FP 514 Tax Flashcards
Carol, age 50, received a salary of $35,000 this year. In addition, she received a gift of $1,000 from her brother. She also made a contribution of $3,500 to her traditional IRA. She files as single, and in addition to her itemized deductions of $4,500, she had unreimbursed medical expenses from major surgery on her knees of $7,600. Which of the following best defines Carol’s taxable income? A) Adjusted gross income less the standard deduction and itemized deductions B) All cash compensation received during the tax year less medical expenses in excess of 7.5% of AGI C) Gross income less adjustments to income, less long-term capital losses D) Adjusted gross income less the greater of the standard deduction or the amount of itemized deductions
D) Explanation Carol’s taxable income is calculated by the greater of itemized deductions or the standard deduction, as well as other deductions from adjusted gross income. LO 1.4.1
Kathy, age 70, is single and an employee of Expo Corporation. Her only sources of income this year are $80,000 of W-2 wages, $6,000 in capital gains, and $1,000 in interest on State of Alabama bonds. Based on this information, Kathy’s adjusted gross income (AGI) for the current year is A) $87,000. B) $86,000. C) $80,000. D) $83,000.
B) Explanation Kathy’s AGI is all income from any source derived except for those items specifically excluded by the Tax Code. The W-2 wages and capital gains total $86,000. The municipal bond interest is excluded by law. Kathy’s AGI is as follows: W-2 income $80,000 Interest on State of Alabama bonds (tax exempt) 0 Capital gains 6,000 AGI $86,000 LO 1.3.1
Which of the following expenses would be tax deductible for a family this year? A) Qualified dividends received B) A contribution to a Roth IRA C) Health insurance premiums for the family, paid by their family business D) Child support payments
C). Explanation Health insurance premiums for a self-employed taxpayer are 100% deductible for AGI. Qualified dividends are included in income. Roth IRA contributions are never deductible. Child support is never deductible. LO 1.5.1
If Parker was paid $7,200 in 2020 for working in a jewelry store and this is his only income for the year, what are the tax effects for him? A) Parker will be taxed at the estates and trusts tax rate for all amounts in excess of $2,100. B) Parker will be taxed on $7,200 at the 10% tax rate. C) Because of Parker’s standard deduction for earned income, he will pay no taxes on the income this year. D) Parker will be taxed on $5,100 at the 10% tax rate.
C) Explanation Because this is all earned income, Parker’s taxable income at the 10% tax rate will be $0 because his earned income is less than the maximum standard deduction of $12,400 in 2020. LO 1.2.1
Louisa’s 12-year-old son was killed in an auto accident on May 15, 2020. Louisa is single. If her AGI in 2020 is $113,000, how much of a child tax credit can she take in her 2020 tax return for her son? A) $0 B) $1,000 C) $500 D) $2,000
D) Explanation As long as all other tests are met, a full child tax credit of $2,000 in 2020 (without reduction) can be taken for a person who dies during the year. LO 1.5.1
During early 2020, Bob, an individual taxpayer, purchased a principal residence, taking out a mortgage of $600,000. In late 2020, he utilizes a home equity loan to borrow $100,000 to pay off credit card balances and an automobile note. Which of the following is CORRECT with respect to the deductibility of the interest on the home equity loan? A) None of the interest is deductible because it is not considered acquisition debt. B) All of the interest is deductible, as the total mortgage debt is under $750,000. C) None of the interest is deductible because the interest on a home equity loan is never deductible. D) All of the interest is deductible because the home equity loan is $100,000 or less.
A) Explanation None of the interest on the home equity loan is deductible. After 2017, only interest on acquisition debt is deductible. Acquisition debt is debt incurred to purchase or renovate (remodel) the residence. LO 1.3.2
Susan’s parents have gifted the children, Bill and Alice, age 9 and 12 respectively, various investments. Alice had investment income of $4,000 in 2020 and earned $1,000 babysitting. Bill’s investments did not perform as well; he only earned $2,000, but his part-time job in Bobby’s jewelry store paid him $6,000. Susan provides more than 50% of each child’s support. Given their earnings, can Susan still list both children as dependents on her tax return this year? A) Yes, both children meet the requirement of a qualifying child under IRS regulations. B) No, she may not claim either child, but Bobby can. C) Yes, it doesn’t matter whether she provided 50% of their support because they are under age 19. D) No, she can claim Alice, but Bill is too old and earned too much money.
A) Explanation Yes, both children meet the requirement of a qualifying child under IRS regulations. For a qualifying child, a taxpayer may claim an individual as a dependent if the individual satisfies all of the following requirements: The individual must meet one of the following relationships: Child, stepchild, foster child, or adopted child of the taxpayer Brother, sister, stepbrother, or stepsister of the taxpayer Descendant of any of the individuals listed above The individual must live with the taxpayer for more than half of the taxable year. The individual must pass an age test (i.e., meet one of the following): Is under age 19 at the close of the tax year Is a full-time student and under age 24 at the close of the tax year Is totally and permanently disabled at any time during the tax year The individual must not have provided more than half of her own support during the tax year. The individual cannot claim any other individual as a dependent. The individual may not file a joint return for the tax year (unless the only reason a return was filed was to obtain a refund of tax withheld). The individual generally must also be a U.S. citizen, U.S. national, or a resident of the United States, Canada, or Mexico. The child must be younger than the taxpayer. LO 1.1.1
For a taxpayer with a health savings account (HSA), A) contributions to an HSA may be made in cash or other property. B) all withdrawals from an HSA are tax free. C) withdrawals from an HSA for qualifying medical expenses are not subject to income tax or penalties. D) the contributions to the HSA are not deductible, but the premiums to the high-deductible health insurance plan are deductible.
C) Explanation Contributions to an HSA are tax deductible and may only be made in cash. Withdrawals from an HSA for qualifying medical expenses are not subject to income tax or penalties; while those of other-than-qualifying medical expenses are subject to both income tax and a 20% penalty unless made after the taxpayer reaches age 65, dies, or becomes disabled. LO 1.3.1
To qualify as a head of household, which of the following requirements must generally be met? I. The taxpayer must usually be unmarried at the end of the taxable year. II. The taxpayer must maintain her home as the principal residence of at least one qualified dependent, with the possible exception of dependent parents, for at least half of the taxable year. III. The taxpayer must be a surviving spouse. IV. The taxpayer must be married at the end of the taxable year. A) II, III, and IV B) II and III C) I and II D) I, II, and III
C) Explanation Statements I and II are correct. Caution: Married persons living apart may be able to qualify as heads of household, and dependent parents may be maintained in a domicile other than the taxpayer’s residence. If the dependent is a parent and the taxpayer is entitled to list the parent as a dependent, a nursing home will qualify as the principal residence. LO 1.1.1
Cindy is the sole proprietor of Pickleball Court Rentals. She has the following items that affect her income tax return: Gross sales $100,000 Operating expenses $46,000 Capital loss $6,000 Health insurance premiums $1,400 Employer’s share of self-employment taxes paid $3,815 Mortgage interest on her home $4,500 TraditionalIRA contribution $5,000 What is Cindy’s AGI? A) $40,785 B) $43,300 C) $36,970 D) $32,485
A) Explanation The employer share of self-employment taxes paid is a deduction when calculating a taxpayer’s AGI. Residential mortgage interest is an itemized deduction. The capital loss deduction is limited to $3,000 and the balance may be carried over to future years. The traditional IRA contribution, health insurance premiums, and the operating expenses are all deductible in calculating AGI. $100,000 − $46,000 − $1,400 − $3,000 − $5,000 − $3,815 = $40,785 AGI LO 1.1.2
Which of the following is least likely to qualify as a valid medical expense deduction? A) A medical expense expended for the taxpayer’s dependent child B) A medical expense expended for the taxpayer C) A medical expense that is reimbursed by insurance Achieved D) A medical expense expended for the taxpayer’s spouse
C) Explanation Qualifying medical expenses include those expended by the taxpayer, the taxpayer’s spouse, and any dependents. To be deductible, the expenses must not be reimbursed by insurance coverage. LO 1.3.1
According to the Internal Revenue Code, which of the following statements regarding gross income is CORRECT? A) Gross income does not include alimony payments. B) Gross income consists only of job wages earned that qualify for Social Security and any dividends earned from investments. C) Gross income consists of all income except for those items that are specifically excluded by the Internal Revenue Code. D) Gross income includes child support payments.
C) Explanation All income is included in gross income unless the Internal Revenue Code specifically excludes that income from taxation. LO 1.3.1
Claudia makes $5,000 a month, and has a disability policy that pays 60% of her salary. Her employer pays 60% of the premium and she pays the remaining 40%. She needed surgery last year and received disability benefits for 60 days. What amount of taxable disability benefits did she receive? A) $3,600 B) $2,400 C) $0 D) $6,000
A) Explanation Claudia received 60 days, or two months, of disability payments in the amount of 60% of her $5,000 monthly salary, or a total of $6,000. Claudia pays 40% of the premium and her employer pays 60%. The portion of the benefits received that was paid by Claudia’s employer was 60% of $6,000, or $3,600, and is taxable. The remaining $2,400 is not taxable to Claudia. LO 1.2.1
Which of the following statements regarding adjusted gross income (AGI) is CORRECT? A) It is the first step in the process of calculating taxable income. B) It is the amount of income that is taxable. C) It represents a ceiling for certain deductions, such as medical expenses and miscellaneous itemized deductions. D) It may result in a phaseout of certain deductions.
D) Explanation AGI equals gross income less certain items that are specifically allowed as adjustments to income. Taxable income equals AGI less allowable deductions (itemized or standard). The level of AGI does impact the deductibility of certain items, such as medical expenses and miscellaneous deductions, by setting floors on the amount deductible. LO 1.1.2
Courtney and Della are considering obtaining a home equity line of credit of $50,000. They will use some of the proceeds to make needed improvements to their personal residence. Della is concerned about the deductibility of the interest. Which of the following statements is(are) CORRECT? I. Home equity interest is not deductible to the extent used for other than home acquisition or improvements. II. All of the home equity loan interest will be deductible for the couple. A) Neither I nor II B) I only C) Both I and II D) II only
B) Explanation Statement I is correct. Home equity loan interest is not deductible on a taxpayer’s income tax return to the extent it is used for other than home acquisition or improvements for the home that secure the mortgage. The interest on the funds used for home improvements is deductible. LO 1.3.2
Mary is an active participant in an employer-sponsored retirement plan, but her husband, Frank, is not. Their combined adjusted gross income (AGI) is $210,000 for 2020. They each contributed $6,000 to an IRA for the current year. Which of the following statements is CORRECT regarding the deductibility of the IRA? A) Neither Mary nor Frank may deduct the IRA contributions. B) Both Frank and Mary may deduct the IRA contributions. C) Mary may deduct her IRA contribution, but Frank may not. D) Frank may deduct his IRA contribution, but Mary may not.
A) Explanation Neither Mary nor Frank may deduct their IRA contributions. The active participant spouse is subject to a MAGI (AGI without the IRA) phaseout between $104,000 and $124,000 in 2020. The spouse who is not an active participant but whose spouse is an active participant may take a deduction for the contribution, subject to a phaseout between $196,000 and $206,000. Because the AGI exceeds $203,000, neither spouse may deduct the IRA contribution. Remember that those phaseouts apply only if the taxpayer (and/or spouse, if married) is an active participant in a company-maintained retirement plan. These phaseouts will be provided on the exam. LO 1.1.1
Emilio sued a supplier two years ago for damages. The trial was last year, and the court awarded Emilio with a large cash award. Which of the following statements regarding the taxation of damages is CORRECT? Compensatory damages are generally income tax free. Punitive damages are generally taxable. A) I only B) Neither I nor II C) II only D) Both I and II
D) Explanation Both statements are correct. LO 1.2.1
Mary and Josh are divorced and have two dependent children. Mary is the custodial parent. Josh is required to pay child support to Mary, who does not work outside of the home. At the beginning of this year, Josh became unemployed and has been unable to find a new job. Because he has not paid any child support this year, Mary and the children moved in with her sister who supported the three of them. By December of the same year, Josh returned to work and resumed child support payments. Who is entitled to list the two children as dependents on their income tax return in 2020? A) No one this year B) Mary, who supplied 10% of their support but has custody per the divorce agreement C) Josh, who provided 10% of their support this year D) Mary’s sister, who provided 80% of the children’s support
D) Explanation Mary’s sister provided more than 50% of the children’s support. As a result of divorce, the custodial parent can claim the children as dependents on their income tax return unless there is a written agreement to the contrary. In addition, two other requirements must be met: The children must receive more than half of their support from both parents (combined) for more than half of the taxable year. If the support requirement is not met, neither parent is allowed to claim the children as dependents. LO 1.1.1
Ron Bates is a single taxpayer with no dependents. His wage income is $156,850, and he has allowable itemized deductions of $14,000. Ron received $1,000 in interest income from a qualified private activity municipal bond and made an IRA contribution of $6,000. He also received workers’ compensation of $4,000 during the year. Ron is not an active participant in a company-maintained retirement plan. What is the amount of Ron’s tax liability for 2020 (round your answer to the nearest dollar)? A) $26,924 B) $29,299 C) $28,339 D) $27,259
A) Explanation The total income of $156,850 is reduced by the deductible IRA contribution of $6,000 to give an AGI of $150,850. The IRA is deductible because Ron is not an active participant in a company-maintained retirement plan. The AGI is reduced by the greater of the allowable itemized deductions of $14,000 or the standard deduction of $12,400 in 2020. This leaves a taxable income of $136,850. The interest income from a qualified private activity municipal bond is excluded from income; however, remember that it is generally a preference item for purposes of the AMT. Also, the workers’ compensation received is tax exempt. Taxable income $136,850 Less (from tax rate schedule) (85.525) Amount over $85,525 $51,325 Times (marginal tax bracket) 24% Tax on amount over $82,500 $12,318 Plus (from tax rate schedule) 14,606 Total tax $26,924 LO 1.5.1
Don and Paul are married. They adopted an infant daughter in December of last year. They have consulted you, a CFP® professional, for advice on how to proceed when filing their federal income tax return this year. What should you recommend as their filing status this year for their federal return? A) Single B) Married filing separately C) Married filing jointly D) Head of household
C) Explanation Having a dependent does not change the filing status for a married couple. LO 1.1.1
Larry and Paula are a married couple who file their federal income tax returns separately. They are both over 65 and still provide full support for a son who has been blind since birth. They live together and do not itemize. They alternate listing their son as a dependent, and it is Paula’s turn this year. Paula will be required to file a federal income tax return if her gross income is at least which of the following amounts in 2020? A) $19,600 B) $13,700 C) $12,400 D) $18,400
B) Explanation The normal filing threshold for the MFS filing status is $12,400 in 2020. For married taxpayers over age 65, the threshold is raised by $1,300 per spouse. The additional blind deduction applies only to the taxpayers themselves, not their dependents. Tangentially, if the other MFS spouse itemizes, the filing threshold is reduced to $5. (IRS pub 501, 2020) Because Larry and Paula still live together, neither can file as head-of-household with a dependent. LO 1.1.1
Which of the following who do not maintain a household for a dependent must use the single filing status? A) Legally separated taxpayer B) Unmarried taxpayer C) Divorced taxpayer D) All of these
D) Explanation A taxpayer who is an unmarried, legally separated, or divorced individual and does not maintain a household for a dependent must use the single filing status. LO 1.1.1
George, whose wife died last November, filed a joint tax return for last year. He did not remarry after his wife’s death and has continued to maintain his home for his two dependent children. In the preparation of his tax return for this year, what is George’s filing status? A) Qualifying widower B) Head of household C) Married filing separately D) Single
A) Explanation George filed a joint return in the year of his wife’s death. He can file as a qualifying widower (also known as surviving spouse) for the two years following his wife’s death if he continues to maintain a home for his dependent children. LO 1.1.1
Beth’s husband died in Year 1. Assume that Beth does not remarry and continues to maintain a home for herself and her dependent child during Year 2, Year 3, and Year 4, providing full support for her child throughout those years. For Year 4, Beth’s filing status will be A) single. B) qualifying widow. C) head of household. D) married filing jointly.
C) Explanation Beth’s Year 4 filing status is head of household. Qualifying widow filing status is only available for 2 years following the death of a spouse (Year 2 and Year 3). LO 1.1.1
Which of the following is NOT a step in the tax calculation process? A) Calculate federal tax on federal taxable income. B) Subtract exclusions from AGI. C) Deduct the greater of itemized deductions or the standard deduction. D) Subtract adjustments to income from total income to get adjusted gross income.
B) Explanation The following are involved in the income tax computation: subtracting adjustments to income from total income to get AGI, and deducting the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. Subtracting exclusions from AGI is not a step in the tax calculation process. Excluded amounts simply do not show up as income on the return. LO 1.1.2
Which one of the following reflects the CORRECT sequence of steps in the tax calculation process? A) Total income minus adjustments to income equals AGI. B) AGI minus adjustments to income equals federal taxable income. C) Calculate federal tax on total income. D)Total income minus standard or itemized deduction(s) equals AGI. LO 1.1.2
A) Explanation Total (gross) income minus adjustments to income equals adjusted gross income (AGI). AGI minus standard or itemized deduction(s) equals federal taxable income.
Which of the following is NOT a step in the tax calculation process? A) Subtract adjustments to income from total income to get adjusted gross income. B)Deduct the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. C) Claim allowable tax credits. D) Calculate federal tax on total income.
D) Explanation The following are involved in the income tax computation: subtracting adjustments to income from total income to get adjusted gross income, subtracting tax withholdings from total tax liability, and deducting the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. Credits are applied to tax liability. The calculation of federal tax is on federal taxable income. LO 1.1.2
Which one of the following steps occurs in the tax calculation process? A) Total withholding is adjusted on Form I-9 B) Tax liability minus tax credits equals refund or tax owed C) Total tax liability minus itemized deductions plus additional taxes owed, equals total tax liability D) Total tax liability equals refund or tax owed
B) Explanation Tax liability minus tax credits equals total tax liability or refund. LO 1.1.2
Jeff Munroe has an annual salary of $140,000 and is not an active participant in a company-maintained retirement plan. He had the following financial transactions during the current tax year: Received a $100,000 cash inheritance due to the death of his brother Received unemployment compensation of $2,000 Had a Schedule C loss of $10,000 (assume material participation) Made an IRA contribution of $6,000 Paid qualified student loan interest of $2,000 What is Jeff’s total income for the current tax year? A) $124,500 B) $126,500 C) $142,000 D) $132,000
D) Explanation The $140,000 salary is reduced by the $10,000 self-employment loss and increased by the unemployment compensation of $2,000. The inheritance is excluded. The IRA contribution is a potential adjustment to income, as is the student loan interest. Thus, those items do not affect the total income. Remember that total income is the figure approximately two-thirds of the way down the front of the 1040. It is the figure from which allowable adjustments to income are subtracted. LO 1.2.1
Lindsey is age 2 and she received $6,000 in municipal bond interest income and $900 in other interest income in 2020. What is the total federal income tax due on her income in 2020? A) $1,400 B) $0 C) $1,495 D) $90
B) Explanation Lindsey owes no federal income taxes in 2020. Municipal bond interest income is not taxable. The $900 in other interest income is less than Lindsey’s $1,100 standard deduction amount. LO 1.2.1
Which of the following are includible in an individual’s gross income for income tax purposes? I. Gambling winnings II. Inheritances III. Interest collected by the taxpayer on federal obligations IV. Scholarships and fellowships in degree programs A) III and IV B) I only C) I and III D) I, III, and IV
C) Explanation Gambling winnings and interest on federal obligations are includible in an individual’s gross income for income tax purposes. The other items are not subject to income taxation. LO 1.2.1
Which one of the following is allowable in the computation of total income? A) Net capital losses of up to $5,000 B) Tax credits C) Charitable contributions D) Loss from a sole proprietorship
D) Explanation Remember that the total income is the amount shown about two-thirds of the way down the front of the Form 1040. It is the amount before the deduction for adjustments to income. Certain deductions are allowed in the computation of total income, such as the deduction for sole proprietorship losses or net capital losses up to $3,000. Charitable contributions are an itemized deduction. LO 1.2.1
Jane, age 35, whose filing status is single, earned a salary of $55,000 in 2020. She also made a $2,000 contribution to her Roth IRA for 2020. Jane had a capital loss of $3,000 during the year. Her uncle, Charles, gave her $100,000 in municipal bonds for which she earned interest of $3,500. In her employment as a sales representative for her company, Jane incurred $650 of unreimbursed business expenses. What is Jane’s adjusted gross income (AGI)? A) $56,800 B) $52,000 C) $53,800 D) $53,300
B) Explanation Jane’s AGI is $52,000 ($55,000 ‒ $3,000). Jane’s $3,000 capital loss is a deduction for calculating AGI. Roth IRA contributions are never deductible from gross income. Municipal bond interest is not included in income. The unreimbursed business expenses are not deductible. LO 1.3.1
Which one of the following statements is true regarding self-employment taxes? A) Net earnings from self-employment must be calculated under the accrual method of accounting. B) The wage base is not adjusted annually for cost of living increases. C) A taxpayer is allowed to deduct one-half of his self-employment tax liability as an adjustment to income. D) Self-employed taxpayers are subject to employer withholding.
C) Explanation A taxpayer may deduct one-half of his self-employment tax liability as an “above the line” adjustment to income. The wage base is adjusted annually for cost of living increases. Net earnings from self-employment are determined under the same accounting method as that used for income tax purposes. Self-employed taxpayers are not subject to employer withholding. LO 1.3.1
Which of the following are adjustments to gross income (above-the-line deductions)? I. Medical expenses II. Capital losses III. Deductible IRA contributions A) II and III B) I and II C) I and III D) II only
A) Explanation Medical expenses are an itemized (below-the-line) deduction. LO 1.3.1
Janet and Bruce Robinson, both age 43, are married taxpayers filing jointly. They have itemized deductions consisting of the following: Home mortgage interest $19,500 State income taxes $8,700 Property taxes $5,200 Charitable contributions $6,200 Tax return preparation fee $895 Unreimbursed employee business expenses $2,100 Unreimbursed medical expenses $18,460 Their AGI for 2020 is $466,000. What is the amount of their allowable itemized deductions? A) $35,700 B) $39,600 C) $37,800 D) $42,595
A) Explanation The total itemized deduction amount is $35,700. Note that the tax preparation fee and the unreimbursed employee business expenses are not deductible. The medical expenses are deductible only to the extent that they exceed 7.5% of AGI for 2020, which they do not. The deduction for the state income taxes and the property taxes is capped at $10,000. Taxes of $10,000, mortgage interest of $19,500, and charitable contributions of $6,200 total $35,700. LO 1.3.2
John and Mary West, married taxpayers filing jointly, have itemized deductions consisting of the following: Home mortgage interest $12,000 State income taxes $18,000 Property taxes $5,150 Charitable contributions $2,250 Unreimbursed employee business expenses $3,200 Medical expenses $14,000 Sales taxes paid $2,650 The Wests’ AGI for 2020 is $400,000. What is the amount of allowable itemized deductions? A) $14,250 B) $24,250 C) $37,400 D) $54,600
B) Explanation Unreimbursed employee expenses are no longer deductible since the Tax Cuts and Jobs Act (TCJA). The medical expenses are deductible only to the extent that they exceed 7.5% of AGI (for 2020), which they do not. The sales taxes would only be deductible in lieu of state income taxes. The overall deduction for taxes (state, local, and property) is limited to $10,000 as a result of TCJA. Home mortgage interest $12,000 State, local, and property taxes $10,000 Charitable contributions $2,250 Total itemized deductions $24,250 LO 1.3.2
Steve and Allison Parker, a married couple in their 40s, file a joint return. They earned combined salaries of $185,000. They received dividend and interest income of $860 from mutual funds. They have allowable itemized deductions of $14,000. They have net capital losses of $5,200. They have two children, ages 12 and 14. What is their taxable income for the 2020 tax year? A) $182,860 B) $156,660 C) $168,860 D) $158,060
D) Explanation The salaries combined with the income from the investments total $185,860. This is reduced by the $3,000 net capital loss to leave an AGI of $182,860. Remember that only $3,000 of net capital loss may be deducted in a given tax year. The AGI is then reduced by the greater of the itemized deductions ($14,000) or the standard deduction ($24,800 in 2020). The deduction for personal and dependency exemptions was repealed by Tax Cuts and Jobs Act (TCJA). LO 1.4.1
The marginal tax rate is obtained by A) finding the tax bracket of total income. B) dividing the calculated tax by taxable income. C) finding the tax bracket of the taxable income amount. D) dividing the calculated tax by total income.
C) Explanation The marginal tax rate is found by finding the tax bracket that contains the taxable income amount; it is the amount at which all subsequent taxable amounts will be taxed (until entering the next tax bracket). The effective tax rate is calculated by dividing the calculated tax by total (gross) income, not taxable income. LO 1.4.2
The effective tax rate is obtained by dividing the amount of tax paid by A) the average tax rate. B) the correct tax bracket. C) the amount of deductions and credits. D) taxable income
D) Explanation The effective tax rate is found by dividing total tax by taxable income. LO 1.4.2
Neil McElroy is an engineer for Causley Computer Inc. In addition, Neil operates a janitorial service that cleans several local office buildings. Neil was divorced in 2019, and his wife received custody of their two children. He has assembled the following information for preparation of his tax return for the current tax year. Neil’s salary $71,500 Interest income $9,500 Monthly alimony paid to ex-spouse $1,500 Monthly child support $500 Purchase of equipment for use in janitorial service $10,000 IRA contribution $6,000 Based on the information given, which of the following are fundamental methods of managing Neil’s tax liability? I. Tax credit: Neil could take an investment tax credit for purchases of qualifying business equipment. II. Deductions for AGI: Neil may deduct alimony payments of $18,000 made to ex-spouse. III. Deductions for AGI: Neil may deduct child support payments of $6,000. IV. Exclusions: Neil could have invested in municipal bonds to receive tax-free income. A) I, II, and IV B) II, III, and IV C) IV only D) I and II
C) Explanation Neil may not deduct alimony paid to his former spouse because the deduction is disallowed for alimony under divorce decrees in 2019 and thereafter. He may invest in municipal bonds to receive tax-free income. There is no investment tax credit for equipment purposes. Some students confuse this with the Section 179 expense election, but that provision provides a deduction, not a credit. Child support payments are specifically nondeductible. LO 1.5.1
John and Karen Postman will spend a total of $5,000 on day care for their two children (ages 9 and 10) in the current tax year. These expenses were incurred to allow both John and Karen to work outside the home. Their adjusted gross income is estimated at $138,000. What is the amount of child and dependent care credit, if any, to which they are entitled? A) $1,750 B) $1,000 C) $0 D) $600
B) Explanation The maximum amount of qualifying expenditures on which the credit may be based is $3,000 per child, or $6,000 for two or more children. In this situation, they spent $5,000. This is multiplied by 20% for taxpayers with an AGI greater than $43,000. Thus, $5,000 × 20% = $1,000. LO 1.5.1
Kurt and Allison Long are married and file a joint income tax return. Their adjusted gross income (AGI) is $180,000 per year. On last year’s tax return, the Longs claimed a $1,200 credit for child care expenses. The Longs are in the 22% marginal income tax bracket. What amount of deductions for AGI would be required to equal the tax benefit of the $1,200 child care credit? A) $936 B) $5,455 C) $264 D) $1,538
B) Explanation $1,200 divided by the 22% marginal income tax bracket gives us $5,455. LO 1.5.1
Your client, Hal Meyer, will receive a deductible loss of $15,100 from a working oil and gas interest. Hal is in a 35% marginal income tax bracket and has asked you the approximate amount of tax savings that this will generate. What is the approximate amount, if any, of tax savings generated by this loss? A) $15,600 B) $5,200 C) $10,400 D) $0
B) Explanation In a 35% tax bracket, a $15,100 loss deduction will save $5,285. Thus, $5,200 is the closest answer. LO 1.5.1
Which of the following statements correctly describes the method for calculating the exclusion ratio for a fixed annuity? A) The number of expected payments is divided by the investment in the annuity contract. B) The investment in the annuity contract is divided by the number of expected payments. C) The total expected return is divided by the investment in the annuity contract. D) The investment in the annuity contract is divided by the total expected return.
D) Explanation The exclusion ratio for a fixed annuity contract is not calculated by dividing the total expected return by the investment in the contract. It is calculated by dividing the investment in the contract by the total expected return. LO 2.1.2
Three years ago, Myla received a gift of 100 shares of public utility stock from her aunt. The fair market value of the stock on the date of the gift was $20 per share. Her aunt had purchased the stock six years earlier at $6 per share. Myla sold this stock for $24 per share last week. What was Myla’s basis in the stock when she sold it? A) $6 per share B) $20 per share C) $14 per share D) $24 per share
A) Explanation The only time that the gifted asset takes the sale price as the basis is when the fair market value on the date of the gift is less than the donor’s basis and the asset is sold at a price between the fair market value on the date of the gift and the donor’s basis. LO 2.1.3
Mike has interest and short-term capital gain income of $9,000 in the current tax year. He paid broker commissions on security purchases of $1,000, paid $1,800 for investment adviser fees, and had $8,500 of investment interest expense. His AGI is $225,000. What amount of investment interest expense may be deducted as an itemized deduction? A) $7,700 B) $6,200 C) $8,000 D)$8,500
D) Explanation Investment interest expense is deductible up to the amount of net investment income, which is $9,000. The net investment income is simply the investment income (interest and short-term capital gains) of $9,000. Remember that the investment adviser fees were a Tier II miscellaneous itemized deduction, which are no longer deductible under the TCJA. The commissions are not a deductible item. The commissions increase the basis of the securities upon purchase and reduce the gain realized upon sale. LO 2.2.1 PREV
Four years ago, Mark received a gift of 500 shares of common stock from his grandfather. The fair market value of the stock on the date of the gift was $335 per share. His grandfather had purchased the stock three years earlier at $425 per share. Mark sold this stock for $200 per share last week. What was Mark’s basis in the stock when he sold it? A) $335 per share B) $200 per share C) $225 per share D) $425 per share
A) Explanation When the fair market value on the date of the gift is less than the donor’s basis in the asset and the sale price is less than the fair market value on the date of the gift, then the fair market value on the date of the gift is used as the donee’s basis. LO 2.1.3
Hardship withdrawals are only allowed from Section 401(k) plans if specifically stated in the plan document and typically for expenses including which of the following?
Vacation costs
Medical expenses
College tuition costs
Insurance premiums
A) II and III
B) II, III, and IV
C) I and III
D) I and II
A) Explanation
Hardship withdrawals are typically allowed for medical expenses, college tuition and fees, the purchase of a principal residence, burial expenses for a spouse or dependents, and to prevent eviction from one’s principal residence or foreclosure on the mortgage of such residence.
LO 2.4.1
Under the modified endowment contract (MEC) rules, which of the following is NOT considered a distribution from the MEC?
A) Dividends received as cash
B) Withdrawals from the contract
C) Loans taken as cash or used to pay premiums
D) Dividends retained by an insurer to pay premiums
D)
Explanation
Dividends retained by the insurer to pay premiums are not treated as distributions from a MEC.
LO 2.1.1
Martha borrowed $40,000 from a bank, using the money for investment purposes. Of that $40,000, she invested $20,000 in tax-exempt municipal bonds and $20,000 in taxable corporate bonds. Which of the following statements regarding Martha is CORRECT?
A) Martha can deduct the interest on $20,000 of the loan for tax purposes.
B) Martha is engaging in an illegal activity.
C) Martha can deduct none of the interest on the loan for tax purposes.
D) Martha can deduct the interest on $40,000 of the loan for tax purposes.
A) Explanation
The IRS does not allow taxpayers to deduct interest on borrowed funds when those funds are used to generate tax-exempt income. Because Martha used $20,000 of the loan to purchase taxable securities, the interest on that $20,000 is deductible as an investment interest expense.
LO 2.2.1
All of the following deductions are allowable in arriving at adjusted gross income except
A) student loan interest (limited).
B) 100% of self-employment tax paid.
C) alimony paid.
D) qualifying contributions to Keogh-qualified and self-employed tax-advantaged plans.
B) Explanation
The deduction for self-employment tax paid is generally limited to the calculated employer share, or 50%, not 100%.
LO 2.4.1
This year, Ken sold several securities that left him with the following types of gains and losses:
Long-term capital gain: $8,000
Short-term capital gain: $1,800
Long-term capital loss: $2,200
Short-term capital loss: $1,000
What is the net capital gain or loss on Ken’s security sales?
A) Net long-term gain of $5,800 and net short-term gain of $800
B) Net long-term gain of $2,640
C) Net long-term loss of $1,400
D) Net long-term gain of $2,320 and net short-term gain of $800
A) Explanation
The long-term gain and loss are netted, leaving a long-term gain of $5,800. Short-term gains and losses are netted, leaving a short-term gain of $800. These are left separate due to the disparate tax treatment of short-term versus long-term gains.
LO 2.1.3
Question 11 of 20
Question ID: 1247305
Your client, Albert, purchased a life insurance policy. He wants you to determine if it is a modified endowment contract (MEC) for tax purposes. To be classified as a MEC, a policy must have which of the following qualities?
I. Be a life insurance policy under state law
II. Meet either the cash value accumulation test or the guideline premium and cash value corridor test
III.Be a contract that was entered into on or after June 21, 1988
IV. Fail to meet the seven-pay test
A) I, II, III, and IV
B) I and II
C) III and IV
D)I, II, and III
A)
To be classified as a MEC, a policy must encompass all of the choices: be a life insurance policy under state law; meet either the cash value accumulation test or the guideline premium and cash value corridor test; be a contract that was entered into on or after June 21, 1988; and fail to meet the seven-pay test.
LO 2.1.1
Which of the following is a form of an annuity?
A) Sustained annuity
B) Fixed annuity
C) Quick annuity
D) Selective annuity
B) Explanation
Selective, quick, or sustained annuities are not recognized categories of annuities. Fixed, variable, immediate, and deferred are all categories of annuities.
LO 2.1.2
A taxpayer intends to use a home equity loan to obtain funds to purchase municipal bonds. Which of the following is CORRECT regarding the income tax implications of this scenario?
A) None of these choices apply.
B) The interest on the home equity loan is not deductible.
C) The municipal bond interest becomes taxable.
D) The interest on the home equity loan is fully deductible.
B)
Explanation
The interest on the municipal bond continues to be tax exempt. There is no deduction allowed for the interest on funds borrowed to purchase tax-exempt securities.
LO 2.2.1
Garret has the following items of income: $1,500 of interest income, $2,800 of qualified dividend income (he has not decided whether to have it taxed at the ordinary or capital gain rate), and a salary of $100,000. Which of these are classified as portfolio income?
A) Salary only
B) Interest income and dividend income
C) Interest income, dividend income, and salary
D) Interest income only
B)
Explanation
Interest and dividends are portfolio income. Salary is active income.
LO 2.2.2
Which of the following statements correctly describes the method for calculating the exclusion amount for variable annuity payments?
A) The number of expected payments is divided by the investment in the annuity contract.
B) The total expected return is divided by the investment in the annuity contract.
C) The investment in the annuity contract is divided by the number of expected payments.
D) The investment in the annuity contract is divided by the total expected return.
C) Explanation
The exclusion ratio for a fixed annuity contract is calculated by dividing the investment in the contract by the total expected return.
For a variable annuity, the exclusion amount is calculated by dividing the investment in the contract by the number of expected payments.
LO 2.1.2
Marge had net earnings from self-employment of $150,000 in 2020. What is her total self-employment tax?
A) $22,950.00
B) $19,691.10
C) $20,308.80
D) $21,092
D) Explanation
Marge’s 2020 self-employment tax is calculated as follows:
Self-employment income$150,000.00
Less $150,000 × 0.0765($11,475.00)
Equals net earnings$138,525.00
Less 2020 taxable wage base($137,700)
Equals SE income subject to Medicare tax$825
Multiplied by 0.029× 0.029
Equals Medicare portion of SE tax$24
Add $137,700 × 0.153$21,068
Total self-employment tax$21,092
LO 2.3.1
Which of the following is NOT a form of an annuity?
A) Deferred annuity
B) Selective annuity
C) Fixed annuity
D) Variable annuity
B) Explanation
A selective annuity is not a recognized category of annuities.
LO 2.1.2
Which of the following statements is CORRECT?
A) A shareholder who receives a Schedule K-1 from an S corporation must calculate and pay self-employment tax on the income.
B) A sole proprietor must pay the 0.9% Additional Medicare Tax on all net self-employment income.
C) Self-employed individuals, such as a sole proprietor or general partner in a partnership, generate self-employment income and must pay both portions of the FICA (Federal Insurance Contributions Act) payroll tax.
D) A general partner reports the income from the Schedule K-1 form provided by the partnership on Schedule C of Form 1040.
C)
Explanation
Self-employed individuals, such as a sole proprietor or general partner in a partnership, generate self-employment income. In turn, such individuals must pay both portions of the FICA (Federal Insurance Contributions Act) payroll tax. A general partner reports the income from the Schedule K-1 form provided by the partnership on Schedule E of Form 1040. A shareholder who receives a Schedule K-1 from an S corporation does not pay self-employment tax on the income. The Additional Medicare Tax of 0.9% also applies to self-employed individuals who have a combined income greater than $200,000 if single and $250,000 if MFJ. The tax is levied on the net earnings from self-employment of the sole proprietor or partner and consists of
the gross income derived from any trade or business, less allowable deductions attributable to this trade or business (generally Schedule C); or
the taxpayer’s distributive share of the ordinary income or loss of a partnership (not an S corporation) engaged in a trade or business (Schedule K-1).
LO 2.3.1
Question 19 of 20
Question ID: 1247318
Charles wants to invest $20,000 to generate income taxable at the capital gain rates and not at ordinary income tax rates. He will hold any investment for at least 18 months. Which of the following investments would achieve Charles’s goal?
I. Buy an office building and rent space to others.
II. Buy stock in a Fortune 500 company.
III. Purchase a quality artwork with appreciation potential.
IV. Purchase a speedboat for personal use only.
A) I and III
B) II and III
C) I, II, III, and IV
D) II and IV
B)
Explanation
Statements II and III are correct. Any qualified dividends on the stock will be taxed at LTCG rates. A sale of the stock or the investment painting after the 18-month holding period will generate either a LTCG or a LTCL depending on the sale price. Rental income is taxed at the ordinary income tax rate. A speedboat for personal use will not generate any income and will likely decrease in FMV 18 months later.
LO 2.2.2
Which of the following is a CORRECT statement regarding the wash sale rules?
A) The wash sale rules do not apply to dealers.
B) The wash sale rules do not apply to sales and investments in mutual funds.
C) Small differences in the maturity dates of bonds will not cause them to be classified as substantially identical.
D) Basis is generally decreased by the amount of the loss that is disallowed on a wash sale.
Explanation
The wash sale rules do not apply to taxpayers who are brokers or dealers of financial instruments.
LO 2.1.3
For two years, Lisa Carson was able to pay the premiums on her whole life policy without borrowing. For the past two years, she has borrowed from the cash value of her whole life policy to pay the premiums. Last year, she paid $95 of interest on the funds she borrowed.
What are the tax implications in this situation?
A) The interest expense is tax deductible because it does not exceed $100.
B) The interest expense is not tax deductible because it does not exceed $100.
C) The interest expense is not tax deductible.
D) The interest is deductible because Lisa is in the business of continuing her insurance and the interest is deductible business interest expense.
C) Explanation
The interest expense is not tax deductible because interest on a loan incurred to purchase personal life insurance protection is considered personal interest, which is not deductible. Personal loan interest is not tax deductible, regardless of whether the lender is a bank or a life insurance company.
LO 2.1.1
Cash value life insurance is often structured like an investment vehicle. However cash value life insurance contains important features that shelter the inside buildup from taxation. Which of the following will NOT be considered when determining whether a policy can maintain its tax favored status?
A) The premium value test
B) The cash guideline premium test and corridor test
C) The cash value accumulation test
D) The death benefit
B) Explanation
Without a death benefit, a contract does not meet the legal definition of life insurance. There are currently two tests—only one of which must be met—in order to classify a product as life insurance for federal income tax purposes: (1) the cash value accumulation test and (2) the cash guideline premium test and corridor test. There is no premium value test.
LO 2.1.1
Which of the following statements correctly defines inside buildup as it refers to life insurance?
A) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-free basis.
B) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-preferred basis.
C) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-annuitized basis.
D) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-deferred basis.
D) Explanation
Accumulations of cash value within a life insurance policy grow on a tax-deferred basis during the insured’s lifetime.
LO 2.1.1
In 1991, John Idler purchased a single premium whole life insurance policy. In the current year his medical expenses are $15,000 and his AGI is $75,000. What is the tax implication to John if he borrows the interest from the policy’s accumulated cash value to pay his current year’s medical expenses?
A) John will not be required to report the amount borrowed as income and will not be allowed a medical expense deduction.
B) John will be required to report the amount borrowed as income, but he will not be allowed a medical expense deduction.
C) John will be required to report the amount borrowed as income and will be allowed a medical expense deduction.
D) John will not be required to report the amount borrowed as income, but he will be allowed a medical expense deduction.
C) Explanation
Amounts borrowed on a single premium whole life policy issued on or after June 21, 1988 (a MEC), are taxable on a last-in, first-out basis; thus, the earnings would be taxable. A medical expense deduction will be allowed regardless of the source of the funds, since the payment would be for a valid medical expense.
LO 2.1.1
Which of the following statements regarding the use of life insurance inside a retirement plan is CORRECT?
A) The premiums paid are a taxable benefit to the employee.
B) If the employee dies prematurely, the survivors will receive no benefits.
C) The premiums paid are NOT a taxable benefit to the employee.
D) The premiums paid are a taxable benefit to the employer.
A)
Explanation
The premiums paid are a taxable benefit to the employee. The main benefit to the employee is in the event of their premature demise, their survivors will still receive ample retirement benefits.
LO 2.1.1
Question #6 of 30
Question ID: 1247542
Matthew Brady, age 47, purchased a deferred annuity in January 1982 for $50,000. In the current year, when the surrender value was $125,000, Matthew took a nonperiodic distribution of $75,000. Which one of the following statements correctly describes the income tax consequences of the distribution?
A) $50,000 is taxable, $25,000 is tax free.
B) $75,000 is taxable income.
C) $75,000 is tax free.
D) $50,000 is tax free, $25,000 is taxable.
D) Explanation
The pre-August 14, 1982, annuity retains first-in, first-out (FIFO) treatment. Thus, the basis of $50,000 is treated as being withdrawn first and is tax free. The remaining $25,000 is taxable. If this were a post-August 13, 1982, contract, it would be treated on a last-in, first-out (LIFO) basis.
LO 2.1.2
Which one of the following is a characteristic of a fixed annuity contract?
A) If a corporation owns the annuity contract, the earnings are not tax deferred.
B) The buyer may choose among a handful of investment options.
C) Fixed annuity contracts are not tax advantaged, unlike other annuity contracts.
D) The annuitant pays now for future fixed or variable payments.
A) Explanation
With a fixed annuity contract, there is no ability to select the investment options; the payments are fixed. Fixed annuity contracts are generally tax advantaged (tax deferred), unless a corporation owns the annuity contract, in which case the earnings are currently taxable. Such is also the case with a variable annuity.
LO 2.1.2
Several years ago, Allison Colbert purchased a deferred fixed annuity. The cost of the annuity was a single payment of $40,000. The annuity will provide monthly payments of $275. At the time the annuitized distributions are to begin, Allison’s life expectancy will be 25 years.
How much of each payment will be excluded from taxation?
A) $206
B) $142
C) $133
D) $57
C) Explanation
Allison is expected to receive $82,500 ($275 × 12 × 25). Her investment in the contract ($40,000) is then divided by the total expected return ($82,500) to determine the excludable portion of each payment. The exclusion ratio is the $40,000 divided by $82,500, which equals 48.48%. 48.48% of $275 = $133 excludable from each payment.
LO 2.1.2
Which one of the following statements is CORRECT with respect to capital gains and losses?
A) Net capital gains are always taxed at a maximum rate of 28%.
B) Net capital gains are always taxed at a flat rate of 15%.
C) Excess capital losses are carried forward for up to five years.
D) Net capital losses are deductible up to $3,000 annually.
D)
Explanation
Net long-term capital gains (LTCG) (from other than unrecaptured Section 1250 income and collectibles) are taxed at rates of 0%, 15%, or 20%.
For married couples filing jointly, the 0% long-term capital gain rate ends at $80,000 of taxable income. For long-term capital gains falling between the $80,000 breakpoint and $496,600 of taxable income (again, for married couples filing jointly), the rate is 15%. For long-term capital gains falling into taxable income levels above $496,600 (MFJ), the rate is 20%. The table shows the breakpoints for LTCG and qualified dividend preferential rates.
LTCG Rates Based on Taxable Income
Filing Status0% rate15% rate20% rate
SingleUnder $40,000$40,000–$441,450Over $441,450
Head of householdUnder $53,600$53,600–$469,050Over $469,050
Married filing jointlyUnder $80,000$80,000–$496,600Over $496,600
Estates and trustsUnder $2,650$2,650–$13,150Over $13,150
Special rates apply to the sale of real estate or collectibles—25% (the maximum rate for gain attributable to straight-line depreciation on real estate), or 28% (maximum rate in the case of collectibles). Net capital losses, the capital losses remaining after netting against capital gains, are deductible up to $3,000 per year with an indefinite carryforward.
LO 2.1.3
Question #10 of 30
Question ID: 1273772
Adrian Brown owned 500 shares of XYZ growth and income fund. She has become increasingly dissatisfied with the performance of the fund and, upon the advice of a friend, decided to execute a “telephone transfer” and switch the balance in the fund to the XYZ intermediate bond fund.
Which one of the following describes the tax effect of such a strategy?
A) No gain or loss will be recognized by the taxpayer, but the basis of the new fund will be reduced by any deferred gain or increased by any unrecognized loss.
B) Gain or loss will be recognized by the taxpayer on the redemption of the old fund.
C) Any loss will be recognized by the taxpayer, but any gain will be deferred through a reduction in the basis of the new fund.
D) No gain or loss will be recognized by the taxpayer, and the basis in the new fund will be the same as that of the old fund.
B) Explanation
A telephone transfer is the same as a sale or other taxable redemption of the fund. Therefore, gain or loss will be recognized based on the difference in the redemption proceeds and the basis in the shares redeemed. This is true even if the transfer is made between two funds in the same fund family.
LO 2.1.3
Question #11 of 30
Question ID: 1247554
Your client, Elaine Dell, is near the highest tax bracket and is contemplating several investments. She is, however, concerned about minimization of her federal income tax liability on the income from the investment.
Which of the following investments would produce income that would be taxed at the lowest potential tax rate?
A) A certificate of deposit
B) A corporate bond fund
C) A zero coupon bond
D) A utility stock with a high dividend yield
D) Explanation
Qualified dividends are generally taxed at a 15% rate (or 20% for taxpayers with higher income levels). All of the other options produce interest income, which is taxable as ordinary income, at the marginal rate of the taxpayer.
LO 2.1.3
Question #12 of 30
Question ID: 1247555
Ann Hamilton owns 500 shares in the XYZ S&P 500 Index Fund. The basis of her investment in this fund is $4,500, while the fair market value is only $2,000. She wants to sell her shares to “lock in” the $2,500 loss, but she is considering buying 500 shares of the GRC Small-Cap Index ETF the following week because she believes that the value is going to increase significantly over a longer period.
As her planner, what can you accurately tell Ann about this scenario?
A) If the loss were disallowed, the basis in the newly acquired shares would be decreased by the disallowed loss.
B) The loss would be a fully deductible capital loss.
C) She should wait a minimum of 61 days after the sale to repurchase the shares so that the loss may be recognized.
D) The basis in the newly acquired shares would be the amount paid for those shares, increased by the $2,500 disallowed loss.
B) Explanation
The wash sale rule disallows a loss if substantially identical securities are purchased prior to 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the amount of the disallowed loss. The S&P 500 mutual fund should not be substantially identical to the small-cap ETF because the funds track very different indices and because of the difference in the way ETFs trade compared with mutual funds.
LO 2.1.3
Bruce and Melissa Parish, married taxpayers filing jointly, have the following items related to their investments during the current tax year:
Investment interest expense $5,000
Interest income $2,500
Short-term capital gains $1,000
Investment adviser’s fees $1,250
Commissions paid on stock purchase $200
Adjusted gross income $60,000
What is the Parishes’ allowable investment interest expense deduction for the current year?
A) $3,500
B) $3,450
C) $5,000
D) $3,250
A) Explanation
Investment interest expense is limited to the taxpayer’s net investment income of $3,500.
LO 2.2.1
Question #14 of 30
Question ID: 1247565
Which one of the following statements is incorrect regarding investment interest expense?
A) Investment interest expense is deductible up to the amount of the net investment income.
B) Excess investment interest expense cannot be carried forward into succeeding tax years.
C) Interest paid or accrued to purchase or carry tax-exempt investments is not deductible.
D) Net investment income is the taxpayer’s investment income—typically interest, nonqualified dividends, and short-term capital gains.
B) Explanation
Excess investment interest expense can be carried forward into succeeding tax years. Investment interest expense is deductible up to the amount of net investment income. The interest on funds borrowed to purchase tax-exempt investments is not deductible. The net investment income is typically interest, nonqualified dividends, and short-term capital gains. Long-term capital gains and qualified dividends may be included at the taxpayer’s election, but the taxpayer must forgo the preferential tax rates on these items.
LO 2.2.1
Question #15 of 30
Question ID: 1247566
Tom Bell has investment income (interest) of $8,000 in the current year. He paid $1,200 in investment adviser fees and had $7,000 of investment interest expense. His AGI is $35,000.
What amount of investment interest expense may be deducted in the current year as an itemized deduction?
A)$6,500
B) $7,000
C) $6,800
D) $8,000
B)
Explanation
Investment interest expense is deductible up to the amount of investment income. The investment income is the interest income of $8,000. However, the deduction cannot exceed the actual investment interest expense of $7,000. Historically, the adviser fees would impact the calculation, but the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the Tier II miscellaneous itemized deductions.
LO 2.2.1
Question #16 of 30
Question ID: 1247567
Michelle Will has interest income of $23,000 in the current tax year. She paid brokers’ commissions of $2,000 on stock purchases and had $40,000 of investment interest expense. What amount, if any, of investment interest expense may be deducted as an itemized deduction?
A) $21,000
B) $33,000
C) $0
D) $23,000
Explanation
LO 2.2.1
D)
For the current tax year, Bob Phillips, an individual taxpayer filing a joint return, has $50,000 of investment interest expense and $20,000 of net investment income (interest and dividends). Bob’s AGI is $200,000. How much investment interest expense, if any, may Bob deduct in the current tax year?
A) $21,000
B) $50,000
C) $20,000
D) $0
C)
Explanation
Investment interest expense is deductible up to the amount of net investment income. The problem tells us that the net investment income is $20,000; thus that is the maximum deduction. The fact that the dividends are included in the net investment income indicates that the taxpayer elected to include them in investment income and is forgoing the preferential rates associated with qualified dividends. The AGI has no bearing on the answer.
LO 2.2.2
Question #18 of 30
Question ID: 1247577
Sheila, a single taxpayer, has taxable income of $460,000. Included in the taxable income is $50,000 of qualified dividends. At what rate(s) will her qualified dividends be taxed?
A) 20% only
B) 15% and 20%
C) 25%
D) 15% only
B) Explanation
The qualified dividends straddle the $441,450 breakpoint (for 2020). Thus, a portion fall into the $40,001 to $441,450 range and are taxed at 15%. The dividends above the $441,450 breakpoint are taxed at 20%.
LO 2.2.2
Samantha received the following dividends in 2020 from her portfolio:
I. Ordinary dividends from HOT stock, a publicly traded company
II. Dividends from Sky High Realty and Trust, a publicly traded REIT
III. Life insurance dividends from her whole life policy
IV. Qualified dividends from BET stock, a publicly traded company
Which of the above is NOT considered taxable?
A) IV only.
B) III only.
C) I and II.
D) II and IV.
B) Explanation
Life insurance dividends are considered a return of premium paid (provided the cumulative dividends received over the life of the policy do not exceed the basis in the policy) and thus are not taxable. The other choices listed are taxable. Qualified dividends are eligible for long term capital gains rates. REIT dividends may qualify for a QBI deduction but nonetheless will still be taxable.
LO 2.2.2
Lindsey is age 2 and her total income was $6,000 in qualified dividends in 2020. What is the tax on the dividends at Lindsey’s rate?
A) $143
B) $95
C) $0
D) $30
C) Explanation
Lindsey is in the 10% marginal income tax bracket. She can use the long-term capital gains tax rate on qualified dividends received. At her income and filing status, that capital gain tax rate is 0%.
LO 2.2.2
Which one of the following is NOT subject to the Medicare contribution tax?
A) Income from a nonperiodic distribution from an annuity
B) Long-term capital gains
C) Qualified Roth distributions
D) Qualified dividends
C) Explanation
Qualified Roth distributions are not subject to the Medicare contribution tax. Only taxable items, such as net capital gains, net rental income, annuity income and dividends, for example, are subject to the Medicare contribution tax.
LO 2.3.1
Which of the following taxpayers may owe the additional Medicare tax in 2020?
Brad and Jane file jointly and have combined wages of $288,000.
Terry’s only income in 2020 is from his investments and totals $290,000.
Jack has earned $150,000 in compensation from his employment at Bland Foods Inc.
Lisa, whose filing status is head of household, is self-employed and has self-employment income of $225,000.
A) I and IV
B) I only
C) IV only
D) I, II, and III
A) Explanation
Statements I and IV are correct. The additional Medicare tax rate is .9%. An individual is liable for the additional Medicare tax if the individual taxpayer’s wages, other compensation, or self-employment income (combined with a spouse if filing as married filing jointly) exceeds the thresholds for the taxpayer’s filing status of a combined income greater than $200,000 if single and $250,000 if married filing jointly.
LO 2.3.1
Terry and Jan are married taxpayers filing a joint tax return. In 2020, their AGI is $310,000, and their net investment income (included in the AGI) is $90,000. What is the amount of their Medicare contribution tax for 2020?
A) $2,280
B) $0
C) $3,420
D) $4,180
A) Explanation
Terry and Jan will pay the 3.8% Medicare contribution tax on $60,000. This is the lesser of the net investment income ($90,000) or the AGI in excess of the threshold amount ($310,000 – $250,000, or $60,000).
In this situation, only $60,000 of the net investment income is subject to the Medicare contribution tax and calculates to $2,280 (60,000 × 0.038).
LO 2.3.1
Clare is a single taxpayer. In 2020, her AGI is $235,000, including a net long-term capital gain of $50,000. What is the amount, if any, of Medicare contribution tax that she must pay?
A) $570
B) $0
C) $1,330
D) $1,900
C) Explanation
She will pay the 3.8% Medicare contribution tax on $35,000. This is the lesser of the net investment income ($50,000) or the AGI in excess of the threshold amount ($235,000 – $200,000, or $35,000). In this situation, only $35,000 of the net investment income is subject to the Medicare contribution tax. Clare will pay a $1,330 Medicare contribution tax (3.8% on $35,000).
LO 2.3.1
Your client Sally, age 30, is designing an educational investment program for her 8-year-old son. She expects to need the funds in about 10 years when her AGI will be approximately $70,000. She wants to invest at least part of the funds in tax-exempt securities. Which of the following investment(s) may yield tax-exempt interest on her federal return if the proceeds were used to finance her son’s education?
I. Treasury bills
II. EE bonds
III. GNMA funds
IV. Zero coupon Treasury bonds
A) II and III
B) III and IV
C) I, III, and IV
D) II only
D) Explanation
Proceeds from EE savings bonds may be exempt if the proceeds are used for qualified higher-education expenses of the taxpayer, spouse, or dependent. There is an AGI phaseout, which for 2020 is approximately $82,350‒$97,350 (2020) for a single taxpayer. (The actual phaseouts are provided on the exam.) All the other options generate currently taxable income. The Treasury bills and GNMA funds both produce taxable income on the federal return (Treasury bill interest would typically be tax exempt on her state return). The zero Treasury also produces taxable income each year as the amortized discount is added to taxable income, even though no cash income is received.
LO 2.4.1
Question #26 of 30
Question ID: 1247601
Tim Jones is single, 21 years old, and in his third year of college. He has an AGI of $35,000 and receives no support from his parents. The college is a Title IV institution where students are eligible to receive federal financial aid, and Tim is pursuing an undergraduate degree in criminal justice. When Tim was 13, his parents established a Uniform Transfers to Minors Act (UTMA) for him, and funded it with EE savings bonds. When Tim was a freshman, he was convicted of a felony drug possession charge.
Which one of the following is CORRECT regarding Tim’s situation?
A) Tim qualifies for the Lifetime Learning Credit.
B) Tim may redeem the EE bonds potentially tax free if the proceeds are used for his qualifying education expenses.
C) Tim could use both the American Opportunity Tax Credit and the Lifetime Learning Credit in the same year.
D) Tim qualifies for the American Opportunity Tax Credit.
A) Explanation
Tim qualifies for the Lifetime Learning Credit. His AGI is under the phaseout range. He is pursuing a degree at an eligible institution. The felony drug conviction would preclude the use of the American Opportunity Tax Credit but not the Lifetime Learning Credit. There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds or unless they are held jointly with a spouse. A bond that has been gifted to another taxpayer does not qualify for the exclusion. The American Opportunity Tax Credit and the Lifetime Learning Credit may not be claimed in the same year for the same student.
LO 2.4.1
Seven years ago, Karen Price purchased U.S. EE savings bonds for $5,000. During the current year, when Karen was 27 years old, she redeemed the bonds to help pay for her graduate school tuition. The accrued value at the time of redemption was $7,000.
Assume Karen incurs $11,000 of tuition expenses in the year. What are the tax consequences upon the redemption of the bonds?
A) A portion of the interest may be excluded.
B) All the interest may be excluded.
C) The income on the bonds is generally subject to state income taxes.
D) All accrued interest is taxable in the current year.
D) Explanation
The exclusion for EE bond interest redeemed to pay for qualifying higher-education expenses applies only to bonds purchased by an individual age 24 or older, and held in that person’s name, or jointly with a spouse. Karen is 27 years old; the bonds were purchased 7 years ago, when Karen was approximately 20. Because Karen does not qualify for the exclusion of the interest income because she was not age 24 or older at the time of purchase. All the interest is taxable in the year the bonds are redeemed. Remember that the interest of EE bonds is deferred until maturity, unless an election has been made to have the interest taxed each year as it accrues. Also, the interest income from EE bonds (and other federal government obligations) is generally not subject to state income tax.
LO 2.4.1
Eight years ago, Joan Allen, a married taxpayer filing jointly, purchased U.S. Series EE savings bonds for $6,000. She titled the bonds jointly with her husband, Hank. During the current year, when Joan was 35 years old, they redeemed the bonds to help pay for Joan’s graduate school tuition. The accrued value at the time of redemption was $8,000. Their AGI for 2020 is estimated to be $100,000.
Assume Joan incurs $8,000 of tuition expenses during the year. What are the tax consequences upon the redemption of the bonds?
A) All accrued interest is taxable in the current year.
B) The interest is taxable at both state and federal levels.
C) All the interest may be excluded.
D) A portion of the interest may be excluded.
C).
Explanation
The EE bond exclusion (for educational purposes) is phased out (for married couples filing jointly) between $123,550 and $153,550 of AGI in 2020. There is no exclusion available when AGI exceeds $153,550. It is not necessary to memorize the exact phaseout amounts because they will be provided on the exam. To qualify for the exclusion, the bonds must be purchased by an individual age 24 or older and held in that person’s name, or jointly with a spouse. EE bonds are not taxable at the state level.
LO 2.4.1
Which one of the following is CORRECT regarding the Coverdell Education Savings Account?
A) Deductible contributions of up to $2,000 may be made per beneficiary.
B) Distributions may be tax free even if made for K-12 expenses.
C) Distributions may be tax free only if made for a full-time student.
D) Room and board may be covered with a tax-free distribution only if the student is full-time.
B) Explanation
The predominant benefit of the Coverdell ESA is distributions may also be used to pay for K-12 expenses. This is unlike the 529 plan which is designed primarily to pay for college expenses (Note: a limited amount of $10,000 may now be withdrawn from a 529 for K-12 expenses per the TCJA).
LO 2.4.1
Which of the following benefits that Claudia has received from her employer can be excluded from taxation?
A) A company car that she uses for personal vacations.
B) $5,000 of graduate education assistance.
C) A year-end bonus.
D) An athletic membership at a local club valued at $1,500 per year.
B) Explanation
Undergraduate and graduate education assistance is excluded from an employee’s income in any one year period, up to a maximum of $5,250. The other options are fully taxable.
LO 2.4.1
Jasmine and Luke, a married couple, bought 100 shares of Mutual Fund B for $3,200 on March 2 of this year. On December 19 of this year, they sold the 100 shares of Mutual Fund B for $3,500. They used the proceeds to purchase a trailer for its FMV of $3,500 and immediately donated it to their church to use for special events. What are the tax consequences of this sale?
A) The couple has a short-term capital gain of $300 on the sale.
B) The couple has a long-term capital gain.
C) There is no recognized gain on the sale because the proceeds were used for a donation.
D) The couple has donated appreciated property.
A) Explanation
The couple have a recognized short-term capital gain of $300. Separately, they have donated property with a value of $3,500 to the church.
LO 3.2.2
Question 2 of 14
Question ID: 1247327
Caroline, age 16, has earned income of $18,605 and interest income of $750 in 2020. She is listed as a dependent on her parents’ income tax return. What is Caroline’s standard deduction for earned income in 2020?
A) $0
B) $12,400
C) $1,100
D) $18,000
B) Explanation
Caroline’s standard deduction for earned income is $12,400 (for 2020), whereas her standard deduction for unearned income is only a maximum of $1,100 (limited to the $750 of actual unearned income in this instance). Caroline would, therefore, elect to offset her total income of $19,355 by the greater of the standard deductions, which is $12,400 in 2020.
LO 3.2.1
Question 3 of 14
Question ID: 1247337
Which of the following adjustment/preference items is also an exclusion item for the purposes of the alternative minimum tax (AMT)?
I. ISO bargain element
II. Exclusion of gain from Section 1202 qualified small business stock
III. Percentage depletion of oil and gas properties in excess of the taxpayer’s adjusted basis at year end
A) II only
B) III only
C) II and III
D) I and III
C)
Explanation
Statements II and III are correct. Statement I is incorrect. The ISO bargain element is not an exclusion item; it is a deferral item.
LO 3.3.2
Question 4 of 14
Question ID: 1247324
A grantor trust is a trust
A) established by the grantor or settlor.
B) whose income is taxed to a beneficiary other than the grantor, but is considered owned by the grantor.
C) whose income is taxed to the trust, but is considered owned by the grantor.
D) whose income is taxed to the grantor.
D) Explanation
A grantor trust is a trust whose income is taxed to the grantor.
LO 3.1.1
Which of the following adjustment/preference items is also a deferral item for the purposes of the alternative minimum tax (AMT)?
I. ISO bargain element
II. Exclusion of gain from Section 1202 qualified small business stock (QSBS)
III. Percentage depletion treated as a tax preference for AMT
A) III only
B) I only
C) II and III
D) I and II
B) Explanation
Statement I is correct. Statements II and III are incorrect. Excluded Section 1202 gain and percentage depletion treated as a tax preference for AMT are exclusion items.
LO 3.3.2
Mira is a single taxpayer, age 67. She has the following itemized deductions:
Home mortgage interest (first mortgage)$15,950
State income taxes$3,120
Property taxes$1,480
Charitable contributions$2,000
Gambling losses$1,500
Unreimbursed employee business expenses$4,600
Tax return preparation fee$400
Medical expenses$24,080
Mira’s AGI for 2020 is $238,500. Included in the AGI is $500 of gambling winnings. What amount of Mira’s itemized deductions would be allowed for purposes of the alternative minimum tax (AMT)?
A) $24,643
B) $34,950
C) $17,950
D) $18,950
A)
Explanation
Of the itemized deductions listed, only the qualifying home mortgage interest of $15,950, the charitable contributions of $2,000, the gambling losses to the extent of winnings of $500, and the $6,193 of medical expenses are allowable for purposes of the AMT. The medical expenses are deductible to the extent they exceed 7.5% of AGI for both regular and AMT purposes.
LO 3.3.2
Pierre, a U.S. citizen, is meeting with his financial advisor regarding some transactions he made during this tax year. He has ample income and has made several charitable donations. They were as follows:
$30,000 to his church for a building addition fund
$100,000 to an orphanage in France in the city his parents lived as children
$10,000 to the United Way
$15,000 to a nonprofit organization in New Orleans that teaches French to children
$50,000 to a gubernatorial campaign in his state
Without regard to AGI limitations, how much of his donations may be deductible on his income tax return?
A) $40,000
B) $55,000
C) $105,000
D) $205,000
B) Explanation
Of the listed donations, the $100,000 to the orphanage is nondeductible because it is a charity located in France. The $50,000 given to the gubernatorial campaign is a nondeductible political donation. The $30,000 given to the church, the $10,000 given to the United Way, and the $15,000 given to the nonprofit organization are deductible donations.
LO 3.2.2
Question 8 of 14
Question ID: 1247334
Jamaal owns a professional service corporation. While capital is not a material income-producing factor, he does use certain equipment in his practice. Jamaal would like to assist his 18-year-old son, Jarod, in financing his education at a college located in another state.
Which one of the following intrafamily transfer techniques would be most appropriate?
A) Gift the equipment to Jarod and then lease it back from him.
B) Set up a short-term revocable trust for Jarod’s benefit.
C) Convert to S corporation status and give Jarod some of the stock.
D) List Jarod as an employee and pay him a salary, even though he cannot provide any meaningful services.
A)
Explanation
The answer is gift the equipment to Jarod and then lease it back from him as the most appropriate intrafamily transfer technique.
LO 3.3.1
Abby, age 16, has earned income of $8,605 and interest income of $750 in 2020. She is claimed as a dependent on her parents’ income tax return. What is Abby’s taxable unearned income in 2020?
A) $2,100
B) $1,100
C) $750
D) $0
D) Explanation
Abby’s taxable unearned income in 2020 is $0 ($750 unearned income − $1,100 standard deduction for unearned income). The standard deduction cannot create a negative amount.
LO 3.2.1
PREV
Question 10 of 14
Question ID: 1247330
Ron and Sandy gave a painting to the local art museum in the current year. The painting had a fair market value of $34,000. He paid $16,500 for it 5 months ago. The museum will display the painting among its collection. What is Ron’s charitable contribution deduction?
A) $16,500
B) $23,000
C) $34,000
D) $13,800
A)
Explanation
Because the artwork is appreciated property held for less than one year, its sale would result in a short-term capital gain. Consequently, the deduction is limited to the lesser of the fair market value or the basis of the gifted property.
LO 3.2.2
PREV
Maxine, an individual taxpayer, donated $100,000 in cash to a qualified public charity in Year 1. Her adjusted gross income was $150,000 in Year 1 and $150,000 in Year 2. She makes no donations to charity in Year 2. How much of a tax deduction will she be allowed for this gift in each of the two tax years?
A) Year 1: $90,000; Year 2: $10,000
B) Year 1: $45,000; Year 2: $35,000
C) Year 1: $45,000; Year 2: $0
D) Year 1: $75,000; Year 2: $5,000
A)
Explanation
Individual cash donations to qualified public charities are limited to 60% of adjusted gross income, but excess amounts may be carried over in subsequent tax years. Sixty percent of Maxine’s Year 1 AGI was $90,000. In Year 1, she can deduct $90,000 of the gift. In Year 2, she can deduct the remainder of $10,000.
LO 3.2.2
The Kimble Family Trust has among its investments a 20% interest in a nonpublicly traded partnership, which generated income this year of $25,000. The trust also had a loss of $15,000 generated by its ownership interest in a real estate limited partnership (RELP). The trust also has portfolio income of $30,000. Which of the following statements is CORRECT?
A) The trust may not own nonpublicly traded passive activity investments.
B) The trust can use the RELP loss to offset portfolio income.
C) The passive activity loss rules do not apply to trust entities.
D) The trust can net the RELP loss against its $25,000 nonpublicly traded partnership income.
D)
Explanation
Because RELPs are nonpublicly traded passive activities, the trust can net the $15,000 loss against the $25,000 income. Trusts may participate in the investment in passive activities and the passive activity rules apply to trusts that own such investments.
LO 3.1.1
In 2020, Floyd, age 15, is a dependent on his parents’ income tax return. When Floyd was born, his parents established an UGMA with corporate bonds and have contributed a little to it every year since. This year, the account generated $5,000 of interest income. There were no distributions from the account this year. Floyd’s parents file jointly, and have taxable income of $80,000.
What is Floyd’s income tax liability for the current year?
A) $777
B) $446
C) $1,029
D) $110
B) Explanation
Floyd’s liability is $446. This is computed as follows:
$5,000
(1,100)limited standard deduction
(1,100)taxed at child’s rate of 10%$1,100 ×10% =$110.00
$2,800taxed at parent’s marginal rate of 12%= $336.00
$446.00
The income earned is taxable, even if the income was not distributed.
LO 3.2.1
Marco had an individual AMT credit two years ago and has not yet used it. Which of the following is correct regarding Marco’s AMT credit?
A) The credit must be applied against the regular income tax liability in the year the credit is created.
B) The credit must be applied against the AMT liability in the next year there is AMT to be paid.
C) The credit can be carried forward indefinitely to be applied against a future alternative minimum tax liability.
D) The credit can be carried forward indefinitely to be applied against a regular income tax liability.
D)
Explanation
The AMT credit created in any one year may be used as a credit against regular income tax in a future year. It may be carried forward indefinitely.
LO 3.3.2
PREV
Danielle created a revocable trust for her two minor sons. She named her bank as trustee. The trust property earned $30,000 in the first year and had taxable income of $28,000 after deducting expenses. This income was left to accumulate for future distributions to be made to each son equally when the youngest son attains age 18. To which of the following will the income of the trust be taxable?
A) Both sons equally
B) The trust
C) Danielle
D) The oldest son after attaining age 18, then the sons equally after the youngest son attains age 18
C)
Explanation
The trust income will be taxed to the grantor, as the trust is revocable. A revocable trust is treated as a grantor trust.
LO 3.1.1
Molly’s grandparents gifted her with substantial securities at her birth eight years ago. In 2020, she has dividends of $10,000 and brokers’ fees of $800 on the activity in the account her parents manage for her. What is her net unearned income taxed at her parents’ rate?
A) $10,000
B) $9,200
C) $7,800
D) $8,950
C)
Explanation
Some of Molly’s unearned income is taxed at her parents’ rate and is calculated as follows: $10,000 UI – $1,100 (standard deduction) – $1,100 (greater of $1,100 for 2020 or amount of allowable itemized deductions directly connected with the production of the unearned income) = $7,800
LO 3.1.1
Alex established a 2503(c) trust for his daughter, Julie, when she entered college four years ago. Alex decided to name his attorney as trustee and give Julie the right to revoke the trust at age 23, when she finished college. Julie did not revoke the trust and chose to allow the trust to continue until she is age 30. Which of the following correctly identifies the taxpayer, if any, who must pay tax on the trust income?
A) The trust, because it is irrevocable and a separate taxable entity
B) Julie, because she allowed the trust to continue past age 23
C) Alex, because this is required by law
D) The attorney as trustee
B)
Explanation
Because Julie waited past age 23 when she had the right to revoke the trust, she is responsible for taxes on the trust given to her.
LO 3.1.1
Alicia is age 16 and she received $6,000 in municipal bond interest income and $900 in other interest income in 2020. Her parents’ marginal tax rate is 28%. What is the total federal income tax due on her income in 2020?
A) $90
B) $735
C) $1,472
D) $0
D)
Explanation
Alicia owes no federal income taxes in 2020. Municipal bond interest income is not taxable. The $900 in other interest income is less than Alicia’s $1,100 standard deduction amount (for 2020).
LO 3.2.1
In 2020, Floyd, age 15, is a dependent on his parents’ income tax return. When Floyd was born, his parents established an UGMA with corporate bonds and have contributed a little to it every year since. This year, the account generated $5,000 of interest income. There were no distributions from the account this year. Floyd’s parents file jointly and have taxable income of $175,000 and are in the 24% MFJ tax bracket. What is Floyd’s income tax liability for the current year?
A) $1,029
B) $782
C) $260
D) $110
B) Explanation
Floyd’s liability is $782. This is computed as follows:
$5,000
($1,100)limited standard deduction
($1,100)taxed at child’s rate of 10%$1,100×10%=$110.00
$2,800taxed at parents’ rate of 24%=$672.00
$782.00
LO 3.2.1
Five years ago, Tom bought 10,000 shares at $10 per share in an intermediate-term bond fund. Today, the shares are worth $200,000 and are paying a nonqualified dividend of $8,000 per year. Tom feels that the stock will continue to appreciate at a rate of 5% per year, including the dividend. Tom wants to establish a college education fund for his two daughters, ages 18 and 9. Neither child has any earned income. Which of the following statements is true?
I. If Tom gives 2,500 shares to his 18-year-old daughter, all income from the 2,500 shares will be taxed in her income tax bracket.
II. If Tom gives 2,500 shares to his 9-year-old daughter, all dividends from the 2,500 shares will be taxed at her marginal rate.
III. Two years from now, if Tom’s older daughter sells her 2,500 shares at $30 per share, Tom will need to report the gain as a long-term capital gain on his personal income tax return.
IV. All interest income received by his 9-year-old daughter that exceeds $2,200 in 2020 will be taxed at the parents’ marginal tax rate.
A) II and III
B) I and IV
C) IV only
D) I and II
C)
Explanation
Statement IV is the only correct statement. The kiddie tax applies to children under 19 years of age. It also applies to children under age 24 if they are full-time students. The kiddie tax does not apply if the child’s earned income exceeds one-half of the child’s support. Thus, I and II are incorrect. There is no requirement that the proceeds of a future sale be reported on the donor’s return. As a result of TCJA, the net unearned income is taxed at the parents’ marginal tax rates.
LO 3.2.1
Teddy, age 12, has interest income of $1,275. He also has earned income from an after-school job that totals $12,500. Teddy is eligible to be treated as a dependent on his parents’ return. What is the amount of Teddy’s standard deduction for 2020?
A) $1,100
B) $12,850
C) $12,400
D) $1,275
C) Explanation
The standard deduction for an individual eligible to be claimed, or treated, as a dependent is the greater of the limited standard deduction of $1,100 or the amount of earned income plus $350, not to exceed the full standard deduction amount of $12,400 (for 2020). $12,500 + $350 = $12,850, but the deduction is limited to the full standard deduction amount of $12,400.
LO 3.2.1
Jeffrey and Karen have given cash gifts to their children over the years. In addition, in 2020
Mark, age 13, earns $2,500 in salary.
Jennifer, age 19, who attends community college for approximately three months per year, earns $2,200 in dividends and capital gains.
Nancy, age 12, earns $2,950 in dividends and interest.
Steven, age 10, earns $900 in dividends and interest.
Whose income is subject to the tax at the parents’ marginal rate?
A) Nancy’s
B) Nancy’s and Mark’s
C) Steven’s
D) Jennifer’s and Nancy’s
A) Explanation
Nancy is the only child up to and including age 18 with unearned income in excess of $2,200 for 2020. Earned income is not subject to taxation at the parental rate. Jennifer is not subject because she is not a full-time student. The kiddie tax applies to children under 19 years of age. It also applies to children under age 24 if they are full-time students. The kiddie tax does not apply if the child’s earned income exceeds one-half of the child’s support. A full-time student is an individual who is a full-time student for at least five calendar months during the tax year.
LO 3.2.1
Which of the following statements regarding the kiddie tax is CORRECT?
I. The kiddie tax provision limits income shifting by preventing families from transferring large amounts of unearned income to children and making the shift effective for income tax purposes.
II. If a child under the age of 19 has unearned income above a specified amount, the excess is taxed at the parents’ marginal tax rates for the year, rather than at the child’s marginal rate.
A) Neither I nor II
B) Both I and II
C) II only
D) I only
B) Explanation
Both statements are correct. The kiddie tax applies to unearned income for children under the age of 19 and full-time students until they reach age 24.
LO 3.2.1
Paul, age 16, is listed as a dependent on his parents’ income tax return. During 2020, he earned $2,600 from a summer job. He also earned $2,600 in interest and dividends from investments that were given to him by his uncle five years ago. How much of Paul’s income, if any, will be taxed to him in 2020 using his uncle’s marginal tax rate of 32%?
A) $2,000
B) $400
C) $2,600
D) $0
D)
Explanation
When applying the kiddie tax, the parents’ marginal tax rate is always used (regardless of the source of the property generating the unearned income). Therefore, none of the income is taxed to Paul using the uncle’s tax rate. The $400 of income ($2,600 − $2,200) is taxed to Paul at his parents’ marginal tax.
LO 3.2.1
Jim is planning to make a charitable contribution to a local university, a qualifying charitable organization. He is going to contribute a piece of real estate that he has owned for six years. The fair market value of the property is $80,000, and his basis in it is $55,000. He has an AGI of $120,000.
Jim wants to maximize the amount of charitable contribution deductions from the donation of the real estate. What is the amount of charitable contribution deduction that Jim may claim in the current year?
A) $55,000
B) $40,000
C) $36,000
D) $60,000
C)
Explanation
The gift of long-term capital gain (LTCG) property is generally based on the fair market value of the property. The university is a 50% organization, a public charity. LTCG property contributed to a 50% organization involves a 30% of AGI limitation, and 30% of $120,000 is $36,000. There is also a $44,000 carryforward for up to five years. Jim could have made a 50% election to maximize the current-year deduction, but that would have reduced his overall deductions. If Jim had made a 50% election, he could have deducted $55,000 in the current year. By forgoing the 50% election, he is allowed to deduct the full $80,000 fair market value—$36,000 this year and $44,000 over the next several years.
LO 3.2.2
Frank Swanson anticipates adjusted gross income of $80,000 during the current tax year. He is considering making a gift of real estate to the public university he attended. Frank’s adjusted basis in this real estate is $50,000. The real estate has a current fair market value of $70,000. Frank has owned the real estate for 19 months. If Frank donates the real estate, what is the maximum allowable charitable deduction Frank can receive for the current tax year?
A) $50,000
B) $40,000
C) $24,000
D) $70,000
B) Explanation
If Frank makes a 50% election, he must utilize the basis of the property but may deduct up to 50% of AGI. This yields a $40,000 current-year deduction with a $10,000 carryforward. If no 50% election were made, the deduction would be based on the fair market value of the property but would be limited to 30% of AGI, which is $24,000, with a $46,000 carryforward.
LO 3.2.2
Kris Swenson anticipates adjusted gross income of $100,000 for the current tax year. She is considering making a gift of a painting to the American Red Cross in the current tax year. Kris’s basis in the painting is $35,000. The painting has a current fair market value of $50,000. Kris has owned the painting for 15 years. If Kris does gift the painting to the American Red Cross this year, what is the maximum allowable charitable deduction she can receive in the current tax year?
A) $30,000
B) $35,000
C) $20,000
D) $50,000
B)
Explanation
The painting would be considered use-unrelated tangible personalty. The deduction for use-unrelated tangible personalty is limited to basis, with a 50% of AGI limitation. Thus, the current-year deduction is $35,000. If the painting had been donated to an art museum, for example, the contribution would be of use-related tangible personalty. Since the painting had been held for the long-term holding period, the deduction would have been $30,000 (long-term capital gain property to a 50% organization uses FMV with a 30% of AGI limitation) with a $20,000 carryforward.
LO 3.2.2
Kevin Riley anticipates adjusted gross income of $120,000 for the current tax year. He has made no charitable gifts during the year, but now he wants to give his church a stamp collection with a fair market value of $70,000. Kevin paid $38,000 for the collection five years ago. The collection is appreciated tangible personal property that is unrelated to the church’s exempt function. What is the maximum allowable charitable deduction Kevin can receive during the current year if he makes an immediate gift of the stamp collection?
A) $36,000
B) $24,000
C) $60,000
D) $38,000
D)
Explanation
The answer is $38,000. Since this is use-unrelated property, the allowable deduction is limited to his basis.
LO 3.2.2
Which of the following statements regarding charitable deductions by corporations is CORRECT?
The corporate statutes of most states permit corporations to make charitable contributions, and the Tax Code permits a charitable deduction for contributions by a corporation.
The charitable deduction is limited to a maximum of 20% of the corporation’s adjusted taxable income. In the event the contribution is in excess of 20% of the corporation’s adjusted taxable income, the balance can be carried forward for up to five years.
A) II only
B) I only
C) Neither I nor II
D) Both I and II
B)
Explanation
Statement II is incorrect because the charitable deduction is limited to a maximum of 10% of the corporation’s adjusted taxable income.
LO 3.2.2
In the current year, Jeff makes the following charitable donations:
Basis. FMV
Inventory used in Jeff’s business
(sole proprietor):$8,000. $6,000
Stock in ABC Co. (acquired 2 years ago):$10,000$40,000
Personal coin collection (acquired 10 years ago):$1,000.$7,000
The ABC stock was given to Jeff’s church, and the coin collection was given to the Boy Scouts of America. Both donees promptly sold the property for the stated FMV. Ignoring percentage limitations on AGI, Jeff’s maximum charitable contribution valuation for deduction purposes available for the current year is
A) $19,000.
B) $53,000.
C) $55,000.
D) $47,000.
D).
Explanation
Jeff’s maximum valuation for deduction purposes available for the current year is $47,000 as follows:
Inventory: $6,000 (as ordinary income property, limited to lesser of basis or FMV)
Stock in ABC Co.: $40,000 (the maximum possible deduction is FMV for this long-term capital gain property)
Personal coin collection: $1,000 (tangible personal property depends on dedicated use of property from standpoint of the charity; this is use-unrelated property because it was given to the Boy Scouts also limited to the lesser of basis or FMV)
LO 3.2.2
Charley lent his friend, Richard, $17,000 for a down payment on a home in a no-interest loan early in the current year. Charley had investment income of $750, and Richard had investment income of $1,200 in the same year. The federal interest rate is 3.5%. Richard has been making payments each month. What recommendations do you make for accounting for the loan made to Richard by Charley?
A) Imputed interest is calculated on the loan to Richard and is considered a gift to Richard from Charley.
B) Charley must develop an amortization schedule using the federal rate of 3.5% to account for Richard’s payments of principal and interest.
C) Because Charley’s investment income is less than $1,000 this year, no interest is imputed to the loan.
D) Because this is a gift loan greater than $10,000 but less than or equal to $100,000, no interest will be imputed to the loan.
A)
Explanation
In a gift loan, the amount of the imputed interest constitutes a gift from the lender to the borrower. For gift loans greater than $10,000 and less than or equal to $100,000, no interest is imputed if the borrower’s investment income for the year does not exceed $1,000. For a gift loan of more than $100,000, the prevailing federal rate of interest will be imputed. For this loan, Richard’s investment income exceeds $1,000 and interest will be imputed.
LO 3.3.1
Imputed interest on a below-market loan (with the IRS providing accepted loan rates) will be paid, unless the gift loan is
A) between friends.
B) from a corporation to a shareholder.
C) less than $10,000 and the gift loan recipient has less than $1,000 in interest income.
D) less than $5,000 and the loan recipient has no interest income.
C) Explanation
In a gift loan, the amount of the imputed interest constitutes a gift from the lender to the borrower. For gift loans greater than $10,000 and less than or equal to $100,000, no interest is imputed if the borrower’s investment income for the year does not exceed $1,000. For a gift loan of more than $100,000, the prevailing federal rate of interest will be imputed.
LO 3.3.1
Chris Burdick anticipates adjusted gross income of $200,000 for the current tax year. He contributed appreciated stock to the United Way. Chris’s adjusted basis in this stock is $50,000. The stock has a current fair market value of $140,000. Chris has owned the stock for 12 years. If Chris does gift the stock to the United Way, what is the maximum allowable charitable deduction he can receive in the current tax year?
A) $50,000
B) $100,000
C) $60,000
D) $140,000
C) Explanation
A gift of long-term capital gain property to a 50% organization is based on the FMV of the property, with the deduction for the current year limited to 30% of AGI.
LO 3.2.2
Claudia, who has an AGI of $40,000, wants to donate a portrait of an ancestor who served in the American Revolution to the museum in her town that houses a collection of Revolution Era items. Her basis in the portrait is $1,750, and it has a fair market value of $2,000. How much can she potentially deduct as a charitable contribution this year, assuming it is her only donation?
A) $1,750 (It is related-use capital gain property, so she must use basis.)
B) $2,000 (It is related-use capital gain property.)
C) $600 (The museum is a 30% organization, so she must use FMV.)
D) None (It is the portrait of a relative.)
B) Explanation
The portrait is related-use, capital gain property. Claudia may deduct an amount up to 50% of her AGI if she uses the basis of the painting and 30% of AGI if she uses FMV. As long as Claudia’s AGI is greater than $6,667, she can deduct the FMV of the portrait.
LO 3.2.2
Question #21 of 30
Question ID: 1247654
Marion donated a truck to the local food bank to use for picking up food donations. Marion had purchased the truck several years ago for $15,000, and it currently has a value of $3,400. Which of the following statements regarding the documentation Marion must have to support his charitable contribution of the truck is CORRECT?
A) A letter from the food bank thanking him for the donation of the truck is sufficient documentation.
B) The documentation must have the description of the property, the name of the receiving charitable organization, the date of the contribution, and the amount of the donation.
C) An appraisal must be attached to Marion’s income tax return for the year of the donation.
D) A noncash contribution under $5,000 needs no documentation to support the donation.
B) Explanation
The donor-taxpayer must have a canceled check, bank record, or a receipt from the donee organization to substantiate the deduction. The documentation must have the amount of cash or description of property, the name of the receiving charitable organization, the date of the contribution, and the amount of the donation. An appraisal is not required for noncash property over $500 and less than or equal to $5,000. However, taxpayers may wish to get an independent appraisal to support the deduction claimed.
LO 3.2.2
Nancy is a single taxpayer and 67 years old. She has the following itemized deductions:
Home mortgage interest (first mortgage)$15,950
State income taxes$3,120
Property taxes$1,480
Charitable contributions$2,000
Gambling losses$1,500
Unreimbursed employee business expenses$4,600
Tax return preparation fee$400
Medical expenses$18,980
Nancy’s AGI for 2020 is $250,000. Included in the AGI is $500 of gambling winnings. What amount of Nancy’s itemized deductions would be allowed for purposes of the AMT?
A) $18,950
B) $18,680
C) $17,950
D) $34,950
B) Explanation
Of the itemized deductions listed, only the qualifying home mortgage interest of $15,950, the charitable contributions of $2,000, and the gambling losses to the extent of winnings of $500, and the $230 of medical expenses are allowable for purposes of the AMT. The medical expenses are deductible to the extent they exceed 7.5% of AGI for both regular and AMT purposes.
LO 3.3.2
Your clients, Joseph and Jane, have read many articles in financial publications about the alternative minimum tax (AMT) and are concerned that some of their investments and activities may cause AMT problems. Which of the following are preference items or adjustments for purposes of the individual AMT?
I. Interest from qualified private-activity municipal bonds issued in 2008
II. Bargain element on the exercise of an incentive stock option
III. Excess of percentage depletion over the property’s adjusted basis
IV. Cost depletion deductions
A) I, II, III, and IV
B) II, III, and IV
C) I, II, and III
D) I and IV
C)
Explanation
By definition, the only listed item that is not an AMT preference item or adjustment is the cost depletion deduction. Note that interest on private-activity municipal bonds issued in 2009 and 2010 is not a preference item for the AMT.
LO 3.3.2
Question #24 of 30
Question ID: 1273794
Which of the following are preference items or adjustments for purposes of the individual alternative minimum tax?
I. Interest on qualified private-activity municipal bonds issued in 2008
II. Excess of percentage depletion over the property’s adjusted basis
III. Investment interest expense in excess of net investment income
IV. Qualified housing interest
A) I, II, III, and IV
B) I and II
C) II and III
D) I only
B)
Explanation
By definition, investment interest expense in excess of net investment income and qualified housing interest are not preference items or adjustments for purposes of the alternative minimum tax. Remember that interest on qualified private-activity municipal bonds issued in 2009 and 2010 is not a preference item.
LO 3.3.2
Which of the following are allowable itemized deductions for purposes of computing the alternative minimum tax?
I. Charitable deductions
II. Qualified housing interest
III. Gambling losses to the extent of gambling winnings
IV. Property taxes
A) II, III, and IV
B) I and III
C) I and II
D) I, II, and III
D) Explanation
Statement IV, property taxes, is the only itemized deduction listed that is not allowed for AMT purposes. State and local income taxes are also disallowed.
LO 3.3.2
Which of the following itemized deductions would be adjustments to regular taxable income in arriving at alternative minimum taxable income (AMTI)?
I. Casualty losses
II. State income taxes paid
III. Standard deduction
IV. Charitable donation made to the local university
A) I and III
B) II and III
C) II, III, and IV
D) I and IV
B) Explanation
Statement I is incorrect because casualty losses are deductible for both regular tax and AMT; no adjustment is necessary. Statement II is correct because state taxes are not deductible for AMT purposes. Statement III is correct because the standard deduction is a positive adjustment when calculating AMT income. Statement IV is incorrect because charitable contributions are deductible for both regular income tax and AMT; no adjustment is necessary.
LO 3.3.2
Which of the following tax preference items are used in calculating the alternative minimum tax (AMT) for an individual?
I. Tax-exempt income from a State of Louisiana general obligation municipal bond
II. Percentage depletion in excess of basis on a mining property
III. Tax-exempt interest on a private-activity bond issued in 2012
IV. Exclusion of gain on the sale of certain qualified small business corporation stock
A) I only
B) I, II, and III
C) II, III, and IV
D) I, II, III, and IV
C) Explanation
Tax-exempt income from a general obligation municipal bond is not a preference for AMT. All of the other items are tax preference items for AMT purposes.
LO 3.3.2
Marvin has all of the following items. All of them are AMT preference items except
A) tax-exempt income from a State of Iowa municipal revenue bond.
B) tax-exempt interest on certain private-activity bonds.
C) percentage depletion in excess of adjusted basis on a mining property.
D) exclusion of gain on the sale of certain qualified small business corporation stock.
A)
Explanation
Tax-exempt income from a municipal revenue bond is not a preference for AMT. All of the other items are preferences for AMT purposes.
LO 3.3.2
Which of the following statements regarding the alternative minimum tax (AMT) or AMT planning are CORRECT?
I. The AMT reduces the tax benefits from certain types of deductions and tax preferences allowable for regular income tax purposes.
II. The starting point for determining alternative minimum taxable income (AMTI) is AGI as reported for regular income tax purposes.
III. It is generally advantageous to defer the payment of real estate taxes to a future year when AMT will be paid in the current year.
IV. It is generally advantageous to accelerate ordinary income into years when AMT will be paid.
A) I and III
B) I, II, and IV
C) I, III, and IV
D) III and IV
C) Explanation
The IRS notes that the starting point for determining AMTI is taxable income as reported for regular income tax purposes on a taxpayer’s IRS Form 1040. Because real estate taxes are not deductible for AMT purposes, it is generally advantageous to defer the payment of such taxes to a year when AMT will probably not be payable. Also, if AMT will be payable in the current year, it is generally advantageous to increase the amount of regular taxable income (e.g., by accelerating ordinary income into the current year) because the total tax payable will likely not be affected by doing so.
LO 3.3.2
Jack bought publicly traded stock seven years ago for $6,000. Its current value on the securities market is $11,000. He has donated this appreciated stock to a charity that provides housing for the homeless. What must Jack do to take the donation as a charitable deduction?
I. Jack must have documentation from the charity substantiating the amount of the donation, the date donated, and the name of the charity.
II. All donations of stock must have a qualified appraisal of the stock attached to the donor’s income tax return.
A) Neither I nor II
B) II only
C) Both I and II
D) I only
D) Explanation
Statement I is correct. In additional, the taxpayer must be in receipt of this documentation by the due date of the return or when the return is filed. Statement II is incorrect because it reads “all” donations of stock must have a qualified appraisal. A qualified appraisal is not required for closely held stock if the amount donated is less than $10,000. The appraisal itself is not attached to the tax return.
LO 3.2.2
Colin and Lucy are meeting with their financial planner, Mark, before the tax year ends to discuss changes in their situation. In March of this year, Lucy’s mother, Joyce, suffered a stroke and required placement in a nursing home. She did not have the funds to pay for it and it fell to the couple to support her stay until her death in November of this year. They would like to know what tax relief they may have for supporting Joyce this year. What should Mark tell the couple?
A) The couple can take a partial tax credit for Joyce this year.
B) Mark should ask for documentation to establish Joyce’s income, the amounts spent on her own support, and how much the couple spent before he provides any recommendations.
C) The couple is assured of at least being able to list Joyce on their tax return this year.
D) Because they paid nursing home expenses for Joyce, the couple is entitled to the dependent care credit on their tax return.
LO 4.2.1
B)
Which of the following is CORRECT concerning married individuals filing a joint income tax return?
I. Legally married spouses may file a joint return even though one spouse has no income or deductions.
II. Legally married spouses’ tax years must begin on the same date.
III. Legally married spouses are not legally separated under a decree of divorce or separate maintenance on the last day of the calendar year.
IV. Neither legally married spouse is a nonresident alien at any time during the year.
A) II and III
B) I, II, and IV
C) IV only
D) I, II, III, and IV
D)
Explanation
All statements are required for legally married spouses to file a joint income tax return.
LO 4.1.1
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