EA Part 1 - Section 2 - Income and Assets

Question 1

Constructively received income must be reported in the tax year it becomes available, regardless of when it is physically received.

Form 1099-NEC = nonemployee compensation

Answer 1

Bartering: is the trading of one product or service for another. Usually there is no exchange of cash. However, the fair market value of the goods and services exchanged must be reported as income by both parties.

Question 2

Which form do employers use to report wages paid to employees for the previous year? = Form W-2.

Employers are required to give each employee their Form W-2 by January 31.

Answer 2

fringe benefit = is a form of compensation that an employer provides to an employee in addition to their regular salary or wages. Fringe benefits can be monetary or non-monetary, and can include:

Monetary benefits
Health insurance, life insurance, retirement plans, vacation pay, bonuses, and employee discounts

Non-monetary benefits
Company cars, gym memberships, free meals or snacks, adoption assistance, and experiences

Question 3

Life insurance payout is not taxable when the payment was the result of the death of insured. True if proceed were paid under an accident or health health insurance policy. However, interest received as a result of life insurance proceeds e.g annuity is taxable.

Answer 3

If you earn less than $10 interest income you don’t have to report schedule B. If you earn more than $1,500 interest income and dividend you have to report schedule B ‘Interest and Ordinary Dividend’ on Tax return.

Question 4

Which type of income is generally NOT reported on an Armed Forces member’s Form W-2? =
VA disability benefits

VA disability compensation for disabilities paid either to veterans or their families are not reported on Form W-2 and are not taxable. Combat pay, overseas extension bonus, and enlistment or reenlistment bonuses are all included on the W-2 for a member of the Armed Forces.

Answer 4

Father Lucian is a Catholic priest who receives a salary plus a housing allowance for rent and utilities. He has not taken a vow of poverty. Which of the following statements is correct?

He must pay both income tax and self-employment tax on his salary, but only self-employment tax for the housing allowance. The housing allowance is not subject to income tax.

Question 5

The rental value of a home or a housing allowance provided to a minister as part of the minister’s pay generally is not subject to income tax but is included in net earnings from self-employment.

Answer 5

Gerald is an ordained minister for the Presbyterian Church. He owns his own home. In addition, he receives a monthly housing allowance from his church that isn’t subject to income tax. He pays regular mortgage interest and property taxes on the home. Which of the following is true regarding the deductibility of these expenses?

Gerald can still deduct his real estate taxes and home mortgage interest. The minister does not have to reduce their deductions by the nontaxable amount of the housing allowance.

Question 6

Renart is an ordained minister in the Blessed Church of Portland. He owns his own home and his monthly house payment is $1,900. His monthly utilities are an additional $450. Fair rental value in his neighborhood is $2,000. He receives a housing allowance from his church in the amount of $1,950 per month. How much of his housing allowance is subject to income tax?

$0
Ministers may exclude from gross income the rental value of a home or a rental allowance to the extent the allowance is used to provide a home, even if deductions are taken for home expenses paid with the allowance. Since the allowance did not exceed his costs, it is excludable from income tax (but not excludable from self-employment tax)

Answer 6

What is the tax treatment for veterans’ disability benefits if the veteran was discharged under honorable conditions?

Exempt from taxation
Veterans’ disability benefits are fully exempt from taxation if the veteran was discharged under honorable conditions. Veterans’ disability benefits (also called VA Disability Compensation) are a type of disability benefit paid specifically to a veteran for disabilities that are service-connected, which means the injury or disease is linked to their military service. The VA typically does not issue Form W-2, Form 1099-R, or any other tax-related document for veterans’ disability benefits.

Question 7

When are long-term disability payments from an insurance policy excluded from income?

When the taxpayer pays the premiums

Long-term disability payments from an insurance policy are excluded from income if the taxpayer (or the employee) pays the premiums for the policy. If both the taxpayer and their employer have paid the premiums for a disability insurance plan, only the amount attributable to the employer’s payments is reported as income. ‘Exam’

What type of interest is exempt from federal tax?

Municipal bond interest.

Interest earned on municipal bonds is exempt from federal income tax. However, this type of interest must still be reported on a taxpayer’s return.

Answer 7

The exemption for Medicare waiver payments applies only if:

The care provider and the care recipient live together in the same home.

Which of the following types of interest income is not taxable to the recipient?

Municipal bond interest

Nontaxable interest includes:

Municipal bond interest (Muni bonds).
Interest redeemed from Series EE and Series I bonds may be excluded from income if used to pay for qualified higher educational expenses during the year and you meet other requirements for the Educational Savings Bond Program.

Question 8

Dividends are not subject to employment taxes. Dividends income is not earned income is investment income. Always get Qualified Dividends.

“Exam” Nondividend distributions (reported in Box 3 of Form 1099-Div) = cooperation paying money they have no earning and profit. Not reported as taxable income. It reduces the basics you have . Once the basic is 0 any additional distributions are capital gains and are taxed as such.

Answer 8

If you receive capital gain distributions from mutual funds they are always treated as long-term regardless of the actual period the mutual funds investment is held. It is also tax exempt.

Declared Dividends: Report the year it was declared this contrary to the rule of the Constructive Received.

Question 9

Constructive Dividends = constructive distributions are assessed under audit, they can have negative consequences for corporations as well as to the shareholder.
Taxable to shareholders and not taxable to the corporations

Answer 9

It’s not good to hold any kind of real estate in a corporation because whenever it’s rent it is considered as a sale.

Exam” Shareholder loan : If a corporation cancels a shareholders’debt without repayment by the shareholder, the amount canceled may be treated as a distribution.

Question 10

Interest income is considered unearned income. Unearned income is income from investments and other sources which is unrelated to employment. Other examples of “unearned income” include interest from savings accounts, capital gain distributions, unemployment compensation, alimony, and dividends from stock.

Answer 10

Interest received on a municipal bond issued by the state of California to fund school buildings is:

Tax-exempt.
Municipal bond funds are one of a few investments in the market that offer exemption from federal tax.

Question 11

Combat pay earned by military servicemembers is generally nontaxable. Which type of pay is never classified as “combat pay”?

Retirement pay of armed forces personnel.

Retirement pay and pensions of armed forces personnel are not considered combat pay, they are merely treated as retirement income. Nontaxable combat pay will usually be shown on Form W-2, Box 12 with code Q.

Answer 11

Which of the following taxpayers may contribute to a Roth IRA in 2023?

Harold, who is 30 and has $34,000 in nontaxable combat pay.correct

Only Harold is allowed to contribute because he has qualifying compensation for the year. Members of the military are allowed to count tax-free combat pay when figuring how much they can contribute to a Roth or traditional IRA.

Question 12

Todd is an ordained minister that wants to request an exemption from Social Security and Medicare Taxes. How is this done?

Todd must file Form 4029.

Todd must file Form 4029, Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits. To be exempt from Social Security and Medicare taxes, a minister, priest, or other clergy, must obtain a Social Security number and file Form 4029, Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits. The exemption from Social Security and Medicare taxes is applicable for self‐employment income and wages.

Answer 12

Gerald is an ordained minister for the Presbyterian Church. He owns his own home. In addition, he receives a monthly housing allowance from his church that isn’t subject to income tax. He pays regular mortgage interest and property taxes on the home. Which of the following is true regarding the deductibility of these expenses?

Gerald can still deduct his real estate taxes and home mortgage interest. The minister does not have to reduce their deductions by the nontaxable amount of the housing allowance.

If a minister receives a housing allowance that isn’t taxable, the minister can still deduct their real estate taxes and home mortgage interest. The minister does not have to reduce their deductions by the nontaxable amount of the housing allowance.

Question 13

When are long-term disability payments from an insurance policy excluded from income?

When the taxpayer pays the premiums

Long-term disability payments from an insurance policy are excluded from income if the taxpayer (or the employee) pays the premiums for the policy. If both the taxpayer and their employer have paid the premiums for a disability insurance plan, only the amount attributable to the employer’s payments is reported as income.

Which type of disability-related payments are generally not taxable at all? =

Worker’s compensation

Answer 13

If both an employee and their employer have paid the premiums for a disability insurance plan, and the employee later becomes disabled and starts to receive long-term disability payments, what portion of the disability benefits must be reported as taxable income by the employee?

Only the amount attributable to the employer’s payments is reported as income.correct

If both the taxpayer and their employer have paid the premiums for a disability insurance plan, only the amount attributable to the employer’s payments is reported as income. Long-term disability payments from an insurance policy can be excluded from income only if the taxpayer (or the employee) pays the full cost of the premiums for the insurance policy.

Question 14

An employee who receives _______ or more per month in cash tips from one job must report the tip income to his employer.

$20
Tips are taxable as follows:

1- Tips paid in cash of $20 or more per month are taxable as wages. These tips are subject to FICA, FUTA, and income tax.
2- Tips of less than $20 a month are subject to income tax but are not subject to FICA or FUTA.
3- The fair market value of noncash tips (such as tickets or movie passes) is subject to income tax but is not subject to FICA or FUTA.

Answer 14

Which types of debts can typically lead to a wage garnishment?

Delinquent tax debts

Wage garnishment occurs when a court orders part of an employee’s salary to be diverted to pay unpaid debts. Employees may have their wages garnished for various reasons, such as when they owe child support, back taxes, or other debts. Regardless of the amounts garnished from the employee’s paycheck, the full amount of gross wages must be included in the employee’s taxable wages at year-end.

Question 15

Under what of the following conditions will a tuition reduction, grant, or scholarship be taxable to a student?

Any portion of a grant or scholarship that is compensation for services will be taxable as wages to the student

A common arrangement is when colleges offer tuition reduction and/or free on-campus housing in lieu of wages to student teachers. However, any portion of a grant or scholarship that is compensation for services is taxable as wages. For example, if a student must serve as a part-time teaching assistant as a condition of their scholarship or grant, then that is payment for work, and would be taxable as wages to the student.

Answer 15

Non-cash tips (for example, concert tickets, sports tickets, or other items) do not have to be reported to the employer, but they must be reported and included in the employee’s gross income at their fair market value.

Unger had the following income items during the year. Which of the following would be fully taxable as wages, and subject to Social Security and Medicare taxes?

$17,000 in severance pay when he quit his job.

Only the $17,000 in severance pay would be fully taxable as wages. Severance pay is considered a type of supplemental wages or employee compensation.

Question 16

worker’s compensation is not treated as wages, and is not taxable. Worker’s compensation should not be confused with disability insurance, sick pay, or unemployment compensation; it is a type of benefit that pays workers who are injured on the job.

Question 17

Lorenzo is an international student and a junior at San Diego State University. He is a citizen of Spain lawfully present in the U.S. in F-1 immigration status. When he came to the U.S. to study three years ago, his parents gave him $20,000 in cash for his living expenses. Lorenzo applied for a scholarship while he was attending the university, and received $4,000 in scholarship funds, which he used to help pay his tuition. Is this taxable income to Lorenzo, who is classified as a nonresident alien for tax purposes?

The scholarship is not taxable and does not have to be reported on Form 1040-NR.

The scholarship is not taxable and does not have to be reported on Form 1040-NR. A foreign student who is a candidate for a degree may be able to exclude some or all income received under a “qualified” scholarship, if the amounts are used for tuition, fees, books, supplies, and required equipment. Amounts used for other purposes, such as room and board or travel, are not excludable. He would not be eligible for education credits.

Answer 17

Toby switched jobs in the middle of the year and ends up working for two different employers. He earns $200,000 in total wages. Social Security taxes are collected on the entire amount. What is true about Toby’s situation?

Toby can claim a refund of the excess Social Security taxes on his Form 1040

Toby has the option to claim a refund on the excess Social Security taxes, since he worked for more than one employer during the year. In this type of scenario, the overpaid Social Security tax will be refunded when Toby files his individual return and claims the excess Social Security withholding as a credit.

Which of the following payments would be deductible as qualifying student loan interest?

Voluntary interest payments on a student loan.

Question 18

Real property: land and anything permanently attached to it. Eg: Buildings, farmland, personal homes etc..

Exam’ Royalty

Personal property: is anything other than real estate. Including furniture, equipment, vehicles, household goods etc..

Question 19

Terrence is a 20% shareholder of Willow Corporation, a C Corporation. The corporation makes the following payments to Terrence during the year. Which of the following would most likely be reclassified as a constructive dividend to Terrence?

A below-market loan made to Terrence by the corporation

Loans to shareholders at “below-market” interest rates would be classified as a constructive dividend. A constructive dividend is a payment or a benefit given to a shareholder in a company that is not intended or classified as a distribution to the shareholder, but which is classified later as a dividend by the IRS and thus becomes taxable to the shareholder, and nondeductible to the corporation. Other examples of constructive dividends include:

1- Excessive compensation, including excessive rents paid to the shareholder
2- Use by shareholders of corporate property
3- Payment of personal expenses with corporate funds
4- Assumption of shareholder debt by the corporation

Which of the following is not taxable as “earned income”? =

Social security and railroad retirement benefits.

Earned income includes all the taxable income and wages a taxpayer receives from working. Taxable earned income includes:

1- Wages, salaries, tips, and other taxable employee pay.
2- Union strike benefits.
3- Long-term disability benefits received prior to minimum retirement age.
4- Net earnings from self-employment.
Most government welfare benefits including food stamps, heating assistance programs, and non-federal assistance benefits from states or local agencies are exempt from federal taxation and not treated as “earned income.” Worker’s compensation, which provides wage replacement and medical benefits to injured workers, is also not taxable.

Answer 19

A constructive dividend is taxable to the shareholder, and not deductible to the corporation, so it has a very negative impact. Constructive dividends are usually assessed under audit. Examples include when a corporation:

1- Pays personal expenses on behalf of an employee-shareholder.
2- Pays an employee-shareholder an unreasonably high salary considering the services actually performed.
3- Rents property from a shareholder and the rent is unreasonably higher than the shareholder would charge an unrelated party for use of the property.
4- Cancels a shareholder’s debt without repayment by the shareholder.
5- Loans money to a shareholder on an interest-free basis or at a below-market rate.

Qualified dividends are a type of dividends that are eligible for taxation at preferential long-term capital gain rates.

Qualified dividends are taxable income.

A nondividend distribution reduces the basis of a taxpayer’s stock. It is not taxed until the basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of the taxpayer’s investment in the stock of the company. When the basis of the stock has been reduced to zero, the taxpayer must report any additional nondividend distributions received as a capital gain.

How are royalties from natural resource extraction, such as mining activities, typically reported?

On Schedule E

For IRS purposes, what activity qualifies a person as a stockbroker or bona-fide “securities dealer”?

A taxpayer engaged in the trade or business of selling securities.

Question 20

Bishakha is age 66 and separated from her husband in the middle of the year. They are not “legally” separated and they have not filed for divorce. Bishakha doesn’t have any dependents, and plans to file MFS (married filing separately). She is still working, and also collects Social Security. What is the base amount that Bishakha must use to calculate the taxable portion of her Social Security?

$0
Bishakha is filing MFS, and separated from her spouse in the middle of the year, which means her base amount is zero.

Note: For a taxpayer who is married filing separately and lived with their spouse at any time during the year, the base amount for calculating the taxability of Social Security benefits is $0, meaning that Bishakha’s Social Security benefits are likely to be at least partially taxable.

Answer 20

Selma and Harry are married and file jointly. They each are paying down their student loans. Their joint AGI is $88,000 in 2023. Selma pays $2,650 in student loan interest during the year, and Harry pays $4,900 in student loan interest on his loan. What is the maximum student loan interest deduction that they can claim on their joint tax return?

$2,500
The student loan interest deduction is limited to $2,500 per tax return, per year.

State income tax refunds are reported to the taxpayer on the Form ________.

Form 1099-G

Question 21

For IRS purposes, what activity qualifies a person as a stockbroker or bona-fide “securities dealer”?

A taxpayer engaged in the trade or business of selling securities.

What types of property qualify for a like-kind exchange?

Real property held in a trade or business or for investment, including land, buildings, and certain unsevered natural products of land.correct

Answer 21

Amelie owns a catering business. She received Form 1099-NEC for $43,000 for several large catering jobs. She also received cash payments that total $12,500 for catering a few private weddings. How must Amelie report these payments?

All the payments are reportable as gross income on her Schedule C

Rebekah filed a joint tax return with her new husband, Noah, and the entire refund was applied to Noah’s overdue student loans. What form should Rebekah file, in order to receive her portion of the refund?

Form 8379

Question 22

Real estate is deducted as an expense in schedule A

When there is property transfer consider using the basis whether it’s divorce.

NB: When property is transferred from one spouse to another during a divorce, typically, there are no tax implications for this transfer. For property transfers to qualify as “incident to a divorce,” the transfer generally must occur within one year after the date the marriage ends.

Gilbert and Brittney are getting divorced. Gilbert has decided to buy Brittney out of their jointly-owned rental property as a condition of the divorce. What is the proper classification of this payment?

A non-deductible property settlement.

When property is transferred from one spouse to another during a divorce, typically, there are no tax implications for this transfer. For property transfers to qualify as “incident to a divorce,” the transfer generally must occur within one year after the date the marriage ends.

Answer 22

Basic of Gifted Property:

On January 30, Tracy received two acres of land as a gift from her brother, Matthew. At the time of the gift, the land had an FMV of $77,000. Matthew’s adjusted basis in the land was $74,000. Tracy then spent $2,000 of her own funds to clear tree stumps from the land. On December 31, Tracy sold the property for $76,500. How should she report this transaction on her tax return?

$500 gain.
($74,000 + $2,000) = $76,000 basis
($76,500 - $76,000) = $500 capital gain on sale

Kareem gives his favorite cousin, Nicole, a gold watch. Two years ago, Kareem paid $4,000 for the watch, but its value has increased to $6,000. What are the tax implications to Nicole?

Nicole’s basis in the watch remains the same as Kareem’s basis

There are no tax implications, and Nicole’s basis in the watch remains the same as Kareem’s basis. Generally, the basis of gifted property for the donee is equal to the donor’s adjusted basis. This is called a “transferred basis.” If FMV equals or exceeds the donor’s basis, the donee’s basis remains the same as the donor’s.

Question 23

Murray purchased a first edition of an Ernest Hemingway novel in the 1920s for $25. Decades later, Murray gave the book to his grandson, Maximus. At the time of the gift, the book had an appraised value of $1,325. Nine months later, Maximus sold the book for $1,650. What is the amount and character of Maximus’ gain from the sale of the first edition book?

$1,625 long-term capital gain

Maximus has a $1,625 long-term capital gain ($1,650 – transferred basis $25). The holding period is long term, because the holding period of his grandfather is “tacked-on” to Maximus’ holding period.

Hester acquired an acre of farmland as a gift from her aunt. At the time of the gift, the acre had a fair market value (FMV) of $19,000. Her aunt’s adjusted basis in the land was $14,000. No gift tax was paid on the gift. No events occurred to increase or decrease her basis in the property. Hester later sold the acre of land at a bargain price of $10,000, because she wanted the cash from a quick sale. What is Hester’s gain (or loss) on the sale?

$4,000 loss
Hester’s loss is $4,000 ($14,000 - $10,000 sale price). Since she sold the property at a loss, her basis in the land for calculating the loss is $14,000, because it is the lower of her aunt’s adjusted basis and the fair market value on the date of the gift.

Can Armed Forces personnel deduct moving expenses covered by government reimbursements?

No, moving expenses covered by government reimbursements are not deductible.

Active-duty members of the Armed Forces may deduct unreimbursed moving expenses if the move was due to a military order and a permanent change of station. However, expenses already reimbursed by the government are not deductible (no double-dipping is allowed!).

What form should be used by Armed Forces personnel to calculate their moving expense deduction?

Form 3903

Answer 23

Horatio’s sister, Melinda, died during the year. Horatio inherited 300 shares of stock from Melinda. She had paid $4,000 for the shares over ten years ago. On the date of Melinda’s death, the stock was valued at $14,500. On December 31, Horatio sold all the stock for $15,100. What is the amount and nature of his gain (or loss)?

$600 long-term capital gain.

Horatio’s gain is $600, and it is long-term. Since Horatio inherited the stock, he uses the stepped-up basis to calculate gain or loss on the stock, (the deceased person’s original basis is irrelevant). The basis of inherited property is generally the FMV of the property on the date of the decedent’s death. Inherited property is always considered long-term, regardless of how long it was held by either the decedent or the beneficiary.

Trenton wishes to sell a home that he inherited from his deceased mother in San Francisco. His mother paid $45,000 for the home over forty years ago. His mother put a new roof on the property two years ago, just before her death, at a cost of $10,500. His mother also owed $5,000 in delinquent property taxes on the home when she died. The fair market value of the home on the date of his mother’s death was $920,000. No estate tax return was filed for his mother’s estate. What is Trenton’s basis in the inherited home?

$920,000

Trenton’s basis in the home is $920,000, the FMV on the date of his mother’s death. Usually, heirs use a stepped-up basis for inherited property, regardless of what the deceased person actually paid for the asset, and regardless of any improvements that the decedent made to the home while they were still alive.

Note: The basis of inherited property is generally the FMV of the property on the date of the decedent’s death. This means that when the property is sold, the gain will be calculated based on the change in value from the date of death.

Question 24

Karen is a full-time teacher at a junior high school. She frequently purchases supplies for the classroom with her own money. Which of the following supplies would not be deductible?

Supplies for courses in health.

Educators can deduct the unreimbursed cost of:

1- Books, supplies and other materials used in the classroom.
2- Equipment, including computer equipment, software and services.
3- COVID-19 protective items to stop the spread of the disease in the classroom. This includes face masks, disinfectant for use against COVID-19, hand soap, hand sanitizer, disposable gloves, tape, paint or chalk to guide social distancing, physical barriers, such as clear plexiglass, air purifiers and other items recommended by the Centers for Disease Control and Prevention.
4- Professional development courses related to the curriculum they teach or the students they teach.

Answer 24

Form 982 used for

Form 982 is used to determine the amount of discharged indebtedness that can be excluded from gross income.

NOTE: Generally, debt is considered canceled when the lender either forgives or discharges the debt for less than the full amount owed. If the taxpayer can exclude the income, they should file Form 982 along with their Form 1040 to report the exclusion.

Question 25

Are income tax refunds from state governments always taxable?

Only if the taxpayer itemized deductions in the year they overpaid those taxes.

Income tax refunds from the state and local governments are not always taxable, but they can be. State tax refunds are only taxable if the taxpayer itemized deductions in the year they overpaid those taxes and only to the extent the amount paid in the previous year reduced their tax liability.