Federal Income Tax

Question 1

FIT is a cross-listed topic, so it is 1.5% of the exam. What aspects might be tested?

Answer 1

1. Determine gross income.
2. Deductions
3. Characterizations
4. Apply rates (progressive) to taxable income to arrive at tax liability
5. Subtract credits from tax liability to reach net tax due

Question 2

Which of the following items may NOT be excluded from a taxpayer’s gross income?

A - Proceeds from a life insurance policy.

B - $500 gift card given as an employee achievement award.

C - Gifts made from detached and disinterested generosity.

D - Gain from the sale of the taxpayer’s principal residence (up to $250,000).

Answer 2

B. $500 gift card given as an employee achievement award cannot be excluded from gross income.

Cash and gift cards do not qualify as an employee achievement award and must be included in gross income. None of the other items are includible in income.

Question 3

T/F: Shareholders in a S-corporation are taxed on their pro rata portion of earnings regardless of whether the earnings are distributed.

Answer 3

True. If the earnings are not distributed, the shareholder’s basis for his or her stock is increased in the amount of the earnings attributed to the shareholder. If the earnings are distributed to the shareholder in subsequent years, the shareholder’s basis in the corporate stock is decreased by the amount distributed.

Question 4

T/F: Damages for emotional distress are included in gross income if they are paid in conjunction with damages for defamation or libel.

Answer 4

True.

Question 5

How are punitive damages treated under the Internal Revenue Code?

Answer 5

They are fully taxable as gross income to the recipient. Punitive damages are intended to punish the wrongdoer, not to compensate the victim. Therefore, they generally represent a windfall to the recipient and are included in the recipient’s taxable income. While damages for emotional distress may be excluded if awarded in conjunction with a physical injury, this rule has not been extended to punitive damages.

Question 6

How are alimony payments treated?

Answer 6

After 2018, alimony payments are excludible to the recipient and not deductible by the payor. But the parties to a separation agreement entered before 2019 may modify the agreement to determine who bears the tax burden on the payments.

If any portion of an alimony payment is fixed by the decree or agreement as being for the support of the payor’s children, that portion is not deductible by the payor, nor is it includible by the recipient.

Question 7

Property acquired by bequest or inheritance may take as its basis the fair market value on which dates?

Answer 7

The date of the decedent’s death.

Six months from the date of the decedent’s death.

At the time of disposition, if disposed of within 6 months after the decedent’s death.

Question 8

What is true regarding the exclusion of gain from the sale of one’s principal residence?

Answer 8

• A single taxpayer can exclude up to $250,000 in gain from the sale or exchange of a principal residence. It can be doubled for taxpayers filing a joint tax return.
• To qualify, the taxpayer must have owned and used the property as his principal residence for at least two of the five years preceding the sale or exchange.
• Exclusion can be used once every two years.

Question 9

If a taxpayer receives a physical personal injury settlement that includes compensation for medical expenses, pain and suffering, lost wages, and punitive damages, which damages may he NOT exclude from his gross income?

Answer 9

punitive damages.

Punitive damages are taxed as gross income.

Question 10

T/F: Wagering losses are allowed only to the extent of the taxable year’s reported gains from wagering transactions.

Answer 10

True. Wagering losses are allowed only to the extent of the taxable year’s reported gains from wagering transactions. All wagering gains are includible in gross income, even gains under $1,000, and there is no special rule for wagers at charitable events.

Question 11

How are child support payments treated under the Internal Revenue Code?

Answer 11

Child support payments are excluded from the recipient’s income and not deductible by the payor. This rule applies regardless of the custody arrangement between the ex-spouses. Child support payments are distinguished from alimony and treated differently.

Question 12

How can a homeowner to take a business deduction with respect to use of her personal residence?

Answer 12

If a homeowner regularly uses a portion of her home exclusively as a principal place of business, or to meet with patients, clients, or customers in the normal course of business, she can deduct business expenses allocable to that portion of the home. However, this use has to be regular, not sporadic, so an office only used to occasionally meet with patients, clients, or customers is not sufficient. Neither is it sufficient to work at least one day a week in the home if the area in which the work is done is not used exclusively for business. There is no requirement that the taxpayer be the president or primary shareholder of the business.

Question 13

If a cash basis taxpayer receives a check for services rendered, in what year must the taxpayer recognize the income?

Answer 13

year taxpayer receives the check.

Under the cash method of accounting, income is reported in the same year that it is received. The rule usually applies when a check is given as payment. It is the time the check is received that matters and not when the check is cashed, even if the check is post-dated. Disbursements follow a similar rule—they are expenses in the year they are paid.

Question 14

If spouses are divorced and they have one or more children who are under the age of 19 or under the age of 24 and a full-time student, which parent is entitled to claim the child(ren) as dependents?

Answer 14

The parent having physical custody of the child(ren) for the greater part of the year is generally entitled to claim the child as a dependent (assuming the parents provide more than half the support for any child claimed as a dependent).

Question 15

Under the general rule, what is the minimum holding period to qualify for long-term capital gain treatment?

Answer 15

12 months

Question 16

If a professional agrees to be compensated for his services with property instead of cash, does the professional need to report the value of the property on his tax return?

Answer 16

Yes, because the property served as compensation for services rendered, and therefore is income.

In cases of non-cash income, the taxpayer must include the fair market value of the property or services rendered on his tax return. If the property serves as payment for professional services, it qualifies as income, not a gift. It does not matter if the value of the property is less than the professional’s normal fee; if he accepts the property as compensation there is no loss to report.

Question 17

To what extent are an individual’s medical expenses deductible if the expenses were not compensated for by insurance or otherwise?

Answer 17

To the extent they exceed 10% of the taxpayer’s adjusted gross income, and insurance premiums can be counted as part of the expense.

Question 18

What is true regarding the charitable contribution deduction for cash contributions?

Answer 18

The deduction is limited to 60% of a taxpayer’s adjusted gross income for cash contributions. The deduction is available for gifts of money or property, but the value of one’s services cannot be deducted. A taxpayer can take a deduction if the taxpayer receives something in exchange for the donation, but only to the extent that the value of what was given exceeds the value of what was received. (For example, if a box of girl scout cookies has a fair market value of $2 but costs $4, the $2 difference is deductible.)

Question 19

For purposes of capital gains, what is a taxpayer’s basis for property given to the taxpayer as a gift during the donor’s life?

Answer 19

Property acquired by an inter vivos gift generally retains the basis it had in the hands of the donor. The value the property had on the date of the gift may be quite different from the property’s basis, since the value of the property may have increased or decreased since the donor obtained the property. Therefore, the property’s value on the date of the gift is not used for the purpose of determining gain.

Question 20

T/F: Earnings of a C corporation are said to be subject to double taxation: they are taxed to the corporation (at corporate tax rates) when earned and they constitute taxable income of the shareholders if distributed to them. Earnings in a C corporation do not flow through the corporation to the shareholders automatically—that is what happens in a S corporation.

Answer 20

True.

Question 21

Virtually all prizes and awards are includible in gross income. Which are not?

Answer 21

Virtually all prizes and awards are includible in gross income. The only exceptions are for certain recognition awards and some modest employee achievement awards (e.g. worth less than $400, is for length of service or safety, it is presented at a meaningful ceremony, and it is not disguised compensation).

Recognition awards, such as the Nobel Peace Prize, are not taxable if the recipient is not required to render future services and the award is turned over by the payor, pursuant to the recipient’s direction, to a governmental or charitable organization. There is no particular exemption for a prize merely because it is given by a charity.

Question 22

T/F: Spouses may make a combined gift and so may exclude a gift to a single recipient that is twice as much as what a single donor could exclude.

Answer 22

True. The annual gift tax exclusion is a “per donee” exclusion; a taxpayer is not limited to one donee annually. Moreover, there is no prohibition against taking an exclusion for gifts made to the same recipient in subsequent years. Finally, the whole point of the exclusions is that the gifts are excluded from the requirement that they be deducted from the lifetime credit

Question 23

How is a transfer of property between former spouses treated upon divorce?

Answer 23

A transfer of property between divorcing spouses is treated as a nontaxable exchange. The spouse receiving the property takes it with a transferred basis (the same basis the property had when the couple was married), so any unrecognized gain or loss will be recognized at the time the recipient sells or exchanges it. This is true even if the transferor receives cash or property as consideration for the transfer.

Question 24

A taxpayer owns a business with his spouse. The business is valued at $7 million. The couple have two children to whom they plan to leave the business when they die. Neither the taxpayer nor his spouse has ever made an inter vivos gift subject to the gift tax. Taxpayer dies and leaves his $3.5 million share of the business to his spouse. What are the federal estate tax consequences of this gift?

Answer 24

No estate tax gift consequence at this time. All amounts given between spouses are exempt from the estate tax. Thus, there is no need to rely on the unified credit. The unified credit is available to a donor to offset taxable gifts made during life or at death; the gift tax is levied on the donor and not the donee. Generation skipping taxes do not apply under the facts here.

Question 25

Taxpayer recently came into some money and would like to give her three children $6 million each. Neither Taxpayer nor her deceased spouse had ever made a taxable gift before. Putting aside the annual gift exclusion, will Taxpayer owe any federal gift tax?

Answer 25

No, because she and her husband have an inflation-adjusted $20 million unified credit. Taxpayers have a unified credit against gift and estate taxes that shields the first $10 million (adjusted annually for inflation) in gifts beyond the annual exclusion amount. Moreover, a spouse may use any unused portion of the credit of a deceased spouse.