Fed. Personal Income Tax - quiz 1

Question 1

Which is most accurate definition of “Gross income?”

1) Gross income must be earned
2) Gross income includes cash or property, but not services
3) Gross income doesn’t need to be earned, nor does it need to come from any particular source
4) Gross income must be in the form of cash

Answer 1

Answer: 3

Gross income means “ all income from whatever source derived”

Includes:

• any economic benefit, or
• any clearly realized accession
• to your wealth

Question 2

When does an individual need not file a tax return?

3 elements

Answer 2

An individual need not file an income tax return if gross income does not exceed the sum of:

(i) the standard deduction,
(ii) her personal exemption, and (iii) any additional standard deduction allowed based on age.

Question 3

which is NOT taken into account for the purpose of determining whether an individual’s gross income requires her to file a tax return?

1) Standard deduction
2) Any additional standard deduction based on age.
3) Her personal exemption
4) Deductions for dependents.

Answer 3

2: Any additional standard deduction based on age

Question 4

With respect to capital gain, stocks:

1) Are not treated as a capital asset, but stock dividends are treated as capital gain.
2) And stock dividends are both treated as ordinary income.
3) Are treated as a capital asset, but stock dividends are not treated as capital gain.
4) Are treated as a capital asset and stock dividends are treated as capital gain.

Answer 4

4: Are treated as a capital asset and stock dividends are treated as capital gain.
- most dividends paid by domestic corporations have been eligible for capital gains rates. Stock has been and continues to be treated as a capital asset.

Question 5

The purpose of nonrecognition treatment in cases of involuntary conversion is to:

1) Tax gain realized on involuntary conversions of property.
2) Restore the taxpayer to the position he held prior to the involuntary conversion.
3) Compensate the taxpayer for losses realized on involuntary conversions of property.
4) Lessen the taxpayer’s liability for gain realized on an involuntary conversion.

Answer 5

2: Restore the taxpayer to the position he held prior to the involuntary conversion

Nonrecognition treatment is given to gain realized on involuntary conversion of property (e.g., destruction, theft, condemnation) if the proceeds realized by the taxpayer are reinvested in similar property. The rationale is that the taxpayer’s reinvestment of the proceeds restores him to the position he held prior to the conversion. To tax him under these circumstances would produce undue hardship. The reinvestment must occur within two years after the close of the taxable year in which any part of the gain was realized, and be in property similar or related in service or use

Question 6

Gains and losses on property are realized:

1) At the time the property is acquired.
2) At the time the property has appreciated or depreciated in value.
3) At the time the property is sold or otherwise disposed of.
4) Exactly one year after the property is acquired.

Answer 6

3: At the time the property is sold or otherwise disposed of.
- Gains and losses are given tax effect only when they are realized. Realization of gain or loss ordinarily occurs at the time an asset is sold or otherwise disposed of.

Question 7

Which of the following is NOT considered reportable under the cash receipts and disbursements method?

1) Interest on a savings account that the taxpayer has not withdrawn.
2) A postdated check cashed by the taxpayer in the normal course of business.
3) Prepaid income in the year in which the taxpayer receives it.
4) Prepaid expenses in the year in which the taxpayer pays them.

Answer 7

1: Prepaid expenses in the year in which the taxpayer pays them.

Explanation:
Prepaid expenses may not be deducted until the year to which they relate. A check is treated as a conditional payment of cash even if post-dated; it is income when received by the taxpayer as long as the taxpayer collects it in the normal course of business. If cash or property having an ascertainable fair market value (e.g., savings account interest) is available to the taxpayer without substantial restriction, it is taxable regardless of whether the taxpayer has actually taken possession of it. Prepaid income is taxable in the year in which the taxpayer receives it.

Question 8

Which would constitute a “qualifying child” for whom a taxpayer may claim an exemption?

1) An infant daughter born on December 31.
2) A five-year-old son who lives with the taxpayer for less than one-half of the year.
3) A 19-year-old married daughter who files a joint tax return with her spouse.
4) A 23-year-old son who is a part-time college student.

Answer 8

1:

A taxpayer may claim a full (not prorated) deduction for a child born at any time during the year. Married children may be claimed as dependents as long as they do not file joint returns with their spouses, and as long as they satisfy all other dependency requirements. Qualifying children must be younger than the taxpayer and under the age of 19 or a full-time student under the age of 24 at the end of the tax year.

Rule: A qualifying child must:

(i) reside with the taxpayer for more than one-half of the taxable year, and
(ii) not have provided more than one-half of her own support for the taxable year.

Question 9

Are personal expenses deductible?

1) No, personal expenses are not deductible.
2) Yes, personal residences sold at a loss are deductible.
3) Yes, family expenses are deductible.
4) Yes, living expenses are deductible.

Answer 9

1:

No deduction is allowed for personal, living, or family expenses. There is also no deduction if a personal residence or other personal use asset is sold at a loss.

Question 10

Are wagering losses an allowable itemized deduction?

1) Wagering losses are always allowable.
2) Wagering losses are not allowed if the taxpayer is also reporting wagering gains.
3) Wagering losses are allowed only to the extent of the taxpayer’s wagering gains.
4) Wagering losses are never allowable.

Answer 10

3:

Losses from wagering transactions are allowed only to the extent of that year’s reported gains from such transactions.

Question 11

Which of the following is a lawful itemized deduction based on incurred interest?

1) Interest on a $2 million first personal residence.
2) Interest on a $90,000 home equity loan, where the property’s fair market value is $100,000.
3) Interest on a loan for the purchase of a $2,000 refrigerator.
4) Interest on indebtedness incurred to acquire tax-exempt securities.

Answer 11

2:
- Interest on home equity loans of up to $100,000 (regardless of the purpose of the borrowing) is deductible, provided the debt amount does not exceed the property’s fair market value.
- Mortgage interest incurred to purchase a first or second personal residence is deductible on loans totaling up to $1 million.
- Personal interest is not deductible.
- Interest on indebtedness incurred to acquire tax-exempt securities is expressly disallowed.

Question 12

Deductible expenses incurred in carrying on a business ____________________:

1) Do not include employee salaries.
2) Must be common or accepted in the business world, but not necessarily in the taxpayer’s particular business or profession.
3) Do not include traveling expenses.
4) Must relate to producing the current year’s income.

Answer 12

4:

Ordinary and necessary expenses paid or incurred during the taxable year in carrying out a business are deductible. “Ordinary and necessary” means that the expenses are common or accepted in the particular business or profession and that they relate to producing the current year’s income. Reasonable salaries, office rentals, office supplies, and traveling expenses are all deductible when incurred for business purposes.

Question 13

Which is an example of a scholarship that must be included in gross income?

1) $1,000 scholarship for books required for courses at an educational institution.
2) $25,000 scholarship for tuition and fees at an educational institution.
3) $15,000 scholarship for supplies and equipment required for courses at an educational institution.
4) $20,000 scholarship that requires the student to work for the scholarship provider in a paid position for two years after graduation.

Answer 13

4:

An individual need not include a qualified scholarship in his gross income. A qualified scholarship is an amount received to cover tuition, fees, books, supplies, and equipment required for courses at an educational institution. The test is whether the primary purpose of the funds is to further the education and training of the recipient in his individual capacity. The scholarship must not be compensation for past or future services.

Question 14

The gain from the sale of a principal residence may be excluded when:

1) The taxpayer owned and used the property as his principal residence for the last five years.
2) he taxpayer owned and used the property as his principal residence for at least two of the last five years.
3) The taxpayer has not used this exclusion in the past five years.
4) The taxpayer paid less than $250,000 for the house.

Answer 14

2:

The gain from the sale of a principal residence may be excluded when a taxpayer owned and used the property as his principal residence for at least two of the five years preceding the sale. This exclusion may be used once every two years. A taxpayer may exclude up to $250,000 in gain (or $500,000 for qualifying joint returns) from the sale of a personal residence.

Question 15

Bequests, devises and inheritances are:

1) Includible in gross income, as is income from any inherited property.
2) Includible in gross income, except that income from any inherited property is excluded.
3) Excludible from gross income, except that income from any inherited property is included.
4) Excludible from gross income, as is income from any inherited property.

Answer 15

3:

Gross income does not include bequests, devises, or inheritances. However, the exclusion from gross income does not apply to the income from any property received as a bequest, devise, or inheritance, or inheritances consisting of income from property.

Question 16

Which is not true regarding the proceeds of a life insurance policy?

1) Proceeds are generally included in the gross income of the beneficiary.
2) Proceeds are generally excluded from the gross income of the beneficiary.
3) Proceeds are taxable if transferred for valuable consideration.
4) Proceeds are partially taxable in deferred payout arrangements where interest has accrued.

Answer 16

1:

Life insurance proceeds are excluded from the beneficiary’s gross income. In deferred payout arrangements, a prorated portion of the proceeds will be exempt from tax, but the interest element will be taxable. If the policy is transferred for valuable consideration, the proceeds will be taxable, unless the transfer is to: (i) the insured, (ii) his partner, (iii) his partnership, or (iv) a corporation in which he is a shareholder or an officer.

Question 17

Which is true regarding tax treatment of shareholder dividends?

1) No portion of a shareholder dividend is includible in the shareholder’s gross income.
2) Payments in excess of earnings and profits will be treated as tax-free to the extent of the shareholder’s basis in the stock.
3) Only payments made in excess of a corporation’s earnings and profits are taxable.
4) Both payments made from the corporation’s earnings and profits and payments made in excess of such earnings and profits are taxable.

Answer 17

2:

• A dividend is a payment made to a shareholder out of the corporation’s current or accumulated earnings and profits.
• Dividends are included in a shareholder’s gross income.
• However, payments in excess of earnings and profits will be treated as tax-free to the extent of the shareholder’s basis in the stock.

Question 18

Which is true of income from an illegal source?

1) The illegal income must be relinquished to the federal government and the taxpayer will not be taxed.
2) The illegal income must be returned to the source and the taxpayer will not be taxed.
3) The illegal income must be returned to the source, and the taxpayer will be both taxed and later entitled to a deduction
4) The illegal income must be returned to the source, and the taxpayer will be taxed and not entitled to a deductio

Answer 18

3:

Illegal income must be returned to the source. The taxpayer must report the income as taxable in the year of receipt, and will be entitled to a deduction in the year he pays the money back.

Question 19

Alimony payments are income that is ____________________.

1) Deductible by the recipient only if they are made pursuant to a divorce decree.
2) Deductible by the payor regardless of whether he is obligated to make them by a divorce or separation agreement.
3) Neither taxable to the recipient nor deductible by the payor.
4) Taxable to the recipient and deductible by the payor unless they agree otherwise.

Answer 19

4:

Cash payments received by a spouse or former spouse pursuant to a divorce or separation instrument are income to the recipient and deductible by the payor. There must be no liability to make such payments after death. This rule will not apply if the divorce or separation agreement provides otherwise. Accordingly, the parties have it within their power to decide who bears the tax burden on alimony payments.

Opposite for child support

Question 20

Which of the following is excluded from taxable gross income?

1) An employee achievement award for longevity valued at $500 given at an award ceremony.
2) A $100 award won on a television quiz show.
3) An employee achievement award in the amount of $250 given to an employee by an employer instead of his usual bonus
4) An unsolicited artistic award in the amount of $5,000 requiring no future services and turned over to charity at the recipient’s request.

Answer 20

4:

Virtually all prizes and awards are included in gross income. Recognition awards may be excluded if: (i) the award was made in recognition of a religious, charitable, scientific, educational, artistic, literary, or civic achievement; (ii) the recipient was selected without any action on his part; (iii) the recipient is not required to render substantial future services; and (iv) the award is turned over by the payor to a governmental or charitable organization at the recipient’s request.

An employee achievement award may be excluded if: (i) the award is tangible personal property with a value not exceeding $400; (ii) the award is for length of service or safety achievement; (iii) the award is presented as part of a meaningful presentation; and (iv) the award is not presented under circumstances suggesting disguised compensation.

Question 21

A debt discharged or canceled for less than its full principal amount is taxable income:

1) If such cancellation is a gift or bequest to the taxpayer.
2) If it is a purchase price reduction and the asset’s cost basis is adjusted downward accordingly.
3) Whenever it occurs as part of a bankruptcy proceeding.
4) To the extent of the difference between the full principal amount and the actual amount paid to satisfy the debt.

Answer 21

4:

• A debt discharged or canceled for less than its full principal amount is taxable income to the extent of the difference between the full principal amount and the actual amount paid to satisfy the debt. -The taxpayer can exclude discharged or canceled debt when: (3 ways)
  (i) Insolvency- the discharge occurs in bankruptcy or when the taxpayer is insolvent, and the taxpayer reduces certain favorable tax attributes to offset the benefit of such exclusion;
  (ii) Reduction in purchase price - the reduction is an adjustment to an asset’s purchase price and the asset’s cost basis is adjusted downward accordingly; or
  (iii) Gift- cancellation is a gift or bequest to the taxpayer.

mnemonic: RIG