Chapter 17 - Tax Consequences of Personal Activites.

Question 1

Define Acquisition Debt

Answer 1

Debt incurred to acquire, construct, or substantially improve a personal residence. The debt must be secured by the residence and is limited to $1 million ($500,000 for married filing separately)

Question 2

Define American Opportunity Credit

Answer 2

An individual tax credit based on the cost of tuition, fees, and course materials paid during the first four years of post-secondary education.
-Maximum annual credit is $2,500 per eligible student and phased out for high-income earners

Question 3

Define Coverdell Education Savings Account.
What are the requirements of beneficiary
What is the contribution limit?

Answer 3

• An investment account through which an individual can save for a beneficiary’s elementary, secondary or higher education expenses on a tax-exempt basis.
• Beneficiary must be under 18
• Contribution Max is $2,000 and phased out for high-income earners

Question 4

Define Creative Assets

Answer 4

Copyrights; literary, musical, or artistic compositions; letters or memoranda; or similar assets.

Question 5

Define Education Savings Bonds

Answer 5

Qualified Series EE savings bonds that can be redeemed tax-free to pay for certain education expenses.

Question 6

Define Hobby Loss

Answer 6

Excess of expenses over revenue from a personal activity not engaged in for profit.

Question 7

Define Home Equity Debt

Answer 7

Debts secured by a personal residence to the extent the debt does not exceed the owner’s equity in the residence. Home owner equity debt is limited to $100,000 ($50,000 for married filing separately)

Question 8

Define Imputed Income From Owner-Occupied Housing

Answer 8

The nontaxable economic benefit (fair rental value) derived by the owner of a home.

Question 9

Define Lifetime Learning Credit

Answer 9

An individual tax credit based on 20% of the cost of tuition, fees, and course materials.
-Maximum annual credit is $2,000 phased out for high-income earners.

Question 10

Define Principal Residence

Answer 10

The home in which an individual resides for most of the year and considers his permanent address.

Question 11

Define Qualified Education Loan

Answer 11

Any debt incurred to pay higher education expenses.

Question 12

Define Qualified Residence Interest

Answer 12

Interest paid on acquisition debt or home equity debt allowed as itemized deduction.

Question 13

Define Qualified Tuition Expenses

Answer 13

Tuition and fees required for enrollment in a post secondary education institution.

Question 14

Define Qualified Tuition Program.

What is the tax status of distributions?

Answer 14

• A savings program sponsored by a state or private educational institution in which individuals can invest to pay future college expenses.
• Distributions are nontaxable to the extent used to pay higher education.

Question 15

Define Vacation Home

Answer 15

A personal residence other that the owner’s principal residence.

Question 16

When does the rule of including the value of prizes received generally apply?

Answer 16

To awards based on professional achievement or merit, academic and athletic awards (Students who are degree candidates at educational institutions may exclude scholarship or fellowship awards to the extend the award pays for tuition, fees, books, supplies, and equipment), awards attributable to luck, and rewards that people receive for performing a special or noteworthy service.

Question 17

What is the major exception to the rule that personal receipts are taxable?

Answer 17

Gifts and inheritances.

Question 18

What is the general tax rule about legal damages about whether to include them as gross income?

Answer 18

They are part of gross income unless they represent compensation for physical injury or illness.

Question 19

For income tax purposes, how is the transfer of ownership of valuable property from one party to another as part of a divorce treated?

Answer 19

As a gift. As a result the transferor recognizes no gain or loss on the disposition of property. The transferee recognizes no gross income on the receipt of the property and take a carryover tax basis from the transferor.

Question 20

How is alimony handled for figuring out income?

Answer 20

• The recipient must include it as part of their gross income
• The payer is allowed to deduct it above-the-line.

Question 21

How is child support handled for figuring out income?

Answer 21

• They are not taxable to the recipient

- Nondeductible by the payer

Question 22

Which of two divorced parents gets to claim the personal exemption and child tax credit for the dependent child by default? What is the exception?

Answer 22

The custodial parent

Unless they sign a written declaration releasing them to the noncustodial parent.

Question 23

How are payments that are received by people who receive need-based assistance from a local, state or federal agency treated?

Answer 23

They are excluded from gross income

Question 24

Is unemployment compensation taxable?

Answer 24

Yes

Question 25

In general terms how is Social Security taxed? 3

Answer 25

• Married couples with less than $32,000 and single individuals with less than $25,000 of modified AGI do not pay tax on their benefits
• Married couples with modified AGI between $32,000 and $44,000 and single individuals with modified AGI between $25,000 and $34,000 pay tax on 50% of their benefits.
• Married couples with more than $44,000 and single individuals with more than $34,000 of modified AGI pay tax on 85% of their benefits.

Question 26

What is a narrow exception to the rule that personal assets are capital assets?

Answer 26

Creative assets. It is not a capital assets in the hands of the person who created it or in the hands of a donee who received the gift from either the creator or the person for whom it was written.

Question 27

What are consumer durables?

Answer 27

Tangible assets that people use for their private use and enjoyment.

Question 28

What are three business related expenses that are not deductible?

Answer 28

Cost of professional wardrobe
Daily commute to work
Routine noonday lunches

Question 29

For what three major categories of personal expenses does the law ben the no-deduction rule?

Answer 29

Local, State, and Foreign Tax Payments
Medical Expenses
Charitable Contributions.

Question 30

What type of medical expenses are deductible? 6

Answer 30

• Payments to health care practitioners
• Payments to treatment facilities
• Certain travel expenses related to medical treatment
• The cost of medical aids (glasses, wheelchairs, etc)
• Prescription drug cost
• Premiums paid to purchase health, accident, and LTC insurance

Question 31

What is the medical care deduction limited to?

Answer 31

The excess of total unreimbursed expenses over 10% of AGI. The percentage decreases to 7.5% if the taxpayer or spouse has reached age 65 by the end of the year.

Question 32

What are several common taxes that individuals pay that are not deductible for federal income tax purposes? 4

Answer 32

Gift tax
Estate tax
Employee payroll tax
Employment taxes paid for household employees

Question 33

What determines if a taxpayer has to include the refunds they got from state or local income tax as a part of their gross income?

Answer 33

Whether they had included the tax paid as a deduction.
-If you take a standard deduction their is not federal tax benefit from their state income tax payment, and the refund would be nontaxable.

Question 34

What must the donee have for a transfer of property to count as a charitable contribution?

Answer 34

A tax-exempted status granted to them by the IRS

Question 35

What is the rationale behind the tax benefit for charitable contributions?

Answer 35

The deduction encourages private citizens to support worthy causes that benefit society as a whole.

Question 36

What is the annual deduction for contributions to public charities limited to?

Answer 36

It cannot exceed 50% of AGI. Any contribution in excess of such limit is carried forward as an itemized deduction for five years.

Question 37

If an individual contributes property that is not a capital asset to charity, how does that affect the deduction?

Answer 37

The deduction will be limited to the lesser of the FMV or the contributor’s basis in the property.

Question 38

What kind of deduction are qualified tuition expenses reported as? Limited to?

Answer 38

Above-The-Line

Limited to $4,000 and phased out for high-income earners

Question 39

What kind of deduction is the interest paid on qualified education loans reported as? Limited to?

Answer 39

Above-The-Line

$2,500 and phased out for high-income earners

Question 40

What is the caveat in claiming either the American Opportunity Credit or the Lifetime Learning Credit?

Answer 40

Individuals cannot claim both a deduction and a credit for the same qualified tuition expenses.

Question 41

What are the tax implications for a loss people sometimes realize on the sale of their personal residence?

Answer 41

It is a nondeductible personal loss.

Question 42

People can claim an itemized deduction for personal property losses arising from casualty or theft. How is casualty defined?

Answer 42

A sudden and unexpected event such as a fire, hurricane, earthquake, automobile accident, or vandalism that damages or destroys property.

Question 43

How is the deductible loss calculated for personal property that was due to a casualty? 4

Answer 43

• The loss is the lesser or the tax basis in the property or the decrease in value from the casualty or theft.
• Then it is reduced by any insurance proceeds so that only the unreimbursed loss is deductible.
• The loss from each casualty (or theft) is reduced by a $100 floor.
• Finally, only the person’s aggregate losses in excess of 10% of AGI is deductible.

Question 44

What is the allowed deduction for hobby losses?

Answer 44

Allowed a deduction for expenses only to the extent of revenues.
This deduction is a miscellaneous itemized deduction subject to the 2% AGI limitation.

Question 45

When is an activity presumed to be a business?

Answer 45

If it generates net income in three out of five consecutive years.

Question 46

How is a gambling loss treated differently than a hobby loss?

Answer 46

Gambling losses aren’t categorized as miscellaneous itemized deductions and therefore are not subject to the 2% AGI limitation.

Question 47

How are gambling wins a losses reported?

Answer 47

Winnings are reported as gross income and losses can be itemized deductions but only up to the amount of gambling wins. A net gambling loss is nondeductible.

Question 48

Why is it preferable for someone to save an amount of money in rents by owning a home than to earn the same amount of money investing?

Answer 48

Because, unlike the investment income, the rent money saved is tax free.

Question 49

What is the major exception to the rule that people who incur debt to finance a personal expenditure cannot deduct the interest paid on the debt.

Answer 49

Qualified residence interest.

Question 50

What is the aggregate of the deductions related to vacation homes limited to?

Answer 50

The gross rents less any mortgage interest or property taxes allocable to the rental property (during the period rented, the other portion can still be deducted as qualified residence interest)

Question 51

What can be deducted for owners who rent out their vacation home?

Answer 51

The expenses of maintaining the home allocable to the rental period on a Schedule E.
Also allowed a depreciation deduction based on the number of days of rental usage.

Question 52

What are the conditions for the exclusion of a gain on the sale of principal residence?

Answer 52

• They must have lived in that home for at least two years during the five-year period ending on the date of the sale.
• Applies to only one sale every two years.
• The exclusion is limited to $250,000 for each sale.

Question 53

How is any gain on a principal residence that is an excess of the exclusion amount taxed?

Answer 53

As a long-term capital gain.

Question 54

How would a person, who realizes a gain on the sale of a principal residence but fails to meet the ownership/use requirement or violates the two year/one sale rule, be eligible for a reduced exclusion?

Answer 54

If they sold the residence because of:

• A change in the place of employment
• Health Reasons
• Unforeseen Circumstances

Question 55

How is a reduced exclusion of gain on the sale of a primary residence calculated?

Answer 55

2 years
That answer times $500,000

Example
$500,000 x (240 days of ownership/use / 730 days (two years) = $164,384