Tag: Modern Marketing Bangalore University BBA Notes

Whether earnings are retained in a partnership or distributed to partners has no effect on the taxation of those earnings, since the partners have to pay tax on the earnings whether they are distributed or not. Earnings are distributed to each partner’s capital account from which distributions are charged against. However, certain types of distributions and any distributions exceeding the partner’s basis may result in gains or losses that must be reported for the year when they occur.

To understand the taxation of partnerships and distributions, it is necessary to know the 2 types of tax bases concerning partnerships. The inside basis is the partnership’s tax basis in the individual assets. The outside basis is the tax basis of each individual partner’s interest in the partnership. When a partner contributes property to the partnership, the partnership’s basis in the contributed property = its fair market value (FMV). However, the outside basis of the partner increases only by the amount of the basis the partner had in the property.

There are 2 types of distributions: a current distribution decreases the partner’s capital account without terminating it, whereas a liquidating distribution pays the entire capital account to the partner, thereby eliminating the partner’s equity interest in the partnership. Generally, losses are only recognized in a liquidating distribution.

The basis of a partnership interest is increased by:

• The partner’s share of partnership taxable income, tax-exempt income.
• Additional contributions to the partnership or other forms of acquisition (e.g., purchases).
• Depletion deductions in excess of the basis of the property subject to depletion.
• An increase in the partner’s share of partnership liabilities (including partnership liabilities assumed by the partner).

A partner’s basis is decreased by:

• The partner’s share of partnership losses and non-deductible, non-capitalized expenditures, including the partner’s share of disallowed partnership losses if such losses reduce the basis of partnership assets without a corresponding effect on its income.
• Distributions of money or other property from the partnership.
• Any reduction in a partner’s allocable share of partnership liabilities. The IRS stated that a reduction in a partner’s share of partnership debt is treated as an advance of cash to the partner and is taken into account at the end of the partnership year. This ruling formalized existing IRS policy that the decrease in basis occurs on the last day of the year and not on the mid-year date when the partner’s share of debt declines.

Cash Distributions

No gain is recognized from a distribution of cash or marketable securities easily convertible to cash, unless the distribution is more than the partner’s outside basis, in which case, the excess is taxable as a capital gain.

Capital Gain = Cash Distribution – Partner’s Outside Basis

Property Distributions

When property is distributed to a partner, then the partnership must treat it as a sale at fair market value (FMV). The partner’s capital account is decreased by the FMV of the property distributed. The book gain or loss on the constructive sale is apportioned to each of the partners’ accounts.

Generally, there are no tax consequences of a current property distribution — there is never a taxable gain or loss, either to the partnership or to the partner. The partnership’s inside basis of the property carries over to become the partner’s basis, thereby reducing the partner’s outside basis by the carryover basis. As with the cash distribution, if the FMV of the property exceeds the partner’s outside basis in the partnership, then the partner’s interest in the partnership is reduced to 0 and the receiving partner’s basis in the distributed property equals his outside basis in the partnership before the distribution. The property basis remaining after subtracting the outside basis is taxable as a gain.

If distributed property also had a secured liability, then the partner assumes the liability which decreases her share of the partnership’s liabilities. The other partners’ share of liabilities is also decreased by the deemed distribution. If any part of the distribution exceeds a partner’s basis in the partnership, then the excess is treated as a capital gain.

If a distribution consists of unrealized receivables or substantially appreciated inventory items, defined as having a FMV exceeding 120% of the partnership’s adjusted basis for the property, then the exchange may be treated as a sale or other taxable exchange, unless the partner contributed the property or the distribution was a distributive share or guaranteed payment to a retiring partner or a deceased partner’s successor in interest.

Allocating Basis

When a partner receives a property distribution, the holding period for the property is added onto the holding period of the partnership plus the holding period of the partner who contributed the property, if applicable.

So if a partner contributed property, with a holding period of 1 year, to the partnership, and the partnership held the property for 2 years, then a distribution of that property to another partner would result in a carryover holding period of 3 years to the receiving partner.

If several properties are distributed to a partner, then basis must be allocated to the individual properties. Generally, the carryover basis of each property will be equal to the partnership’s basis in the property, but since the total property basis cannot exceed the partner’s outside basis minus any money received, then any excess basis must be allocated among the properties.

Basis must 1st be allocated to unrealized receivables and inventory items. If there is any excess basis over the partnership’s interest, then the assigned bases must be reduced by the excess. Any remaining allocable basis is then assigned to the remaining properties, reduced by any excess basis over the partner’s remaining interest. Any basis increase should 1st be allocated to property with unrealized appreciation in proportion to that appreciation; any remaining basis should be allocated among all properties in proportion to their FMV.

A partnership is a business arrangement in which two or more people own an entity, and personally share in its profits, losses, and risks. The exact form of partnership used can give some protection to the partners. A partnership can be formed by a verbal agreement, with no documentation of the arrangement at all.

A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations. Organizations may partner to increase the likelihood of each achieving their mission and to amplify their reach. A partnership may result in issuing and holding equity or may be only governed by a contract.

The Partnership Agreement

When a verbal partnership agreement is used, there may be subsequent disagreements among the owners at a later date regarding what was originally agreed to. Consequently, it makes sense to create a written document that states how certain situations are to be handled. This partnership agreement should at least cover the following topics:

• The rights and responsibilities of each partner
• Whether partners are designated as general partners or limited partners, since this impacts their responsibility for the liabilities of the partnership
• The proportions of partnership gains and losses to be apportioned to each partner
• Procedures related to the withdrawal of funds from the partnership, as well as any limitations on these withdrawals
• How key decisions are to be resolved
• Provisions regarding how to add and terminate partners
• What happens to partnership interests if a partner dies.
• What steps to follow to dissolve the partnership
• The proportions of residual cash paid out to the partners in a liquidation

Additional Partnership Formation Activities

In addition to the partnership agreement, the partners must engage in a number of other formation activities that are common to all types of businesses. These actions include:

• Register the business name
• Obtain an employer identification number
• Obtain any licenses required by governments where the partnership plans to operate, such as a sales tax license
• Open a bank account in the name of the partnership
• File an annual informational return with the Internal Revenue Service.

Forms of partnership

As common law there are two basic forms of partnership:

Limited partnership (LP): a partnership in which general partners manage the partnership’s operations, and limited partners forego the right to manage the business in exchange for limited liability for the partnership debts. The liability of limited partners is limited to their investment in the partnership.

General partnership: a partnership in which all partners manage the business and are personally liable for its debts. General partners have an obligation of strict liability to third parties injured by the Partnership. General partners may have joint liability or joint and several liability depending upon circumstances.

Silent partners

A silent partner or sleeping partner is one who still shares in the profits and losses of the business, but who is not involved in its management. Sometimes the silent partner’s interest in the business will not be publicly known. A silent partner is often an investor in the partnership, who is entitled to a share of the partnership’s profits. Silent partners may prefer to invest in limited partnerships in order to insulate their personal assets from the debts or liabilities of the partnership.

According to section 4 of the Partnership Act of 1932,”Partnership is defined as the relation between two or more persons who have agreed to share the profits of a business carried on by all or any one of them acting for all”. This definition superseded the previous definition given in section 239 of Indian Contract Act 1872 as – “Partnership is the relation which subsists between persons who have agreed to combine their property, labor, skill in some business, and to share the profits thereof between them”. The 1932 definition added the concept of mutual agency. The Indian Partnerships have the following common characteristics:

1) A partnership firm is not a legal entity apart from the partners constituting it. It has limited identity for the purpose of tax law as per section 4 of the Partnership Act of 1932.

2) Partnership is a concurrent subject. Contracts of partnerships are included in the Entry no.7 of List III of The Constitution of India (the list constitutes the subjects on which both the State government and Central (National) Government can legislate i.e. pass laws on).

3) Unlimited Liability. The major disadvantage of partnership is the unlimited liability of partners for the debts and liabilities of the firm. Any partner can bind the firm and the firm is liable for all liabilities incurred by any firm on behalf of the firm. If property of partnership firm is insufficient to meet liabilities, personal property of any partner can be attached to pay the debts of the firm.

4) Partners are Mutual Agents. The business of firm can be carried on by all or any of them acting for all. Any partner has authority to bind the firm. Act of any one partner is binding on all the partners. Thus, each partner is ‘agent’ of all the remaining partners. Hence, partners are “mutual agents”. Section 18 of the Partnership Act, 1932 says “Subject to the provisions of this Act, a partner is the agent of the firm for the purpose of the business of the firm”.

5) Oral or Written Agreements. The Partnership Act, 1932 nowhere mentions that the Partnership Agreement is to be in written or oral format. Thus, the general rule of the Contract Act applies that the contract can be ‘oral’ or ‘written’ as long as it satisfies the basic conditions of being a contract i.e. the agreement between partners is legally enforceable. A written agreement is advisable to establish existence of partnership and to prove rights and liabilities of each partner, as it is difficult to prove an oral agreement.

6) Number of Partners is minimum 2 and maximum 50 in any kind of business activities. Since partnership is ‘agreement’ there must be minimum two partners. The Partnership Act does not put any restrictions on maximum number of partners. However, section 464 of Companies Act 2013, and Rule 10 of Companies (Miscellaneous) Rules, 2014 prohibits partnership consisting of more than 50 for any businesses, unless it is registered as a company under Companies Act, 2013 or formed in pursuance of some other law. Some other law means companies and corporations formed via some other law passed by Parliament of India.

7) Mutual agency is the real test. The real test of ‘partnership firm’ is ‘mutual agency’ set by the Courts of India, i.e. whether a partner can bind the firm by his act, i.e. whether he can act as agent of all other partners.

Types of Partners

Not all partners of a firm have the same responsibilities and functions. There can be various types of partners in a partnership. Let us study the types of partners and their rights and duties.

Dormant Partner: Also known as a sleeping partner, he will not participate in the daily functioning of the business. But he will still have to make his share of contribution to the capital. In return, he will have a share in the profits. His liability will also be unlimited.

Active Partner: As the name suggests he takes active participation in the business of the firm. He contributes to the capital, has a share in the profit and also participates in the daily activities of the firm. His liability in the firm will be unlimited. And he often will act as an agent for the other partners.

Secret Partner: Here the partner’s association with the firm is not public knowledge. He will not represent the firm to outside agents or parties. Other than this his participation with respect to capital, profits, management and liability will be the same as all the other partners.

Partner by Estoppel: If a person makes it out to be, through their conduct or behaviour, that they are partners in a firm and he does not correct them, then he becomes a partner by estoppel. However, this partner too will have unlimited liability.

Nominal Partner: This partner is only a partner in name. He allows the firm to use the name of his firm, and the attached goodwill. But he in no way contributes to the capital and hence has no share in the profits. He does not involve himself in the firm’s business. But his liability too will be unlimited.

Importance of Registering a Partnership Firm

The registration of a partnership firm is optional and not compulsory under the Indian Partnership Act. It is at the discretion of the partners and voluntary. The firm’s registration can be done at the time of its formation or incorporation or during the continuance of the partnership business.

However, it is always advisable to register the partnership firm as a registered firm enjoys certain special rights and benefits as compared to the unregistered firms. The benefits that a partnership firm enjoy are:

A partner can sue against any partner or the partnership firm for enforcing his rights arising from a contract against the partner or the firm. In the case of an unregistered partnership firm, partners cannot sue against the firm or other partners to enforce his right.

The registered firm can file a suit against any third party for enforcing a right from a contract. In the case of an unregistered firm, it cannot file a suit against any third party to enforce a right. However, any third party can file a suit against the unregistered firm.

The registered firm can claim set-off or other proceedings to enforce a right arising from a contract. The unregistered firm cannot claim set off in any proceedings against it.

Procedure for Registering a Partnership Firm

Step 1: Application for Registration

An application form has to be filed to the Registrar of Firms of the State in which the firm is situated along with prescribed fees. The registration application has to be signed and verified by all the partners or their agents.

The application can be sent to the Registrar of Firms through post or by physical delivery, which contains the following details:

• The name of the firm.
• The principal place of business of the firm.
• The location of any other places where the firm carries on business.
• The date of joining of each partner.
• The names and permanent addresses of all the partners.
• The duration of the firm.

Step 2: Selection of Name of the Partnership Firm

Any name can be given to a partnership firm. But certain conditions need to be followed while selecting the name:

• The name should not contain words like emperor, crown, empress, empire or any other words which show sanction or approval of the government.
• The name should not be too similar or identical to an existing firm doing the same business.

Step 3: Certificate of Registration

If the Registrar is satisfied with the registration application and the documents, he will register the firm in the Register of Firms and issue the Registration Certificate. The Register of Firms contains up-to-date information on all firms, and anybody can view it upon payment of certain fees.

An application form along with fees is to be submitted to the Registrar of Firms of the State in which the firm is situated. The application has to be signed by all partners or their agents.

Documents for Registration of Partnership

The documents required to be submitted to Registrar for registration of a Partnership Firm are:

• Application for registration of partnership (Form 1)
• Certified original copy of Partnership Deed.
• Specimen of an affidavit certifying all the details mentioned in the partnership deed and documents are correct.
• PAN Card and address proof of the partners.
• Proof of principal place of business of the firm (ownership documents or rental/lease agreement).

A partnership firm is a type of entity where more than one person is carrying out business under one entity. Partnerships firms in India are of two types – Registered partnership firms and unregistered partnership firms.

Registering a Partnership is the right choice for small enterprises as the formation is straightforward and there are minimal regulatory compliances.

The Partnership Act has been in existence in India since 1932, making partnerships one of the oldest types of business entities in India. A partnership firm can even be registered after it is formed. There are as such no penalties for non-Registration of a Partnership firm.

But unregistered Partnership firms are denied certain rights under section 69 of the Partnership Act that majorly deals with the effects of non-Registration of Partnership firms.

For the purpose of filing tax returns for a partnership firm, one must use the Form ITR-5. The form ITR-5 is used to file tax returns for the partnership firm itself and not for the partners of the firm. One must not confuse form ITR-5 and ITR-3. Similar to all other income tax return filings, ITR-5 can be filed online via the income tax departments online portal.

Also, it needs to be noted that while filing these returns, one does not need to attach any supporting documents along with it. These documents need to be submitted to the Income Tax Department only if they are specifically asked for.

It is compulsory for a firm to file income tax return electronically with or without digital signature. The firm can also file income tax return under Electronic Verification Code. However, a partnership firm is compelled to do e-filing of its income tax returns when the partnership firm is required to get an audit. While filing the income tax returns, the partners must have a class 3 digital signature for verification of the filing process.

Tax rate for a partnership firm

A partnership firm is required to file a partnership firm income tax return under the Income Tax Act,1961. Partnership firms are liable to pay income tax at the rate of 30% of total income. Besides, a partnership firm is liable to pay an income tax surcharge of 12% if the total income exceeds Rs.1 crores.

Additional to the income tax and surcharge a partnership firm must pay the education cess and the secondary higher education cess.

Education Cess is applicable on the amount of the income tax and the applicable surcharge at the rate of 2%. Secondary and higher education cess is applicable on the amount of the income tax and the applicable surcharge at the rate of 1%.

Alternative minimum tax

Similar to a private limited company or LLP, partnership firms are also required to pay alternate minimum tax at the rate of 18.5% of “adjusted total income”. Alternate minimum tax would be increased by the applicable surcharge, education cess, and secondary and higher education cess.

Allowed deductibles

While calculating the payable income tax an individual must check the available deductible income

• Salaries, bonuses, remunerations, commissions paid to the non-working partners of the firm.
• Remunerations or interest paid to the partners of the firm is not under the terms of the partnership.
• If remuneration paid to partners is following the terms of the partnership deed but such transactions were made or were concerning anything that pre-dates the partnership deed.

Procedure for filing Income tax returns of a partnership firm.

The income tax return of a partnership firm can be filed online through the income tax website or manually. If the income tax return is filed online then a class 2 digital signature will be required for the partner of the firm. Also, online income tax return filing is mandatory for partnership firms required to obtain an audit.

The deadline for filing an income tax for a partnership firm is dependent upon whether the firm is required to be audited or not. The deadlines for filing income tax return are as follows:

Where the firm is not required to be audited: The income tax returns must be filed by 31st July.

Where the firm is required to be audited: The firm has to file its income tax returns by 31st October

Many partnership agreements require that a partner who wishes to dispose of his interest in the partnership do so by surrendering it to the partnership in exchange for a liquidating distribution. Many partnership agreements do not allow the unrestricted sale to the public since the remaining partners do not want to be forced to accept anyone who may not be desirable for the business, who may not have the requisite skills, or who may not get along with the other partners. The partnership agreement will also often contain a formula for determining the liquidating distribution that reduces the partner’s basis in the partnership to 0.

Liquidating distributions are based on the fair market value (FMV) of a partner’s capital account, so the partnership property must be revalued and unrecorded intangible assets, such as goodwill, must be included. The value of the liquidating distribution = the amount received by the withdrawing partner + any extinguished apportioned debt.

Liabilities. When a third-party buy a partnership interest, the buyer generally assumes the selling partner’s share of indebtedness of the partnership, and thus, is added on to the sale price.

Hot Assets

A partnership that has unrealized receivables and inventory, i.e., hot assets, that, when sold by the partnership, causes it to recognize ordinary income complicates the taxation of the selling partner’s interest, since some of the gain or loss may be ordinary rather than capital. The selling partner must recognize the income just as if those assets were sold, with the ordinary income being allocated to the partner. This rule prevents the conversion of ordinary income into capital income that is usually taxed at a lower rate through the sale of the partnership interest.

Unrealized receivables consist of accounts receivable of a cash basis partnership and anything that is sold that is subject to depreciation recapture rules.

Abandonment or Worthlessness of Partnership Interest:

Depending upon the circumstances, the abandonment or worthlessness of a partnership interest may give rise to a loss deduction under Code Sec. 165. Whether the loss is capital or ordinary depends on whether or not the loss results from the sale or exchange of a capital asset. If there is an actual or deemed distribution from the partnership, the transaction is treated as a sale or exchange of the partnership interest and any resulting loss is capital, except as provided in Code Sec. 751(b) (relating to inventory and unrealized receivables).

See Code Sec. 731(a), Code Sec. 741, and Rev. Rul. 93-80, 1993-2 C.B. 239. Thus, for example, if the abandonment results in the relief of the partner’s share of the partnership’s liabilities, the loss will be capital even if no other consideration is received. In addition, the receipt of a de minimis amount of consideration will cause the loss to be a capital loss. However, a partner who does not receive any consideration and is not relieved of a liability may take an ordinary loss on the abandonment of a partnership interest. Citron, B. Philip, (1991) 97 TC 200.

Sale of Entire Interest When a partnership interest is sold, it is necessary to allocate partnership profit or loss between the transferor-partner and the transferee-partner. Generally, the taxable year of the partnership as a whole does not close on the sale or exchange of a partner’s interest. Code Sec. 706(c)(1) ; Reg § 1.706-1(c)(1) . This is true even though the transfer often results in the partnership’s technical dissolution under the nontax rules of most jurisdictions.

However, a partnership’s taxable year closes with respect to a partner who sells his entire partnership interest. Code Sec. 706(c)(2)(A); Reg § 1.706-1(c)(2) . Accordingly, the selling partner’s distributive share of the partnership’s tax items for the short period, ending on the disposition date, is included in his tax return for his taxable year that includes the sale date. Reg § 1.706-1(c)(2)(i).

Thus, if the sale occurs in December of Year 2, a selling calendar year partner in a January fiscal year partnership may be required to include as many as 23 months of partnership income on his Year 2 return (his share of the partnership’s income for the partnership year ending January of Year 2 and his share of the partnership’s income from January of Year 2 to December of Year 2). The other partners will not be affected by the sale.

The selling partner’s share of partnership tax items may be determined either by making an “interim closing” of the partnership books and determining the amount of partnership’s items up to the day of the sale. However, if the partners agree, the partnership’s income, gain, loss, deduction, and credit for the entire year may be allocated between the selling partner and the buyer. This can be done by estimating what the partner’s share of the partnership’s items would have been had he remained a partner until the end of the year and prorating these items between the selling partner and the buyer. The proration may be based on the portion of the taxable year that has elapsed before the sale, exchange, or liquidation or may be determined under any other reasonable method. Reg § 1.706-1(c)(2)(ii).

A 501(c) organization is a nonprofit organization in the federal law of the United States according to Internal Revenue Code Section 501(c) (26 U.S.C. § 501(c)) and is one of over 29 types of nonprofit organizations exempt from some federal income taxes. Sections 503 through 505 set out the requirements for obtaining such exemptions. Many states refer to Section 501(c) for definitions of organizations exempt from state taxation as well. 501(c) organizations can receive unlimited contributions from individuals, corporations, and unions.

For example, a nonprofit organization may be tax-exempt under section 501(c)(3) if its primary activities are charitable, religious, educational, scientific, literary, testing for public safety, fostering amateur sports competition, preventing cruelty to children, or preventing cruelty to animals.

According to the IRS Publication 557, in the Organization Reference Chart section, the following is an exact list of 501(c) organization types and their corresponding descriptions.

Forming a tax-exempt organization

The tax-exempt organization is not really an entity choice, but rather a declaration of how your particular entity will conduct its business. When used in reference to nonprofit organizations, the term “tax-exempt” generally refers to net profits of an organization (income minus expenses) being exempt from state or federal taxes. While a nonprofit organization can be established by incorporating, the entity is not automatically tax-exempt upon filing the articles of incorporation with the state.

Tax-exempt status can only be achieved by applying and receiving approval from the Internal Revenue Service (IRS). The most common organization is called a Section 501(c)(3) public charity or private foundation, established for purposes that are religious, educational, charitable, scientific, literary, safety-oriented or amateur sports-related. (There are also a number of other IRS-designated organization types that are considered tax-exempt but not charitable. Examples include trade associations, social clubs and certain advocacy organizations involved in political lobbying. Check out the IRS classification chart for additional information.)

The application process is difficult, and professional help is recommended. It requires the filing of IRS Form 1023 within the first 27 months of the organization’s formation. The form is quite lengthy, and a typical application package can range from 25 to 75 pages and take more than 100 hours to complete. A two-tiered filing fee structure ($300 and $750) allows very small organizations to apply at a reduced rate, compared to larger, more traditional tax-exempt organizations.

While the IRS generally rejects less than one-tenth of all applicants, another third are abandoned by the filer either out of frustration or inability to answer IRS follow-up questions. The process typically takes between two to 12 months, depending on the need for follow-up information. A negative determination by the IRS can be appealed, or the organization may choose to apply again, but either way it will be difficult once the initial application is rejected.

Advantages of tax-exempt status. One of the primary benefits of being considered tax-exempt is the ability to accept contributions and donations that are tax-deductible to the donor. Additional benefits include, but are not limited to:

• Exemption from federal and/or state income taxes.
• Possible exemption from state sales and property taxes (varies by state).
• Ability to apply for grants and other public or private allocations available only to IRS-recognized 501(c)(3) organizations.
• Potentially higher thresholds before incurring federal and/or state unemployment tax liabilities.
• The public legitimacy of IRS recognition.
• Discounts on U.S. Postal bulk-mail rates and other services.

The income of an estate of a deceased person is that which is received by the estate during the period of administration or settlement. The period of administration or settlement is the period actually required by the administrator or executor to perform the ordinary duties of administration, such as the collection of assets and the payment of debts, taxes, legacies, and bequests, whether the period required is longer or shorter than the period specified under the applicable local law for the settlement of estates. For example, where an executor who is also named as trustee under a will fails to obtain his discharge as executor, the period of administration continues only until the duties of administration are complete and he actually assumes his duties as trustee, whether or not pursuant to a court order. However, the period of administration of an estate cannot be unduly prolonged. If the administration of an estate is unreasonably prolonged, the estate is considered terminated for Federal income tax purposes after the expiration of a reasonable period for the performance by the executor of all the duties of administration. Further, an estate will be considered as terminated when all the assets have been distributed except for a reasonable amount which is set aside in good faith for the payment of unascertained or contingent liabilities and expenses (not including a claim by a beneficiary in the capacity of beneficiary). Notwithstanding the above, if the estate has joined in making a valid election under section 645 to treat a qualified revocable trust, as defined under section 645(b)(1), as part of the estate, the estate shall not terminate under this paragraph prior to the termination of the section 645 election period. See section 645 and the regulations thereunder for rules regarding the termination of the section 645 election period.

Generally, the determination of whether a trust has terminated depends upon whether the property held in trust has been distributed to the persons entitled to succeed to the property upon termination of the trust rather than upon the technicality of whether or not the trustee has rendered his final accounting. A trust does not automatically terminate upon the happening of the event by which the duration of the trust is measured. A reasonable time is permitted after such event for the trustee to perform the duties necessary to complete the administration of the trust. Thus, if under the terms of the governing instrument, the trust is to terminate upon the death of the life beneficiary and the corpus is to be distributed to the remainderman, the trust continues after the death of the life beneficiary for a period reasonably necessary to a proper winding up of the affairs of the trust. However, the winding up of a trust cannot be unduly postponed and if the distribution of the trust corpus is unreasonably delayed, the trust is considered terminated for Federal income tax purposes after the expiration of a reasonable period for the trustee to complete the administration of the trust. Further, a trust will be considered as terminated when all the assets have been distributed except for a reasonable amount which is set aside in good faith for the payment of unascertained or contingent liabilities and expenses (not including a claim by a beneficiary in the capacity of beneficiary).

(c)

(1) Except as provided in subparagraph (2) of this paragraph, during the period between the occurrence of an event which causes a trust to terminate and the time when the trust is considered as terminated under this section, whether or not the income and the excess of capital gains over capital losses of the trust are to be considered as amounts required to be distributed currently to the ultimate distributee for the year in which they are received depends upon the principles stated in § 1.651(a)-2. See § 1.663-1 et seq. for application of the separate share rule.

(2)

(i) Except in cases to which the last sentence of this subdivision applies, for taxable years of a trust ending before September 1, 1957, subparagraph (1) of this paragraph shall not apply and the rule of subdivision (ii) of this subparagraph shall apply unless the trustee elects to have subparagraph (1) of this paragraph apply. Such election shall be made by the trustee in a statement filed on or before April 15, 1959, with the district director with whom such trust’s return for any such taxable year was filed. The election provided by this subdivision shall not be available if the treatment given the income and the excess of capital gains over capital losses for taxable years for which returns have been filed was consistent with the provisions of subparagraph (1) of this paragraph.

(ii) The rule referred to in subdivision (i) of this subparagraph is as follows: During the period between the occurrence of an event which causes a trust to terminate and the time when a trust is considered as terminated under this section, the income and the excess of capital gains over capital losses of the trust are in general considered as amounts required to be distributed for the year in which they are received. For example, a trust instrument provides for the payment of income to A during her life, and upon her death for the payment of the corpus to B. The trust reports on the basis of the calendar year. A dies on November 1, 1955, but no distribution is made to B until January 15, 1956. The income of the trust and the excess of capital gains over capital losses for the entire year 1955, to the extent not paid, credited, or required to be distributed to A or A’s estate, are treated under sections 661 and 662 as amounts required to be distributed to B for the year 1955.

(d) If a trust or the administration or settlement of an estate is considered terminated under this section for Federal income tax purposes (as for instance, because administration has been unduly prolonged), the gross income, deductions, and credits of the estate or trust are, subsequent to the termination, considered the gross income, deductions, and credits of the person or persons succeeding to the property of the estate or trust.

An asset is something of value that your business owns, like buildings, machinery, equipment, and vehicles. When you sell a capital asset (used for investment or to make a profit), you can sell it at a gain or loss. The difference between the original cost (called the basis) and the sales price is either a capital gain or a capital loss.

For example, if you own business equipment, you may add to the basis by upgrading the equipment or reduce the basis by taking certain deductions and by depreciation. The cost at purchase plus the changes create an adjusted basis at the time you sell the equipment. The difference in this adjusted basis and the sales price is either a capital gain or a capital loss.

Capital gains tax is a tax charged on all capital gains. These gains are taxed differently, depending on how long they are held. If you own the asset for more than a year before you sell it, your capital gain is long-term. If you hold it one year or less, the gain is short-term.

To calculate your capital gains tax rate for your tax return, you must separate short-term and long-term capital gains on all the assets you sold during the year to get a net short-term and net long-term capital gain (or loss).

The net long-term capital gain is taxed is usually no higher than 15% for most taxpayers, but there are some exceptions.

A net short-term capital gain is usually taxed as ordinary income, based on your tax rate.

At the time of Sale of any Real Estate Property, Tax is liable to be paid on the Gains earned on the sale of the Real Estate Property. Such Gains could either be Short Term Capital Gains or Long Term Capital Gains. The basis of such Classification in the Income Tax Return has been given below:

• Short Term Capital Gain (STCG): If the Real Estate Property is held for less than 24 Months.
• Long Term Capital Gain (LTCG): If the Real Estate Property is held for more than 24 Months (Reduced from 36 to 24 Months from FY 2017-18 onwards).

Full Value of Consideration

Full Value of Consideration means what the transferor receives or is entitled to receive as consideration for the Sale of Property /Asset. This Value may be in cash or in kind i.e. in exchange for an Asset.

In case of exchange of an asset, the full value for the computation of Capital Gains shall be the Fair Market Value of the Property (Asset) granted in exchange. Fair Market Value in relation to Capital Gains means the price which the Property (Asset) would normally fetch if sold in the open market on the Relevant Date.

In case, the full value of consideration is received in installments in different years, the entire value of consideration shall be the Market Value of the Property/Asset granted in exchange.

Expenses on Transfer

Expenses on Transfer include any expenditure incurred, whether directly or indirectly, for the purpose of transfer like Advertisement Expense, Brokerage Expense, Stamp Duty, Registration Fees, and Legal Expenses etc. However, any expense which has been claimed as a deduction under any other provision of the Income Tax Act cannot be claimed as a deduction under this Clause.

Cost of Acquisition

Cost of Acquisition is the price which the assessee has paid, or the amount which the assessee has incurred, for acquiring the Property /Asset. The Expenses incurred at the time of completing the title are a part of the cost of acquisition.

In cases where the Capital Asset became the property of the assessee in any of the manners mentioned below, the cost of acquisition shall be deemed to be the cost for which the previous owner of the property acquired it:

• On the Distribution of Assets/ Total Partition of HUF.
• Under a Gift or Will.
• By Succession, Inheritance or Devolution.
• On Distribution of Assets on Liquidation of a Company.

Capital gains on depreciable asset

Under Section 50 of Income Tax Act, if you have sold a capital asset forming part of a block of assets, including building and machinery, on which the depreciation has been allowed under the law, the income arising from the sale is treated as short-term capital gain.

The reader must note here that as land is not a depreciable asset and so, cannot form part of a block of assets in absence of rate of depreciation. Hence, the provisions of Section 50 cannot be invoked, in case of sale of land. If land is held for a period of more than 24 months, the gains earned through the transactions is taxed as long­term capital gains.

Computation of profit or loss from sale of business property in an asset block

Unlike regular accounting where the depreciation is calculated with reference to the cost or written down value of each asset, the depreciation for a particular block of assets is computed in an aggregate manner. If there are more than one assets in one particular block of assets, the depreciation is calculated on the value arrived at after adding the cost of acquisition for the assets purchased during the year and falling under the same block of assets, to the written down value of the block at the beginning of the year and by reducing the sale price of one or more assets sold during the year.

Passive income comprises of earnings which are derived via a rental property, limited partnership, or any other enterprise in which any individual is not involved in active participation. Usually, passive income is taxable.

Paying Income tax is one thing, which most of the people do not like. Everyone tries to minimize their income tax by some or the other means.

A few analysts consider portfolio income as passive income, and hence, interest and dividends would be regarded as passive income. Passive income requires little to no effort in order to earn and maintain. It is termed as progressive passive income when an earner puts in little effort to generate income.

A passive income investment will make the life of an investor easier in several ways, especially when a hands-off approach is chosen. The four passive income investment options include – Real Estate, Peer-to-Peer Lending, Dividend Stocks, and Index Funds. These four options indicate varying levels of risk and diversification. As with any kind of financial investment, it’s vital to gauge the expected returns with respect to a passive income opportunity versus the potential for loss.

There are three types of passive activities:

Cash flows via property income, inclusive of profits from ownership of capital, rent via ownership of resources such as rental income, cash flows from a property or from any piece of real estate, and in the form of interest through owning financial assets.

• Trade/business-related activities in which an individual does not take part in the operations of a business other than investing during the year.
• Royalties, i.e. payments initiated by one firm (the licensee) to another firm/an individual (the licensor) for the right to utilise the latter’s intellectual property (music, video, book).

Tax free Passive income

Agricultural Income:

Agricultural Income is exempted from tax. However, the income from agriculture (if earned more than Rs 5000 a year) has to be taken into consideration for calculating the tax payable.

Dividends received from your shares or equity mutual funds

You receive dividends from your stocks or equity mutual funds (dividend option). This dividend money you get is also tax-free in your hand. However, the bad side of the story is that company anyways pays the dividend distribution tax to govt before giving the dividends to its shareholders. Hence, anyways we are getting slightly less share of profits in our hand anyway.

Now after budget 2018, the dividends from equity shares or mutual funds will be taxed at a flat rate of 10% above the threshold limit of Rs 1,00,000 in a financial year. Before budget 2018, the profits from equity after a year was 100% tax free.

Profits from shares or equity mutual funds after a year

When you earn any profits from your shares or equity mutual funds after holding it for minimum 1 yrs, it is called Long-term Capital gains, and it is 100% tax exempted as per current tax rules.

Now after budget 2018, the profits from shares or equity will be taxed at a flat rate of 10% above the threshold limit of Rs 1,00,000 in a financial year. Before budget 2018, the profits from equity after a year was 100% tax free.

Any amount received through WILL or Inheritance

There is no inheritance tax in India now. So, anything you get in inheritance through WILL is not taxable in your hands. It becomes your property and now when you invest that money, only the interest part earned on that property will be taxed.

Money received from your EPF account after 5 yrs

The money one gets from their EPF account is also tax-free, provided the money is taken out after 5 yrs of service.

Money got under VRS scheme up to Rs 5 Lacs

If a person takes VRS (Voluntary retirement scheme) than any amount received up to Rs 5 lacs is income tax-free. However, not everyone is eligible for it. Only employees of Public sector companies or an authority established under a Central or State govt is eligible for this.

Maturity or Claim amount received by Life Insurance Company

The money you get from life insurance companies on maturity, claim or surrender is 100% tax-free provided, If the premium paid does not exceed 20% of the sum assured. I am quoting new amendments which have come in recent years.

As per amendments introduced in the Finance Act, 2003, (i.e., with effect from April 1, 2003), any proceeds received on account of maturity/surrender of an insurance policy were exempt from tax only if the premium paid did not exceed 20% of the sum assured.

Interest on saving bank interest up to Rs 10,000 a year

From 2013 onwards, a new section 80 TTA is introduced under which, the interest on your saving bank account up to Rs 10,000 is not taxable. So if your saving bank interest for a year is Rs 20,000, then out of that Rs 10,000 is exempted and only the rest Rs 10,000 will be added to your taxable income.

Adjusted gross income (AGI) is an individual’s total gross income minus specific deductions. It is used to calculate taxable income, which is AGI minus allowances for personal exemptions and itemized deductions. For most individual tax purposes, AGI is more relevant than gross income.

Gross income is sales price of goods or property, minus cost of the property sold, plus other income. It includes wages, interest, dividends, business income, rental income, and all other types of income. Adjusted gross income is gross income less deductions from a business or rental activity and 21 other specific items.

Several deductions (e.g. medical expenses and miscellaneous itemized deductions) are limited based on a percentage of AGI. Certain phase outs, including those of lower tax rates and itemized deductions, are based on levels of AGI. Many states base state income tax on AGI with certain deductions.

Adjustments

Gross income is reduced by certain items to arrive at adjusted gross income. These include:

• Expenses of carrying on a trade or business including most rental activities (other than as an employee)
• Certain business expenses of teachers, reservists, performing artists, and fee-basis government officials.
• Health savings account deductions.
• Certain moving expenses.
• One-half of self-employment tax.
• Allowable contributions to certain retirement arrangements (SEP IRA, SIMPLE IRA, and qualified plans) and Individual Retirement Accounts (IRAs).
• Penalties imposed by financial institutions and others on early withdrawal of savings.
• Alimony paid (which the recipient must include in gross income).
• College tuition, fees, and student loan interest (with limitations and exceptions).
• Jury duty pay remitted to the juror’s employer.
• Domestic production activities deduction.
• Certain other items of limited applicability.

An Income Tax penalty is a punitive measure which applies to assessees who make default in compliance with the Income Tax Act. The Act has introduced various penalties for contraventions committed by taxpayers. The penalty prescribed as per the Income Tax Act can either be mandatory or leviable at the discretion of a tax authority. In this article, the various income tax penalties are discussed.

Audit and Audit Report

• If the assessee fails to get his accounts audited, obtain audit report, or furnish report of such auditor, a penalty will be leviable at the ₹1,50,000 or ½% of the total sale/ Turnover/ gross receipts whichever is lesser.
• Failure of assessee to furnish Audit report related to foreign transaction, a penalty @ ₹1,00,000 will be payable.

TDS/TCS

• Where a person fails to deduct tax at source, he will be liable to pay a penalty equal to the amount of tax which he has failed to deduct/ pay.
• Where a person fails to collect tax at source, he will be liable to pay a penalty equal to the amount of tax which he has failed to collect.
• Failure to furnish TDS/TCS statement or furnishing incorrect statements, shall attract a penalty ranging from ₹10,000 to ₹1,00,000.
• Failure to furnish information/ furnishing inaccurate information related to TDS deduction related regarding Non-residents shall attract a penalty of ₹100,000.

Penalty for Failure to Comply with Notice

According to the Income Tax Act, an Income Tax Assessing Officer is allowed to issue a notice demanding the taxpayer to file an income tax return. The officer can demand the assessee to produce documents pertaining to an income tax assessment. If a taxpayer may fail to comply with a notice from an Income Tax Officer. In such cases, the taxpayer shall be liable for a penalty of Rs.10,000 for each instance of failure to comply. The officer may also require the taxpayer to furnish in writing any information. The taxpayer should get the accounts audited or re-audited by a Chartered Accountant.

Undisclosed income

• Where the income determined includes undisclosed income, a penalty @10% is payable. However, no such penalty will be leviable, if such income was included in the return and tax was paid before the end of the relevant previous year.
• Where Search has been initiated on/ after 1/7/2012 but before 15/12/2016,
• If undisclosed income is admitted during the course of search and assessee pays tax and interest and files return, a penalty @ 10% of such undisclosed income is payable.
• If undisclosed income is not admitted but the same is furnished in the return filed after such search, 20% of such undisclosed income is payable.
• In all other cases, penalty is leviable @ 60%

Penalty for Concealing Income

The taxpayer may endeavour to reduce his tax liability by concealing income or by furnishing inaccurate particulars of income. In such cases, a penalty can be levied by the Assessing Officer. Penalty for such contravention shall be 100% to 300% of the tax evaded.

Penalty for Not Maintaining Book of Accounts

The Income-tax Act mentions that a taxpayer is bound by the need to maintain books of account. The taxpayer may fail to maintain books of account. In such cases a penalty of up to Rs.25000 is applicable.

Default in making payment of tax

The amount of penalty leviable will be as determined by the Assessing Officer. However, the amount will not exceed the amount of tax in arrears.