified by special circumstances.
When goods are accidentally destroyed before the passing of title, the seller is released from obligation to perform
When the agreed upon delivery method becomes impracticable, a practical alternative must be tendered and accepted
A liquidated damages clause may specify the amount of damages to be received by a party in the case of breach by the other, provided it is reasonable
Commercial Paper — Module 28
NEGOTIABLE INSTRUMENTS
Commercial Paper
Types of Commercial Paper
Note
Two-party instrument: Maker and payee
Promise to pay
Examples: Promissory note, and Certificate of deposit
Draft
Three-party instrument: Drawer, drawee, and payee
Order to pay
Examples: Trade acceptance—Draft used for a sale of goods; Check—Draft drawn on a bank and payable on demand
Requirements for Negotiability
For commercial paper to be negotiable, certain requirements must be met. It must be
Payable at a fixed time or on demand
For a certain amount
Payable in money
Payable to order of a specific party or to bearer (not required for checks)
Contain an unconditional promise to pay or an unconditional order to pay
Signed by the maker or drawer Famous instruments are negotiable instruments
Transfers of Negotiable Instruments
Transfer may be made by
1) Negotiation—Transferee has same rights as transferor or superior rights Bearer paper—Negotiated by delivery alone
Order paper—Negotiated by delivery and endorsement
Types of Endorsements
Blank—Signature of payee, converts order paper to bearer paper
Special—Specifies endorsee, paper becomes payable to order of endorsee
Qualified—Contains words of qualification, such as “without recourse”
Does not restrict further negotiation
Endorser does not guarantee payment upon dishonor
Endorser with knowledge of defense against instrument will be liable
Restrictive—Places conditions on payment to subsequent endorsee
Does NOT prevent further negotiation
Holder in Due Course (HDC)
A holder can be a HDC if 3 requirements are met
Instrument taken for value
Taken in good faith
Without notice of defects
A holder may have same rights as a HDC under the shelter provision
Must receive instrument after a HDC
Not personally considered a HDC unless the 3 requirements are met, but will still have the rights of HDC
Defenses against a Negotiable Instrument
Real Defenses
Valid against all holders, including holder in due course
Includes
Forgery
Fraud in the execution—signer is not aware that item is a negotiable instrument
Material alteration
Discharge in bankruptcy
Minority
Extreme duress
Personal Defenses
Not valid against a HDC, but valid against a mere holder
Include
Breach of contract
Lack of consideration
Imposter or fictitious name given by payee
Simple duress
Fraud in the inducement—Instrument signed based on misleading information
Contract Liability of Parties
These parties are liable for the face value of the instrument
Primary Liability
Maker of promise to pay and acceptor of a draft
Unconditionally obligated to pay
Subject to appropriate defenses
Secondary Liability
Any other (other than maker or acceptor) party who signs the instrument has secondary liability; this includes
Endorsers
Drawers
Guarantor of instrument
Liable if party with primary liability does not pay
Timely notice of primary party’s refusal to pay must be given to secondary parties
Warranty Liability of Parties
If a party breaches a warranty, the nonbreaching party may demand a refund of what it paid for the instrument.
Transferor’s Warranty Liability
A transferor of the instrument who was given value promises subsequent transferees that
The transferor has good title to the instrument
All signatures are authentic and authorized
There are no valid defenses against the transferor
The instrument has not been altered
No knowledge of bankruptcy of the maker, drawer, or acceptor
Presentor’s Warranty Liability
Any holder of the instrument, whether they actually present the instrument for payment or not, is warranting to the payor of an instrument that the holder has good title.
Avoiding Liability
There are circumstances where there is no liability
A party who has not signed an instrument has no contract liability
No one has primary liability on a draft until it has been accepted
A holder may discharge another party from liability by
Canceling (crossing out) the party’s endorsement
Materially altering the instrument
Releasing the collateral of the party with primary liability
A party may eliminate its contract liability by signing “without recourse”
Other Instruments
Documents of Title
Relate to goods, rather than money
Can be negotiable
Must contain words “bearer” or “to order of”
If to order, goods must be delivered to that party or subsequent endorsee
A document of title can be duly negotiated if the purchaser
Takes it in good faith
Gives value
Takes it in the ordinary course of business or finance, not in settlement of a money obligation
A warehouse receipt is issued by a party storing goods for a fee who has a duty of reasonable care.
The receipt should include
Location of the goods
Date of issue
Whether the goods are deliverable to bearer, a specific party, or to the order of a specific party
Description of the goods
Warehouseman’s signature
A bill of lading is issued by a carrier of goods who is strictly liable
Investment Securities
Include bonds & shares of stock
Can be bearer or registered
Transferor makes certain implied warranties
Transfer is effective
Transfer does not violate rights of another party
Certificate is genuine and has not been materially altered
Secured Transactions — Module 29
SECURED TRANSACTIONS
An agreement where a creditor receives additional assurance of repayment from a debtor who provides collateral in which the creditor obtains an interest
Collateral
The personal property that is subject to the creditor’s security interest
Types of Collateral
Goods
Consumer goods are goods for personal use
Equipment is goods used for business
Inventory is goods used for resale
Indispensible paper
Intangibles
Security Agreement
The agreement between the debtor and creditor that gives the creditor a security interest in the debtor’s collateral
Requirements for a valid security agreement
In writing, except when creditor has physical possession of collateral
Signed by the debtor
A description of the collateral
Attachment & Perfection
Attachment
Gives secured creditor right to collateral upon default of debtor
Conditions for attachment—all 3 must be met
Creditor gives value to debtor
Debtor has rights in the property
Creditor takes possession of property or obtains written security agreement A security interest attaches to collateral and the creditor grips the debtor’s property
Perfection
Gives secured creditor a claim to the property that is superior to others
Perfection occurs when the secured interest has attached and 1 of the following:
A financing statement has been filed
A purchase money security interest (PMSI) is perfected automatically when it attaches in a consumer sale
The creditor has taken possession of the property A creditor should perfect a security interest asap (as soon as possible)
Priorities among Claims
A PMSI has highest priority if the creditor fulfills requirements
Requirements for PMSI in noninventory goods to have highest priority
Must be perfected within 20 days of debtor possessing collateral
Requirements for PMSI in inventory to have highest priority
Must be perfected prior to debtor receiving inventory
Written notice must be given to other perfected interests prior to debtor receiving inventory
Among Other Claims
If all perfected by filing, in order of filing date
If perfection by filing vs perfection by possession, in order of perfection date
Buyers of Property
A buyer of goods in the ordinary course of business is not subject to security interest (i.e., the security interest cannot be enforced against a buyer in the ordinary course of business)
A good-faith buyer of used consumer goods from another consumer takes them free of any security interest except those perfected by filing
Default by Debtor
Repossession by Creditor
1) Debtor can exercise right of redemption by paying off loan 2) Proceeds from sale of repossessed property are distributed in the following order: Reasonable expenses of sale
Pay secured party’s claim
Satisfy other secured claims in order of priority
Excess to debtor
Credit Card Debt
Holders and issuers of credit cards protected against fraudulent use under the Credit Card Fraud Act (CCFA), which prohibits
Possession of unauthorized cards
Counterfeiting or altering credit cards
Using credit card numbers
Conspiring to use cards reported as stolen
A holder is only liable for unauthorized use up to $50. Holder must have accepted card and
Holder was given notice of potential liability
Holder was provided means of notifying issuer of loss or theft
Unauthorized use must have been prior to notification
Issuer provided means of identifying authorized user
Bankruptcy — Module 30
BANKRUPTCY
Voluntary Filing—Chapter 7
Means testing added by Bankruptcy Act of 2005, prohibiting Chapter 7 filing when
Consumer debtor monthly income exceeds certain specified amounts in the bankruptcy code
Debtor current monthly income is reduced by Monthly expenses Payment made on secured debts, and Payment made to priority general creditors
Debtor must meet with an authorized credit counselor within 180 days prior to filing for bankruptcy
Involuntary Filing—Chapter 7
12 or More Unsecured Creditors
Requires 3 or more unsecured creditors to file petition
Total undisputed claims of petitioners ≥ $14,425
Fewer than 12 unsecured creditors
Requires only 1 or more unsecured creditors to file petition
Total undisputed claims of petitioners ≥ $14,425
Powers of Bankruptcy Trustee
Avoidance
Enables trustee to obtain return of debtor’s property
Applies to
1) Fraudulent transfers 2) Statutory liens against debtor’s property 3) After-filing date transfers 4) Voidable preferences His attempt to transfer the property caused a flap Voidable preferences
Transfers of property made by debtor that can be recovered by trustee
To be a voidable preference, the transfer must be made
Within ninety days of filing of petition if to a noninsider
Within one year of filing if to an insider
For a pre-existing (antecedent) debt
While the debtor is insolvent
The transfer exceeds the amount that the creditor would obtain through bankruptcy In essence, the transferee gets no pie and must return the debtor’s property
Distribution of Assets
Order of Distribution
1) Secured creditors 2) Priority claims 3) Unsecured creditors Secured Creditors
Fully secured creditors obtain collateral
Property satisfies debt
If value of property exceeds debt, then excess is added to bankrupt’s estate
Partially secured creditors obtain collateral
Property does not satisfy debt
Debt exceeds value of property, then excess debt becomes unsecured claim
Priority Claims
Certain creditors will be paid first, in order of priority
1) Support payments (including alimony and child support) 2) Trustee fees & administrative expenses of the bankruptcy 3) Obligations created after petition filing by creditors before settlement (i.e. involuntary gap creditors) 4) Payroll and benefits arising within 180 days of petition—up to $11,725 per employee 5) Individual deposits on consumer goods not received—up to $2,600 per individual 6) Taxes owed to federal, state, and local governments A trustee about to pay nonpriority creditors should stop it and pay the priority claims first Unsecured Creditors
Each level of priority claims must be paid in full before the next level of priority claim is paid
If there are insufficient assets to pay a level in full, then that level is paid on a pro rata basis. For example, each claim might receive 50 cents for each dollar it is owed.
Claims below the group paid on a pro rata basis receive nothing.
Exceptions to Discharge
Certain debts are not discharged as a result of bankruptcy
Student loans of debtor
Taxes accruing within 3 years of the bankruptcy
Unscheduled debt causing credit not to be notified of bankruptcy
Pension and profit sharing obligations to employees
Intentional force or fraud against another person
Domestic support obligations for alimony and child support A debtor is stupid if
he thinks he can use bankruptcy to get these debts discharged
Denial of Discharge
Court may deny discharge of all unpaid debts in limited circumstances
Bankruptcy offense, such as hiding assets from the bankruptcy trustees, committed by debtor
Active operations continue for partnership, corporation, or any business entity
Discharge previously obtained within past 8 years A court will completely deny a debtor any discharge for bad behavior
Business Reorganizations — Chapter 11
Plan for Repayment
Agreed to by debtor and creditors
Debtor continues to operate business
Debtor or creditor’s committee files reorganization plan
Submitted to each class of creditors
Must be approved by at least 1/2 of claims
Total of approving claims ≥ 2/3 of total amount of claims
Court Confirmation of Plan
For confirmation, must provide for payment of priority general creditors:
Administrative expenses
Gap creditors
Employee claims for wages, salaries, & benefits
Consumer deposits
Upon confirmation, plan is binding on debtor & creditors
Discharge
Debtor discharged from debts arising before confirmation
Exceptions to discharge
Debts protected under plan
Debts exempt from discharge under plan of liquidation
Repayment Plans — Chapter 13
Qualifying Debtors
Available to debtors with
Regular income
Generally limited to individuals, or small businesses
Debtor’s Plan
Provides for
Debtor’s future income controlled by trustee
Full payment of priority claims
Similar treatment to all claims within a given class of claims
Plan confirmed by courts
Alternatives to Bankruptcy
Composition of creditors
Agreement between debtor & certain creditors
Creditors agree to accept portion of their claims
Remainder of claims of agreeing creditors discharged
Assignment for the benefit of creditors (general assignment)
Debtor transfers property to trustee
Trustee applies property proportionately to debts
Debtor not discharged from remaining claims
Debtor - Creditor Relationships — Module 31
SURETYSHIP
Sureties
Types of Sureties
Surety—Party agreeing to answer for debts of another
Cosureties—Two or more parties responsible for the same debt of another
Obligations of Sureties
Guarantees obligation of principal debtor
Immediately liable upon default—Creditor not required to
Collect from principal debtor
Use collateral of debtor
Provide notice of default to surety
Rights of Sureties
Exoneration—Require the principal debtor to pay the obligation
Reimbursement—Obtain repayment from principal debtor
Subrogation—Obtain rights of creditor against debtor & debtor’s collateral
Contribution—Receive proportionate payment from cosureties
Defenses of Sureties
Statute of Frauds—A surety contract must be in writing to be enforceable
Capacity—Surety must have capacity to enter into contract
Bankruptcy—A surety can be released in bankruptcy, but is not released due to the principal debtor’s bankruptcy
Misrepresentation—Surety is released due to fraudulent misrepresentations of principal debtor known to creditor
Cosureties
Obligations of Cosureties
Cosureties are individually liable to the creditor up to the maximum amount that the cosurety guaranteed.
Cosureties may demand a contribution from other cosureties, if a cosurety pays
more than its proportionate share of the debt.
To calculate proportionate share of cosureties:
1. Add up total amount guaranteed by all cosureties 2. Divide each individual cosurety’s guarantee by the total in 1. above 3. Multiply the resulting percentage and the amount of the defaulted debt 4. The result is that cosurety’s proportionate share If a cosurety is released by the creditor, the remaining sureties are not liable for the proportionate share of the released surety.
Agency — Module 32
AGENCY
The Agency Relationship
Agent works on behalf of the principal
Agent owes fiduciary duty to the principal to act in the principal’s best interests; fiduciary duties include duty of:
Loyalty
Obedience
Due care
Liability
Generally, principals can be held liable for the actions of their agents, but principals are not responsible for the actions of independent contractors
Contract Liability
If the third party is suing the principal/agent for breach of contract, then consider what authority the agent had to enter into the contract and the disclosure status of the principal.
Tort Liability
If agent commits a tort while in the scope of the principal’s employment, then the third party holds the principal liable, or the agent liable, or both the principal and agent liable; this is joint and several liability.
If agent commits a tort outside the scope of employment, then only the agent is liable.
Terminating Agent’s Authority
Authority of agent terminates in certain cases
Agreement—Principal and agent agree to end of authority
Unilateral—Principal dismisses agent or agent resigns Actual authority terminated even if in breach of contract
Operation of law—Death, insanity, incapacity, or illegality of subject matter of
agency
Apparent authority can still exist, unless authority was terminated by operation of law, then all authority is terminated
Principal can avoid responsibility of agent’s subsequent (after termination) acts by giving
Personal notice to third parties who dealt with agent
Public (also known as constructive) notice for all others
Notice not required when termination is by operation of law
Regulation of Business Employment, Environment, and Antitrust — Module 33
ENVIRONMENTAL LAW
Laws passed to protect the environment.
Under the National Environmental Policy Act (NEPA), all federal agencies are required to consider the impact upon the environment in making decisions
The Environmental Protection Agency (EPA) coordinates and administers environmental policies
Recommendations for actions affecting the environment must be accompanied by an environmental impact statement which
Describes the environmental impact of proposed actions
Discusses effects that cannot be avoided
Discusses alternatives to the proposed actions
Indicates differences between short-term and long-term effects
Provides details of irreversible commitments of resources
The Clean Air Act
Regulates air pollution from mobile sources (automobiles) and stationary sources (factories). Under the Act
Factories with toxic air pollutants must use the best available emission controls
Penalties may be up to $25,000 per day
In addition
The EPA can assess a penalty equal to the violator’s benefit
Private citizens can sue violators
Knowing violators may be subject to criminal liability
The Federal Water Pollution Control Act (Clean Water Act)
Protects navigable waterways & wetlands regulating discharges of heated water by nuclear power plants and dredging of wetlands. It is intended to
Make water safe for swimming
Protect fish & wildlife
Eliminate water pollution
Sanctions against violators include
Civil penalties ranging from $10,000 to $25,000 per day
Possible criminal liability
Injunctions preventing pollution
Requirement to clean up or pay for cleaning up pollution
Property owners may
Bring suit against the EPA to enforce compliance
Bring state or citizens’ suits against violators
The Noise Control Act
This Act
Sets standards for noise emissions
Prohibits distribution of products violating standards
Imposes penalties of up to $50,000 per day and imprisonment for 2 years
The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund)
Regulates toxic chemicals, including
Pesticides & herbicides
Chemicals & chemical compounds
Industrial, agricultural, & household wastes
Also regulates the cleanup of hazardous waste disposal sites.
Authorizes cleanup of site when release of hazard chemicals occurs or is threatened
Can recover cost of cleanup from all parties associated with the site, including the party Generating the waste Transporting the waste to the site Who owned or operated the site at the time of disposal Who currently owns or operates the site
EMPLOYMENT
Various laws regulate the relationship between employers & employees. They are primarily designed to protect the rights of workers. They
Prevent wrongful termination
Protect “whistle-blowers”
Protect employee privacy
Health & Safety
Occupational Safety & Health Act (OSHA)
Designed to provide safe & healthy workplace. Department of Labor: Sets standards, conducts inspections, & enforces OSHA. Under OSHA
Workplace must be free of recognized hazards
Employees may file complaints of unsafe workplace without fear of discharge
Employees may refuse to work in high risk areas without fear of discharge
When employees are injured
The company must maintain records of injuries and illnesses
Records must be available for inspection by OSHA inspector
OSHA employees may inspect any facility covered by OSHA with permission of employer or a search warrant.
Workers’ Compensation
Workers’ compensation laws compensate employees injured on the job.
All eligible employees must be covered
Injured employees are compensated regardless of negligence
The employer covers the entire cost of workers’ compensation.
Workers’ compensation insurance may be obtained from the state or a private insurer
Employers may be self-insured in certain states
Coverage falls under theory of strict liability.
Employees are covered, even when personally at fault
Liability not reduced for employee negligence or assumption of risk
Covered injuries must be accidental and must occur on the job. Employees accepting benefits may not file a negligence claim against the employer. Benefits may include
Burial expenses
Prosthetic devices
Monthly payments to surviving dependents
Retirement & Security Income
Federal Insurance Contributions Act (FICA)
The Social Security Act provides for
Old age or retirement benefits
Benefits to survivors & divorced spouses
Payments for disability & to disabled children
Medicare benefits
Benefits are paid for by contributions by employer & amounts withheld from employee. If an employer fails to withhold
The employer must pay the employee’s share
The employer may be reimbursed by the employee
Unreimbursed amounts are compensation to the employee
Self-employed individuals must pay both the employer and the employee’s share
Employee Retirement Income Security Act (ERISA)
Two types of private pension plans
Contributory—Employer & Employee make payments to plan
Noncontributory—Only employer makes payments to plan
ERISA regulates private pension plans with requirements for funding and vesting.
Employers may not deduct & accrue contributions without making payments to the plan.
Employee contributions must vest immediately.
Employer contributions must vest over a reasonable time, usually within 5 years.
Does not require employer to have pension plan; only regulates employers that have a pension plan
Federal Unemployment Tax Act (FUTA)
FUTA provides compensation to employees losing their jobs.
Applies in the case of business reversals
Does not apply to terminations for cause
Does not apply to employees leaving voluntarily or refusing reasonable employment after losing their jobs
FUTA taxes are paid by employers.
Not all employers are subject to FUTA
Amounts paid for state unemployment taxes reduce required FUTA payments
Other Employment Laws
COBRA
COBRA protects employees from losing medical insurance upon termination of employment.
Applies to voluntary & involuntary terminations
Applies to employees reducing hours below requirements for insurance coverage
Allows employee 60 days to decide to continue coverage
May continue coverage for up to 18 months for employee, spouse, and other insured family members
Continued coverage is paid for by the former employee
FMLA (Family and Medical Leave Act)
FMLA applies to employers with 50 or more employees. It provides employees up to 12 weeks of unpaid family or medical leave in a 12-month period.
Health coverage continues during the leave
The employee is guaranteed employment upon return
FLSA (Fair Labor Standards Act)
FLSA regulates child labor, overtime compensation, hours in a workweek, & minimum wage.
Prohibits oppressive child labor.
Specify types of work appropriate for children
Restricts number of hours children may work
Establishes rules for overtime compensation.
Rate is at least 1½ times regular rate
Applies to hours in excess of 40 in any week
Certain employees exempt including executives, administrative employees, professional employees, & outside salespersons
Establishes minimum wage amount that applies to all employees.
Unions & Collective Bargaining
National Labor Relations Act (NLRA)
Gives employees the right to form unions and bargain collectively
If union is elected, requires that union and management bargain in good faith about mandatory bargaining subjects: Hours, wages, and other conditions of employment
Allows unions to strike over mandatory bargaining subjects
The NLRA prohibits
Interfering with employee attempts to form, join, or assist labor organizations
Dominating or contributing to a labor organization
Discriminating against employees filing charges or testifying under NLRA
Discrimination
The Civil Rights Act & Equal Pay Act
Title VII of the Civil rights Acts prohibits selection or promotion of employees based on race, color, religion, national origin, or gender
Employers must only reasonably accommodate religious needs of employees
Applies to both intentional discrimination (disparate treatment) and unintentional discrimination (disparate impact)
Equal Pay Act prohibits discrimination in payment to employees based on gender
Gender protection was extended by the Pregnancy Discrimination Act
Requires treatment of pregnant employee as being temporarily disabled
Employer must change work assignments, grant paid disability leave, and grant leave without pay
ADEA
The ADEA prohibits employment discrimination based on age. It applies to
Employers with 20 or more employees engaged in interstate commerce
Applies to employees at least 40 years old
Prohibits mandatory retirement for nonmanagerial employees
Employee must prove they were
A member of a protected group
Qualified for the position from which they were discharged
Discharged under circumstances inferring age discrimination
ADA (Americans with Disabilities Act) & Rehabilitation Act
The ADA prevents discrimination against physically or mentally disabled workers
otherwise qualified to participate in the work force.
Prohibits employer refusal to hire otherwise qualified disabled person
Requires employer to make reasonable accommodations for disabled persons unless they can demonstrate undue hardship
Prevents employer from asking about known disabilities and requiring a physical exam as a condition of employment unless required of other employees
The ADA also protects disabled persons from discrimination in use of public transportation and privately operated public accommodations.
The Rehabilitation Act, similar to the ADA, applies to federal employees, employers receiving financial aid, and employers with federal contracts of $2,500 or more.
Affirmative Action
Affirmative action programs are designed to eliminate discriminatory practices in hiring, retaining, and promoting employees.
Attempt to remedy effects of past discrimination
Give preferential treatment to members of protected groups
Generally, such programs are permitted if required by court order
Defenses
An employer can defend against an action for discrimination by demonstrating actions were due to
Business necessity
Bona fide occupational qualifications
A fair seniority system
Employee misconduct
ANTITRUST
Laws created to promote consumer welfare by enhancing competition
Enforcement
Government may enforce either criminally or civilly.
Private parties may enforce civilly only, but will receive treble (triple) damages if successful.
The Sherman Act
Horizontal Restraints
Involve agreements between competitors
Most horizontal agreements are illegal per se, which means automatically illegal.
Vertical Restraints
Involve agreements between separate businesses in the chain of distribution
Vertical restraints are examined under the rule of reason
Courts examine whether the precompetitive effects of the agreement outweigh the anticompetitive effects of the agreement.
If the agreement on balance is more procompetitive, then the agreement is legal.
Monopolization
Illegal to use monopoly power, generally shown by a market share of 70% or more, to obtain or maintain a monopoly
Intent to monopolize must be proven as well
Clayton Act
Mergers
Mergers that create a substantial lessening of competition are illegal
Mergers that raise entry barriers or create a very concentrated market will substantially lessen competition
Tying Arrangements
Where a seller with economic power forces a buyer to purchase two separate products
The products are tied together so that the purchaser must buy both products
Robinson—Patman Act
Prohibits sellers from charging different prices to different buyers for the same goods; known as price discrimination
Property — Module 34
PROPERTY
Personal Property
Ownership
Acquired through
Possession if not owned
Inheritance
Gift
Confusion through commingling of identical goods
Accession through improvement by other party
Production Ways to obtain ownership of personal property such as a PIG or a CAP
Real Property
Includes land and all permanent structures attached to the land. Also includes mineral and air rights.
Ownership
A fee simple interest is the absolute right to sell or transfer property
Deeds—Voluntary transfers from grantor to grantee; this document transfers ownership of the real property
Warranty deed—“I own this property and am transferring it to you free of claims of third parties that I have not made you aware of.”
Grant deed—“I own this property and am transferring it to you having created no claims against it that I have not told you about.”
Quitclaim deed—“I transfer my interest in this property, if any, to you.”
Adverse possession—Involuntary transfer to party taking possession
Eminent domain—Government takes title
Co-ownership
Tenants in Common
No right of survivorship
May have unequal ownership interests
Joint Tenancy
Right of survivorship
Ownership interests must be identical
Easements are a nonpossessory interest which allows the owner of the easement to use another’s property
Important Property Documents
Contract
Recites the terms of the bargain
Must be in writing
Identify the parties
Provide the purchase price
Describe the property
Deed
Transfers the real property
Must contain the seller’s signature
Must contain a description of the property
Mortgage
A secured interest in real property
Must be signed by the mortgagor (borrower)
Must contain a description of the property
Recording Documents
Documents are not required to be recorded, but they should be recorded to preserve one’s legal rights in the property
Deeds, mortgages, and easements are the primary documents that should be recorded
Each state has a recording statute that determines priority if there are multiple recordings of the same interest
Race Statute: First party to record has the best priority
Notice Statute: If a subsequent recorder of an interest did not have notice of a prior unrecorded interest, then the subsequent party has priority regardless of who records first
Notice-Race Statue: If a subsequent recorder of an interest did not have notice of a prior unrecorded interest, then whichever party records first has the superior interest
For either of the notice statues, the subsequent party cannot have a superior interest if the earlier interest was recorded or if the subsequent party was aware of the earlier interest
Leases
Leases extending beyond one year must be in writing to be enforceable
A lessee is entitled to a covenant of quiet enjoyment
A landlord makes an implied warranty of habitability
Bailments
Created when
Property delivered to bailee
Bailee takes possession
Bailee has absolute duty to return property to bailor
Types of bailees Liable Carrier Strict liability—liable whether or not negligent Warehouser Liable only when negligent Intellectual Property
Trademarks
Provide protection for distinctive marks (e.g., symbols, words, letters, pictures, etc.) that are used to identify goods.
Trademarks may be registered with the government to maximize protection.
Trademarks must be in use or the trademark is lost; if trademark is not used for 3 years the trademark is abandoned.
Infringement
When an unauthorized entity uses a mark that is likely to cause confusion or deception to a buyer
Also includes a weakening of the mark
Patents
Gives inventor exclusive right to use or sell an invention for a period of 20 years
Invention
Must be novel, useful, and nonobvious
Ideas not patentable, but their actual application is patentable
Copyrights
Provides protection for original expressions of ideas (e.g., movies, books artistic works, etc.)
Last for life of creator plus 70 years
Copyrighted works may be used without the permission of the creator under the fair use doctrine
Educational, news, commentary, and not for profit purposes are groups who may fairly use copyrighted material
Use of reasonable portions of the work are permitted
Computer Technology Rights
Software may be copyrighted and/or patented
E-mailing, photocopying, scanning copyrighted material violates copyright laws unless covered by the fair use doctrine.
Trade Secrets
Owner must take extraordinary steps to protect secrecy of the information.
Illegal misappropriation occurs when a competitor or an employee wrongfully obtains, uses, or sells a trade secret.
Parties are legally allowed to discover a trade secret through independent reverse engineering.
Individual Taxation — Module 35
INDIVIDUAL INCOME TAX
Computing Individual Income Tax
Gross income
− Adjustments = Adjusted gross income (AGI) − Standard deduction or itemized deductions − Exemptions = Taxable income × Tax rate = Tentative tax amount − Credits + Self-employment tax + Alternative minimum tax + Total tax − Prepayments = Tax due or refund amount Accounting Method
Individuals generally use the cash method—Not allowed for
Accounting for purchase & sales of inventory
C corporations or partnerships with a C corporation partner
Tax shelters
Business with average gross receipts > $5,000,000
Income is reported when
Cash is received
Property is received
Taxpayer receives an unrestricted right to cash or property (constructive receipt)
Expenses are deducted when
Cash is paid
A check is disbursed
An expense is charged to a credit card
Gross Income
Compensation for Services
Included
Wages, salaries, & tips
Bonuses & commissions
Fees for jury duty
Discounts on purchases of employer’s merchandise to the extent in excess of gross profit percentage
Taxable fringe benefits such as use of company vehicle for personal purposes
Excluded
Health insurance paid by employer
Cost of group term life insurance up to $50,000 in coverage
Employer-provided educational assistance (limited to $5,250)
Fringe benefits incurred for employer’s benefit, such as housing provided to on-site hotel manager
Prizes & Awards
Generally taxable
Excluded from income if an employee achievement award of tangible personal property received from employer for years of employment or safety achievement
Interest
Included in income
Interest received or credited to taxpayer
Interest accrued on zero-coupon bond
Amortization of bond discount
Interest on U.S. Treasury obligations
Interest on tax refunds & insurance policies
Interest portion of annuities received
Interest on Series HH U.S. savings bonds
Excluded from income
Interest on state and municipal bonds
Interest on series EE bonds if the redemption proceeds are used to finance the higher education of the taxpayer, spouse, or dependents
Dividends
Generally included in gross income
Ordinary income distributions from Real Estate Investment Trusts (REITs) are taxed as ordinary income
Capital gain distributions from REITs are taxed as long-term capital gains
Excluded from income
Nontaxable stock dividends
Distributions received from an S corporation
Dividends received on a life insurance policy
Dividends received from mutual funds investing in tax-exempt bonds
Special favorable tax rate available for qualified dividends through 2012
Tax rate 15% if ordinary rate higher than 15%
Tax rate 0% if ordinary rate would otherwise be 10% or 15%
Stock on which the dividend is paid must be held for > 60 days during the 121-day period beginning 60 days before the ex-dividend date
Available for distributions from mutual funds only to extent mutual fund received dividends from taxable corporations
Available for dividends from foreign corporations traded on U.S. stock exchanges
Special rate not available for some dividends
Distributions from REITs
Distributions from partnerships and S corporations
Mutual fund dividends that represent interest income (such as from bond funds)
Other Income
Additional items included in gross income
Rents & royalties including rent collected in advance & nonrefundable deposits
Discount on nonqualified stock option upon exercise
Injury awards for punitive damages or lost profits
85% of social security benefits of high income taxpayers (modified AGI > $60,000)
State tax refunds if originally claimed as an itemized deduction
Proceeds from a traditional IRA of contributions previously deducted
Proceeds from a traditional IRA representing earnings of IRA
Alimony received in cash provided the payments will terminate upon recipient’s death
Unemployment compensation
Additional items excluded from gross income
Damages received for physical injury or lost wages
Workers’ compensation benefits
Social security received by low income taxpayers (modified AGI < $25,000)
Portion of traditional IRA or pension withdrawal of prior nondeductible contributions
Qualified Roth IRA withdrawals
Federal tax refunds
Gifts & inheritances
Life insurance proceeds paid by reason of death
Divorce property settlements
Child support payments
Adjustments for AGI
Items that may be deducted as adjustments for AGI include
Interest on student loans
Employment tax—50% of self-employment tax paid
Moving expense
Business owner health insurance premiums for self and family
Retirement plan contributions
Alimony paid
College tuition and fees (unless American Opportunity or Lifetime Learning Credit claimed)
Early withdrawal penalties on time deposits I EMBRACE adjustments that reduce AGI & lower taxes
Moving Expenses
Moving expenses are deducted if 3 conditions are met
Taxpayer moved due to change in location of job or business
Taxpayer remains employed for at least 39 weeks after the move
Commute from old residence to new job at least 50 miles longer than commute from old residence to old job
Amounts deductible include direct costs of moving family & belongings
Airfares
Shipping & temporary storage
Cost of traveling (including lodging) and transportation to new location (auto depreciation, gas, repairs), or standard mileage rate
Business Expenses (Schedule C)
Include all reasonable business expenses
Employee wages & payroll taxes
Contributions to employee retirement plans
Employee fringe benefits
Interest on business loans
Business taxes
Casualty losses on business property
50% of business meals & entertainment
Bad debts when accounts are written off (generally no deduction for cash method taxpayers)
Gifts to customers & clients up to $25 per recipient per year
A net business loss reduces wages & business income, including net rental income, with any excess carried back or forward
Rent & Royalty Expenses (Schedule E)
Expenses incurred on property generating rent or royalty income reduce the amount of rent or royalty income reported on Schedule E and include
Depreciation or amortization
Mortgage interest
Property taxes
Insurance and maintenance
Rental & royalty properties are generally considered passive activities
Any activity in which the investor does not materially participate
Any real estate rental activity
Passive activity losses are not generally deductible
Investor actively managing real estate rental property with AGI below $100,000 may deduct up to $25,000 per year (reduced by 50% of AGI > $100,000)
Real estate broker or developer may deduct real estate losses if eligibility requirements met
Nondeductible passive activity losses may be carried forward indefinitely or deducted when property sold
Contributions to Retirement Plans
Amounts deducted for contributions to retirement plans are subject to limitations
A self-employed individual may deduct contributions to a defined-contribution
self-employed retirement plan up to the lesser of $50,000, or 100% of earned (for 2012)
An employee may exclude contributions (up to specified amount) contributed to a 401(k) plan
A taxpayer may deduct up to $5,000 for 2012 (plus additional $1,000 if 50 or over) contributed to a traditional IRA, not to exceed earned income
A married couple may deduct contributions to an IRA for each spouse, even though only one spouse has earned income
In order to deduct traditional IRA contributions, taxpayer must
Not participate in a qualified pension or profit-sharing plan at work, and
Have adjusted gross income below a specified level
Roth IRAs
Individuals may contribute to a Roth IRA instead of a traditional IRA
Not available to taxpayers with very high AGI
Subject to same contribution limitation as traditional IRA
Contributions are not deductible
Neither contributions nor earnings subject to income tax when withdrawn
Withdrawn earnings are not taxable provided
Taxpayer is a least 59½ years old
Taxpayer is disabled, deceased, or using withdrawal for first home purchase
Coverdell Education Savings Accounts (ESAs)
Taxpayer may establish ESA
Not available to taxpayers with very high AGI
May contribute up to $2,000 annually for each qualified beneficiary
Must be on behalf of beneficiary under age 18
Contributions not deductible
Distributions not taxable if used for qualified higher education expenses
Additional for AGI Deductions
Penalties paid for early withdrawal, such as cashing a certificate of deposit before maturity, reduce AGI
Employees may be entitled to a jury duty deduction
Applies when employer pays regular salary to employee during jury duty
Employee recognizes both salary and jury duty fees as income
Portion of jury duty fees remitted to employer are deducted in calculating AGI
Deductions
Standard Deduction
Basic standard deduction depends on filing status
Additional standard deduction allowed for
Taxpayer is 65 or older
Spouse is 65 or older
Taxpayer is blind
Spouse is blind
Deduction will be greater of available standard deduction or total of itemized deductions
Itemized Deductions
Itemized deductions include amounts paid for
Contributions
Other deductions
Medical expenses subject to 7½% of AGI threshold
Miscellaneous expenses subject to 2% of AGI threshold
Interest
Taxes
Theft or casualty losses Most taxpayers are committed to deducting the maximum amount allowed
Contributions
Charitable contributions are deductible in the period
Payment is made to a qualified charity
Property is given to a qualified charity
Payment to a qualified charity is charged to a credit card
The amount of the deduction includes
Cash contributions
Property at FMV if contribution of capital gain property
Costs incurred in assisting the charity
The deduction does not include
The value of services performed
The value of goods or services received in return for a contribution
The deduction is limited
Maximum deduction = 50% of AGI (30% if appreciated capital gain property)
Nondeductible amounts may be carried forward up to 5 years
Other Itemized Deductions
Additional items may be claimed as itemized deductions, including
Gambling losses to the extent of winnings included in AGI
Estate taxes on income in respect of a decedent
Amortization of bond premium
Medical Expenses
Deductible medical expenses include
Fees to doctors, hospitals, & other providers of medical care
Amounts paid for prescription drugs
Premiums for health insurance coverage
Transportation to doctor, hospital, or other provider
The deduction is reduced by
Reimbursements received or to be received from insurance
7½% of AGI
Miscellaneous Expenses
Deductible miscellaneous expenses include
Employee business expenses
Investment expenses
Tax preparation fees
Employee business expenses include reasonable unreimbursed costs such as
Union or professional dues
Trade journals
Transportation to clients or customers
Costs incurred on business trips including airfare, hotel, taxi, telephone, & 50% of business meals & entertainment
Uniforms
Depreciation on business assets owned by employee
Continuing education required to maintain employment
Employee business expenses do not include commuting to work or education obtained to qualify for new occupation (such as a CPA review course)
Deductible investment expenses include
Safe-deposit box rent
Subscriptions to investment periodicals
Fees paid to financial advisors
Cost of collecting income
Total miscellaneous expenses are reduced by 2% of AGI
Interest Expense
Deductible interest includes interest on home mortgage loans on first or second home
Loans to buy, build, or improve the home up to $1,000,000
Loans on home equity up to $100,000
Loans on second homes are included provided the total falls within the limitations
Interest on personal indebtedness is not deductible
Car loans
Credit card debt
Taxes
Deductible taxes include
State and local income taxes (sales taxes may be claimed instead if higher)
Real property taxes
Personal property taxes (including vehicle fees that are based on FMV)
Foreign taxes paid, unless foreign tax credit is elected
Certain taxes are not deductible
Inheritance tax
Federal taxes, including federal income tax & FICA
Fines
Licensing & vehicle registration fees (unless based on FMV of vehicle)
Casualty or Theft Losses
Amount deductible based on decline in value of property as a result of theft or casualty
May not exceed adjusted basis for property
Must result from an identifiable event rather than a gradual decline in value
Each loss is reduced by
Insurance reimbursements received or expected
$100 floor
Total losses for the year are further reduced by
10% of AGI
If NOL results from casualty & theft losses, can carry back 3 years instead of normal 2 years.
Exemptions
Taxpayers may deduct personal exemptions and exemptions for dependents ($3,800 each for 2012)
Personal Exemptions
A taxpayer may claim a personal exemption as a reduction of taxable income
A married couple may take one exemption for each spouse on a joint return
An individual who is a dependent on someone else’s tax return may not claim a personal exemption
Dependency Exemptions
Dependency requirements
Must be US citizen, or resident of US, Canada, or Mexico
Must not file joint return with spouse
Exception—no tax liability would exist for either spouse on separate returns
Must be qualifying child or qualifying relative of taxpayer
Qualifying Child must satisfy 4 additional requirements
Relationship—taxpayer’s child, stepchild, sibling (or a descendent of any of these individuals)
Age—child must be under age 19, or under 24 and full-time student
Support—child must not provide more than half of own support
Housing—child must live with taxpayer for more than half of year
Qualifying Relative—must satisfy 4 additional requirements
Must not be qualifying child
Related to taxpayer (closer than cousin), or live in taxpayer’s household for entire year (exceptions include birth, death, illness, education, military service)
Support—taxpayer must provide more than half of dependent’s support
Gross income—dependent’s gross income must be less than amount of exemption
($3,800 for 2012)
Credits
Several credits may reduce a taxpayer’s total tax
Dependent care credit
Credit for the aged & disabled
Earned income credit
Child tax credit
American Opportunity & lifetime learning credits
Foreign tax credit
Earned Income Credit
To qualify, taxpayer must meet 2 conditions
Taxpayer has earned income
Taxpayer provides support for a dependent child or grandchild
The earned income credit is refundable
Treated as if paid
Results in refund if credit exceeds tax liability
Credit for Aged or Disabled
Allowed for individuals with low income who are over 65 or permanently disabled
Dependent Care Credit
A credit is allowed for
Generally 20% × amounts paid to care for a qualifying dependent
Maximum payments subject to credit = $3,000 for 1 dependent, $6,000 for 2 or more dependents
Taxpayers with AGI ≤ $15,000 may take credit of 35% (reduced by 1% for each $2,000 above AGI of $15,000 until reduced to 20% at AGI of $43,000)
Dependent must be either
Child under age 13
Disabled spouse or dependent of any age
Child Tax Credit
May be claimed for each child under 17
Credit $1,000 per child for 2012, but reduced for high-income taxpayers
Modified HOPE Credit
May be claimed for first four years of postsecondary education
Credit equals 100% of first $2,000 of tuition and fees plus 25% of next $2,000
Maximum credit $2,500 per qualified family member
Lifetime Learning Credit
May be claimed for tuition and fees not eligible for American Opportunity Credit
Credit equals 20% of first $10,000 of tuition and fees
Maximum credit $2,000 per family
Self-Employment Tax
Employer & employees pay payroll taxes
Medicare tax paid equally on 100% of wages
FICA paid equally on wages up to a base amount ($110,100 for 2012)
Self-employed individuals pay employer’s & employee’s shares
Net earnings from self-employment × Rate = Self-employment tax
50% of self-employment tax is deduction for AGI
Alternative Minimum Tax (AMT)
Taxable income
± Adjustments & preferences = Alternative minimum taxable income (AMTI) − Exemption = Base × Tax rate = Tentative minimum tax − Regular tax liability = AMT The primary adjustments to income in calculating AMTI are
Standard deduction
Interest on home equity loans
Medical expenses subject to 10% of AGI limitation
Personal and dependency exemptions
Local and state tax deductions
Employee and investment expenses subject to the 2% of AGI rule
The primary preferences are
Private activity bond interest Incentive stock options Excess depreciation It’s as simple as pie to remember the adjustments and preferences for AMTI AMTI is reduced by the exemption amount (varies based on filing status)
$74,450 for joint filers
$48,450 for individuals
$37,225 married filing separately
Resulting base amount × Tax rate = Tentative minimum tax
26% × first $175,000
28% × (Base amount – $175,000)
Tentative minimum tax – Regular income tax = AMT adjustment
If tentative minimum tax > regular income tax = difference increases tax amount
If tentative minimum tax > regular income tax = no AMT
AMT paid is allowed as a credit (minimum tax credit) that can be carried forward to reduce future regular tax liability
Tax Payments
Tax payments include
Excess payroll taxes withheld
Federal income taxes withheld
Estimated tax payments
Excess Payroll Taxes
Employees with 2 or more employers
Total wages may exceed base amount for FICA ($110,100 for 2012)
Maximum FICA = Base amount × FICA rate
Excess withheld treated as tax payment
Penalties for Late Payment
Penalty imposed for late payment of taxes unless
Underpayment for year < $1000
Payments ≥ 90% of current year’s liability
Taxes paid ≥ 100% of prior year’s liability (110% for taxpayers with AGI > $150,000)
Filing Status
A taxpayer’s filing status will determine the rates and various amounts used in computing taxable income & the tax liability
Married Couples
Choice of 2 alternatives
Married, filing jointly
Married, filing separately
Must be married as of last day of year or date of death if one spouse died during the year
Unmarried Individuals
One of 3 alternatives
1) Qualified widow or widower Must be providing > half the costs of maintaining household for dependent child
Available for 2 years after death of spouse
Joint return was filed for year of spouse’s death
2) Head of household Generally must provide > half of costs of maintaining household for qualifying child or dependent relative living in the same home as taxpayer for more than ½ of year
Taxpayer’s parent need not live in same home if taxpayer maintains parent’s household and parent qualifies as taxpayer’s dependent
3) Single—all others Carryover Rules
Carryback Carryforward Charitable contributions No 5 years Net operating losses 2 years∗ 20 years Net capital losses Corporations 3 years 5 years Individuals No
Indefinitely Investment interest No Indefinitely Net passive losses No Indefinitely, or deducted when investment sold Net gambling losses No No NOTE: NOL carryback 3 years for casualty & theft losses & small business federal disaster losses.
Tax Return Schedules
An individual files his or her tax return on a Form 1040 along with some or all of the following supplementary schedules
Schedule A—Itemized Deductions
Schedule B—Interest & Dividend Income
Schedule C—Profit or Loss From Business
Schedule D—Capital Gains & Losses
Schedule E—Supplemental Income & Loss
Form 4797—Sale of Business Property
Schedule 1116—Foreign Tax Credit
Filing Requirements
Who Must File
Individuals with
Gross income > personal exemption + standard deduction
Net earnings from self-employment ≥ $400
Gross income > personal exemption (if married filing separately)
When to File
Individual tax returns due on or before April 15
Automatic six-month extension available to October 15
Claims for Refunds
Overstatement of income on original return
Amended return on form 1040X
Must file within 3 years from when return was filed, or two years from payment of tax, whichever is later
A return filed early is treated as filed on due date
Statute of Limitations
Time IRS has to impose additional taxes & penalties on taxpayer
Begins day after return is filed or due date including extensions, whichever is later
Time period depends on nature of error
Taxpayer Error Time Period Simple negligence 3 years Gross income omission ≥ 25% of income on return 6 years Fraud or failure to file No
limit Depreciation
Depreciable Real Property
Depreciable real property is Section 1250 property, subject to the following rules:
Recovery Period
27.5 years for residential real property
39 years for nonresidential real property
Depreciation Method
Depreciation calculated using straight-line method
Midmonth Convention
Year of purchase & year of sale
Assumed purchased or sold in middle of month of transaction
½ month’s depreciation taken regardless of date of transaction
Depreciable Personal Property
Depreciable personal property is Section 1245 property, subject to the following rules.
Recovery Period
Determined by class of asset
Equipment, office furniture and fixtures—7 years
Cars, light trucks, computers, and office equipment—5 years
Small tools—3 years
Depreciation Method
General MACRS method is 200% declining balance method, but taxpayer may elect to use either of 2 other methods
150% declining balance method (class-by-class election)
Straight-line method using the alternative depreciation system (ADS)
Half-Year Convention
Generally required
Assumes assets acquired or sold in middle of tax year
Half-year’s depreciation taken in year of acquisition & in year of sale
Midquarter Convention
Must be used if >40% of all personal property placed in service during last 3
months of tax year
Assumes assets acquired or sold in middle of quarter in which transaction occurs
Results in 1/8 of annual deduction if property placed in service during last quarter of year
Section 179 Expense Election
Annual election to treat the cost of qualifying property as expense instead of capital expenditure
Applies to new or used tangible personal property purchased for use in a business
Deductible up to lower of net business earnings or $139,000 for 2012
Reduced dollar-for-dollar by cost of property acquired in excess of $560,000 for 2012
Amount deducted reduces depreciable basis of assets Example—Company purchases $539,000 of used business equipment during September 2012 (assume no other property purchases during year). Taxpayer wants to claim maximum deduction for 2012 Section 179 Election—$139,000 deduction (maximum allowed for 2012) Regular MACRS Depreciation—$57,143 ($400,000 basis after Section 179 deduction × 2/7 DDB × ½ year) Total Deduction for 2012—$196,143 ($139,000 + $57,143)
Transactions in Property — Module 36
PROPERTY TRANSACTIONS
Realized Gain or Loss
Amount realized
− Adjusted basis = Realized gain or loss Amount Realized
Cash received
+ FMV of property received + Net debt relief − Direct selling expenses = Amount realized Net debt relief = Liabilities transferred − Liabilities assumed
Adjusted Basis
Initial basis
+ Improvements − Depreciation − Costs recovered ± Adjustments = Adjusted basis Initial Basis Property converted from personal use to business or investment use Lower of actual basis or FMV on date of conversion Inherited property FMV at date of death or alternate valuation date (date of distribution up to 6 months after death) Property received as gift Gain = Same as donor’s basis (transferred basis) Loss = Lesser of (a) Gain basis, or (FMV) at date of gift Sec. 1245 Depreciation Recapture
Applies to the disposition of depreciable personal property (e.g., trucks, autos, machinery, equipment)
Realized gain
− Depreciation recapture (treated as ordinary income) = Section 1231 gain Amount of depreciation recapture
Realized gain > accumulated depreciation – use amount of gain
Realized gain ≥ accumulated depreciation – use accumulated depreciation
Taxation of Gains & Losses
Tax Treatment Ordinary assets Inventory
Business receivables
Self-created artistic works
Business assets held ≤ year
Regular rates Section 1231 assets (business assets held > year) Depreciable or amortizable business assets
Land used in business
Net gain—generally treated as LTCG Net loss—ordinary loss deduction Capital assets all others INDIVIDUALS LTCG – Reduced rates STCG – Regular rates Net loss – Max of $3,000 during current year. Carryforward indefinite. CORPORATIONS Net loss—not deductible Carryback 3 years. Carryforward 5 years. Related-Taxpayer Transactions
Related taxpayers include
Taxpayer’s spouse, brothers, sisters, ancestors (parent, grandparent, etc.), lineal descendants (child, grandchild, etc.)
Corporation or partnership where direct or constructive ownership > 50%
Tax effects
Losses—not deductible by seller Buyer’s basis—purchase price Buyer’s subsequent gain on sales—taxed to extent subsequent gain > nondeductible loss Special Transactions
Type of Transaction Special Rule Sale of personal assets Gain recognized as capital gain; losses are not deductible Wash sales—Taxpayer acquires same stock or securities within 30 days before or after selling stock or securities at a loss Loss not recognized, but added to basis of new stock or securities Related-party transactions Losses not recognized Like-kind exchanges Losses not recognized Gains recognized to extent of boot received Involuntary conversions Replacement property acquired within 2 years of end of year in which gain realized for casualty or theft, 3 years for
condemnation If cost of replacement property ≥ proceeds—no gain recognized If cost of replacement property < proceeds—Gain recognized = Proceeds – cost or replacement property Installment sale Gain recognized: Gross Profit × Amount received in year ÷ Total sales price Sale of principal residence If taxpayer owned and lived in home at least two of the five years preceding sale Up to $250,000 of gain excluded ($500,000 for married filing jointly). Gain in excess of exclusion is recognized as capital gain. Excluded gain does not affect basis of new residence
Partnership Taxation — Module 37
PARTNERSHIP TAXATION
Formation of Partnerships
Contribution of Assets
When a partner contributes cash or property for a partnership interest, the transfer is generally nontaxable
Partner’s basis in partnership = basis for assets contributed
Partnership’s basis for assets = partner’s basis (transferred basis)
Contribution of Services
When a partner contributes services for an interest in partnership capital, the FMV of the partnership interest received is taxable as compensation
Partner recognized income and basis for partnership interest = FMV
Partnership recognizes expense or asset = FMV
Changes in Liabilities
Changes in liabilities are treated as a change in the flow of money and either increase or decrease a partner’s basis—
Increased by an increase in partnership liabilities, or an increase in individual liabilities (treat as a contribution of money and increase basis)
Decreased by a decrease in partnership liabilities, or a decrease in individual liabilities (treat as a distribution of money and decrease basis)
Partnership’s Tax Year
Adoption or change of partnership tax year restricted by tax years used by its partners
1) Adopt same tax year as used by partners owning > 50% of partnership interests 2) If partners owning > 50% of interests do not have same year, adopt tax year used by partners owning ≥ 5% interest if all have same tax year 3) If all partners with ≥ 5% interest do not have same tax year, use year that results in least deferral of income to partners Taxation of Partnerships
Partnerships are pass-through entities, not taxable entities
Similar to S corporations
Partnership files Form 1065 tax return; due by 15th day of fourth month following end of tax year
Prepare form K-1 for each partner indicating partner’s share of income & expenses
Partnership’s income & expenses pass through to partners
Separate items into ordinary income and deductions items which can be netted, and items having special tax characteristics which must be separately passed through to partners to retain those characteristics
Partner combines with similar items incurred individually from other sources
Combined amounts subject to normal limitations at partner level
Guaranteed Payments to Partners
Guaranteed payments to partners are amounts partners are entitled to regardless of partnership’s profit or loss
May be
Salary for services performed
Interest based on capital investment in partnership
Taxed as follows
Partner recognizes as ordinary income (generally self-employment income)
Partnership deducts in calculating partnership ordinary income or loss
Partners’ Distributive Shares
Partners report their distributive share of all partnership items for the partnership year that ends with (or within) their taxable year
Items are deemed to pass through on the last day of partnership tax year
Partner’s Basis
Initial basis
± Changes in liabilities + Partner’s share of income (including tax-exempt income) − Distributions (Cash + the adjusted basis of property) − Partner’s share of expenses and losses (including nondeductible items) = Partner’s basis for partnership interest Initial basis = cash, adjusted basis of property, & FMV of services contributed
Partner’s share of income or loss = partner’s proportionate share of all of partnership’s income & expenses, regardless of nature
Distributions = cash and adjusted basis of property distributed to partner
Partner’s proportionate share of partnership’s liabilities are added to basis
Partner’s liabilities that are transferred to the partnership reduce basis
Distributions
Nonliquidating Distributions
Cash distributed
Reduces partner’s basis for partnership interest
Taxable to extent distribution > basis
Noncash property distributed
Basis to partner = lower of partnership’s basis for property or partner’s basis for partnership interest
Basis for partnership interest reduced by partner’s basis for distributed property
No gain or loss recognized by partnership or partners
Liquidating Distributions
Distributions to partner that terminate partner’s entire partnership interest
Cash distributions
Difference between amount received & partner’s basis for partnership interest = recognized gain or loss
Remaining basis in partnership = $0
Noncash property distributions
Basis of property to partner = former basis for partnership interest
Remaining basis in partnership = $0
Generally no gain or loss recognized
Sale of Partnership Interest
Determining Gain or Loss
Amount realized from sale
− Basis for partnership interest = Gain or loss Amount realized = Cash + FMV of property received + Assumption of selling partner’s share of partnership liabilities
Include partner’s share of liabilities in basis for partnership interest
Taxation of Gains & Losses
Gain or loss divided into 2 segments
Ordinary income will result to extent of partner’s share of unrealized receivables & appreciated inventory (unrealized receivables include recapture potential in depreciable assets)
Any remaining amount is capital gain or loss
Termination
Partnership terminates and its tax year closes when either
Partnership no longer has at least two partners, or stops doing business
More than 50% of total partnership interests are sold within a 12-month period
Corporate Taxation — Module 38
CORPORATE INCOME TAX
Section 351 Transfer to Controlled Corporation
No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if the transferors of property (in the aggregate) control the corporation
Property includes cash and everything but services
Control is the ownership of at least 80% of the corporation’s stock
Services for Stock
Taxable transaction
Taxable compensation to shareholder = FMV of stock
Shareholder basis for stock = FMV
Corporation has expense or asset = FMV of stock
Property for Stock
Generally a nontaxable transaction
Whenever shareholders providing cash & property have total ownership ≥ 80%
Shareholder basis for stock = basis for asset given (exchanged basis) + gain recognized – boot received
Corporation basis for asset = same as shareholder’s basis + gain recognized to shareholder
Taxable transaction
When shareholders providing cash & property have ownership ≥ 80%
Shareholder recognizes gain or loss = FMV − Basis
Shareholder basis for stock = FMV
Corporation basis for asset = FMV
Computing Corporate Income Tax
Gross income
− Deductions = Taxable income × Tax rate = Preliminary tax liability + Personal holding company tax + Accumulated earnings tax + Alternative minimum tax = Total tax liability − Credits = Net tax liability − Estimated payments = Tax due (or refund) Gross Income
General concept of gross income applies to a corporation
Corporation never recognizes gain or loss when it issues its own stock
Corporation’s net capital gain is taxed at ordinary rates
No income is recognized by a corporation on receipt of capital contribution
If received from a shareholder, property has a transferred basis
If received from a nonshareholder, property has a zero basis
Deductions
Deductible expenses include
Ordinary & reasonable operating expenses
Compensation costs including wages & bonuses
Employer payroll taxes
Fringe benefits including health & life insurance when employee selects beneficiary
Interest on business indebtedness
Bad debts when a specific debt is written off
Meals & entertainment × 50%
Straight-line amortization of goodwill over 15 years
May deduct up to $5,000 of organizational expenditures (reduced by excess of costs over $50,000) and amortize remaining costs over 180 months beginning with the month that business begins. Business investigation and start-up costs (advertising, employee training) are subject to same rule.
Nondeductible expenses include
Fines, penalties, & punitive damages
Compensation in excess of $1,000,000 paid to each of 5 highest paid executives
Accrued compensation and charitable pledges not paid within 2½ months after year-end
Interest expense on debt used to acquire nontaxable investments
Premiums on key person insurance if company is beneficiary
Club dues
Cost of issuing, printing, & selling stock
Charitable Contributions
1) Generally deductible when paid, but accrual method can elect to deduct when accrued if authorized by board of directors before year-end and paid within 2½ months after year-end 2) Excess carried forward 5 years 3) Deduction limited to 10% of contribution base which is TI before charitable contributions, DRD, NOL carryback, capital loss carryback, and domestic production activities deduction Dividends-Received Deduction
1) Determine % for deduction Corporation’s ownership < 20%—Deduct 70%
Ownership ≥ 20% but < 80%—Deduct 80%
Ownership ≥ 80%—Deduct 100% if consolidated tax return not filed
2) Apply % to dividends or taxable income before deduction, whichever is lower 3) Exception—If % × dividends > taxable income, use entire amount, resulting in loss Does not apply to
Dividends from a foreign corporation
Dividends from a tax exempt organization
Personal Holding Company (PHC) Tax
Corporation is subject to PHC tax if 2 conditions apply
1) Interest, dividends, rents, royalties, or personal service contracts > 60% of gross income 2) 5 or fewer shareholders own > 50% stock PHC tax
Self-assessed on Schedule PH which is attached to Form 1120
Amount = 15% × Undistributed PHC income
Added to regular tax
Can be reduced by actual and consent dividends
Consent dividends—Hypothetical dividends that are treated as paid on last day of corporation’s tax year. Shareholders report dividend income and increase stock basis by the amount of consent dividend.
Accumulated Earnings Tax
The accumulated earnings tax is not self assessed
Does not apply to PHCs
Generally assessed on earnings accumulated in excess of reasonable business needs
Corporation allowed to deduct accumulated earnings credit which is greater of Earnings needed to satisfy reasonable business needs, or Minimum credit of $250,000 (or $150,000 for service corporation) less AEP at beginning of year
Accumulated earnings tax = 15% × Accumulated taxable income
Added to regular tax
Can be reduced by actual and consent dividends
Alternative Minimum Tax (AMT)
Regular taxable income
± Preferences & adjustments = Pre-ACE alternative minimum taxable income (AMTI) ± ACE adjustment [75% of difference between pre-ACE AMTI and adjusted current earnings (ACE)] = Alternative minimum taxable income − Exemption ($40,000 less 25% of AMTI over $150,000) = Base × Tax rate (20%) = Tentative minimum tax − Regular tax liability = AMT Adjustments & preferences are added back to or deducted from taxable income in computing AMTI. They include
Interest on private activity bonds
Difference between regular tax 200% DB depreciation and 150% DB depreciation allowed for AMT purposes
Installment can’t be used for sale of inventory-type items
Adjusted current earnings (ACE) adjustment
ACE = Adjusted current earnings
Pre-ACE AMTI
+ Nontaxable revenues − Nondeductible expenses = ACE Adjustments to taxable income in computing ACE generally include
Seventy percent dividends received deduction
Life Insurance proceeds
Municipal bond interest on general obligation bonds There’s a slim chance that you’ll avoid the AMT.
ACE adjustment = 75% × (ACE − Pre-ACE AMTI)
AMTI is reduced by the exemption amount
Exemption = $40,000 − 25% × (AMTI − $150,000)
Resulting base amount × AMT tax rate = Tentative minimum tax
Tentative minimum tax – Regular income tax = AMT
If tentative minimum tax > regular income tax, it increases the amount of tax paid
AMT paid in current year is carried forward as credit to reduce regular taxes in future years
Foreign Tax Credit
Reduces US income tax for amount of income taxes paid to foreign jurisdictions
Credit = smaller of
Amount of foreign tax paid, or
Foreign taxable income ÷ Total taxable income × Total US tax liability
Supplemental Tax Schedules
Corporations complete 2 supplemental schedules on their tax returns
Schedule M-1 reconciles book income to taxable income
Schedule M-2 reconciles beginning to ending retained earnings per books
Schedule M-3is a more detailed version of the M-1 required for corporations with total assets in excess of $10 million
Nonliquidating Distributions to Shareholders
Property Distributions
Treated as dividends when paid from earnings & profits (E&P)
Can be paid out of current E&P computed at end of tax year, even if accumulated E&P is negative amount
Can be paid out of accumulated E&P, even if current E&P is negative amount to extent of accumulated E&P still remaining at distribution date
Distribution in excess of E&P
Nontaxable return of stock basis
Capital gain to extent in excess of stock basis
Property Distributions
When noncash property is distributed
Corporation recognizes gain if FMV > basis
Corporation not permitted to recognize loss if FMV < basis
Shareholder recognizes dividend equal to FMV of property − liabilities assumed
Shareholder’s basis for property received = FMV
Corporate Complete Liquidation
Distributions of assets upon termination are liquidating distributions
Corporation recognizes gain or loss when FMV ≠ basis in assets distributed
Shareholder generally recognizes capital gain or loss when FMV ≠ basis in stock
Upon liquidation of an at least 80%-owned subsidiary
Subsidiary recognizes no gain or loss on distribution of assets to parent
Parent recognizes no gain or loss on cancellation of stock
Parent’s basis for assets = same as subsidiary’s basis (transferred basis)
Tax attributes of subsidiary (E&P, NOLs, credits) carry over to parent
Corporate Reorganizations
Mergers & Acquisitions
Assets, liabilities, and tax attributes of acquired corporation are transferred to acquiring corporation
When shareholders receive stock in acquiring corporation for shares in acquired corporation
No gain or loss recognized except to extent of cash or other boot received
Basis for new shares = Basis for old shares + gain recognized – boot received
Spin-offs and split-offs
One corporation divides into 2 or more separate corporations
Affiliated Corporation Transactions
Affiliated parent-subsidiary relationship exists when one corporation owns at least 80% of total voting power and total value of another corporation’s outstanding stock
Companies may elect to file consolidated return
Intercompany dividends and gains and losses on intercompany transactions are eliminated in consolidation process
Section 1244 Stock
Treatment as section 1244 stock applies if 2 conditions are met
Stock was issued as part of first $1,000,000 of capital raised by company
Shareholder must be the original holder of stock, and an individual or partnership
Sale or exchange of section 1244 stock
Gains treated as capital gains
Losses treated as ordinary deduction to maximum of $50,000 per year ($100,000 on joint return). Loss in excess of limitation treated as capital loss
S CORPORATIONS
S Corporation–a pass-through entity
Eligibility Requirements
S corporation status requires all of the following:
# of shareholders ≤ 100
Husband and wife are treated as a single shareholder (all descendents and spouses within 6 generations of a single ancestor may elect to be treated as a single shareholder)
Shareholders limited to individuals, estates, and trusts with one income beneficiary
Only 1 class of stock (voting and nonvoting stock are treated as a single class of stock)
Election
Corporation must elect S corporation status
All shareholders must elect unanimously
All eligibility requirements must be met on date of election
Election made during first 2½ months of tax year is generally effective for that year
Election made after first 2½ months of tax year is generally effective for following year
Conversion from C to S Corporation
An S corporation is generally not taxed on its income
When a C corporation elects S corporation status, it may be subject to
1) Built-in gain (BIG) tax—Applies when company sells appreciated built-in gain assets within 10 years of election S corporation pays tax at highest corporate rate (35%) on net recognized built-in gain FMV of assets at effective date of election − Adjusted basis of assets = Net unrealized built-in gain
2) Tax on excess net passive investment income—Applies when investment income > 25% of gross receipts from all sources and corporation has AE&P from C years S corporation pays tax at highest corporate rate (35%) on lessor of passive investment income in excess of 25%, or taxable income
Gains on sales of stocks or securities not considered passive investment income
Taxation of S Corporations
S corporation is a pass-through entity
S corporation must file
Form 1120S tax return (due 2½ months after end of year)
Form K-1 for each shareholder indicating each shareholder’s share of income & expenses
S corporation’s income & expenses pass through to individual shareholders
All ordinary income and deduction items can be netted with the net amount passed through to shareholders
All items having special tax characteristics must be separately stated when passed through to shareholders
Each item is combined with comparable items recognized by the shareholder
S Corporation Earnings
Pass-Through Item Tax Treatment Capital gains & losses Combined with shareholder’s capital gains and losses Section 1231 gains & losses Combined with shareholder’s Sec. 1231 gains and losses Charitable contributions Subject to 30% and 50% limitations at shareholders level Interest & dividend income & related expenses Investment interest expense deductible to extent of net investment income Net rent & royalty income Subject to passive activity loss limitations Section 179 deduction Subject to dollar limitation at both corporate and shareholder level Tax credits Limited to shareholder’s tax liability Tax-exempt income & related expenses Income exempt to shareholders Expenses not deductible by shareholder Tax preferences & adjustments Used to compute shareholder’s AMT Net all ordinary and deduction items (nonseparately stated income or loss) Treated as ordinary income or loss Loss deduction limited to shareholder’s stock and debt basis Shareholder’s Basis
A shareholder’s basis for S corporation stock is adjusted in the following order
Initial basis
+ Share of income (including exempt income) − Distributions received − Share of loss (including nondeductible expenses) = Basis for stock All S corporation income and deduction items are allocated per-share, per-day
A shareholder who disposes of stock is treated as the shareholder for the day of disposition
Basis adjustments for distributions are taken into account before expenses and losses
Distributions to shareholders are generally a nontaxable return of stock basis
because they represent income that has already been taxed to the shareholder
Termination of S Corporation Status
Either of the following will cause a corporation to lose its S corporation status:
Shareholders owning > 50% of shares vote to revoke election
Fail eligibility requirements. Termination is effective on date eligibility requirement failed.
Once terminated, corporation must generally wait 5 years to elect again
Other Taxation Topics — Module 39
TAXATION OF ESTATES & TRUSTS
Estates
Results from death of individual
Assets become part of estate
Investments generate income
Estate taxed on earnings
Trusts
Types of Trusts
Simple trusts
Must distribute all income each year
Cannot make charitable contributions
Cannot distribute trust corpus (principal)
Complex trusts—all others
Trust Operations
Taxation of Trusts
Grantor (revocable) trust
Creator has right to withdraw assets at any time
Earnings taxed to creator (as if trust did not exist)
Irrevocable trust
Creator generally may not withdraw assets
Trust taxed separately from creator or beneficiaries
Computing Taxable Income of Trusts & Estates
Gross income
− Deductions − Exemption = Taxable income Gross Income
Same rules as for individuals
Includes
Rents
Dividends
Interest
Capital gains
Deductions
Generally similar to those available to individual
In addition
Charitable contributions—No limit on amount
Management fees—Fees paid to trustee or executor Trust or estate may have nontaxable income Proportionate amount of fees not deductible
Distributions paid—Amounts paid to beneficiaries
Exemption
Estate—$600
Simple trust—$300
Complex trust—$100
Distributable Net Income (DNI)
DNI is maximum amount of distribution that can be taxed to income beneficiary
Includes most income & expense items on trust tax return
Includes municipal bond interest
Does not include net capital gains (allocated to principal)
Taxation of Beneficiaries
Not taxed on inheritance of estate property
Taxed on distributions of income up to DNI
Filing Issues
Trusts Estates Reporting period Calendar year Calendar or fiscal year Begins on date of death Tax return due date April 15 of following year 3½ months after close of year Estimated quarterly tax payments Required Not required for first 2 years Required after Exemption amount Simple—$300
Complex—$100 $600 Estate & Gift Tax
Total taxable gifts during lifetime
+ Total taxable estate = Total taxable transfers × Tax rates = Tentative tax amount − The unified credit − Other credits = Tax due Taxable Gifts
Include
Gifts of cash or FMV of noncash property
Discount on sale of property to family member
Reduction in interest on loans to family members at low rates
Exclude
Donations to political organizations & charities
Discounts given in negotiated transaction between independent parties
Parental support of minor child
Payments to college or health care provider for donee’s tuition or medical care
Reduce by
Marital deduction (unlimited)
Gift exclusions
Marital Deduction—Property given to a spouse is not taxable if spouse obtains either
Complete ownership of property
Right as trust beneficiary to income from property for remainder of beneficiary’s life (Qualified Terminable Interest Property trust or QTIP trust)
Gift Exclusions
May exclude up to $13,000 per donee per year in 2012 if gift of present interest
Married couple making gift-splitting election may exclude twice as much per donee per year
Donee must generally receive present interest in gift
Donee obtains an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property
If donee is given a future interest, present value of gift is fully taxable (no $13,000 exclusion)
Taxable Estate
Gross estate—All property owned at time of death
Includes
Proceeds from life insurance policies where deceased could change beneficiary
Assets held in revocable trust
Half of property owned jointly with spouse
FMV of property x % of cost furnished by decedent if property held in joint tenancy with other than spouse
Gifts of life insurance policies within three years of death
Gift tax paid on all transfers made within three years of death
Valued at either
Fair value at date of death
Alternate valuation date (earlier of date of distribution from estate or six months after death)
Reduce by
Charitable bequests
Marital deduction
Casualty losses
Expenses and liabilities
Charitable bequests—Unlimited deduction for amounts left to charitable organizations
Marital deduction—Unlimited amount subject to same rules as gifts
Expenses & Liabilities—Deductions for
Liabilities incurred prior to death
Funeral costs
Administrative fees
Medical expenses
State death taxes
Administrative fees may be deducted as either a liability on the estate tax return, or an expense deduction on the estate’s income tax return
Medical expenses incurred during decedent’s lifetime may be deducted as claims against the estate, or as a medical deduction on the decedent’s income tax return if paid within one year of death
State death taxes are now only a deduction (no longer qualify as a credit).
Tax Due
Tentative Amount
Total taxable transfers
× Tax rates (from table) = Tentative tax amount Unified Credit
Credit designed to remove relatively small gifts and estates from the transfer tax
The exemption equivalent of the credit is $5 million, for both gift and estate tax purposes for 2012 (scheduled to be $1 million after 2012)
Other Credits
Credit for death tax paid to foreign country on real estate owned in that country
Gift taxes paid on prior transfers (actually considered prepayment of liability rather than credit, but has same effect as credit to reduce balance due)
Generation-Skipping Tax
Owed on transfers (both gifts and inheritances) two or more generations below
transferor
Transfers to grandchildren, great-nieces, and great-nephews normally included
Not applicable if immediate generation below is deceased (no GST on transfer to grandchild if the transferor’s child is deceased)
Exemption equivalent for GST same dollar amount as gift and estate tax exemption ($5 million for 2012; scheduled to be $1 million after 2012)
GST owed in addition to applicable gift and estate taxes
Property Received by Inheritance or Gift
Inheritance
Excluded from recipient’s gross income
Basis—Fair market value reported on estate return
Value at date of death (use this if no estate tax return filed)
Value at alternate valuation date if elected on estate return (earlier of date of distribution to recipient or fair value exactly six months after death)
Holding period—automatically long-term
Gift
Receipt of gift excluded from recipient’s gross income
Donee’s basis for gain—basis (& holding period) same as donor’s
Donee’s basis for loss—lesser of gain basis, or FMV at date of gift
If FMV at date of gift is used to determine a loss, then holding period begins on date of gift
If donee’s selling price is below gain basis and above loss basis, then no gain or loss
Tax Return Due Dates
Assuming taxable year ended December 31
Tax Return Due Date Individual income tax return April 15 of following year Amended individual income tax return Within 3 years from when original return filed (early return treated as filed on due date) Gift tax return April 15 of following year Trust income tax return April 15 of following year Estate income tax return April 15 of following year Partnership tax return April 15 of following year Corporate tax return March 15 of following year S corporation tax return March 15 of following year S corporation status election March 15 of current year Exempt organization tax return May 15 of following year Estate tax return 9 months after date of death
INCOME TAX RETURN PREPARERS
Procedures for Return Preparation
Make reasonable effort to obtain client information to answer all questions on return, except
Information not readily available and not significant in determining tax liability
Meaning of question is unclear
Answer is voluminous and return states data will be supplied upon examination
Need not verify client information
Must make reasonable inquiries when information appears incorrect or incomplete
Should ask about availability of support where required by IRS (e.g., log for travel & entertainment expenses or receipt for charitable contributions over $250)
Should refer to past returns of client when feasible
When CPA becomes aware of error on return
Inform the client (written communication of important advice preferred, but not required)
Recommend appropriate correction or notification
Consider withdrawing from relationship if client refuses to correct (must not notify IRS without client permission)
Tax Preparer Penalties
Minor violations
Disclose confidential information from client’s return
Endorse or deposit client’s refund for preparer’s benefit
Fail to sign return as preparer
Fail to provide client with copy of filed return
Fail to keep copies of client returns for at least 3 years
Fail to keep list for at least 3 years of employees preparing returns
Major violations
Understatement of tax liability due to an undisclosed position for which there is not substantial authority (at least 40% probability of success): penalty is greater of $1,000 or 50% of income to be derived from return or claim
Willful attempt to understate tax liability, or intentional or reckless disregard of rules and regulations; penalty is greater of $5,000 or 50% of income to be derived from return or claim
No violation
Adequate disclosure and a showing that there was a reasonable basis (at least 20% probability of success) for the position
Reasonable cause for the understatement and the preparer acted in good faith
Use estimates when client did not maintain adequate records
Rely on information supplied by client not appearing incorrect or inconsistent
Index
Acceptance
Accountants’ Liability
Accounting Method
Accumulated Earnings Tax
ADA & Rehabilitation Act
Additional for AGI Deductions
ADEA
Adjusted Basis
Adjustments for AGI
Affirmative Action
Agency
Alternative Minimum Tax (AMT)
Alternatives to Bankruptcy
Amount Realized
Articles of Incorporation
Assignment
Attachment
Auditor Common Law Liability
Auditor Liability Under Federal Securities Laws
Avoidance
Avoiding Liability
Bailments
Bankruptcy
Breach of Contract
Business Combinations
Business Expenses (Schedule C)
Business Reorganizations – Chapter 11
Buyer’s Remedies
C.O.D.
Carryover Rules
Characteristics of Corporations
Child Tax Credit
Civil Rights Act (CRA)
Claims for Refunds
Clean Air Act
COBRA
Commercial Paper
Compensation for Services
Comprehensive Environmental Response
Compensation and Liability Act
Computing Corporate Income Tax
Computing Taxable Income of Trusts & Estates
Concurrent Interests
Consideration
Contracts
Contributions
Contributions to Retirement Plans
Conversion To S Corporation
Corporate Formation
Corporate Income Tax
Corporate Reorganizations
Corporate Termination
Corporations
Cosureties
Coverdell Education Savings Accounts (ESAs)
Credit Card Debt
Credit for Aged or Disabled
Credits
Deductions
Default by Debtor
Defenses Against a Negotiable Instrument
Defenses of Sureties
Delegation
Denial of Discharge
Dependent Care Credit
Dependent Exemptions
Depreciable Personal Property
Depreciable Real Property
Depreciation
Depreciation Recapture
Directors & Officers
Discharge
Dissolution
Distributable Net Income (DNI)
Distributions
Distributions to Stockholders
Dividends
Dividends-Received Deduction
Documents of Title
Duties of Directors & Officers
Earned Income Credit
Employee Retirement Income Security Act (ERISA)
Employment
Enforceability
Environmental Law
Equal Pay Act
Estate & Gift Tax
Estates
Exceptions to Discharge
Excess Payroll Taxes
Exemptions
Express Warranties
Federal Insurance Contributions Act (FICA)
Federal Securities Regulations
Federal Unemployment Tax Act (FUTA)
Federal Water Pollution Control Act
Filing Status
Firm Offer
FLSA
FMLA
Foreign Tax Credit
Formation of Contracts
Formation of Partnerships
Formation of S Corporations
Fraud
Generation Skipping Tax
Gift
Goods In Transit
Gross Income
Guaranteed Payments to Partners
Half-Year Convention
Holder in Due Course (HDC)
Income Tax Return Preparers
Independence, Integrity, & Objectivity
Individual Income Tax
Inheritance
Insider Trading
Interest
Interest Expense
Investment Securities
Involuntary Filing – Chapter 7
Itemized Deductions
Leases
Liability as a Tax Preparer
Liability of Entering and Exiting Partners
Liability Under 33 Act
Liability Under 34 Act
Lifetime Learning Credit
Limited Liability
Limited Liability Arrangements
Limited Liability Companies (LLCs)
Limited Liability Partnerships
Limited Partnerships
Liquidating Distributions
Medical Expenses
Midmonth Convention
Midquarter Convention
Miscellaneous Expenses
Modified HOPE Credit
Moving Expenses
National Labor Relations Act (NLRA)
Negligence
Negotiable Instruments
Noise Control Act
Nonliquidating Distributions
Obligations of Common Carriers
Occupational Safety & Health Act (OSHA)
Offer
Order of Distribution
Other Income
Other Itemized Deductions
Other Rights of Shareholders
Parent-Subsidiary Transactions
Parol Evidence Rule
Partner’s Basis
Partners’ Authority
Partners’ Liability
Partners’ Property Rights
Partners’ Rights
Partnership
Partnership Characteristics
Partnership Dissolution
Partnership Taxation
Penalties for Late Payment
Perfection
Personal defenses
Personal Exemptions
Personal Holding Company (PHC) Tax
Personal Property
Powers of Bankruptcy Trustee
Powers of the Board of Directors
Primary Liability
Priorities Among Claims
Priority Claims
Private Securities Litigation Reform Act of 1995
Prizes & Awards
Product Liability
Promoters
Property
Property Dispositions
Property Received by Inheritance or Gift
Proxies
Real Defenses
Real Property
Realized Gain or Loss
Rejection
Related Party Sales
Rent & Royalty Expenses (Schedule E)
Repayment Plans – Chapter 13
Reporting
Requirements for Combinations
Requirements for Negotiability
Rights & Obligations
Rights of Directors
Rights of Officers
Rights of Sureties
Risk of Loss
Roth IRAs
S Corporation Earnings
S Corporations
Sale of Partnership Interest
Sale on Approval
Sale or Return
Sales
Sarbanes-Oxley Act of 2002
Schedule M-1
Schedule M-2
Secondary Liability
Section 1244 Stock
Secured Creditors
Secured Transactions
Securities Act of 1933
Securities Exchange Act of 1934
Securities Exempt from Registration
Self-Employment Tax
Seller’s Remedies
Seller’s Warranties
Shareholder’s Basis
Shareholders
Special Transactions
Standard Deduction
Standards for Consulting Services
Standards for Tax Practice
Statutes of Limitations
Summary of Auditor Liability
Superfund
Suretyship
Tax Payments
Tax Preparer Penalties
Tax Return Due Dates
Tax Return Schedules
Tax Year
Taxable Estate
Taxable Gifts
Taxation of Beneficiaries
Taxation of Estates & Trusts
Taxation of Gains & Losses
Taxation of Partnerships
Taxation of S Corporations
Taxation of Trusts
Taxes
Terminating Agent’s Authority
Termination of S Corporation Status
Theft or Casualty Losses
Title
Transactions Exempt from Registration
Transfers of Negotiable Instruments
Trust Operations
Trusts
Types of Agency
Types of Endorsements
Types of Sureties
Unified Credit
Unions & Collective Bargaining
Unsecured Creditors
Validity
Validity & Enforceability
Voidable Preferences
Voluntary Filing – Chapter 7
Warranty of Fitness
Warranty of Merchantability
Warranty of Title
When to File
Who Must File
Workers’ Compensation
Preface
About the Author
About the Contributors
Professional and Legal Responsibilities — Module 23
Accountants’ Liability
Federal Securities Acts — Module 24
Federal Securities Regulations
Business Structure — Module 25
Partnership
Corporations
Contracts — Module 26
Contracts
Sales — Module 27
Sales
Commercial Paper — Module 28
Negotiable Instruments
Secured Transactions — Module 29
Secured Transactions
Bankruptcy — Module 30
Bankruptcy
Debtor - Creditor Relationships — Module 31
Suretyship
Agency — Module 32
Agency
Regulation of Business Employment, Environment, and Antitrust — Module 33
Environmental Law
Employment
Antitrust
Property — Module 34
Property
Individual Taxation — Module 35
Individual Income Tax
Transactions in Property — Module 36
Property Transactions
Partnership Taxation — Module 37
Partnership Taxation
Corporate Taxation — Module 38
Corporate Income Tax
S Corporations
Other Taxation Topics — Module 39
Taxation of Estates & Trusts
Income Tax Return Preparers
Index
Copyright © 2013 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada.
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ISBN: 978-1-118-41062-2 (paperback); 978-1-118-60750-3 (ebk); 978-1-118-60763-3 (ebk); 978-1-118-60766-4 (ebk)
Preface
This publication is a comprehensive, yet simplified study program. It provides a review of all the basic skills and concepts tested on the CPA exam, and teaches important strategies to take the exam faster and more accurately. This tool allows you to take control of the CPA exam.
This simplified and focused approach to studying for the CPA exam can be used:
As a handy and convenient reference manual
To solve exam questions
To reinforce material being studied
Included is all of the information necessary to obtain a passing score on the CPA exam in a concise and easy-to-use format. Due to the wide variety of information covered on the exam, a number of techniques are included:
Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists
Formulas and equations that simplify complex calculations required on the exam
Simplified outlines of key concepts without the details that encumber or distract from learning the essential elements
Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal conflict, or developing an audit program
Pro forma statements, reports, and schedules that make it easy to prepare these items by simply filling in the blanks
Proven techniques to help you become a smarter, sharper, and more accurate test taker
This publication may also be useful to university students enrolled in Intermediate, Advanced and Cost Accounting; Auditing, Business Law, and Federal Income Tax classes; Economics, and Finance classes.
Good Luck on the Exam, Ray Whittington, PhD, CPA
ABOUT THE AUTHOR
Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University. Prior to joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University. From 1989 through 1991, he was the Director of Auditing Research for the American Institute of Certified Public Accountants (AICPA), and he previously was on the audit staff of KPMG. He previously served as a member of the Auditing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Regents of the Institute of Internal Auditors. Professor Whittington has published numerous textbooks, articles, monographs, and continuing education courses.
ABOUT THE CONTRIBUTORS
Edward C. Foth, PhD, CPA, Administrator of the Master of Science in Taxation Program at DePaul University. Professor Foth is the author of CCH Incorporated’s Study Guide for Federal Tax Course, Study Guide for CCH Federal Taxation: Comprehensive Topics, and coauthor of their S Corporation Guide. Professor Foth prepared the answer explanations to the multiple-choice and task-based simulation questions in Income Taxes, wrote new questions, selected the mix of questions, and updated items to reflect revisions in the tax law.
Brad McDonald, JD, is an instructor of Business Law and Statistics at Northern Illinois University. He has taught business law since 1987 and has taught the Business Law section of the Northern Illinois CPA review course since 1998. He wrote and revised most of the Business Law modules. He prepared and revised answer explanations for the multiple-choice and simulation questions.
Professional and Legal Responsibilities — Module 23
ACCOUNTANTS’ LIABILITY
Liability under Common Law
An accountant may be liable under common law due to negligence or fraud.
Negligence
A loss due to negligence occurs when an accountant violates the duty to perform professional services in a competent manner. NEGligence may consist of
Nondisclosure of information to a client
Errors previously discovered not being corrected
GAAP not being followed
Best defense to common law negligence is that appropriate professional standards were followed.
Simple negligence
Careless mistakes
Defense of lack of privity may be available But client and intended third-party beneficiaries have privity Foreseen third parties have privity in majority of states under tort law Foreseen third parties lack privity in states conforming to Ultramares case
Gross negligence
Reckless disregard for the truth
Lack of privity not valid as defense
Fraud
Fraud refers to conduct that involves all of the following:
Material false representation of fact
Justifiable reliance on the information
Awareness of the false information by the accountant
The falsity was made with the ultimate intent to deceive
The party must have suffered damages
Scienter refers to the accountant’s knowledge of a false representation or material omission of fact with the intent to deceive.
Potential defenses against fraud include
Lack of intent to deceive
Immateriality
Lack of privity is not a valid defense
Liability under Federal Securities Regulations
Auditors are liable under both the Securities Act of 1933 (33 Act) and the Securities Exchange Act of 1934 (34 Act).
Liability under 33 Act
Accountants are liable under Section 11 of the 33 Act
Liable if financial statements contain untrue statement or material omission
Liable to anyone acquiring security without knowledge of error
To be successful, the plaintiff need not prove
Privity
Scienter
Reliance
Defenses the accountant may use include
Plaintiff’s knowledge of the error
Due diligence in performance of services
Liability under 34 Act
Accountants are liable under Rule 10b-5 of the 34 Act
Liable for oral or written misrepresentations of fact
Liable for wrongful act committed through mail, interstate commerce, or a national securities exchange
To be successful, the plaintiff must prove
Scienter
Reliance
Defenses the accountant may use include
Plaintiff’s knowledge of the error
Lack of reliance by plaintiff
Summary of Auditor Liability
Elements in action taken against an accountant
1) There is a misstatement or omission of a material fact 2) Plaintiff has reasonably relied upon the information 3) Plaintiff suffered a loss 4) Accountant was in error Auditor Common Law Liability
Auditor Liability under Federal Securities Laws
1933 Act Section 11 1934 Act Rule 10b-5 Who may bring action Any purchaser Any purchaser Accountant’s error resulting in action Lack
of due diligence Recklessness or intentional misconduct (scienter) Plaintiff must prove Elements 1 & 3 only All 4 elements Private Securities Litigation Reform Act of 1995
Requires auditor of publicly held company to include specific substantive procedures designed to
Identify illegal acts, including management fraud, having a direct and material effect on the financial statements
Identify significant related-party transactions
Determine if there is substantial doubt related to the entity’s ability to continue as a going concern
Illegal acts must be reported to management and board of directors must be notified
Board of directors must
Notify the SEC within 1 business day
Provide auditor with copy of report to SEC
If auditor not notified
Resign from engagement
Notify SEC within 1 business day of board’s failure to meet deadline
Responsibilities under the Sarbanes-Oxley Act
CPAs and CPA firms may be criminally prosecuted for destroying or falsifying records
Created the Public Company Accounting Oversight Board (PCAOB) Registers CPA firms that audit public (issuer) companies Sets standards on auditing, quality control, independence for registered CPA firms Restricts the types of services that a CPA firm may perform for an issuer audit client Requires rotation of audit partner every 5 years Requires audits of internal control over financial reporting
Public companies must disclose whether they have adopted code of ethics for company’s officers
For audit committees of the board of directors All members must be independent Must have at least one financial expert
Requires the CEO and CFO to certify to company’s financial statements
Liability as a Tax Preparer
Penalties
Actions by an accountant preparing a client’s tax return can result in penalties
Not providing client with copy of return
Failing to sign return as a preparer
Endorsing & cashing client’s refund check
Liability to Client
Other actions may create a liability to a tax client
Failing to file a return timely
Not advising client of tax elections
Neglecting evaluation of joint versus separate returns
Regulation of Accountants
State boards of accountancy issue licenses to practice in a state Investigate violations of professional standards and ethics May revoke license to practice
AICPA and state societies of CPAs Investigate violations of professional ethics through Joint Ethics Enforcement Program (JEEP) May admonish, sanction, suspend, or expel a member
The AICPA Uniform Accountancy Act (UAA) Provides guidance to states in establishing accountancy laws Contains rules for education, reciprocity, continuing education, etc.
The Securities Exchange Commission Investigates CPAs and CPA firms that violate SEC rules May disbar an accountant or firm from auditing public (issuer) companies
The Public Company Accounting Oversight Board (PCAOB) Registers and performs inspections of firms that audit public (issuer) companies Firms that audit more than 100 issuers are inspected every year Firms that audit 100 or less issuers are inspected every three years For substandard performance the PCAOB may: Prescribe remedial actions such as improvements in quality control Suspend an individual or firm from auditing issuers
Standards for Consulting Services
When performing consulting services, a CPA must adhere to certain general standards
Professional competence
Due professional care
Planning & supervision
Obtaining sufficient relevant data
Specific standards related to consulting services include
Serving the client
Establishing an understanding with the client as to the nature, scope, & limitation of services
Communicate with the client about conflicts of interest, scope of services, or benefits to be derived
Standards for Tax Practice
A CPA performing tax services
May not recommend a tax position that lacks merit
Must make a reasonable effort to answer applicable questions on the return
May rely on client information when preparing the return
Must make reasonable inquiries about questionable or incomplete information
May use estimates
Federal Securities Acts — Module 24
FEDERAL SECURITIES REGULATIONS
Securities Act of 1933 (33 Act)
The 33 Act requires
Registration of securities offered for sale to the public
Information be provided as part of that registration
Nonexempt securities must be registered before being offered to sale to the public
Through the mails
In interstate commerce
Registration consists of a registration statement, which includes the prospectus
The registration statement describes the use of proceeds & contains audited financial statements
The prospectus describes the securities, the company, & the risk
Once registration statement is filed
1) Oral offers to sell shares may be made 2) 20 day waiting period before registration is effective 3) During waiting period company may obtain an underwriter & issue a “red herring” (preliminary prospectus) 4) After waiting period, securities can be bought & sold 5) After waiting period, a tombstone ad informs investors about obtaining prospectus In addition to federal registration laws, states require registration under “blue-sky laws”
Securities Exempt from Registration
Certain securities are exempt from registration. The 1933 Act doesn’t apply to these securities at all.
Exempt securities include
Government securities
Regulated by federal agency (banks and railroads)
Insurance policy
Nonprofit organization
Debt maturing within 9 months (known as commercial paper)
Transactions Exempt from Registration
Certain transactions may qualify for exemption from registration. The securities themselves remain subject to the 1933 Act for other purposes or subsequent transactions that aren’t exempt.
Exempt transactions include
Splits, dividends, and other exchanges with existing shareholders without charge
Casual sales by parties other than issuers, underwriters, dealers, directors, officers, or 10% or greater shareholders
Intrastate offers (as long as shares aren’t resold to nonresidents for 9 months)
Private placements under Regulation D
Small issues under Regulation A
Securities Exchange Act of 1934 (34 Act)
The 34 Act established the SEC & made it responsible for
Requiring disclosures concerning offerings on national securities exchanges
Regulating activities of securities brokers
Investigating securities fraud
Companies are required to file periodic reports if
Company’s securities are traded on securities exchanges
Company’s assets > $10,000,000 & more than 500 unaccredited shareholders or 2,000 or more total shareholders (This does not include shares obtained from a qualified employee compensation plan)
Registration
Information required upon registration
Financial structure & nature of business
Names of officers & directors
Disclosure of bonus & profit-sharing arrangements
Reporting
Required reports include
10-K (annual report)—includes audited financial statements
10-Q & 8-K (periodic reports)—update information in original registration
Proxies
Shareholders may sign proxies authorizing the company to vote their shares. The company must file a preliminary copy of the proxy statement with the SEC at least 10 days before it is sent to shareholders.
Insider Trading
Insider trading must be reported to the SEC.
Insiders include agents of the issuer, such as attorneys, or directors, officers, and owners of 10% or more of any class of stock
Short swing profits must be returned to the company
Sarbanes-Oxley Act of 2002
Expands powers of SEC to regulate financial reporting
CEO and CFO must certify in writing that financial reports are accurate
Management is responsible for internal control
Officers must disclose knowledge of internal control deficiencies to auditor and audit committee
Must also disclose evidence of fraud, even if immaterial, by employees involved in internal control
Prohibits most personal loans by company to officers
Requires insiders to report trades within 2 business days
The Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010
Designed “to promote the financial stability of the United States by improving accountability and transparency in the financial system”
Created the Financial Stability Oversight Council to identify and react to emerging risks
Increased the types of financial companies that could be seized and liquidated by the FDIC
Created the Federal Insurance Office to regulate insurance companies
Prohibits any “banking entity” from engaging in proprietary trading
Gives authority to the Commodity Futures Trading Commission and the SEC to regulate the derivatives (swaps) markets
The act includes broad changes in executive compensation policies for public companies including requiring The national exchanges to issue rules requiring companies to develop compensation-recovery arrangements (clawback policies) That all members of the compensation committee of the board of directors be independent A shareholder nonbinding vote on executive compensation at least every three years A nonbinding vote by shareholders on “golden parachutes” that result from major transactions
Provides that the SEC will increase its compliance activities regarding securities trading, and will pay awards to whistle-blowers
The Act requires mortgages securitizers or originators to retain an economic interest in a portion of the credit risk of any securitized asset they sell
Business Structure — Module 25
PARTNERSHIP
Partnership Characteristics
Partners’ Rights
1) Participation in management 2) Sharing of profits & losses Percentages may be specified in partnership agreement
Equal sharing of profits and losses when not specified
3) Property rights Partners’ Property Rights
Partner’s interest; this is only a partner’s right to profits
Right to share of profits & capital upon termination
May be sold or assigned
Buyer or assignee does not have same rights as partner
Right to specific property
Partnership purposes only
Individual partners may not sell or assign
Partners’ Authority
Authority to bind partnership & other partners
Actual authority – express or implied
Apparent authority – reasonable third party would believe partner has authority
Individual partner does not have apparent authority to
Admit a new partner
Guarantee debts of a third party
Admit a claim in court or submit a legal claim to binding arbitration
Sell or pledge partnership property (other than ordinary sales of inventory)
Partner has apparent authority for any other action that appears to be in the course of partnership business unless both of the following occur:
Partners mutually agree on a limit to the authority
Third parties are notified of this limit
Partners’ Liability
Jointly & severally liable
Liable for debts of partnership & torts committed by other partners engaged in partnership business
Right of contribution from other partners
Creditor must attempt to collect from partnership before partners unless partnership in bankruptcy
Notice is required after a partner dissociates from the partnership to avoid liability for later actions
Personal notice to third parties who dealt with the partner (actual notice)
Public notice for all others (constructive notice)
A statement of dissociation, filed with the state’s secretary of state, will provide notice 90 days after it is filed
Liability of Entering and Exiting Partners
Entering partner:
Not personally liable for debts created before entering, but may lose capital contributed to partnership
Personally liable for all debts created after entering
Exiting partner:
Liable for all debts created prior to exiting unless creditors perform a novation to release the exiting partner
Not liable for debts created after exiting as long as proper notice has been given to third parties of the exit
Formation of Partnership
Creation of partnership does not require government approval, and is created by agreement
Written – When a partnership falls within the Statute of Frauds (such as when partners agree that the term of the partnership will exceed one year), the partnership agreement must be in writing and signed by all parties
Oral – In other circumstances, an oral agreement will be sufficient
Implied – Even in the absence of a written or oral agreement, if two or more people are sharing the profits from a venture, there is legal presumption that they are partners unless they can demonstrate otherwise.
Partnership Dissolution
Partnership does not automatically dissolve upon
Withdrawal of a partner
Death or bankruptcy of a partner
Remaining partners with majority vote may continue partnership
Individual partners have right to withdraw
Withdrawing partner may be in breach of contract
Distributions upon liquidation
1st to creditors for loans
2nd to partners for capital contributions
3rd any remainder is given to partners as profits
Limited Liability Arrangements
Limited Partnerships
Basic requirements
At least one general partner with unlimited liability
At least one limited partner
Must file certificate with the state that contains the names of all general partners
Status of limited partners
Have right to profits but not to participation in management or use of property
Limited partner who participates in management or uses property loses limited liability protection
Limited Liability Partnerships (LLPs)
Partners have unique status under this arrangement
All partners may participate in management
Partners are personally liable for own negligence, malpractice, or fraud
Partners are liable for negligence, malpractice by employees/partners under their immediate supervision
Partners are not liable for negligence, malpractice, or fraud committed by other partners
Taxed as partnership (income and losses passed through to individual returns of partners)
Form of organization common in many licensed professions (accountants, attorneys)
Limited Liability Companies (LLCs)
Characteristics of corporations & partnerships
Limited liability to all members
All members may participate in management
Multiple member LLC taxed as partnership (unless members elect to be taxed as corporation)
Single member LLC taxed as sole proprietorship
CORPORATIONS
Characteristics of Corporations
Corporations are legal entities, separate from their owners.
They are generally taxed on their own income
Shareholders are taxed only on distributed income
Shareholders are not liable for corporate obligations
Corporations are incorporated by the various states
Domestic – A corporation that is operating within the state of incorporation
Foreign – A corporation when it is operating in a different state
Alien – A corporation when it is operating in a different country
Foreign and alien corporations must obtain approval to operate in the other state, or they will not have the protection of its courts and be subject to fines (as well as the normal taxes and fees that would have been owed had they qualified to operate in that state)
S Corporations
S corporations provide liability protection to shareholders, but are not taxed on their own income.
Corporate income passes through and is taxed to the shareholders
Shareholders are not taxed on distributions
Requirements for S corporations
Domestic corporation
Not member of affiliated group
100 or fewer shareholders
Only one class of stock
Shareholders generally need to be individuals and United States residents
Articles of Incorporation
Primary document in process of incorporation. Includes
Name of corporation
Capital structure
Name & address of registered agent
Name & address of each incorporator
Corporate purpose
State issues certificate of incorporation or corporate charter.
Incorporators elect board of directors
Board of directors adopts initial bylaws
Promoters
Prior to formation of corporation, promoters may act on behalf of proposed corporation
They do not have status of agents, as no principal exists to give them authority
Contracts made on behalf of corporation bind promoter instead
Promoter still has fiduciary duty to proposed corporation to act loyally and in good faith
Board of directors may adopt or reject contracts previously made by promoter
Promoters remains liable to other party to contract unless granted a novation by them
Promoters have no special right to compensation for services rendered before corporation has been formed
Directors & Officers
Shareholders elect directors, who
Set corporate policy
Select officers
May terminate officers
Rights of Directors
Directors’ rights include
Notification of meetings
Participation in oversight of company
Access to books and records
In addition, directors may receive
Compensation
Indemnification in the form of reimbursement of losses incurred in corporation-related lawsuits
Powers of the Board of Directors
Board, not individual directors, is an agent of the corporation
Acts as a single body – individual directors are not agents and may not act alone
Hires, fires, and sets salaries of officers
Issues stock to buyers at mutually agreed prices
Board may also repurchase shares and retire them or hold them as treasury shares
Board sets dividend policy, determining if there are sufficient resources to pay a dividend that year and setting the amount of the dividend
Dividends may not be declared if the corporation is insolvent or will be made so by dividend
Dividends that exceed retained earnings require shareholder approval
Rights of Officers
Officers are selected & supervised by directors who also set their compensation. Officers are responsible for the day to day operations of the corporation. An officer
May be a director & may be a stockholder
Is an agent of the corporation as an officer
May be entitled to indemnification
Duties of Directors & Officers
Directors & officers have a fiduciary responsibility to the corporation and owe it the duties of care & loyalty.
Care – They must act honestly & prudently when conducting corporate affairs
Loyalty – They must subordinate personal interests to those of the corporation
The duty of loyalty prohibits
Competing with the corporation
Using corporate opportunities for personal gain
Having interests in conflict with the corporation’s
Trading based on inside information
Authorizing transactions detrimental to minority shareholders
Selling control over the corporation
Shareholders
Shareholders also have certain rights & obligations.
Dividends
Dividends are declared at the discretion of the directors and may be paid in cash, property, or stock.
Undeclared dividends do not carry forward to future periods
Undeclared dividends on cumulative preferred stock do carry forward. These dividends in arrears
Are not a liability of the corporation until declared
Must be paid prior to payment of current dividends in subsequent periods
Dividends may not be declared if they threaten the corporation’s solvency.
Other Rights of Shareholders
Shareholders may reasonably inspect & copy corporate books & records
May designate a CPA or attorney as an agent
Must have legitimate reason for inspection such as investigation of management misconduct or commencing a derivative suit
A derivative suit is brought by stockholders
Against an officer or director of the corporation who has breached a fiduciary duty
On behalf of the corporation; thus any proceeds from such an action belong to the corporation, not the shareholder who brought the derivative suit
Shareholders may vote on fundamental changes to the corporation. These include
Consolidation or merger with other corporations
Voluntary dissolution of the corporation
Shareholders may have the right of appraisal
Applies when they dissent to amendments that materially and adversely affect shareholder rights
Gives shareholder the right to the fair value for shares held
Shareholders may have preemptive rights
Must be provided for in articles of incorporation or charter
Give shareholder the right to purchase proportionate amount of newly issued shares
Shareholders have right to transfer shares
Corporation must not hinder transfers
Close corporations may require stock to be offered first to other shareholders before being sold to outsiders
Limited Liability
Shareholders are entitled to limited liability, indicating they will not be liable
beyond their investment. Shareholders are not personally liable, even when
The corporation is an S corporation
The corporation has performed an ultra vires act, beyond its authority
The corporation was formed solely for the purpose of limited liability
The shareholder is a director, officer, or employee of the corporation
The courts will “pierce the corporate veil” and shareholders will be personally liable when
The corporation was undercapitalized upon formation
The corporation’s resources are commingled with those of the shareholders
Business Combinations
Combinations may be in the form of a merger or a consolidation
Merger – one or more companies are absorbed by another
Consolidation – two or more corporations form a new entity
Requirements for Combinations
Certain conditions must be met before a combination can occur
Directors of each combining corporation must approve
A merger plan must be given to all shareholders of all combining corporations
A majority of shareholders of each combining company must approve the plan
Dissenting shareholders have an appraisal right to be paid a fair amount for shares held on the date of the combination. To qualify, they must
File an objection to the merger
Not vote in favor of the proposal
Make a written demand that the stock be purchased at an appraised price
Dissolution
A corporation can be dissolved as a result of an action by the shareholders or by the directors.
1) Directors may pass a resolution to dissolve the corporation The resolution is submitted to the shareholders
It must be approved by a majority
Upon dissolution, the corporation is liquidated.
Contracts — Module 26
CONTRACTS
Formation of Contracts
Elements
In order to form a valid contract, there are 3 required elements
Offer
Acceptance
Consideration With all 3 elements, a contract is as sturdy as an oac (okay, so it should be oak) tree
Offer
Expresses intent to enter into contract
To be effective, the offer must be definite as to terms and received by the offeree
To be definite, an offer generally includes
Price
Subject matter
Time for performance
Terms considered definite if reasonable person could determine them
An offer may be revoked at any time until accepted
A promise to hold an offer open for a specified time is not binding unless supported by consideration
A revocation is effective when received by the offeree
Acceptance
Acceptance is generally effective when dispatched (mailbox rule)
Not effective until received when
Offer so specifies
Accepted by unauthorized means
Sent by means not equal to or better than that used to communicate offer
Acceptance must be the same terms as offer (mirror image rule)
A modification represents a counteroffer
Initial offer is rejected and offeree makes a new offer
Rejection
Rejection of an offer is effective when received by the offeror
Terminates original offer
If rejection is followed by acceptance, whichever is received first is effective
Consideration
Given in exchange for promise to form contract
Must be legally sufficient
Bargained for
Legal value: Party agrees to do something that s/he is otherwise not obligated to do, or refraining from an action that the party has a legal right to do
Does not have to be of equal value
Consideration may take various forms
May involve forfeiting a legal right
May be performed by a third party
May not consist of past performance or preexisting obligation
Validity & Enforceability
In certain circumstances, no valid contract exists. Even if a contract exists, it may not be enforceable.
A condition precedent is a condition that must be met before a contract becomes enforceable
A condition subsequent is a condition that, upon being met, releases a party from obligation
Validity
Certain factors may indicate that there is no valid contract
Fraud—A party entering into a contract due to a fraudulent misrepresentation will not be held to it. The contract is
Void due to fraud in the execution (Deceived into thinking it isn’t a contract)
Voidable due to fraud in the inducement
Ability—A party that does not have the capacity to enter into a contract will not be held to it
The contract is generally voidable.
The party may ratify or disaffirm the contract upon obtaining capacity.
Influence—A party entering a contract due to being improperly influenced (undue influence) may not be held to it. The contract is voidable.
Legality—A party entering into an illegal contract will generally not be held to it. The contract is void.
Violation of a licensing statute designed to raise revenues does not make the contract illegal.
Violation of a licensing statute designed to protect the public does make the contract illegal.
Error—A party entering into a contract by mistake will generally not be held to it. The contract is
Voidable in the case of mutual mistake (both parties were in error)
Unenforceable when the other party should have recognized the mistake or when
there is a material clerical error
Duress or force—A party forced to sign a contract will not be held to it. The contract is
Void if the duress is extreme, such as a threat of physical harm
Voidable if the duress is simple, such as a threat of breaching a contract These are the reasons the contract failed.
Enforceability
Under the Statute of Frauds, executory must be in writing, or have written evidence, to be enforceable. These include
A guarantee of the debt of another
A sale of goods for $500 or more
A contract that cannot be completed within one year
A contract involving an interest in land
LEGGY, Executory promises for Land, Goods, Guaranteeing another’s debts, and that cannot be completed within one Year need a writing.
If the contract itself is not in writing, then a sufficient writing is a writing or combination of writings that
Identifies the parties to the contract,
Identifies the terms of the contract, and
Contains the signature of the party to be charged (sued)
Parol Evidence Rule
Oral evidence generally cannot be used to contradict a written contract. The Rule excludes
Negotiations and agreements prior to the written contract
Oral agreements occurring at the same time as the written agreement
The Rule allows
Oral agreements occurring after the written agreement
Clarification of ambiguous terms in the written agreement
Evidence that the contract was void or voidable
Rights & Obligations
Unless otherwise specified
A party may assign their rights in a contract to a third party
A contract may delegate their obligations under a contract to a third party
A third party obtaining rights in a contract is a third party beneficiary
An intended beneficiary has rights under the contract
An unintended or incidental beneficiary has no rights under the contract
Assignment
When a party with rights to a contract assigns those rights, the assignor warrants
The assignor will not impair the assignment
The rights being assigned do exist
The assignor is not aware of information adverse to the assignment
Delegation
When a party delegates their obligations under a contract, they remain obligated to the other party to the contract.
Discharge
A party may also be released from obligations by being discharged. Discharge can result from a variety of circumstances.
Satisfactory performance
A condition precedent was not met
The contract was rescinded
An accord and satisfaction—different performance is accepted in place of the contracted for performance
Discharge may also occur as an operation of law.
Performance becomes impossible
Death or incapacity of the obligated party when personal services are required by that party under the contract
Discharge in bankruptcy
Illegality of the obligation
Breach of Contract
Nonperformance, resulting in a breach of contract, changes the relationship between the parties.
1) A material breach by one party releases the other. 2) Most breaches are nonmaterial; the remedy is normally compensatory damages. 3) One may inform the other that they will not perform resulting in an anticipatory breach of contract. The other party could Cancel the contract
Sue for compensatory damages immediately
Damages
An injured party may seek damages.
Money damages may include
Compensatory damages to recover losses
Consequential damages cover indirect costs & anticipated losses, but are only available if they are foreseeable to the breaching party.
Punitive damages are not available for breach of contract
Nominal damages ($1) are awarded when the nonbreaching party fails to prove damages.
Liquidated damage clauses specify the amount an injured party will received; such clauses are enforceable if the specified damages are reasonable.
Specific performance, requiring the other party to perform their obligations, may be appropriate when the subject of the contract is unique, such as real estate.
An action resulting from breach must be brought within the time period specified
in the relevant statute of limitations.
Sales — Module 27
SALES
Contracts involving the sale or lease of goods are covered by the Uniform Commercial Code and are subject to special rules.
Offer, Acceptance, & Enforceability
Like other contracts, elements of a sales contract include offer, acceptance, and consideration.
Offer
An offer under sales law may be incomplete as to terms provided the parties intend to enter into a contract.
A firm offer cannot be revoked for a specified time of up to 3 months, regardless of a lack of consideration. A firm offer must be
Made by a merchant
In a signed writing
Acceptance
Acceptance of a sales contract does not have to mirror the offer. A timely and definite indication of acceptance with different or additional terms is valid.
1) The different or additional terms are generally considered proposals. 2) If the contract is between merchants, the different or additional terms are part of the contract unless The offer required acceptance of the specified terms
The changes materially change the offer
The other party objects on a timely basis
An offer to buy goods for prompt or current shipment
May be accepted by a promise to ship promptly
May be accepted by prompt shipment of conforming goods
Enforceability
Modifications of existing contracts are enforceable, even if or not supported by additional consideration.
Under the Statute of Frauds, sales contracts in the amount of $500 or more, including modifications, must be in writing to be enforceable.
An oral contract between merchants for $500 or more will be enforceable if: There is a written confirmation signed by one party, and The other party fails to make a timely written objection.
Other oral contracts for $500 or more that will be enforceable include
A contract for specially manufactured goods
A contracted admitted to by the party
Portions of a contract that have already been performed
Goods in Transit
Title
Contract may specify when title passes to buyer.
When goods are not delivered
Title passes when document of title is delivered
In absence of document of title, title passes when goods have been identified to the contract
Title transfers to the buyer for both conforming and nonconforming goods. Title reverts back to seller if when goods are rejected by the buyer.
Risk of Loss
Risk of loss may pass with title or at the time specified by the contract. Risk remains with the seller
When nonconforming goods are sent
Until delivery when the shipper’s vessel is used for shipment
Until delivered to a common carrier in a shipment contract
Until delivered to their destination by a common carrier in a destination contract
When goods are not delivered
A merchant seller retains the risk of loss until the buyer has possession of the goods
A nonmerchant seller transfers the risk of loss when tendering delivery to the buyer
Obligations of Common Carriers
In shipment contract, common carrier is a bailee in a mutual-benefit bailment. Standard of care is based on strict liability
Responsible for loss regardless of negligence
Amount of loss is limited by law
Special Sales
Sale on Approval
Seller is actually making offer to sell goods
Buyer takes possession
Risk of loss remains with seller
Buyer is bailee owing duty of reasonable care
Title & risk of loss transfer to buyer upon acceptance or after grace period
Sale or Return
Goods are sold & delivered to buyer
Title & risk of loss transfer to buyer
Buyer may return goods to seller at buyer’s risk & cost
Title & risk revert back to seller upon return
COD
Buyer generally has right to inspect goods before making payment
Buyer gives up right to inspect before payment in contract specifying COD shipment
Seller’s Warranties
Warranty of Title
Automatic warranty of any seller. Warrants
Seller is transferring good & valid title
Goods are free from liens other than those that buyer is aware of
Goods are free from claims of third parties
May be disclaimed with specific language in contract only
Warranty of Merchantability
Implied warranty of merchant seller. Warrants
Goods are reasonably fit for ordinary use
May be disclaimed with specific mention of merchantability in disclaimer
May be disclaimed by use of recognizable phrases such as “as is”
Warranty of Fitness for a Particular Purpose
Implied warranty of any seller.
Seller must know purpose for which buyer will use goods and that buyer is relying on seller’s knowledge in selecting goods for the purpose
May be disclaimed in writing with specific mention of fitness in disclaimer
May also be disclaimed by use of recognizable phrases such as “as is”
Express Warranties
Created by the words or actions of seller
Product Liability
Manufacturer and seller of defective product may be liable to injured party under theory of strict liability, protecting consumers from unsafe products. To hold a manufacturer/seller liable the following elements are required:
Defendant is in the business of selling/manufacturing the product
The product was in an unreasonably dangerous condition (defective) when it left the seller’s control
The unreasonably dangerous condition caused the plaintiff’s injury/damages
Manufacturers/sellers are liable despite
No privity of contract with injured party
Ignorance of defect & lack of negligence
Lack of due care exercised by injured party
Liability for injury from defective product may not be disclaimed.
Breach of Contract
Different remedies are available to buyer & seller for the other party’s breach of a sales contract.
Seller’s Remedies
When a buyer is in breach, the seller may
Cancel the contract
Recover damages
Damages may include
The contract price of the goods if they cannot be resold
The difference between the contract price and the sales price if they can be resold
Incidental damages for costs incurred as a result of the buyer’s breach
Punitive damages are not available
Buyer’s Remedies
A seller is in breach by not shipping goods or by shipping nonconforming goods. Nonconforming goods include a combination of conforming & nonconforming goods.
When goods are not shipped, the buyer may
Obtain specific performance if the goods are unique
Cover the contract by acquiring goods elsewhere and recovering the excess cost from the seller
When nonconforming goods are shipped, the buyer may void the contract. The buyer
May reject all, some, or none of the goods shipped
Must notify the seller of the rejection
Give the seller an opportunity to cure the defect on a timely basis
Must follow reasonable instructions from the seller in disposing of rejected goods
May avoid costs incurred in relation to the rejected goods
When partial payment is made to an insolvent seller, the buyer may recover or capture goods identified to the contract that are in the possession of the seller under the
right of replevin.
Special Circumstances
Remedies available to the parties may be modified by special circumstances.
When goods are accidentally destroyed before the passing of title, the seller is released from obligation to perform
When the agreed upon delivery method becomes impracticable, a practical alternative must be tendered and accepted
A liquidated damages clause may specify the amount of damages to be received by a party in the case of breach by the other, provided it is reasonable
Commercial Paper — Module 28
NEGOTIABLE INSTRUMENTS
Commercial Paper
Types of Commercial Paper
Note
Two-party instrument: Maker and payee
Promise to pay
Examples: Promissory note, and Certificate of deposit
Draft
Three-party instrument: Drawer, drawee, and payee
Order to pay
Examples: Trade acceptance—Draft used for a sale of goods; Check—Draft drawn on a bank and payable on demand
Requirements for Negotiability
For commercial paper to be negotiable, certain requirements must be met. It must be
Payable at a fixed time or on demand
For a certain amount
Payable in money
Payable to order of a specific party or to bearer (not required for checks)
Contain an unconditional promise to pay or an unconditional order to pay
Signed by the maker or drawer Famous instruments are negotiable instruments
Transfers of Negotiable Instruments
Transfer may be made by
1) Negotiation—Transferee has same rights as transferor or superior rights Bearer paper—Negotiated by delivery alone
Order paper—Negotiated by delivery and endorsement
Types of Endorsements
Blank—Signature of payee, converts order paper to bearer paper
Special—Specifies endorsee, paper becomes payable to order of endorsee
Qualified—Contains words of qualification, such as “without recourse”
Does not restrict further negotiation
Endorser does not guarantee payment upon dishonor
Endorser with knowledge of defense against instrument will be liable
Restrictive—Places conditions on payment to subsequent endorsee
Does NOT prevent further negotiation
Holder in Due Course (HDC)
A holder can be a HDC if 3 requirements are met
Instrument taken for value
Taken in good faith
Without notice of defects
A holder may have same rights as a HDC under the shelter provision
Must receive instrument after a HDC
Not personally considered a HDC unless the 3 requirements are met, but will still have the rights of HDC
Defenses against a Negotiable Instrument
Real Defenses
Valid against all holders, including holder in due course
Includes
Forgery
Fraud in the execution—signer is not aware that item is a negotiable instrument
Material alteration
Discharge in bankruptcy
Minority
Extreme duress
Personal Defenses
Not valid against a HDC, but valid against a mere holder
Include
Breach of contract
Lack of consideration
Imposter or fictitious name given by payee
Simple duress
Fraud in the inducement—Instrument signed based on misleading information
Contract Liability of Parties
These parties are liable for the face value of the instrument
Primary Liability
Maker of promise to pay and acceptor of a draft
Unconditionally obligated to pay
Subject to appropriate defenses
Secondary Liability
Any other (other than maker or acceptor) party who signs the instrument has secondary liability; this includes
Endorsers
Drawers
Guarantor of instrument
Liable if party with primary liability does not pay
Timely notice of primary party’s refusal to pay must be given to secondary parties
Warranty Liability of Parties
If a party breaches a warranty, the nonbreaching party may demand a refund of what it paid for the instrument.
Transferor’s Warranty Liability
A transferor of the instrument who was given value promises subsequent transferees that
The transferor has good title to the instrument
All signatures are authentic and authorized
There are no valid defenses against the transferor
The instrument has not been altered
No knowledge of bankruptcy of the maker, drawer, or acceptor
Presentor’s Warranty Liability
Any holder of the instrument, whether they actually present the instrument for payment or not, is warranting to the payor of an instrument that the holder has good title.
Avoiding Liability
There are circumstances where there is no liability
A party who has not signed an instrument has no contract liability
No one has primary liability on a draft until it has been accepted
A holder may discharge another party from liability by
Canceling (crossing out) the party’s endorsement
Materially altering the instrument
Releasing the collateral of the party with primary liability
A party may eliminate its contract liability by signing “without recourse”
Other Instruments
Documents of Title
Relate to goods, rather than money
Can be negotiable
Must contain words “bearer” or “to order of”
If to order, goods must be delivered to that party or subsequent endorsee
A document of title can be duly negotiated if the purchaser
Takes it in good faith
Gives value
Takes it in the ordinary course of business or finance, not in settlement of a money obligation
A warehouse receipt is issued by a party storing goods for a fee who has a duty of reasonable care.
The receipt should include
Location of the goods
Date of issue
Whether the goods are deliverable to bearer, a specific party, or to the order of a specific party
Description of the goods
Warehouseman’s signature
A bill of lading is issued by a carrier of goods who is strictly liable
Investment Securities
Include bonds & shares of stock
Can be bearer or registered
Transferor makes certain implied warranties
Transfer is effective
Transfer does not violate rights of another party
Certificate is genuine and has not been materially altered
Secured Transactions — Module 29
SECURED TRANSACTIONS
An agreement where a creditor receives additional assurance of repayment from a debtor who provides collateral in which the creditor obtains an interest
Collateral
The personal property that is subject to the creditor’s security interest
Types of Collateral
Goods
Consumer goods are goods for personal use
Equipment is goods used for business
Inventory is goods used for resale
Indispensible paper
Intangibles
Security Agreement
The agreement between the debtor and creditor that gives the creditor a security interest in the debtor’s collateral
Requirements for a valid security agreement
In writing, except when creditor has physical possession of collateral
Signed by the debtor
A description of the collateral
Attachment & Perfection
Attachment
Gives secured creditor right to collateral upon default of debtor
Conditions for attachment—all 3 must be met
Creditor gives value to debtor
Debtor has rights in the property
Creditor takes possession of property or obtains written security agreement A security interest attaches to collateral and the creditor grips the debtor’s property
Perfection
Gives secured creditor a claim to the property that is superior to others
Perfection occurs when the secured interest has attached and 1 of the following:
A financing statement has been filed
A purchase money security interest (PMSI) is perfected automatically when it attaches in a consumer sale
The creditor has taken possession of the property A creditor should perfect a security interest asap (as soon as possible)
Priorities among Claims
A PMSI has highest priority if the creditor fulfills requirements
Requirements for PMSI in noninventory goods to have highest priority
Must be perfected within 20 days of debtor possessing collateral
Requirements for PMSI in inventory to have highest priority
Must be perfected prior to debtor receiving inventory
Written notice must be given to other perfected interests prior to debtor receiving inventory
Among Other Claims
If all perfected by filing, in order of filing date
If perfection by filing vs perfection by possession, in order of perfection date
Buyers of Property
A buyer of goods in the ordinary course of business is not subject to security interest (i.e., the security interest cannot be enforced against a buyer in the ordinary course of business)
A good-faith buyer of used consumer goods from another consumer takes them free of any security interest except those perfected by filing
Default by Debtor
Repossession by Creditor
1) Debtor can exercise right of redemption by paying off loan 2) Proceeds from sale of repossessed property are distributed in the following order: Reasonable expenses of sale
Pay secured party’s claim
Satisfy other secured claims in order of priority
Excess to debtor
Credit Card Debt
Holders and issuers of credit cards protected against fraudulent use under the Credit Card Fraud Act (CCFA), which prohibits
Possession of unauthorized cards
Counterfeiting or altering credit cards
Using credit card numbers
Conspiring to use cards reported as stolen
A holder is only liable for unauthorized use up to $50. Holder must have accepted card and
Holder was given notice of potential liability
Holder was provided means of notifying issuer of loss or theft
Unauthorized use must have been prior to notification
Issuer provided means of identifying authorized user
Bankruptcy — Module 30
BANKRUPTCY
Voluntary Filing—Chapter 7
Means testing added by Bankruptcy Act of 2005, prohibiting Chapter 7 filing when
Consumer debtor monthly income exceeds certain specified amounts in the bankruptcy code
Debtor current monthly income is reduced by Monthly expenses Payment made on secured debts, and Payment made to priority general creditors
Debtor must meet with an authorized credit counselor within 180 days prior to filing for bankruptcy
Involuntary Filing—Chapter 7
12 or More Unsecured Creditors
Requires 3 or more unsecured creditors to file petition
Total undisputed claims of petitioners ≥ $14,425
Fewer than 12 unsecured creditors
Requires only 1 or more unsecured creditors to file petition
Total undisputed claims of petitioners ≥ $14,425
Powers of Bankruptcy Trustee
Avoidance
Enables trustee to obtain return of debtor’s property
Applies to
1) Fraudulent transfers 2) Statutory liens against debtor’s property 3) After-filing date transfers 4) Voidable preferences His attempt to transfer the property caused a flap Voidable preferences
Transfers of property made by debtor that can be recovered by trustee
To be a voidable preference, the transfer must be made
Within ninety days of filing of petition if to a noninsider
Within one year of filing if to an insider
For a pre-existing (antecedent) debt
While the debtor is insolvent
The transfer exceeds the amount that the creditor would obtain through bankruptcy In essence, the transferee gets no pie and must return the debtor’s property
Distribution of Assets
Order of Distribution
1) Secured creditors 2) Priority claims 3) Unsecured creditors Secured Creditors
Fully secured creditors obtain collateral
Property satisfies debt
If value of property exceeds debt, then excess is added to bankrupt’s estate
Partially secured creditors obtain collateral
Property does not satisfy debt
Debt exceeds value of property, then excess debt becomes unsecured claim
Priority Claims
Certain creditors will be paid first, in order of priority
1) Support payments (including alimony and child support) 2) Trustee fees & administrative expenses of the bankruptcy 3) Obligations created after petition filing by creditors before settlement (i.e. involuntary gap creditors) 4) Payroll and benefits arising within 180 days of petition—up to $11,725 per employee 5) Individual deposits on consumer goods not received—up to $2,600 per individual 6) Taxes owed to federal, state, and local governments A trustee about to pay nonpriority creditors should stop it and pay the priority claims first Unsecured Creditors
Each level of priority claims must be paid in full before the next level of priority claim is paid
If there are insufficient assets to pay a level in full, then that level is paid on a pro rata basis. For example, each claim might receive 50 cents for each dollar it is owed.
Claims below the group paid on a pro rata basis receive nothing.
Exceptions to Discharge
Certain debts are not discharged as a result of bankruptcy
Student loans of debtor
Taxes accruing within 3 years of the bankruptcy
Unscheduled debt causing credit not to be notified of bankruptcy
Pension and profit sharing obligations to employees
Intentional force or fraud against another person
Domestic support obligations for alimony and child support A debtor is stupid if
he thinks he can use bankruptcy to get these debts discharged
Denial of Discharge
Court may deny discharge of all unpaid debts in limited circumstances
Bankruptcy offense, such as hiding assets from the bankruptcy trustees, committed by debtor
Active operations continue for partnership, corporation, or any business entity
Discharge previously obtained within past 8 years A court will completely deny a debtor any discharge for bad behavior
Business Reorganizations — Chapter 11
Plan for Repayment
Agreed to by debtor and creditors
Debtor continues to operate business
Debtor or creditor’s committee files reorganization plan
Submitted to each class of creditors
Must be approved by at least 1/2 of claims
Total of approving claims ≥ 2/3 of total amount of claims
Court Confirmation of Plan
For confirmation, must provide for payment of priority general creditors:
Administrative expenses
Gap creditors
Employee claims for wages, salaries, & benefits
Consumer deposits
Upon confirmation, plan is binding on debtor & creditors
Discharge
Debtor discharged from debts arising before confirmation
Exceptions to discharge
Debts protected under plan
Debts exempt from discharge under plan of liquidation
Repayment Plans — Chapter 13
Qualifying Debtors
Available to debtors with
Regular income
Generally limited to individuals, or small businesses
Debtor’s Plan
Provides for
Debtor’s future income controlled by trustee
Full payment of priority claims
Similar treatment to all claims within a given class of claims
Plan confirmed by courts
Alternatives to Bankruptcy
Composition of creditors
Agreement between debtor & certain creditors
Creditors agree to accept portion of their claims
Remainder of claims of agreeing creditors discharged
Assignment for the benefit of creditors (general assignment)
Debtor transfers property to trustee
Trustee applies property proportionately to debts
Debtor not discharged from remaining claims
Debtor - Creditor Relationships — Module 31
SURETYSHIP
Sureties
Types of Sureties
Surety—Party agreeing to answer for debts of another
Cosureties—Two or more parties responsible for the same debt of another
Obligations of Sureties
Guarantees obligation of principal debtor
Immediately liable upon default—Creditor not required to
Collect from principal debtor
Use collateral of debtor
Provide notice of default to surety
Rights of Sureties
Exoneration—Require the principal debtor to pay the obligation
Reimbursement—Obtain repayment from principal debtor
Subrogation—Obtain rights of creditor against debtor & debtor’s collateral
Contribution—Receive proportionate payment from cosureties
Defenses of Sureties
Statute of Frauds—A surety contract must be in writing to be enforceable
Capacity—Surety must have capacity to enter into contract
Bankruptcy—A surety can be released in bankruptcy, but is not released due to the principal debtor’s bankruptcy
Misrepresentation—Surety is released due to fraudulent misrepresentations of principal debtor known to creditor
Cosureties
Obligations of Cosureties
Cosureties are individually liable to the creditor up to the maximum amount that the cosurety guaranteed.
Cosureties may demand a contribution from other cosureties, if a cosurety pays
more than its proportionate share of the debt.
To calculate proportionate share of cosureties:
1. Add up total amount guaranteed by all cosureties 2. Divide each individual cosurety’s guarantee by the total in 1. above 3. Multiply the resulting percentage and the amount of the defaulted debt 4. The result is that cosurety’s proportionate share If a cosurety is released by the creditor, the remaining sureties are not liable for the proportionate share of the released surety.
Agency — Module 32
AGENCY
The Agency Relationship
Agent works on behalf of the principal
Agent owes fiduciary duty to the principal to act in the principal’s best interests; fiduciary duties include duty of:
Loyalty
Obedience
Due care
Liability
Generally, principals can be held liable for the actions of their agents, but principals are not responsible for the actions of independent contractors
Contract Liability
If the third party is suing the principal/agent for breach of contract, then consider what authority the agent had to enter into the contract and the disclosure status of the principal.
Tort Liability
If agent commits a tort while in the scope of the principal’s employment, then the third party holds the principal liable, or the agent liable, or both the principal and agent liable; this is joint and several liability.
If agent commits a tort outside the scope of employment, then only the agent is liable.
Terminating Agent’s Authority
Authority of agent terminates in certain cases
Agreement—Principal and agent agree to end of authority
Unilateral—Principal dismisses agent or agent resigns Actual authority terminated even if in breach of contract
Operation of law—Death, insanity, incapacity, or illegality of subject matter of
agency
Apparent authority can still exist, unless authority was terminated by operation of law, then all authority is terminated
Principal can avoid responsibility of agent’s subsequent (after termination) acts by giving
Personal notice to third parties who dealt with agent
Public (also known as constructive) notice for all others
Notice not required when termination is by operation of law
Regulation of Business Employment, Environment, and Antitrust — Module 33
ENVIRONMENTAL LAW
Laws passed to protect the environment.
Under the National Environmental Policy Act (NEPA), all federal agencies are required to consider the impact upon the environment in making decisions
The Environmental Protection Agency (EPA) coordinates and administers environmental policies
Recommendations for actions affecting the environment must be accompanied by an environmental impact statement which
Describes the environmental impact of proposed actions
Discusses effects that cannot be avoided
Discusses alternatives to the proposed actions
Indicates differences between short-term and long-term effects
Provides details of irreversible commitments of resources
The Clean Air Act
Regulates air pollution from mobile sources (automobiles) and stationary sources (factories). Under the Act
Factories with toxic air pollutants must use the best available emission controls
Penalties may be up to $25,000 per day
In addition
The EPA can assess a penalty equal to the violator’s benefit
Private citizens can sue violators
Knowing violators may be subject to criminal liability
The Federal Water Pollution Control Act (Clean Water Act)
Protects navigable waterways & wetlands regulating discharges of heated water by nuclear power plants and dredging of wetlands. It is intended to
Make water safe for swimming
Protect fish & wildlife
Eliminate water pollution
Sanctions against violators include
Civil penalties ranging from $10,000 to $25,000 per day
Possible criminal liability
Injunctions preventing pollution
Requirement to clean up or pay for cleaning up pollution
Property owners may
Bring suit against the EPA to enforce compliance
Bring state or citizens’ suits against violators
The Noise Control Act
This Act
Sets standards for noise emissions
Prohibits distribution of products violating standards
Imposes penalties of up to $50,000 per day and imprisonment for 2 years
The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund)
Regulates toxic chemicals, including
Pesticides & herbicides
Chemicals & chemical compounds
Industrial, agricultural, & household wastes
Also regulates the cleanup of hazardous waste disposal sites.
Authorizes cleanup of site when release of hazard chemicals occurs or is threatened
Can recover cost of cleanup from all parties associated with the site, including the party Generating the waste Transporting the waste to the site Who owned or operated the site at the time of disposal Who currently owns or operates the site
EMPLOYMENT
Various laws regulate the relationship between employers & employees. They are primarily designed to protect the rights of workers. They
Prevent wrongful termination
Protect “whistle-blowers”
Protect employee privacy
Health & Safety
Occupational Safety & Health Act (OSHA)
Designed to provide safe & healthy workplace. Department of Labor: Sets standards, conducts inspections, & enforces OSHA. Under OSHA
Workplace must be free of recognized hazards
Employees may file complaints of unsafe workplace without fear of discharge
Employees may refuse to work in high risk areas without fear of discharge
When employees are injured
The company must maintain records of injuries and illnesses
Records must be available for inspection by OSHA inspector
OSHA employees may inspect any facility covered by OSHA with permission of employer or a search warrant.
Workers’ Compensation
Workers’ compensation laws compensate employees injured on the job.
All eligible employees must be covered
Injured employees are compensated regardless of negligence
The employer covers the entire cost of workers’ compensation.
Workers’ compensation insurance may be obtained from the state or a private insurer
Employers may be self-insured in certain states
Coverage falls under theory of strict liability.
Employees are covered, even when personally at fault
Liability not reduced for employee negligence or assumption of risk
Covered injuries must be accidental and must occur on the job. Employees accepting benefits may not file a negligence claim against the employer. Benefits may include
Burial expenses
Prosthetic devices
Monthly payments to surviving dependents
Retirement & Security Income
Federal Insurance Contributions Act (FICA)
The Social Security Act provides for
Old age or retirement benefits
Benefits to survivors & divorced spouses
Payments for disability & to disabled children
Medicare benefits
Benefits are paid for by contributions by employer & amounts withheld from employee. If an employer fails to withhold
The employer must pay the employee’s share
The employer may be reimbursed by the employee
Unreimbursed amounts are compensation to the employee
Self-employed individuals must pay both the employer and the employee’s share
Employee Retirement Income Security Act (ERISA)
Two types of private pension plans
Contributory—Employer & Employee make payments to plan
Noncontributory—Only employer makes payments to plan
ERISA regulates private pension plans with requirements for funding and vesting.
Employers may not deduct & accrue contributions without making payments to the plan.
Employee contributions must vest immediately.
Employer contributions must vest over a reasonable time, usually within 5 years.
Does not require employer to have pension plan; only regulates employers that have a pension plan
Federal Unemployment Tax Act (FUTA)
FUTA provides compensation to employees losing their jobs.
Applies in the case of business reversals
Does not apply to terminations for cause
Does not apply to employees leaving voluntarily or refusing reasonable employment after losing their jobs
FUTA taxes are paid by employers.
Not all employers are subject to FUTA
Amounts paid for state unemployment taxes reduce required FUTA payments
Other Employment Laws
COBRA
COBRA protects employees from losing medical insurance upon termination of employment.
Applies to voluntary & involuntary terminations
Applies to employees reducing hours below requirements for insurance coverage
Allows employee 60 days to decide to continue coverage
May continue coverage for up to 18 months for employee, spouse, and other insured family members
Continued coverage is paid for by the former employee
FMLA (Family and Medical Leave Act)
FMLA applies to employers with 50 or more employees. It provides employees up to 12 weeks of unpaid family or medical leave in a 12-month period.
Health coverage continues during the leave
The employee is guaranteed employment upon return
FLSA (Fair Labor Standards Act)
FLSA regulates child labor, overtime compensation, hours in a workweek, & minimum wage.
Prohibits oppressive child labor.
Specify types of work appropriate for children
Restricts number of hours children may work
Establishes rules for overtime compensation.
Rate is at least 1½ times regular rate
Applies to hours in excess of 40 in any week
Certain employees exempt including executives, administrative employees, professional employees, & outside salespersons
Establishes minimum wage amount that applies to all employees.
Unions & Collective Bargaining
National Labor Relations Act (NLRA)
Gives employees the right to form unions and bargain collectively
If union is elected, requires that union and management bargain in good faith about mandatory bargaining subjects: Hours, wages, and other conditions of employment
Allows unions to strike over mandatory bargaining subjects
The NLRA prohibits
Interfering with employee attempts to form, join, or assist labor organizations
Dominating or contributing to a labor organization
Discriminating against employees filing charges or testifying under NLRA
Discrimination
The Civil Rights Act & Equal Pay Act
Title VII of the Civil rights Acts prohibits selection or promotion of employees based on race, color, religion, national origin, or gender
Employers must only reasonably accommodate religious needs of employees
Applies to both intentional discrimination (disparate treatment) and unintentional discrimination (disparate impact)
Equal Pay Act prohibits discrimination in payment to employees based on gender
Gender protection was extended by the Pregnancy Discrimination Act
Requires treatment of pregnant employee as being temporarily disabled
Employer must change work assignments, grant paid disability leave, and grant leave without pay
ADEA
The ADEA prohibits employment discrimination based on age. It applies to
Employers with 20 or more employees engaged in interstate commerce
Applies to employees at least 40 years old
Prohibits mandatory retirement for nonmanagerial employees
Employee must prove they were
A member of a protected group
Qualified for the position from which they were discharged
Discharged under circumstances inferring age discrimination
ADA (Americans with Disabilities Act) & Rehabilitation Act
The ADA prevents discrimination against physically or mentally disabled workers
otherwise qualified to participate in the work force.
Prohibits employer refusal to hire otherwise qualified disabled person
Requires employer to make reasonable accommodations for disabled persons unless they can demonstrate undue hardship
Prevents employer from asking about known disabilities and requiring a physical exam as a condition of employment unless required of other employees
The ADA also protects disabled persons from discrimination in use of public transportation and privately operated public accommodations.
The Rehabilitation Act, similar to the ADA, applies to federal employees, employers receiving financial aid, and employers with federal contracts of $2,500 or more.
Affirmative Action
Affirmative action programs are designed to eliminate discriminatory practices in hiring, retaining, and promoting employees.
Attempt to remedy effects of past discrimination
Give preferential treatment to members of protected groups
Generally, such programs are permitted if required by court order
Defenses
An employer can defend against an action for discrimination by demonstrating actions were due to
Business necessity
Bona fide occupational qualifications
A fair seniority system
Employee misconduct
ANTITRUST
Laws created to promote consumer welfare by enhancing competition
Enforcement
Government may enforce either criminally or civilly.
Private parties may enforce civilly only, but will receive treble (triple) damages if successful.
The Sherman Act
Horizontal Restraints
Involve agreements between competitors
Most horizontal agreements are illegal per se, which means automatically illegal.
Vertical Restraints
Involve agreements between separate businesses in the chain of distribution
Vertical restraints are examined under the rule of reason
Courts examine whether the precompetitive effects of the agreement outweigh the anticompetitive effects of the agreement.
If the agreement on balance is more procompetitive, then the agreement is legal.
Monopolization
Illegal to use monopoly power, generally shown by a market share of 70% or more, to obtain or maintain a monopoly
Intent to monopolize must be proven as well
Clayton Act
Mergers
Mergers that create a substantial lessening of competition are illegal
Mergers that raise entry barriers or create a very concentrated market will substantially lessen competition
Tying Arrangements
Where a seller with economic power forces a buyer to purchase two separate products
The products are tied together so that the purchaser must buy both products
Robinson—Patman Act
Prohibits sellers from charging different prices to different buyers for the same goods; known as price discrimination
Property — Module 34
PROPERTY
Personal Property
Ownership
Acquired through
Possession if not owned
Inheritance
Gift
Confusion through commingling of identical goods
Accession through improvement by other party
Production Ways to obtain ownership of personal property such as a PIG or a CAP
Real Property
Includes land and all permanent structures attached to the land. Also includes mineral and air rights.
Ownership
A fee simple interest is the absolute right to sell or transfer property
Deeds—Voluntary transfers from grantor to grantee; this document transfers ownership of the real property
Warranty deed—“I own this property and am transferring it to you free of claims of third parties that I have not made you aware of.”
Grant deed—“I own this property and am transferring it to you having created no claims against it that I have not told you about.”
Quitclaim deed—“I transfer my interest in this property, if any, to you.”
Adverse possession—Involuntary transfer to party taking possession
Eminent domain—Government takes title
Co-ownership
Tenants in Common
No right of survivorship
May have unequal ownership interests
Joint Tenancy
Right of survivorship
Ownership interests must be identical
Easements are a nonpossessory interest which allows the owner of the easement to use another’s property
Important Property Documents
Contract
Recites the terms of the bargain
Must be in writing
Identify the parties
Provide the purchase price
Describe the property
Deed
Transfers the real property
Must contain the seller’s signature
Must contain a description of the property
Mortgage
A secured interest in real property
Must be signed by the mortgagor (borrower)
Must contain a description of the property
Recording Documents
Documents are not required to be recorded, but they should be recorded to preserve one’s legal rights in the property
Deeds, mortgages, and easements are the primary documents that should be recorded
Each state has a recording statute that determines priority if there are multiple recordings of the same interest
Race Statute: First party to record has the best priority
Notice Statute: If a subsequent recorder of an interest did not have notice of a prior unrecorded interest, then the subsequent party has priority regardless of who records first
Notice-Race Statue: If a subsequent recorder of an interest did not have notice of a prior unrecorded interest, then whichever party records first has the superior interest
For either of the notice statues, the subsequent party cannot have a superior interest if the earlier interest was recorded or if the subsequent party was aware of the earlier interest
Leases
Leases extending beyond one year must be in writing to be enforceable
A lessee is entitled to a covenant of quiet enjoyment
A landlord makes an implied warranty of habitability
Bailments
Created when
Property delivered to bailee
Bailee takes possession
Bailee has absolute duty to return property to bailor
Types of bailees Liable Carrier Strict liability—liable whether or not negligent Warehouser Liable only when negligent Intellectual Property
Trademarks
Provide protection for distinctive marks (e.g., symbols, words, letters, pictures, etc.) that are used to identify goods.
Trademarks may be registered with the government to maximize protection.
Trademarks must be in use or the trademark is lost; if trademark is not used for 3 years the trademark is abandoned.
Infringement
When an unauthorized entity uses a mark that is likely to cause confusion or deception to a buyer
Also includes a weakening of the mark
Patents
Gives inventor exclusive right to use or sell an invention for a period of 20 years
Invention
Must be novel, useful, and nonobvious
Ideas not patentable, but their actual application is patentable
Copyrights
Provides protection for original expressions of ideas (e.g., movies, books artistic works, etc.)
Last for life of creator plus 70 years
Copyrighted works may be used without the permission of the creator under the fair use doctrine
Educational, news, commentary, and not for profit purposes are groups who may fairly use copyrighted material
Use of reasonable portions of the work are permitted
Computer Technology Rights
Software may be copyrighted and/or patented
E-mailing, photocopying, scanning copyrighted material violates copyright laws unless covered by the fair use doctrine.
Trade Secrets
Owner must take extraordinary steps to protect secrecy of the information.
Illegal misappropriation occurs when a competitor or an employee wrongfully obtains, uses, or sells a trade secret.
Parties are legally allowed to discover a trade secret through independent reverse engineering.
Individual Taxation — Module 35
INDIVIDUAL INCOME TAX
Computing Individual Income Tax
Gross income
− Adjustments = Adjusted gross income (AGI) − Standard deduction or itemized deductions − Exemptions = Taxable income × Tax rate = Tentative tax amount − Credits + Self-employment tax + Alternative minimum tax + Total tax − Prepayments = Tax due or refund amount Accounting Method
Individuals generally use the cash method—Not allowed for
Accounting for purchase & sales of inventory
C corporations or partnerships with a C corporation partner
Tax shelters
Business with average gross receipts > $5,000,000
Income is reported when
Cash is received
Property is received
Taxpayer receives an unrestricted right to cash or property (constructive receipt)
Expenses are deducted when
Cash is paid
A check is disbursed
An expense is charged to a credit card
Gross Income
Compensation for Services
Included
Wages, salaries, & tips
Bonuses & commissions
Fees for jury duty
Discounts on purchases of employer’s merchandise to the extent in excess of gross profit percentage
Taxable fringe benefits such as use of company vehicle for personal purposes
Excluded
Health insurance paid by employer
Cost of group term life insurance up to $50,000 in coverage
Employer-provided educational assistance (limited to $5,250)
Fringe benefits incurred for employer’s benefit, such as housing provided to on-site hotel manager
Prizes & Awards
Generally taxable
Excluded from income if an employee achievement award of tangible personal property received from employer for years of employment or safety achievement
Interest
Included in income
Interest received or credited to taxpayer
Interest accrued on zero-coupon bond
Amortization of bond discount
Interest on U.S. Treasury obligations
Interest on tax refunds & insurance policies
Interest portion of annuities received
Interest on Series HH U.S. savings bonds
Excluded from income
Interest on state and municipal bonds
Interest on series EE bonds if the redemption proceeds are used to finance the higher education of the taxpayer, spouse, or dependents
Dividends
Generally included in gross income
Ordinary income distributions from Real Estate Investment Trusts (REITs) are taxed as ordinary income
Capital gain distributions from REITs are taxed as long-term capital gains
Excluded from income
Nontaxable stock dividends
Distributions received from an S corporation
Dividends received on a life insurance policy
Dividends received from mutual funds investing in tax-exempt bonds
Special favorable tax rate available for qualified dividends through 2012
Tax rate 15% if ordinary rate higher than 15%
Tax rate 0% if ordinary rate would otherwise be 10% or 15%
Stock on which the dividend is paid must be held for > 60 days during the 121-day period beginning 60 days before the ex-dividend date
Available for distributions from mutual funds only to extent mutual fund received dividends from taxable corporations
Available for dividends from foreign corporations traded on U.S. stock exchanges
Special rate not available for some dividends
Distributions from REITs
Distributions from partnerships and S corporations
Mutual fund dividends that represent interest income (such as from bond funds)
Other Income
Additional items included in gross income
Rents & royalties including rent collected in advance & nonrefundable deposits
Discount on nonqualified stock option upon exercise
Injury awards for punitive damages or lost profits
85% of social security benefits of high income taxpayers (modified AGI > $60,000)
State tax refunds if originally claimed as an itemized deduction
Proceeds from a traditional IRA of contributions previously deducted
Proceeds from a traditional IRA representing earnings of IRA
Alimony received in cash provided the payments will terminate upon recipient’s death
Unemployment compensation
Additional items excluded from gross income
Damages received for physical injury or lost wages
Workers’ compensation benefits
Social security received by low income taxpayers (modified AGI < $25,000)
Portion of traditional IRA or pension withdrawal of prior nondeductible contributions
Qualified Roth IRA withdrawals
Federal tax refunds
Gifts & inheritances
Life insurance proceeds paid by reason of death
Divorce property settlements
Child support payments
Adjustments for AGI
Items that may be deducted as adjustments for AGI include
Interest on student loans
Employment tax—50% of self-employment tax paid
Moving expense
Business owner health insurance premiums for self and family
Retirement plan contributions
Alimony paid
College tuition and fees (unless American Opportunity or Lifetime Learning Credit claimed)
Early withdrawal penalties on time deposits I EMBRACE adjustments that reduce AGI & lower taxes
Moving Expenses
Moving expenses are deducted if 3 conditions are met
Taxpayer moved due to change in location of job or business
Taxpayer remains employed for at least 39 weeks after the move
Commute from old residence to new job at least 50 miles longer than commute from old residence to old job
Amounts deductible include direct costs of moving family & belongings
Airfares
Shipping & temporary storage
Cost of traveling (including lodging) and transportation to new location (auto depreciation, gas, repairs), or standard mileage rate
Business Expenses (Schedule C)
Include all reasonable business expenses
Employee wages & payroll taxes
Contributions to employee retirement plans
Employee fringe benefits
Interest on business loans
Business taxes
Casualty losses on business property
50% of business meals & entertainment
Bad debts when accounts are written off (generally no deduction for cash method taxpayers)
Gifts to customers & clients up to $25 per recipient per year
A net business loss reduces wages & business income, including net rental income, with any excess carried back or forward
Rent & Royalty Expenses (Schedule E)
Expenses incurred on property generating rent or royalty income reduce the amount of rent or royalty income reported on Schedule E and include
Depreciation or amortization
Mortgage interest
Property taxes
Insurance and maintenance
Rental & royalty properties are generally considered passive activities
Any activity in which the investor does not materially participate
Any real estate rental activity
Passive activity losses are not generally deductible
Investor actively managing real estate rental property with AGI below $100,000 may deduct up to $25,000 per year (reduced by 50% of AGI > $100,000)
Real estate broker or developer may deduct real estate losses if eligibility requirements met
Nondeductible passive activity losses may be carried forward indefinitely or deducted when property sold
Contributions to Retirement Plans
Amounts deducted for contributions to retirement plans are subject to limitations
A self-employed individual may deduct contributions to a defined-contribution
self-employed retirement plan up to the lesser of $50,000, or 100% of earned (for 2012)
An employee may exclude contributions (up to specified amount) contributed to a 401(k) plan
A taxpayer may deduct up to $5,000 for 2012 (plus additional $1,000 if 50 or over) contributed to a traditional IRA, not to exceed earned income
A married couple may deduct contributions to an IRA for each spouse, even though only one spouse has earned income
In order to deduct traditional IRA contributions, taxpayer must
Not participate in a qualified pension or profit-sharing plan at work, and
Have adjusted gross income below a specified level
Roth IRAs
Individuals may contribute to a Roth IRA instead of a traditional IRA
Not available to taxpayers with very high AGI
Subject to same contribution limitation as traditional IRA
Contributions are not deductible
Neither contributions nor earnings subject to income tax when withdrawn
Withdrawn earnings are not taxable provided
Taxpayer is a least 59½ years old
Taxpayer is disabled, deceased, or using withdrawal for first home purchase
Coverdell Education Savings Accounts (ESAs)
Taxpayer may establish ESA
Not available to taxpayers with very high AGI
May contribute up to $2,000 annually for each qualified beneficiary
Must be on behalf of beneficiary under age 18
Contributions not deductible
Distributions not taxable if used for qualified higher education expenses
Additional for AGI Deductions
Penalties paid for early withdrawal, such as cashing a certificate of deposit before maturity, reduce AGI
Employees may be entitled to a jury duty deduction
Applies when employer pays regular salary to employee during jury duty
Employee recognizes both salary and jury duty fees as income
Portion of jury duty fees remitted to employer are deducted in calculating AGI
Deductions
Standard Deduction
Basic standard deduction depends on filing status
Additional standard deduction allowed for
Taxpayer is 65 or older
Spouse is 65 or older
Taxpayer is blind
Spouse is blind
Deduction will be greater of available standard deduction or total of itemized deductions
Itemized Deductions
Itemized deductions include amounts paid for
Contributions
Other deductions
Medical expenses subject to 7½% of AGI threshold
Miscellaneous expenses subject to 2% of AGI threshold
Interest
Taxes
Theft or casualty losses Most taxpayers are committed to deducting the maximum amount allowed
Contributions
Charitable contributions are deductible in the period
Payment is made to a qualified charity
Property is given to a qualified charity
Payment to a qualified charity is charged to a credit card
The amount of the deduction includes
Cash contributions
Property at FMV if contribution of capital gain property
Costs incurred in assisting the charity
The deduction does not include
The value of services performed
The value of goods or services received in return for a contribution
The deduction is limited
Maximum deduction = 50% of AGI (30% if appreciated capital gain property)
Nondeductible amounts may be carried forward up to 5 years
Other Itemized Deductions
Additional items may be claimed as itemized deductions, including
Gambling losses to the extent of winnings included in AGI
Estate taxes on income in respect of a decedent
Amortization of bond premium
Medical Expenses
Deductible medical expenses include
Fees to doctors, hospitals, & other providers of medical care
Amounts paid for prescription drugs
Premiums for health insurance coverage
Transportation to doctor, hospital, or other provider
The deduction is reduced by
Reimbursements received or to be received from insurance
7½% of AGI
Miscellaneous Expenses
Deductible miscellaneous expenses include
Employee business expenses
Investment expenses
Tax preparation fees
Employee business expenses include reasonable unreimbursed costs such as
Union or professional dues
Trade journals
Transportation to clients or customers
Costs incurred on business trips including airfare, hotel, taxi, telephone, & 50% of business meals & entertainment
Uniforms
Depreciation on business assets owned by employee
Continuing education required to maintain employment
Employee business expenses do not include commuting to work or education obtained to qualify for new occupation (such as a CPA review course)
Deductible investment expenses include
Safe-deposit box rent
Subscriptions to investment periodicals
Fees paid to financial advisors
Cost of collecting income
Total miscellaneous expenses are reduced by 2% of AGI
Interest Expense
Deductible interest includes interest on home mortgage loans on first or second home
Loans to buy, build, or improve the home up to $1,000,000
Loans on home equity up to $100,000
Loans on second homes are included provided the total falls within the limitations
Interest on personal indebtedness is not deductible
Car loans
Credit card debt
Taxes
Deductible taxes include
State and local income taxes (sales taxes may be claimed instead if higher)
Real property taxes
Personal property taxes (including vehicle fees that are based on FMV)
Foreign taxes paid, unless foreign tax credit is elected
Certain taxes are not deductible
Inheritance tax
Federal taxes, including federal income tax & FICA
Fines
Licensing & vehicle registration fees (unless based on FMV of vehicle)
Casualty or Theft Losses
Amount deductible based on decline in value of property as a result of theft or casualty
May not exceed adjusted basis for property
Must result from an identifiable event rather than a gradual decline in value
Each loss is reduced by
Insurance reimbursements received or expected
$100 floor
Total losses for the year are further reduced by
10% of AGI
If NOL results from casualty & theft losses, can carry back 3 years instead of normal 2 years.
Exemptions
Taxpayers may deduct personal exemptions and exemptions for dependents ($3,800 each for 2012)
Personal Exemptions
A taxpayer may claim a personal exemption as a reduction of taxable income
A married couple may take one exemption for each spouse on a joint return
An individual who is a dependent on someone else’s tax return may not claim a personal exemption
Dependency Exemptions
Dependency requirements
Must be US citizen, or resident of US, Canada, or Mexico
Must not file joint return with spouse
Exception—no tax liability would exist for either spouse on separate returns
Must be qualifying child or qualifying relative of taxpayer
Qualifying Child must satisfy 4 additional requirements
Relationship—taxpayer’s child, stepchild, sibling (or a descendent of any of these individuals)
Age—child must be under age 19, or under 24 and full-time student
Support—child must not provide more than half of own support
Housing—child must live with taxpayer for more than half of year
Qualifying Relative—must satisfy 4 additional requirements
Must not be qualifying child
Related to taxpayer (closer than cousin), or live in taxpayer’s household for entire year (exceptions include birth, death, illness, education, military service)
Support—taxpayer must provide more than half of dependent’s support
Gross income—dependent’s gross income must be less than amount of exemption
($3,800 for 2012)
Credits
Several credits may reduce a taxpayer’s total tax
Dependent care credit
Credit for the aged & disabled
Earned income credit
Child tax credit
American Opportunity & lifetime learning credits
Foreign tax credit
Earned Income Credit
To qualify, taxpayer must meet 2 conditions
Taxpayer has earned income
Taxpayer provides support for a dependent child or grandchild
The earned income credit is refundable
Treated as if paid
Results in refund if credit exceeds tax liability
Credit for Aged or Disabled
Allowed for individuals with low income who are over 65 or permanently disabled
Dependent Care Credit
A credit is allowed for
Generally 20% × amounts paid to care for a qualifying dependent
Maximum payments subject to credit = $3,000 for 1 dependent, $6,000 for 2 or more dependents
Taxpayers with AGI ≤ $15,000 may take credit of 35% (reduced by 1% for each $2,000 above AGI of $15,000 until reduced to 20% at AGI of $43,000)
Dependent must be either
Child under age 13
Disabled spouse or dependent of any age
Child Tax Credit
May be claimed for each child under 17
Credit $1,000 per child for 2012, but reduced for high-income taxpayers
Modified HOPE Credit
May be claimed for first four years of postsecondary education
Credit equals 100% of first $2,000 of tuition and fees plus 25% of next $2,000
Maximum credit $2,500 per qualified family member
Lifetime Learning Credit
May be claimed for tuition and fees not eligible for American Opportunity Credit
Credit equals 20% of first $10,000 of tuition and fees
Maximum credit $2,000 per family
Self-Employment Tax
Employer & employees pay payroll taxes
Medicare tax paid equally on 100% of wages
FICA paid equally on wages up to a base amount ($110,100 for 2012)
Self-employed individuals pay employer’s & employee’s shares
Net earnings from self-employment × Rate = Self-employment tax
50% of self-employment tax is deduction for AGI
Alternative Minimum Tax (AMT)
Taxable income
± Adjustments & preferences = Alternative minimum taxable income (AMTI) − Exemption = Base × Tax rate = Tentative minimum tax − Regular tax liability = AMT The primary adjustments to income in calculating AMTI are
Standard deduction
Interest on home equity loans
Medical expenses subject to 10% of AGI limitation
Personal and dependency exemptions
Local and state tax deductions
Employee and investment expenses subject to the 2% of AGI rule
The primary preferences are
Private activity bond interest Incentive stock options Excess depreciation It’s as simple as pie to remember the adjustments and preferences for AMTI AMTI is reduced by the exemption amount (varies based on filing status)
$74,450 for joint filers
$48,450 for individuals
$37,225 married filing separately
Resulting base amount × Tax rate = Tentative minimum tax
26% × first $175,000
28% × (Base amount – $175,000)
Tentative minimum tax – Regular income tax = AMT adjustment
If tentative minimum tax > regular income tax = difference increases tax amount
If tentative minimum tax > regular income tax = no AMT
AMT paid is allowed as a credit (minimum tax credit) that can be carried forward to reduce future regular tax liability
Tax Payments
Tax payments include
Excess payroll taxes withheld
Federal income taxes withheld
Estimated tax payments
Excess Payroll Taxes
Employees with 2 or more employers
Total wages may exceed base amount for FICA ($110,100 for 2012)
Maximum FICA = Base amount × FICA rate
Excess withheld treated as tax payment
Penalties for Late Payment
Penalty imposed for late payment of taxes unless
Underpayment for year < $1000
Payments ≥ 90% of current year’s liability
Taxes paid ≥ 100% of prior year’s liability (110% for taxpayers with AGI > $150,000)
Filing Status
A taxpayer’s filing status will determine the rates and various amounts used in computing taxable income & the tax liability
Married Couples
Choice of 2 alternatives
Married, filing jointly
Married, filing separately
Must be married as of last day of year or date of death if one spouse died during the year
Unmarried Individuals
One of 3 alternatives
1) Qualified widow or widower Must be providing > half the costs of maintaining household for dependent child
Available for 2 years after death of spouse
Joint return was filed for year of spouse’s death
2) Head of household Generally must provide > half of costs of maintaining household for qualifying child or dependent relative living in the same home as taxpayer for more than ½ of year
Taxpayer’s parent need not live in same home if taxpayer maintains parent’s household and parent qualifies as taxpayer’s dependent
3) Single—all others Carryover Rules
Carryback Carryforward Charitable contributions No 5 years Net operating losses 2 years∗ 20 years Net capital losses Corporations 3 years 5 years Individuals No
Indefinitely Investment interest No Indefinitely Net passive losses No Indefinitely, or deducted when investment sold Net gambling losses No No NOTE: NOL carryback 3 years for casualty & theft losses & small business federal disaster losses.
Tax Return Schedules
An individual files his or her tax return on a Form 1040 along with some or all of the following supplementary schedules
Schedule A—Itemized Deductions
Schedule B—Interest & Dividend Income
Schedule C—Profit or Loss From Business
Schedule D—Capital Gains & Losses
Schedule E—Supplemental Income & Loss
Form 4797—Sale of Business Property
Schedule 1116—Foreign Tax Credit
Filing Requirements
Who Must File
Individuals with
Gross income > personal exemption + standard deduction
Net earnings from self-employment ≥ $400
Gross income > personal exemption (if married filing separately)
When to File
Individual tax returns due on or before April 15
Automatic six-month extension available to October 15
Claims for Refunds
Overstatement of income on original return
Amended return on form 1040X
Must file within 3 years from when return was filed, or two years from payment of tax, whichever is later
A return filed early is treated as filed on due date
Statute of Limitations
Time IRS has to impose additional taxes & penalties on taxpayer
Begins day after return is filed or due date including extensions, whichever is later
Time period depends on nature of error
Taxpayer Error Time Period Simple negligence 3 years Gross income omission ≥ 25% of income on return 6 years Fraud or failure to file No
limit Depreciation
Depreciable Real Property
Depreciable real property is Section 1250 property, subject to the following rules:
Recovery Period
27.5 years for residential real property
39 years for nonresidential real property
Depreciation Method
Depreciation calculated using straight-line method
Midmonth Convention
Year of purchase & year of sale
Assumed purchased or sold in middle of month of transaction
½ month’s depreciation taken regardless of date of transaction
Depreciable Personal Property
Depreciable personal property is Section 1245 property, subject to the following rules.
Recovery Period
Determined by class of asset
Equipment, office furniture and fixtures—7 years
Cars, light trucks, computers, and office equipment—5 years
Small tools—3 years
Depreciation Method
General MACRS method is 200% declining balance method, but taxpayer may elect to use either of 2 other methods
150% declining balance method (class-by-class election)
Straight-line method using the alternative depreciation system (ADS)
Half-Year Convention
Generally required
Assumes assets acquired or sold in middle of tax year
Half-year’s depreciation taken in year of acquisition & in year of sale
Midquarter Convention
Must be used if >40% of all personal property placed in service during last 3
months of tax year
Assumes assets acquired or sold in middle of quarter in which transaction occurs
Results in 1/8 of annual deduction if property placed in service during last quarter of year
Section 179 Expense Election
Annual election to treat the cost of qualifying property as expense instead of capital expenditure
Applies to new or used tangible personal property purchased for use in a business
Deductible up to lower of net business earnings or $139,000 for 2012
Reduced dollar-for-dollar by cost of property acquired in excess of $560,000 for 2012
Amount deducted reduces depreciable basis of assets Example—Company purchases $539,000 of used business equipment during September 2012 (assume no other property purchases during year). Taxpayer wants to claim maximum deduction for 2012 Section 179 Election—$139,000 deduction (maximum allowed for 2012) Regular MACRS Depreciation—$57,143 ($400,000 basis after Section 179 deduction × 2/7 DDB × ½ year) Total Deduction for 2012—$196,143 ($139,000 + $57,143)
Transactions in Property — Module 36
PROPERTY TRANSACTIONS
Realized Gain or Loss
Amount realized
− Adjusted basis = Realized gain or loss Amount Realized
Cash received
+ FMV of property received + Net debt relief − Direct selling expenses = Amount realized Net debt relief = Liabilities transferred − Liabilities assumed
Adjusted Basis
Initial basis
+ Improvements − Depreciation − Costs recovered ± Adjustments = Adjusted basis Initial Basis Property converted from personal use to business or investment use Lower of actual basis or FMV on date of conversion Inherited property FMV at date of death or alternate valuation date (date of distribution up to 6 months after death) Property received as gift Gain = Same as donor’s basis (transferred basis) Loss = Lesser of (a) Gain basis, or (FMV) at date of gift Sec. 1245 Depreciation Recapture
Applies to the disposition of depreciable personal property (e.g., trucks, autos, machinery, equipment)
Realized gain
− Depreciation recapture (treated as ordinary income) = Section 1231 gain Amount of depreciation recapture
Realized gain > accumulated depreciation – use amount of gain
Realized gain ≥ accumulated depreciation – use accumulated depreciation
Taxation of Gains & Losses
Tax Treatment Ordinary assets Inventory
Business receivables
Self-created artistic works
Business assets held ≤ year
Regular rates Section 1231 assets (business assets held > year) Depreciable or amortizable business assets
Land used in business
Net gain—generally treated as LTCG Net loss—ordinary loss deduction Capital assets all others INDIVIDUALS LTCG – Reduced rates STCG – Regular rates Net loss – Max of $3,000 during current year. Carryforward indefinite. CORPORATIONS Net loss—not deductible Carryback 3 years. Carryforward 5 years. Related-Taxpayer Transactions
Related taxpayers include
Taxpayer’s spouse, brothers, sisters, ancestors (parent, grandparent, etc.), lineal descendants (child, grandchild, etc.)
Corporation or partnership where direct or constructive ownership > 50%
Tax effects
Losses—not deductible by seller Buyer’s basis—purchase price Buyer’s subsequent gain on sales—taxed to extent subsequent gain > nondeductible loss Special Transactions
Type of Transaction Special Rule Sale of personal assets Gain recognized as capital gain; losses are not deductible Wash sales—Taxpayer acquires same stock or securities within 30 days before or after selling stock or securities at a loss Loss not recognized, but added to basis of new stock or securities Related-party transactions Losses not recognized Like-kind exchanges Losses not recognized Gains recognized to extent of boot received Involuntary conversions Replacement property acquired within 2 years of end of year in which gain realized for casualty or theft, 3 years for
condemnation If cost of replacement property ≥ proceeds—no gain recognized If cost of replacement property < proceeds—Gain recognized = Proceeds – cost or replacement property Installment sale Gain recognized: Gross Profit × Amount received in year ÷ Total sales price Sale of principal residence If taxpayer owned and lived in home at least two of the five years preceding sale Up to $250,000 of gain excluded ($500,000 for married filing jointly). Gain in excess of exclusion is recognized as capital gain. Excluded gain does not affect basis of new residence
Partnership Taxation — Module 37
PARTNERSHIP TAXATION
Formation of Partnerships
Contribution of Assets
When a partner contributes cash or property for a partnership interest, the transfer is generally nontaxable
Partner’s basis in partnership = basis for assets contributed
Partnership’s basis for assets = partner’s basis (transferred basis)
Contribution of Services
When a partner contributes services for an interest in partnership capital, the FMV of the partnership interest received is taxable as compensation
Partner recognized income and basis for partnership interest = FMV
Partnership recognizes expense or asset = FMV
Changes in Liabilities
Changes in liabilities are treated as a change in the flow of money and either increase or decrease a partner’s basis—
Increased by an increase in partnership liabilities, or an increase in individual liabilities (treat as a contribution of money and increase basis)
Decreased by a decrease in partnership liabilities, or a decrease in individual liabilities (treat as a distribution of money and decrease basis)
Partnership’s Tax Year
Adoption or change of partnership tax year restricted by tax years used by its partners
1) Adopt same tax year as used by partners owning > 50% of partnership interests 2) If partners owning > 50% of interests do not have same year, adopt tax year used by partners owning ≥ 5% interest if all have same tax year 3) If all partners with ≥ 5% interest do not have same tax year, use year that results in least deferral of income to partners Taxation of Partnerships
Partnerships are pass-through entities, not taxable entities
Similar to S corporations
Partnership files Form 1065 tax return; due by 15th day of fourth month following end of tax year
Prepare form K-1 for each partner indicating partner’s share of income & expenses
Partnership’s income & expenses pass through to partners
Separate items into ordinary income and deductions items which can be netted, and items having special tax characteristics which must be separately passed through to partners to retain those characteristics
Partner combines with similar items incurred individually from other sources
Combined amounts subject to normal limitations at partner level
Guaranteed Payments to Partners
Guaranteed payments to partners are amounts partners are entitled to regardless of partnership’s profit or loss
May be
Salary for services performed
Interest based on capital investment in partnership
Taxed as follows
Partner recognizes as ordinary income (generally self-employment income)
Partnership deducts in calculating partnership ordinary income or loss
Partners’ Distributive Shares
Partners report their distributive share of all partnership items for the partnership year that ends with (or within) their taxable year
Items are deemed to pass through on the last day of partnership tax year
Partner’s Basis
Initial basis
± Changes in liabilities + Partner’s share of income (including tax-exempt income) − Distributions (Cash + the adjusted basis of property) − Partner’s share of expenses and losses (including nondeductible items) = Partner’s basis for partnership interest Initial basis = cash, adjusted basis of property, & FMV of services contributed
Partner’s share of income or loss = partner’s proportionate share of all of partnership’s income & expenses, regardless of nature
Distributions = cash and adjusted basis of property distributed to partner
Partner’s proportionate share of partnership’s liabilities are added to basis
Partner’s liabilities that are transferred to the partnership reduce basis
Distributions
Nonliquidating Distributions
Cash distributed
Reduces partner’s basis for partnership interest
Taxable to extent distribution > basis
Noncash property distributed
Basis to partner = lower of partnership’s basis for property or partner’s basis for partnership interest
Basis for partnership interest reduced by partner’s basis for distributed property
No gain or loss recognized by partnership or partners
Liquidating Distributions
Distributions to partner that terminate partner’s entire partnership interest
Cash distributions
Difference between amount received & partner’s basis for partnership interest = recognized gain or loss
Remaining basis in partnership = $0
Noncash property distributions
Basis of property to partner = former basis for partnership interest
Remaining basis in partnership = $0
Generally no gain or loss recognized
Sale of Partnership Interest
Determining Gain or Loss
Amount realized from sale
− Basis for partnership interest = Gain or loss Amount realized = Cash + FMV of property received + Assumption of selling partner’s share of partnership liabilities
Include partner’s share of liabilities in basis for partnership interest
Taxation of Gains & Losses
Gain or loss divided into 2 segments
Ordinary income will result to extent of partner’s share of unrealized receivables & appreciated inventory (unrealized receivables include recapture potential in depreciable assets)
Any remaining amount is capital gain or loss
Termination
Partnership terminates and its tax year closes when either
Partnership no longer has at least two partners, or stops doing business
More than 50% of total partnership interests are sold within a 12-month period
Corporate Taxation — Module 38
CORPORATE INCOME TAX
Section 351 Transfer to Controlled Corporation
No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if the transferors of property (in the aggregate) control the corporation
Property includes cash and everything but services
Control is the ownership of at least 80% of the corporation’s stock
Services for Stock
Taxable transaction
Taxable compensation to shareholder = FMV of stock
Shareholder basis for stock = FMV
Corporation has expense or asset = FMV of stock
Property for Stock
Generally a nontaxable transaction
Whenever shareholders providing cash & property have total ownership ≥ 80%
Shareholder basis for stock = basis for asset given (exchanged basis) + gain recognized – boot received
Corporation basis for asset = same as shareholder’s basis + gain recognized to shareholder
Taxable transaction
When shareholders providing cash & property have ownership ≥ 80%
Shareholder recognizes gain or loss = FMV − Basis
Shareholder basis for stock = FMV
Corporation basis for asset = FMV
Computing Corporate Income Tax
Gross income
− Deductions = Taxable income × Tax rate = Preliminary tax liability + Personal holding company tax + Accumulated earnings tax + Alternative minimum tax = Total tax liability − Credits = Net tax liability − Estimated payments = Tax due (or refund) Gross Income
General concept of gross income applies to a corporation
Corporation never recognizes gain or loss when it issues its own stock
Corporation’s net capital gain is taxed at ordinary rates
No income is recognized by a corporation on receipt of capital contribution
If received from a shareholder, property has a transferred basis
If received from a nonshareholder, property has a zero basis
Deductions
Deductible expenses include
Ordinary & reasonable operating expenses
Compensation costs including wages & bonuses
Employer payroll taxes
Fringe benefits including health & life insurance when employee selects beneficiary
Interest on business indebtedness
Bad debts when a specific debt is written off
Meals & entertainment × 50%
Straight-line amortization of goodwill over 15 years
May deduct up to $5,000 of organizational expenditures (reduced by excess of costs over $50,000) and amortize remaining costs over 180 months beginning with the month that business begins. Business investigation and start-up costs (advertising, employee training) are subject to same rule.
Nondeductible expenses include
Fines, penalties, & punitive damages
Compensation in excess of $1,000,000 paid to each of 5 highest paid executives
Accrued compensation and charitable pledges not paid within 2½ months after year-end
Interest expense on debt used to acquire nontaxable investments
Premiums on key person insurance if company is beneficiary
Club dues
Cost of issuing, printing, & selling stock
Charitable Contributions
1) Generally deductible when paid, but accrual method can elect to deduct when accrued if authorized by board of directors before year-end and paid within 2½ months after year-end 2) Excess carried forward 5 years 3) Deduction limited to 10% of contribution base which is TI before charitable contributions, DRD, NOL carryback, capital loss carryback, and domestic production activities deduction Dividends-Received Deduction
1) Determine % for deduction Corporation’s ownership < 20%—Deduct 70%
Ownership ≥ 20% but < 80%—Deduct 80%
Ownership ≥ 80%—Deduct 100% if consolidated tax return not filed
2) Apply % to dividends or taxable income before deduction, whichever is lower 3) Exception—If % × dividends > taxable income, use entire amount, resulting in loss Does not apply to
Dividends from a foreign corporation
Dividends from a tax exempt organization
Personal Holding Company (PHC) Tax
Corporation is subject to PHC tax if 2 conditions apply
1) Interest, dividends, rents, royalties, or personal service contracts > 60% of gross income 2) 5 or fewer shareholders own > 50% stock PHC tax
Self-assessed on Schedule PH which is attached to Form 1120
Amount = 15% × Undistributed PHC income
Added to regular tax
Can be reduced by actual and consent dividends
Consent dividends—Hypothetical dividends that are treated as paid on last day of corporation’s tax year. Shareholders report dividend income and increase stock basis by the amount of consent dividend.
Accumulated Earnings Tax
The accumulated earnings tax is not self assessed
Does not apply to PHCs
Generally assessed on earnings accumulated in excess of reasonable business needs
Corporation allowed to deduct accumulated earnings credit which is greater of Earnings needed to satisfy reasonable business needs, or Minimum credit of $250,000 (or $150,000 for service corporation) less AEP at beginning of year
Accumulated earnings tax = 15% × Accumulated taxable income
Added to regular tax
Can be reduced by actual and consent dividends
Alternative Minimum Tax (AMT)
Regular taxable income
± Preferences & adjustments = Pre-ACE alternative minimum taxable income (AMTI) ± ACE adjustment [75% of difference between pre-ACE AMTI and adjusted current earnings (ACE)] = Alternative minimum taxable income − Exemption ($40,000 less 25% of AMTI over $150,000) = Base × Tax rate (20%) = Tentative minimum tax − Regular tax liability = AMT Adjustments & preferences are added back to or deducted from taxable income in computing AMTI. They include
Interest on private activity bonds
Difference between regular tax 200% DB depreciation and 150% DB depreciation allowed for AMT purposes
Installment can’t be used for sale of inventory-type items
Adjusted current earnings (ACE) adjustment
ACE = Adjusted current earnings
Pre-ACE AMTI
+ Nontaxable revenues − Nondeductible expenses = ACE Adjustments to taxable income in computing ACE generally include
Seventy percent dividends received deduction
Life Insurance proceeds
Municipal bond interest on general obligation bonds There’s a slim chance that you’ll avoid the AMT.
ACE adjustment = 75% × (ACE − Pre-ACE AMTI)
AMTI is reduced by the exemption amount
Exemption = $40,000 − 25% × (AMTI − $150,000)
Resulting base amount × AMT tax rate = Tentative minimum tax
Tentative minimum tax – Regular income tax = AMT
If tentative minimum tax > regular income tax, it increases the amount of tax paid
AMT paid in current year is carried forward as credit to reduce regular taxes in future years
Foreign Tax Credit
Reduces US income tax for amount of income taxes paid to foreign jurisdictions
Credit = smaller of
Amount of foreign tax paid, or
Foreign taxable income ÷ Total taxable income × Total US tax liability
Supplemental Tax Schedules
Corporations complete 2 supplemental schedules on their tax returns
Schedule M-1 reconciles book income to taxable income
Schedule M-2 reconciles beginning to ending retained earnings per books
Schedule M-3is a more detailed version of the M-1 required for corporations with total assets in excess of $10 million
Nonliquidating Distributions to Shareholders
Property Distributions
Treated as dividends when paid from earnings & profits (E&P)
Can be paid out of current E&P computed at end of tax year, even if accumulated E&P is negative amount
Can be paid out of accumulated E&P, even if current E&P is negative amount to extent of accumulated E&P still remaining at distribution date
Distribution in excess of E&P
Nontaxable return of stock basis
Capital gain to extent in excess of stock basis
Property Distributions
When noncash property is distributed
Corporation recognizes gain if FMV > basis
Corporation not permitted to recognize loss if FMV < basis
Shareholder recognizes dividend equal to FMV of property − liabilities assumed
Shareholder’s basis for property received = FMV
Corporate Complete Liquidation
Distributions of assets upon termination are liquidating distributions
Corporation recognizes gain or loss when FMV ≠ basis in assets distributed
Shareholder generally recognizes capital gain or loss when FMV ≠ basis in stock
Upon liquidation of an at least 80%-owned subsidiary
Subsidiary recognizes no gain or loss on distribution of assets to parent
Parent recognizes no gain or loss on cancellation of stock
Parent’s basis for assets = same as subsidiary’s basis (transferred basis)
Tax attributes of subsidiary (E&P, NOLs, credits) carry over to parent
Corporate Reorganizations
Mergers & Acquisitions
Assets, liabilities, and tax attributes of acquired corporation are transferred to acquiring corporation
When shareholders receive stock in acquiring corporation for shares in acquired corporation
No gain or loss recognized except to extent of cash or other boot received
Basis for new shares = Basis for old shares + gain recognized – boot received
Spin-offs and split-offs
One corporation divides into 2 or more separate corporations
Affiliated Corporation Transactions
Affiliated parent-subsidiary relationship exists when one corporation owns at least 80% of total voting power and total value of another corporation’s outstanding stock
Companies may elect to file consolidated return
Intercompany dividends and gains and losses on intercompany transactions are eliminated in consolidation process
Section 1244 Stock
Treatment as section 1244 stock applies if 2 conditions are met
Stock was issued as part of first $1,000,000 of capital raised by company
Shareholder must be the original holder of stock, and an individual or partnership
Sale or exchange of section 1244 stock
Gains treated as capital gains
Losses treated as ordinary deduction to maximum of $50,000 per year ($100,000 on joint return). Loss in excess of limitation treated as capital loss
S CORPORATIONS
S Corporation–a pass-through entity
Eligibility Requirements
S corporation status requires all of the following:
# of shareholders ≤ 100
Husband and wife are treated as a single shareholder (all descendents and spouses within 6 generations of a single ancestor may elect to be treated as a single shareholder)
Shareholders limited to individuals, estates, and trusts with one income beneficiary
Only 1 class of stock (voting and nonvoting stock are treated as a single class of stock)
Election
Corporation must elect S corporation status
All shareholders must elect unanimously
All eligibility requirements must be met on date of election
Election made during first 2½ months of tax year is generally effective for that year
Election made after first 2½ months of tax year is generally effective for following year
Conversion from C to S Corporation
An S corporation is generally not taxed on its income
When a C corporation elects S corporation status, it may be subject to
1) Built-in gain (BIG) tax—Applies when company sells appreciated built-in gain assets within 10 years of election S corporation pays tax at highest corporate rate (35%) on net recognized built-in gain FMV of assets at effective date of election − Adjusted basis of assets = Net unrealized built-in gain
2) Tax on excess net passive investment income—Applies when investment income > 25% of gross receipts from all sources and corporation has AE&P from C years S corporation pays tax at highest corporate rate (35%) on lessor of passive investment income in excess of 25%, or taxable income
Gains on sales of stocks or securities not considered passive investment income
Taxation of S Corporations
S corporation is a pass-through entity
S corporation must file
Form 1120S tax return (due 2½ months after end of year)
Form K-1 for each shareholder indicating each shareholder’s share of income & expenses
S corporation’s income & expenses pass through to individual shareholders
All ordinary income and deduction items can be netted with the net amount passed through to shareholders
All items having special tax characteristics must be separately stated when passed through to shareholders
Each item is combined with comparable items recognized by the shareholder
S Corporation Earnings
Pass-Through Item Tax Treatment Capital gains & losses Combined with shareholder’s capital gains and losses Section 1231 gains & losses Combined with shareholder’s Sec. 1231 gains and losses Charitable contributions Subject to 30% and 50% limitations at shareholders level Interest & dividend income & related expenses Investment interest expense deductible to extent of net investment income Net rent & royalty income Subject to passive activity loss limitations Section 179 deduction Subject to dollar limitation at both corporate and shareholder level Tax credits Limited to shareholder’s tax liability Tax-exempt income & related expenses Income exempt to shareholders Expenses not deductible by shareholder Tax preferences & adjustments Used to compute shareholder’s AMT Net all ordinary and deduction items (nonseparately stated income or loss) Treated as ordinary income or loss Loss deduction limited to shareholder’s stock and debt basis Shareholder’s Basis
A shareholder’s basis for S corporation stock is adjusted in the following order
Initial basis
+ Share of income (including exempt income) − Distributions received − Share of loss (including nondeductible expenses) = Basis for stock All S corporation income and deduction items are allocated per-share, per-day
A shareholder who disposes of stock is treated as the shareholder for the day of disposition
Basis adjustments for distributions are taken into account before expenses and losses
Distributions to shareholders are generally a nontaxable return of stock basis
because they represent income that has already been taxed to the shareholder
Termination of S Corporation Status
Either of the following will cause a corporation to lose its S corporation status:
Shareholders owning > 50% of shares vote to revoke election
Fail eligibility requirements. Termination is effective on date eligibility requirement failed.
Once terminated, corporation must generally wait 5 years to elect again
Other Taxation Topics — Module 39
TAXATION OF ESTATES & TRUSTS
Estates
Results from death of individual
Assets become part of estate
Investments generate income
Estate taxed on earnings
Trusts
Types of Trusts
Simple trusts
Must distribute all income each year
Cannot make charitable contributions
Cannot distribute trust corpus (principal)
Complex trusts—all others
Trust Operations
Taxation of Trusts
Grantor (revocable) trust
Creator has right to withdraw assets at any time
Earnings taxed to creator (as if trust did not exist)
Irrevocable trust
Creator generally may not withdraw assets
Trust taxed separately from creator or beneficiaries
Computing Taxable Income of Trusts & Estates
Gross income
− Deductions − Exemption = Taxable income Gross Income
Same rules as for individuals
Includes
Rents
Dividends
Interest
Capital gains
Deductions
Generally similar to those available to individual
In addition
Charitable contributions—No limit on amount
Management fees—Fees paid to trustee or executor Trust or estate may have nontaxable income Proportionate amount of fees not deductible
Distributions paid—Amounts paid to beneficiaries
Exemption
Estate—$600
Simple trust—$300
Complex trust—$100
Distributable Net Income (DNI)
DNI is maximum amount of distribution that can be taxed to income beneficiary
Includes most income & expense items on trust tax return
Includes municipal bond interest
Does not include net capital gains (allocated to principal)
Taxation of Beneficiaries
Not taxed on inheritance of estate property
Taxed on distributions of income up to DNI
Filing Issues
Trusts Estates Reporting period Calendar year Calendar or fiscal year Begins on date of death Tax return due date April 15 of following year 3½ months after close of year Estimated quarterly tax payments Required Not required for first 2 years Required after Exemption amount Simple—$300
Complex—$100 $600 Estate & Gift Tax
Total taxable gifts during lifetime
+ Total taxable estate = Total taxable transfers × Tax rates = Tentative tax amount − The unified credit − Other credits = Tax due Taxable Gifts
Include
Gifts of cash or FMV of noncash property
Discount on sale of property to family member
Reduction in interest on loans to family members at low rates
Exclude
Donations to political organizations & charities
Discounts given in negotiated transaction between independent parties
Parental support of minor child
Payments to college or health care provider for donee’s tuition or medical care
Reduce by
Marital deduction (unlimited)
Gift exclusions
Marital Deduction—Property given to a spouse is not taxable if spouse obtains either
Complete ownership of property
Right as trust beneficiary to income from property for remainder of beneficiary’s life (Qualified Terminable Interest Property trust or QTIP trust)
Gift Exclusions
May exclude up to $13,000 per donee per year in 2012 if gift of present interest
Married couple making gift-splitting election may exclude twice as much per donee per year
Donee must generally receive present interest in gift
Donee obtains an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property
If donee is given a future interest, present value of gift is fully taxable (no $13,000 exclusion)
Taxable Estate
Gross estate—All property owned at time of death
Includes
Proceeds from life insurance policies where deceased could change beneficiary
Assets held in revocable trust
Half of property owned jointly with spouse
FMV of property x % of cost furnished by decedent if property held in joint tenancy with other than spouse
Gifts of life insurance policies within three years of death
Gift tax paid on all transfers made within three years of death
Valued at either
Fair value at date of death
Alternate valuation date (earlier of date of distribution from estate or six months after death)
Reduce by
Charitable bequests
Marital deduction
Casualty losses
Expenses and liabilities
Charitable bequests—Unlimited deduction for amounts left to charitable organizations
Marital deduction—Unlimited amount subject to same rules as gifts
Expenses & Liabilities—Deductions for
Liabilities incurred prior to death
Funeral costs
Administrative fees
Medical expenses
State death taxes
Administrative fees may be deducted as either a liability on the estate tax return, or an expense deduction on the estate’s income tax return
Medical expenses incurred during decedent’s lifetime may be deducted as claims against the estate, or as a medical deduction on the decedent’s income tax return if paid within one year of death
State death taxes are now only a deduction (no longer qualify as a credit).
Tax Due
Tentative Amount
Total taxable transfers
× Tax rates (from table) = Tentative tax amount Unified Credit
Credit designed to remove relatively small gifts and estates from the transfer tax
The exemption equivalent of the credit is $5 million, for both gift and estate tax purposes for 2012 (scheduled to be $1 million after 2012)
Other Credits
Credit for death tax paid to foreign country on real estate owned in that country
Gift taxes paid on prior transfers (actually considered prepayment of liability rather than credit, but has same effect as credit to reduce balance due)
Generation-Skipping Tax
Owed on transfers (both gifts and inheritances) two or more generations below
transferor
Transfers to grandchildren, great-nieces, and great-nephews normally included
Not applicable if immediate generation below is deceased (no GST on transfer to grandchild if the transferor’s child is deceased)
Exemption equivalent for GST same dollar amount as gift and estate tax exemption ($5 million for 2012; scheduled to be $1 million after 2012)
GST owed in addition to applicable gift and estate taxes
Property Received by Inheritance or Gift
Inheritance
Excluded from recipient’s gross income
Basis—Fair market value reported on estate return
Value at date of death (use this if no estate tax return filed)
Value at alternate valuation date if elected on estate return (earlier of date of distribution to recipient or fair value exactly six months after death)
Holding period—automatically long-term
Gift
Receipt of gift excluded from recipient’s gross income
Donee’s basis for gain—basis (& holding period) same as donor’s
Donee’s basis for loss—lesser of gain basis, or FMV at date of gift
If FMV at date of gift is used to determine a loss, then holding period begins on date of gift
If donee’s selling price is below gain basis and above loss basis, then no gain or loss
Tax Return Due Dates
Assuming taxable year ended December 31
Tax Return Due Date Individual income tax return April 15 of following year Amended individual income tax return Within 3 years from when original return filed (early return treated as filed on due date) Gift tax return April 15 of following year Trust income tax return April 15 of following year Estate income tax return April 15 of following year Partnership tax return April 15 of following year Corporate tax return March 15 of following year S corporation tax return March 15 of following year S corporation status election March 15 of current year Exempt organization tax return May 15 of following year Estate tax return 9 months after date of death
INCOME TAX RETURN PREPARERS
Procedures for Return Preparation
Make reasonable effort to obtain client information to answer all questions on return, except
Information not readily available and not significant in determining tax liability
Meaning of question is unclear
Answer is voluminous and return states data will be supplied upon examination
Need not verify client information
Must make reasonable inquiries when information appears incorrect or incomplete
Should ask about availability of support where required by IRS (e.g., log for travel & entertainment expenses or receipt for charitable contributions over $250)
Should refer to past returns of client when feasible
When CPA becomes aware of error on return
Inform the client (written communication of important advice preferred, but not required)
Recommend appropriate correction or notification
Consider withdrawing from relationship if client refuses to correct (must not notify IRS without client permission)
Tax Preparer Penalties
Minor violations
Disclose confidential information from client’s return
Endorse or deposit client’s refund for preparer’s benefit
Fail to sign return as preparer
Fail to provide client with copy of filed return
Fail to keep copies of client returns for at least 3 years
Fail to keep list for at least 3 years of employees preparing returns
Major violations
Understatement of tax liability due to an undisclosed position for which there is not substantial authority (at least 40% probability of success): penalty is greater of $1,000 or 50% of income to be derived from return or claim
Willful attempt to understate tax liability, or intentional or reckless disregard of rules and regulations; penalty is greater of $5,000 or 50% of income to be derived from return or claim
No violation
Adequate disclosure and a showing that there was a reasonable basis (at least 20% probability of success) for the position
Reasonable cause for the understatement and the preparer acted in good faith
Use estimates when client did not maintain adequate records
Rely on information supplied by client not appearing incorrect or inconsistent
Index
Acceptance
Accountants’ Liability
Accounting Method
Accumulated Earnings Tax
ADA & Rehabilitation Act
Additional for AGI Deductions
ADEA
Adjusted Basis
Adjustments for AGI
Affirmative Action
Agency
Alternative Minimum Tax (AMT)
Alternatives to Bankruptcy
Amount Realized
Articles of Incorporation
Assignment
Attachment
Auditor Common Law Liability
Auditor Liability Under Federal Securities Laws
Avoidance
Avoiding Liability
Bailments
Bankruptcy
Breach of Contract
Business Combinations
Business Expenses (Schedule C)
Business Reorganizations – Chapter 11
Buyer’s Remedies
C.O.D.
Carryover Rules
Characteristics of Corporations
Child Tax Credit
Civil Rights Act (CRA)
Claims for Refunds
Clean Air Act
COBRA
Commercial Paper
Compensation for Services
Comprehensive Environmental Response
Compensation and Liability Act
Computing Corporate Income Tax
Computing Taxable Income of Trusts & Estates
Concurrent Interests
Consideration
Contracts
Contributions
Contributions to Retirement Plans
Conversion To S Corporation
Corporate Formation
Corporate Income Tax
Corporate Reorganizations
Corporate Termination
Corporations
Cosureties
Coverdell Education Savings Accounts (ESAs)
Credit Card Debt
Credit for Aged or Disabled
Credits
Deductions
Default by Debtor
Defenses Against a Negotiable Instrument
Defenses of Sureties
Delegation
Denial of Discharge
Dependent Care Credit
Dependent Exemptions
Depreciable Personal Property
Depreciable Real Property
Depreciation
Depreciation Recapture
Directors & Officers
Discharge
Dissolution
Distributable Net Income (DNI)
Distributions
Distributions to Stockholders
Dividends
Dividends-Received Deduction
Documents of Title
Duties of Directors & Officers
Earned Income Credit
Employee Retirement Income Security Act (ERISA)
Employment
Enforceability
Environmental Law
Equal Pay Act
Estate & Gift Tax
Estates
Exceptions to Discharge
Excess Payroll Taxes
Exemptions
Express Warranties
Federal Insurance Contributions Act (FICA)
Federal Securities Regulations
Federal Unemployment Tax Act (FUTA)
Federal Water Pollution Control Act
Filing Status
Firm Offer
FLSA
FMLA
Foreign Tax Credit
Formation of Contracts
Formation of Partnerships
Formation of S Corporations
Fraud
Generation Skipping Tax
Gift
Goods In Transit
Gross Income
Guaranteed Payments to Partners
Half-Year Convention
Holder in Due Course (HDC)
Income Tax Return Preparers
Independence, Integrity, & Objectivity
Individual Income Tax
Inheritance
Insider Trading
Interest
Interest Expense
Investment Securities
Involuntary Filing – Chapter 7
Itemized Deductions
Leases
Liability as a Tax Preparer
Liability of Entering and Exiting Partners
Liability Under 33 Act
Liability Under 34 Act
Lifetime Learning Credit
Limited Liability
Limited Liability Arrangements
Limited Liability Companies (LLCs)
Limited Liability Partnerships
Limited Partnerships
Liquidating Distributions
Medical Expenses
Midmonth Convention
Midquarter Convention
Miscellaneous Expenses
Modified HOPE Credit
Moving Expenses
National Labor Relations Act (NLRA)
Negligence
Negotiable Instruments
Noise Control Act
Nonliquidating Distributions
Obligations of Common Carriers
Occupational Safety & Health Act (OSHA)
Offer
Order of Distribution
Other Income
Other Itemized Deductions
Other Rights of Shareholders
Parent-Subsidiary Transactions
Parol Evidence Rule
Partner’s Basis
Partners’ Authority
Partners’ Liability
Partners’ Property Rights
Partners’ Rights
Partnership
Partnership Characteristics
Partnership Dissolution
Partnership Taxation
Penalties for Late Payment
Perfection
Personal defenses
Personal Exemptions
Personal Holding Company (PHC) Tax
Personal Property
Powers of Bankruptcy Trustee
Powers of the Board of Directors
Primary Liability
Priorities Among Claims
Priority Claims
Private Securities Litigation Reform Act of 1995
Prizes & Awards
Product Liability
Promoters
Property
Property Dispositions
Property Received by Inheritance or Gift
Proxies
Real Defenses
Real Property
Realized Gain or Loss
Rejection
Related Party Sales
Rent & Royalty Expenses (Schedule E)
Repayment Plans – Chapter 13
Reporting
Requirements for Combinations
Requirements for Negotiability
Rights & Obligations
Rights of Directors
Rights of Officers
Rights of Sureties
Risk of Loss
Roth IRAs
S Corporation Earnings
S Corporations
Sale of Partnership Interest
Sale on Approval
Sale or Return
Sales
Sarbanes-Oxley Act of 2002
Schedule M-1
Schedule M-2
Secondary Liability
Section 1244 Stock
Secured Creditors
Secured Transactions
Securities Act of 1933
Securities Exchange Act of 1934
Securities Exempt from Registration
Self-Employment Tax
Seller’s Remedies
Seller’s Warranties
Shareholder’s Basis
Shareholders
Special Transactions
Standard Deduction
Standards for Consulting Services
Standards for Tax Practice
Statutes of Limitations
Summary of Auditor Liability
Superfund
Suretyship
Tax Payments
Tax Preparer Penalties
Tax Return Due Dates
Tax Return Schedules
Tax Year
Taxable Estate
Taxable Gifts
Taxation of Beneficiaries
Taxation of Estates & Trusts
Taxation of Gains & Losses
Taxation of Partnerships
Taxation of S Corporations
Taxation of Trusts
Taxes
Terminating Agent’s Authority
Termination of S Corporation Status
Theft or Casualty Losses
Title
Transactions Exempt from Registration
Transfers of Negotiable Instruments
Trust Operations
Trusts
Types of Agency
Types of Endorsements
Types of Sureties
Unified Credit
Unions & Collective Bargaining
Unsecured Creditors
Validity
Validity & Enforceability
Voidable Preferences
Voluntary Filing – Chapter 7
Warranty of Fitness
Warranty of Merchantability
Warranty of Title
When to File
Who Must File
Workers’ Compensation
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