Federal Taxation

Question 1

Debt Forgiveness

Answer 1

Generally debt cancellation constitutes taxable income in the amount cancelled. But there is an exception for student loans forgiven for students working in specific professions (public service) for a certain period. This type of loan forgiveness is excluded from gross income.

Question 2

Life Insurance Proceeds

Answer 2

Life insurance proceeds paid to a beneficiary upon the death of the insured are excluded from the beneficiary’s gross income.

Question 3

Inheritance of Property

Answer 3

An inheritance of property is excludable from gross income. The person inheriting the property takes a “stepped-up” basis in the property, which is the fair market value of the decedent’s property on the date of death.

Question 4

Awards from Employers

Answer 4

Awards from employers are generally includable in employee’s gross income in the year received, with exceptions for length of service and safety awards under $400.

Question 5

Minimis Fringe Benefit

Answer 5

A good or service with little value, and accounting for it would be unreasonable and administratively impractical (e.g., holiday gifts).

Question 6

Damages

Answer 6

Damages, including settlement payments or compensation for personal physical injuries or sickness as well as lost wages are excluded from gross income. A taxpayer may not deduct a casualty loss attributable to personal property, unless the loss is attributable to a federally declared disaster.

Question 7

Sale of Home

Answer 7

Gain from the sale or exchange of a principal residence is excluded from gross income, subject to a cap of $250,000. Married individuals, if filing jointly, can exclude up to $500,000. To qualify for this exclusion, the taxpayer must have occupied the residence for at least two years during the five-year period ending on the date of the sale.

Question 8

Unemployment Compensation

Answer 8

Unemployment compensation greater than $2,400 is includable in gross income

Question 9

Basis in Property

Answer 9

To determine the basis in property, the initial basis is adjusted by the cost of capital improvements and/or any depreciation.

Question 10

Deduction for Home Mortgage Interest

Answer 10

Interest paid on debt that is secured by the taxpayer’s principal residence or second residence is generally deductible as an itemized deduction.

Question 11

Personal Expenses

Answer 11

Generally, personal, living, or family expenses are not deductible unless subject to an exception. The determination of whether an expense is a business or personal expense depends on the origin of the expense. Hence, if the origin of the expense is for business, it may be deducted.

Question 12

Ordinary and Necessary Expenses

Answer 12

An ordinary and necessary trade or business expense is generally deductible. An “ordinary” expense is a cost that is customary or expected in the life of a business. An expense need not be a common or frequently occurring expense to be ordinary; it merely must be reasonably related to conduct of the business. A “necessary” expense is a cost that is appropriate and helpful to the business.

Question 13

Capital Cost

Answer 13

A capital cost is a purchase that will yield benefits extending beyond one year, whereas an expense is a purchase that will yield benefits for one year or less. Traditionally, capital costs could not be expensed immediately, but had to be taken incrementally over the useful life of the asset through depreciation. However, taxpayers may now elect to deduct from gross income the cost of tangible personal property (subject to an annual $1 million cap).

Question 14

Calculating Tax Liability

Answer 14

To determine an individual’s tax liability for each item, gross income must first be calculated (i.e., all income from whatever source derived). Then, after reducing that number by certain deductions, the adjusted gross income (AGI) can be determined.

Question 15

Salary

Answer 15

An employee must include compensation for services from an employer in the form of wages or salary in the employee’s gross income. Unless expressly excluded by statute, any accession to wealth is includable in gross income, as ordinary income.

Question 16

Employer-Paid Qualified Plan Retirement Contribution

Answer 16

Contributions made by an employer to a qualified retirement plan are not included in an employee’s gross income.

Question 17

Medical Insurance Premium

Answer 17

An employer contribution to a health plan is excludable from the employee’s gross income.

Question 18

Fringe Benefits

Answer 18

Gross income does not include certain fringe benefits, including working condition fringe benefits. These benefits are provided by the employer but would require business expense deduction if purchased by the employee.

Question 19

Stock

Answer 19

If an employee receives employer stock as compensation that is subject to a risk of forfeiture and the transfer is not pursuant to a qualified plan, the employee is not required to report the value of the stock as income until the employee is substantially vested in the stock. This requires the employee to have the right to transfer the stock to anyone, and the substantial risk of forfeiture must have lapsed. An employee may elect to include the value of the shares at the time of receipt or when they vest.

Question 20

Reimbursement of Moving Expenses

Answer 20

Moving expenses are nontaxable only if the taxpayer is a member of the armed forces on active duty and, due to a military order, taxpayer, taxpayer’s spouse, or the taxpayer’s dependents move because of a permanent change of station.

Question 21

Gifts

Answer 21

If property is received as a gift, the done generally takes the donor’s adjusted basis in the property (i.e., a “carryover” basis). However, if the donor’s adjusted basis in the property exceeds the fair market value (“FMV”) of the property at the time of the gift, the donee’s basis is the FMV of the property instead.

Question 22

Long-Term Capital Gain

Answer 22

A capital asset that has a holding period of more than one year, gain or loss on its sale or exchange is characterized as long-term. Long-term capital gain is taxed at a lower rate than income.

Question 24

Capital Gain

Answer 24

Capital gain is calculated by subtracting the original purchase price from the amount the taxpayer sold the property for.