Federal Income Taxation: At-Risk Limitation and the Passive Loss Rules

Federal Income Taxation HW#9
Name Course Instructor Date
.
Please answer the following questions at the end of Chapter 11:1-2, 4-5, 7, 10-11, 24, & 25
1) Identify two rules designed to limit the tax benefits a taxpayer may obtain from a tax shelter investment. In an e-mail to your instructor, describe how these rules reduce or defer the recognition of tax losses
Tax shelters are financial investment schemes that were used to avoid or defer taxes. As there was potential for tax avoidance, these were used to obtain deductions and credits when ventures were not expected to generate profit. Two rules that limit benefits from a tax shelter investment were adopted "at-risk limitation" and "passive loss rules."
At-risk limitation:
The at-risk limitation is a provision to limit tax shelters' scope so that investments resulting in potential losses do not gate the tax cut or evasion. The tax rule reduces tax evasion as taxpayers are prevented from intentionally making losses in investments to avoid taxes
Passive loss rules:
Taxpayers accumulate gains and losses from passive, active, and portfolio activities. This rule prevents prevent using passive losses to offset earned or ordinary income. Federal and state governments increase their tax collections from eligible taxpayers as taxpayers are prevented from deducting passive losses from investment
2, List some events that increase or decrease an investor's at-risk amount. What strategies can a taxpayer employ to increase the at-risk amount to claim a higher deduction for losses?
Events increasing at-risk amount
* Increases in liability
* The amount of cash borrowed
* The contribution made in cash
* The share of the activity's income
Events decreasing at-risk amount:
* The share of the activity's loss
* The withdrawal of cash
* The adjusted basis activity of property from the activity
4 Explain the meaning of the terms active income, portfolio income, and passive activity income.
Active income
Active income is earned directly by the taxpayer through their contribution. The income is earned as wages, salary, commissions, bonuses, and other direct earnings.
Portfolio income
The income includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. There is also gain or loss from property disposal when this produces portfolio income or is held for investment purposes.
Passive activity income
The income is from any trade or business or income-producing activity in which the taxpayer does not ma...