Chartered Life Underwriter (CLU) Income Taxation of Individuals and Businesses Syllabus

What is the Net Investment Income Tax (NIIT) rate and what does it apply to?

A 3.8% surtax applied to the lesser of net investment income or the amount of modified AGI exceeding the threshold; net investment income includes interest, dividends, capital gains, rents, royalties, and passive income.

What are the MAGI thresholds for the Net Investment Income Tax?

$250,000 for married filing jointly and qualifying surviving spouse, $125,000 for married filing separately, and $200,000 for single and head of household (these thresholds are not indexed for inflation).

How is a sole proprietorship taxed?

It is a pass-through (disregarded) entity; income and expenses are reported on Schedule C of the owner's Form 1040, with net profit subject to both income tax and self-employment tax.

How is partnership income taxed and reported to partners?

A partnership is a pass-through entity that files an information return (Form 1065) and passes income, deductions, and credits through to partners via Schedule K-1; partners are taxed on their distributive share whether or not it is distributed.

What is the self-employment tax rate and what does it cover?

15.3% on net self-employment earnings - 12.4% for Social Security (up to the wage base) plus 2.9% for Medicare (no cap); one-half of the SE tax is deductible above the line.

How is a C corporation taxed, and what is double taxation?

A C corporation pays a flat 21% corporate income tax on its earnings; when after-tax earnings are distributed as dividends, shareholders are taxed again - this two-level taxation of the same earnings is double taxation.

What are the key eligibility requirements to elect S corporation status?

Be a domestic corporation, have no more than 100 shareholders, have only allowable shareholders (individuals, certain trusts, estates - no partnerships, corporations, or nonresident aliens), and have only one class of stock.

How is S corporation income taxed?

As a pass-through entity, the S corporation generally pays no entity-level federal income tax; income, deductions, and credits flow through to shareholders pro rata via Schedule K-1 and are taxed at the shareholder level, avoiding double taxation.

How can an S corporation reduce employment taxes compared to a sole proprietorship?

An S corporation shareholder-employee pays employment taxes only on reasonable compensation (W-2 wages); remaining profits passed through as distributions are not subject to self-employment/payroll taxes.

How is a single-member LLC taxed by default versus a multi-member LLC?

By default a single-member LLC is a disregarded entity taxed like a sole proprietorship (Schedule C); a multi-member LLC is taxed as a partnership - but either may elect to be taxed as a C or S corporation.

What is the primary nontax advantage of an LLC?

Limited liability protection for its members combined with flexible management and pass-through taxation - members are generally not personally liable for the LLC's debts.

What is the Qualified Business Income (QBI) deduction and its maximum percentage?

Under Section 199A, eligible owners of pass-through businesses may deduct up to 20% of their qualified business income, subject to taxable income thresholds and limitations.

What is a Specified Service Trade or Business (SSTB) and how does it affect the QBI deduction?

An SSTB (e.g., health, law, accounting, consulting, financial services, performing arts) loses the QBI deduction once taxable income exceeds the upper phase-out threshold; below the lower threshold the deduction is allowed in full.

What wage/property limitation applies to the QBI deduction for higher-income taxpayers?

Above the income thresholds, the deduction is limited to the greater of 50% of W-2 wages paid, or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property.

What is income shifting and why is it used?

Income shifting moves income from a high-tax-rate taxpayer to a lower-rate taxpayer (e.g., family members) or to a lower-rate entity to reduce the family's overall tax burden.

What is the kiddie tax and what does it prevent?

The kiddie tax taxes a child's net unearned income above a threshold at the parents' marginal tax rate, preventing parents from shifting investment income to children to exploit lower rates.

How can a cash-basis taxpayer use income timing to reduce taxes?

By deferring income recognition into a later (lower-rate) year and accelerating deductible expenses into the current (higher-rate) year, or vice versa when rates are expected to rise - shifting the timing of cash receipts and payments.

What is the purpose of the Alternative Minimum Tax (AMT)?

The AMT is a parallel tax system that recalculates income with fewer deductions/preferences to ensure high-income taxpayers who use many tax-reduction items still pay a minimum amount of tax.

How is the AMT generally computed?

Start with regular taxable income, add back preference items and adjustments to get alternative minimum taxable income (AMTI), subtract the AMT exemption, apply the AMT rates (26%/28%); the taxpayer pays the AMT only if it exceeds the regular tax.

Name three common AMT preference or adjustment items.

Interest on private activity municipal bonds, the bargain element on incentive stock option exercises, accelerated depreciation, and certain itemized deduction add-backs (any three).

What are the AMT tax rates?

26% on AMTI up to the breakpoint and 28% on AMTI above it (the breakpoint is indexed annually).

What is a passive activity under the passive activity loss rules?

A trade or business in which the taxpayer does not materially participate, or (with limited exceptions) any rental activity, regardless of the taxpayer's level of participation.

What is the general rule for deducting passive activity losses?

Passive losses can only offset passive income; excess (suspended) passive losses are carried forward and become fully deductible when the taxpayer disposes of the entire interest in the activity in a taxable transaction.

What is the $25,000 rental real estate loss allowance?

Taxpayers who actively participate in rental real estate may deduct up to $25,000 of passive rental losses against nonpassive income; this allowance phases out between $100,000 and $150,000 of MAGI.

What do the at-risk rules limit?

They limit a taxpayer's deductible losses from an activity to the amount the taxpayer has economically at risk - generally cash and the adjusted basis of property contributed plus amounts borrowed for which the taxpayer is personally liable (recourse debt).

How do the at-risk rules and passive activity rules interact in determining deductible losses?

At-risk limits are applied first (a loss is deductible only up to the at-risk amount), then the passive activity loss rules are applied to whatever amount survives the at-risk limitation.

What is the key tax advantage of a Roth IRA versus a traditional IRA?

Roth IRA contributions are made with after-tax dollars and qualified distributions (including earnings) are tax-free; traditional IRA contributions may be deductible but distributions are taxed as ordinary income.

What is the tax treatment of contributions and growth in a 401(k) plan?

Traditional 401(k) contributions are made pre-tax (reducing current taxable income), earnings grow tax-deferred, and distributions are taxed as ordinary income; a Roth 401(k) reverses this with after-tax contributions and tax-free qualified distributions.

What are the main federal tax advantages of a 529 college savings plan?

Contributions are not federally deductible, but earnings grow tax-deferred and withdrawals are tax-free when used for qualified education expenses (contributions may qualify for a state deduction).

How are gains inside a non-qualified deferred annuity taxed during accumulation and at withdrawal?

Earnings grow tax-deferred inside the annuity; on withdrawal, gains are taxed as ordinary income (LIFO - earnings come out first), and pre-59½ withdrawals may incur a 10% penalty.

What is the triple tax advantage of a Health Savings Account (HSA)?

Contributions are tax-deductible (or pre-tax), earnings grow tax-free, and distributions for qualified medical expenses are tax-free - making it one of the most tax-favored vehicles available.