Income Tax

Question 1

Which of the following is a capital asset?

a) A copyright on a textbook owned by the author.
b) A painting owned by an art collector.
c) Office furniture used in a business.
d) A note receivable.

Answer 1

Answer: B

A painting owned by an art collector is a capital asset. In contrast, a painting owned by the artist or a copyright owned by the author is an ordinary income asset. Office furniture used in a business is depreciable property used in a trade or business, so it would be Section 1231 property rather than a capital asset. A note receivable is specifically excluded from being a capital asset under Section 1221.

Question 2

Which assets are not capital assets?

Answer 2

All assets are capital assets except ACID (Accounts/notes receivable, Copyrights and creative works, Inventory, and Depreciable property used in a trade or business).

Question 3

Pat buys a new machine costing $58,000. She pays freight of $6,000 to get the new machine to her factory. She has also paid an additional 5% of the purchase price for sales tax. She hired a local company to install the equipment and paid them $10,000. What is Pat’s basis in her new machine?

a) $64,000
b) $66,900
c) $74,000
d) $76,900

Answer 3

Answer: D

Pat’s basis in her new machine is equal to the total costs associated with obtaining the machine and installing it in her factory. Therefore, her basis is $76,900 ($58,000 + $6,000 + $2,900 + $10,000).

Question 4

Aunt Suzie recently died and left her niece, Jean, 1,000 shares of ABC stock. Suzie acquired the stock on December 12, 2020, for $25 per share. Suzie dies February 14, 2021. Assume that Jean sold the stock for $28 per share on February 28, 2021. What is the nature of her gain?

a) Short-term capital gain.
b) Long-term capital gain.
c) Part short-term capital gain, part long-term capital gain.
d) Ordinary income

Answer 4

Answer: B

Gain on all inherited assets is long-term capital gain.

Question 5

What is the formula to determine the basis of gifted property when gift tax is paid?

Answer 5

The donee’s basis is determined using the following formula:

Donor’s Basis + ([Net Appreciation in Value of Gift / Value of Taxable Gift] x Gift Tax Paid)

Question 6

Mike gifted 100 shares of ABC stock to James. Mike (the donor) had a basis in the stock of $40 per share. At the time of the gift, the FMV of each share was $65. What is James’ basis in the 100 shares of stock?

a) $25 per share for a total of $2,500.
b) $40 per share for a total of $4,000.
c) $65 per share for a total of $6,500.
d) $105 per share for a total of $10,500.

Answer 6

Answer: B

Under the general rule, James’ basis is equal to the basis of the donor (Mike).

Question 7

Mike gifted 100 shares of ABC stock to James. Mike (the donor) had a basis in the stock of $40 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $65. If James sells the ABC stock for $90 per share 10 months after the date of the gift, what will his gain or loss be?

a) $2,500 long-term capital gain
b) $2,500 short-term capital gain
c) $5,000 long-term capital gain
d) $9,000 short-term capital gain

Answer 7

Answer: C

James’ basis in the stock is $40 per share for a total basis of $4,000. The total sale price was $9,000 ($90 x 100 shares). Therefore, James’ gain is $5,000 ($9,000 - $4,000). The gain is long-term capital gain because James’ holding period tacks onto that of the donor.

Question 8

Allison gifted 100 shares of XYZ stock to Joe. Allison (the donor) had a basis in the stock of $55 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $40. What are the tax consequences to Joe if he sells the stock 2 years after the date of the gift for $48 per share?

a) $700 loss.
b) $800 gain.
c) $1,500 gain.
d) No gain or loss.

Answer 8

Answer: D

There is no gain or loss because the amount realized from the sale ($4,800) is more than the FMV at the date of the gift ($4,000), but less than the donor’s adjusted basis in the stock ($5,500).

Question 9

Donna gifted 100 shares of DDD stock to Colin. Donna (the donor) had a basis in the stock of $40 per share and had held the stock for more than two years prior to the gift. At the time of the gift, the FMV of each share was $65. Donna paid $2,600 in gift tax on the transfer of the shares of stock and the annual exclusion did not apply to this transfer. What is Colin’s basis in the DDD stock?

a) $25 per share or $2,500 total.
b) $40 per share or $4,000 total.
c) $50 per share or $5,000 total
d) $65 per share or $6,500 total.

Answer 9

Answer: C

Colin gets to add $1,000 to Donna’s basis because Donna paid gift tax on the transfer. Colin’s adjusted basis is calculated as follows: $4,000 + [(2500  6500) x 2600] = $5,000

Question 10

Brody and Tanya recently sold some land they owned for $150,000. They received the land five years ago as a wedding gift from Brody’s Aunt Jeanette. Aunt Jeanette purchased the land many years ago when the property was worth $20,000. At the time of the gift, the property was worth $100,000, and Aunt Jeanette paid $47,000 in gift tax (the annual exclusion did not apply to this transfer). What is the long-term capital gain on the sale of the property?

a) $42,400.
b) $50,000.
c) $92,400.
d) $130,000.

Answer 10

Answer: C

In general, when a donor makes a gift of property other than cash to a donee, the donee will take the property at the donor’s adjusted basis. The holding period of the donee will include the holding period of the donor for purposes of subsequent transfers and the determination of long- or short-term capital gains. An exception to the general basis rule occurs when the donor gives property with a fair market value in excess of his adjusted basis and the donor pays gift tax. The gift tax associated with the appreciation is added to the donor’s original adjusted basis to determine the donee’s basis. Thus, the basis would be:

$20,000 + ([$80,000 / $100,000] x $47,000) = $57,600

The gain on the asset would be $150,000 - $57,600 = $92,400.

Question 11

Carl and Caroline are getting a divorce. As part of the overall negotiations, Carl agrees to pay Caroline $200 per month and transfer to Caroline the ownership of a second home (not their personal residence) that has a value of $300,000, a mortgage of $140,000, and an adjusted taxable basis of $185,000. They have owned the property for three years. Assuming that they get the divorce and within three months Caroline sells the second home for $310,000, what are her tax consequences?

a) $10,000 STCG; $115,000 LTCG
b) $125,000 LTCG
c) $125,000 STCG
d) No recognized gain due to $250,000 exemption.
e) $10,000 STCG

Answer 11

Answer: B

This is not Section 121 personal residence. The transferee in a divorce takes the basis of the transferor ($185,000) and the holding period tacks on.

$310,000 (sale price) - $185,000 (adjusted taxable basis) = $125,000 long-term capital gain.

Question 12

Melanie purchased 100 shares of LawnCare Inc. for $5,000 three years ago. Last week, she sold those shares to her sibling, Isaiah, for $4,200. Isaiah sells the shares today for $4,300. Which of the following best represents Isaiah’s sale?

a) $100 Long-term capital gain
b) $100 Short-term capital gain
c) $700 Short-term capital loss
d) No tax loss or gain

Answer 12

Answer: D

A related party transaction of loss property follows the double basis rule. Isaiah will have a basis of $5,000 for gains and a basis of $4,200 for loss. Isaiah’s sale price of $4,300 falls between the double basis created and will have no gain or loss. Melanie will not be able to take a loss on the sale to her sibling.

Question 13

Josiah incurred some extensive medical bills and is currently out of work due to his injuries. His sibling Josey purchased 200 shares SportEx stock 10 years ago for $8,600. The stock is worth $7,500 currently, and Josey gifts it to Josiah to help with his medical bills. Josiah sells it for $7,400. Which statement best represents the transaction for Josiah?

a) $100 Long-term capital loss
b) $100 Short-term capital loss
c) $1,200 Short-term capital loss
d) No tax loss or gain

Answer 13

Answer: B

A related party transaction of loss property follows the double basis rule. Isaiah will have a basis of $8,600 for gains and a basis of $7,500 for loss. Josiah’s sale price of $7,400 falls below the double basis created and will have a short-term capital loss. The gift of loss property uses the gift date for loss sales. If the stock had been sold for greater than $8,600 the original holding period would have been used. Josey will not be able to take a loss on the gift to his sibling.

Question 14

When does the wash sale rule apply?

Answer 14

Index fund for Index fund - wash sale rule applies.

Index fund for Managed large-cap fund - wash sale rules do not apply.

Question 15

Tip!

Answer 15

The government does not like losses.

Question 16

Jack and Jill, who are married filing jointly, purchased a personal residence 18 months ago for $685,000. Jack and Jill sold the residence today for $925,000 and want to know the tax conse-quences of this transaction. They were required to move because of their employment. How much gain must Jack and Jill recognize this year?

a) $0
b) $240,000
c) $375,000
d) $925,0000

Answer 16

Answer: A

Because Jack and Jill sold their house due to employment reasons, they are eligible for a reduced exclusion even though they did not meet the two-year rules. Jack and Jill realized a gain of $240,000 on the sale of their house ($925,000 - $685,000). They are eligible, however, for a reduced exclusion of $375,000 ($500,000 x 18/24). Because their reduced exclusion exceeds their realized gain, they will not have any recognized gain on the sale of their home. They owned and used 18 months out of 24 months; therefore, they have a reduced exclusion equal to 75% of $500,000.

Question 17

Rufus and Jiya purchased a beach-front residence to rent out for the next year until they retire and move there permanently. The purchase price was $300,000 and rents collected over the rental year totaled $45,000. Upon retirement they promptly moved into the beach home and lived there for four years before downsizing to be closer to family. If their sales price was $500,000, how much of the gain is taxable?

a) $0
b) $20,000
c) $40,000
d) $200,000

Answer 17

Answer: C

The $40,000 is taxable because that is the appreciation attributable to the non-qualified use period. (1 year of non-qualified use) / (5 years of ownership) x ($200,000 of appreciation) = $40,000. Only qualified use as a principal residence qualifies for the exemption, which makes the remaining $160,000 nontaxable. The first year they owned the property it was for rental use, a non-qualified use for section 121 gain exclusion.

Question 18

What is the tax treatment of gains and losses for different types of assets?

Answer 18

Question 19

James had the attached capital transactions. What is James’ net capital gain or loss?

a) Long-term capital gain of $22,700.
b) Long-term capital gain of $8,700.
c) Short-term capital loss of $14,000.
d) Long-term capital loss of $3,000; carryover short-term capital loss of $11,000.

Answer 19

Answer: B

James has a long-term capital gain of $25,700 ($12,000 + $6,200 + $7,500) and a long-term cap-ital loss of $3,000, for a total net long-term capital gain of $22,700. James does not have any short-term capital gain, but he does have a short-term capital loss of $14,000. When James’ long-term capital gains and short-term capital losses are netted, the result is a net long-term capital gain of $8,700.

Question 20

What is the net of the attached long-term capital gain and the long-term capital loss?

a) Long-term capital loss of $21,400.
b) Long-term capital gain of $16,500.
c) Long-term capital loss of $9,000.
d) Long-term capital gain of $22,700.

Answer 20

Answer: D

The net long-term capital gain and long-term capital loss is $22,700 ($25,700 - $3,000).

Question 21

What is the net of the attached short-term capital gain and the short-term capital loss?

a) Short-term capital loss of $300.
b) Short-term capital loss of $6,500.
c) Short-term capital loss of $7,800.
d) Short-term capital loss of $14,000.

Answer 21

Answer: D

James does not have any short-term capital gain. James’ short-term capital loss is $14,000.

Question 22

Tip!

Answer 22

Never gift or sell an asset to a related party when the donor’s basis is greater than the FMV of the asset.

Question 23

Bill owns 1,000 shares of KMA stock. He bought it in 1998 for $40,000 ($40.00 per share). The current FMV of the stock is $32,000. Bill sells the KMA stock to his brother Jack Hass for $32,000. Jack sells the KMA stock to Gerry Brennan (a friend) for $38,500 six months later. What are the tax consequences for Bill and Jack?

a) $8,000 LTCL to Bill; $6,500 LTCG to Jack.
b) $8,000 LTCL to Bill; $6,500 STCG to Jack.
c) No gain or loss to Bill; no gain or loss to Jack.
d) No gain or loss to Bill; $3,500 LTCL to Jack.

Answer 23

Answer: C

This is really Section 267 in action. A transferor in a Section 267 transaction cannot take a loss. If the FMV is below the transferor’s basis, the transferee’s basis is FMV for losses and the transferor’s basis for gains. In this case, there was no loss for Bill because the loss is disallowed under Section 267. Jack had no gain or loss because he had a dual basis and sold the stock at a price between the gain and loss basis.

Question 24

Which of the following is not a Section 1231 asset?

a) Copyright owned by an author
b) Timber
c) Coal
d) Same-sex livestock

Answer 24

Answer: A

Copyrights owned by the author of the copyrighted work are not depreciable assets used in a trade or business.

Question 25

Tip!

Answer 25

The only way to have a Section 1231 gain on a Section 1245 property is to sell it for more than it was originally purchased for.

Any sale amount in excess of the original purchase price of a Section 1245 (capital gain) asset is a Section 1231 (ordinary) gain.

Question 26

Part 1:

Roscoe sells equipment used in his business for $18,000. He had originally purchased the equipment for $15,000 and had taken $7,000 of depreciation. What is the Section 1231 gain for Roscoe?

a) $11,000
b) $8,000
c) $7,000
d) $3,000

Part 2:

How much of the gain is taxed as ordinary income?

a) $0
b) $11,000
c) $3,000
d) $7,000

Answer 26

Answer: D

This is a Section 1245 depreciable property used in a trade or business. To determine any Section 1231 gain, the full amount of depreciation must be recaptured as ordinary income. Therefore, only when the sale price exceeds the original purchase price will there be a Section 1231 gain. $18,000 (sale price) - $8,000 (adjusted taxable basis) =$10,000 (gain) $10,000 (gain) - $7,000 (Section 1245 recapture) = $3,000 (Section 1231 gain)

Answer: D

Question 27

Part 1:

Jack and Jill exchange like-kind real estate assets as listed below:

Jack’s Old Asset: FMV $50,000, Adjusted Taxable Basis $23,000 Jill’s Old Asset: FMV $70,000

If Jack pays Jill cash of $20,000 plus Jack’s old asset, how much gain does Jack have to recognize?

a) 0
b) $20,000
c) $23,000
d) $27,000

Part 2:

What is Jack’s basis in his new asset?

a) $20,000
b) $23,000
c) $27,000
d) $43,000

Part 3:

Assume Jill’s adjusted basis in her old asset was $45,000. How much gain must Jill recognize?

a) $5,000
b) $10,000
c) $15,000
d) $20,000

Part 4:

How much is Jill’s basis in her new asset given that her basis in her old asset was $45,000?

a) $50,000
b) $25,000
c) $20,000
d) $45,000

Part 5:

Assume Jill’s basis in the old asset was $55,000. How much gain must Jill recognize on the transaction?

a) $5,000
b) $10,000
c) $15,000
d) $20,000

Part 6:

What is Jill’s basis in her new asset if her basis in the old asset was $55,000?

a) $50,000
b) $45,000
c) $40,000
d) $35,000

Answer 27

Part 1:

Answer: A

Jack has exchanged his real estate asset for a more valuable asset. Therefore, recognize no gain and add the boot paid by Jack ($20,000) to the old basis and continue to defer the $27,000 of gain.

Part 2:

Answer: D

Jack’s basis is determined by adding the boot that he paid ($20,000) to the basis in his old asset ($23,000) for a total of $43,000.

Part 3:

Answer: D

Recall that the FMV of Jill’s old asset was $70,000. Given that her basis was $45,000, she had $25,000 of deferred gain related to her old asset. Because she received boot of $20,000, she must recognize that amount in gain. Note that Jill still has remaining deferred gain of $5,000 relating to the new asset.

Part 4:

Answer: D

Jill still has a $45,000 basis in her new asset because she recognized gain on the boot that she received, but she did not receive boot in excess of her deferred gain.

Part 5:

Answer: C

If Jill’s old asset had a FMV of $70,000 and her basis was $55,000, then she had $15,000 of deferred gain in her old asset. She received $20,000 of boot from Jack, but she is only required to recognize gain on the receipt of boot to the extent of the deferred gain. The excess $5,000 boot will reduce her basis in the new asset to $50,000.

Part 6:

Answer: A

Jill’s basis in her old asset was $55,000 and she had $5,000 of excess boot (over the deferred gain related to the old asset). Therefore, her $55,000 carryover basis is reduced by $5,000, for a basis in the new asset of $50,000.

Question 28

Part 1:

Boudreaux’s office building was completely demolished by Hurricane Cindy. When the building was destroyed (August 29, YR1), the building had a FMV of $1,000,000 and Boudreaux’s adjusted basis in the building was $450,000. Assuming that Boudreaux’s insurance adjustor determines on February 14, YR2, that Boudreaux should be paid $1,000,000, what is the last date he can reinvest under Section 1033 to avoid recognition of gain?

a) August 29, YR3
b) August 29, YR4
c) December 31, YR3
d) December 31, YR4

Part 2:

How much cash must Boudreaux invest in order to avoid recognition?

a) $0
b) $450,000
c) $550,000
d) $1,000,000

Answer 28

Part 1:

Answer: D

Reinvestments under Section 1033 related to natural disasters must be made by the end of the year of realization plus two years. Therefore, Boudreaux must reinvest by December 31, YR4. Realization occurred when the claim was finally determined, which was February 14, YR2.

Part 2:

Answer: A

There is no requirement to invest cash; however, Boudreaux must replace the destroyed property with property that has a FMV of at least $1,000,000.

Question 29

Which of the following are correct tax-free exchanges? 1. Life Insurance for Life Insurance 2. Life Insurance for an Annuity 3. An Annuity for an Annuity 4. An Annuity for a Life Insurance Policy

a) 1 only
b) 1 and 2 only.
c) 1, 2, and 3 only.
d) 1, 2, 3, and 4.

Answer 29

Answer: C

The only option that is not a tax-free exchange of like-kind assets under Section 1035 is an annuity exchanged for a life insurance policy.

Question 30

Bob and Barbara are married and file a joint tax return. Bob is 68 years old and Barbara is 67 years old. Barbara is legally blind. What is Bob and Barbara’s standard deduction?

a) $25,100
b) $26,450
c) $27,800
d) $29,150

Answer 30

Answer: D

Bob and Barbara are entitled to a standard deduction of $29,150. They are entitled to the basic standard deduction for taxpayers married filing jointly ($25,100), plus one additional deduction for Bob since he is age 65 or older ($1,350) and two additional deductions for Barbara since she is age 65 or older and blind ($1,350 + $1,350).

Question 31

On April 30, Ava, age 60, received a distribution from her qualified plan of $150,000. She had an adjusted basis in the plan of $500,000 and the fair market value of the account as of April 30 was $625,000. Calculate the taxable amount of the distribution without regard to any applicable penalty.

a) Not taxable.
b) $30,000 taxable.
c) $120,000 taxable.
d) $150,000 taxable.

Answer 31

Answer: B

To calculate the amount of the distribution that is return of adjusted basis, the adjusted basis in the plan is divided by the fair market value of the plan as of the day of the distribution. This ratio is then multiplied times the gross distribution amount. As such, $120,000 (($500,000 / $625,000) x $150,000) of the $150,000 distribution is return of adjusted taxable basis. Accordingly, $30,000 ($150,000 - $120,000) will be subject to income tax.

Question 32

Aidan loans $11,000 to his sister, Avril. Why would interest not be imputed on this loan?

a) Interest would not be imputed because the loan is less than the amount of the annual exclusion.
b) Interest would not be imputed because loans of $100,000 or less are exempt from both income tax and gift tax consequences.
c) Interest would not be imputed if Avril has unearned income of $500.
d) Interest would not be imputed if Avril’s earned income is less than $1,000.

Answer 32

Answer: C

Answer A is incorrect because gift loans do not qualify for the annual exclusion. Answer B is incorrect; loans of less than $10,000 are exempt from both income tax and gift tax consequences. Answer D is incorrect because whether interest is imputed on this loan is based on Avril’s level of unearned income, not earned income.

Question 33

Sally is awarded $75,000 in compensatory damages for harm to her reputation. In addition, she was awarded $200,000 in punitive damages. How much of these awards must Sally recognize in income?

a) $0
b) $75,00
c) $200,000
d) $275,000

Answer 33

Answer: D

Only compensatory damages for bodily injury are excludable from gross income. Compensatory damages without bodily injury are includable as are punitive damages.

Question 34

What are the possible deductions from AGI?

Answer 34

• Medical Expenses (in excess of 7.5% percent of AGI) Tax Certainty and Disaster Tax Relief Act of 2020 set the medical expense AGI floor to 7.5% permanently.
  
  • Taxpayers may deduct expenditures for themselves or their dependents that are not reimbursed. Eligible expenses include:
    
    • Prescriptions
    • Noncosmetic surgeries
    • Some qualified long-term care services
  • Insurance premiums including schedule for long-term care policies
    
    • Tuition for special, medically necessary schools (e.g., school for deaf or blind dependent)
    • Capital expenditures
      
      • On the advice of a physician
      • To the extent that the fair market value of the property is not increased
      • Includes operating expenses (e.g., cost of operating a pool)
      • For handicapped entrances and railings, there is no increased value test (note that this does not apply to elevators)
• Certain state and local taxes
  
  • Taxpayers may deduct property taxes (both real estate and ad valorem) - only US property.
  • Taxpayers may deduct state income tax paid, or state and local sales tax (actual or standardized table amount).
  • Taxes are capped to $10,000 total per TCJA 2017.
• Contributions to qualified charitable organizations
  
  • Depending upon the classification of the charitable organization and the type of donated property, the income deduction limitation for individual contributions is either 20 percent, 30 percent, 50 percent or 60 percent of the donor’s AGI. Overall, the total deductible contributions for the tax year cannot exceed 50 percent of the donor’s AGI.
  • Public charities include churches, schools, hospitals and governmental entities. This group includes familiar charities and organizations such as the Red Cross, Salvation Army, ASCPA, etc.
  • Private Charities: Contributions to exempt organizations that do not fit the definition of public charity. These charities include veterans organizations, fraternal orders, and certain private foundation that support comes from a small group as opposed to the public. This group is subject to either a 20 percent or 30 percent of AGI limitation, depending on the type of property contributed.
    
    • Special Rules and Carry-forward of Disallowed Contributions o If a taxpayer makes donations to both a public and private charitable organization during a year, the 50 percent donations are considered first. Any charitable contribution deductions disallowed because of the AGI limitations may be carried over for five years and are used in a first-in-first-out order. The carryover amounts retain their classifications as 20 percent, 30 percent, 50 percent or 60 percent donations.

Question 35

Who qualifies as an eligible child for purposes of the Child Tax Credit?

Answer 35

Stepchildren and foster children under age 17.

Question 36

Who qualifies as a dependent under the Child & Dependent Care Credit, and how much is the credit?

Answer 36

• Dependent under age 13, or
• Handicapped dependent or spouse.
• Eligible care costs x Applicable percentage
• Applicable percentage ranges from 20% to 35% (2021)
  
  • AGI of $43,000 and above are at 20%. The expenditures that qualify are the lesser of actual costs or $3,000 for one qualified individual, and $6,000 for two or more qualified individuals (2021). ($3,000 for one child or $6,000 for two children).
  • The deduction for care cannot be made for care provided by a dependent of the taxpayer. For example, you cannot pay your 16 year old child to watch your 9 year old and take a tax credit.

Question 37

How does the Kiddie Tax apply?

Answer 37

The Kiddie Tax only applies to “unearned income” in excess of $2,200 (2021).

• Standard deduction of $1,100 (2021) for unearned income.
• The next $1,100 (2021) of income is taxed at the child’s marginal rate.
• Therefore, the Kiddie Tax does not apply unless the child has unearned income greater than $2,200.
• Additional unearned income is taxed at the parent’s rate.

Question 38

What are the AMT Preference Items?

Answer 38

Preferences tend to arise because of deductions or exclusions that provide substantial benefits.

• Unlike adjustments, preferences can only be positive (i.e., increase AMTI).
• Thus, preferences reduce the benefits initially received when computing regular tax.

1. Percentage depletion
   
   • The amount of percentage depletion taken for regular tax in excess of the adjusted basis of the property at the end of the year is a preference item.
2. Intangible drilling costs
   
   • AMT requires 10-year amortization. Intangible drilling costs are currently deductible for regular tax.
   • Preference is excess of regular tax deduction over [AMT amortization plus (65% x net oil & gas income)].
3. Interest on private activity bonds
   
   • This interest is not taxable for regular tax purposes, but is included in income for AMT purposes.
   • Expenses incurred in carrying these bonds are not deductible for regular tax purposes, but offset the interest income in computing the AMT preference.

Question 39

Part 1:

David invests in a limited partnership and pays $250,000 for a 10% interest in the partnership. David receives a K-1 showing his proportional share of losses as $75,000. This is his only investment. How much of the loss is suspended under the at-risk rules?

a) $0
b) $75,000
c) $175,000
d) $250,000

Part 2:

How much of the loss is suspended under the passive activity rules?

a) $0
b) $75,000
c) $175,000
d) $250,000

Answer 39

Part 1:

Answer: A

David has $250,000 at risk. Therefore, he is not required to suspend any of his share of the partnership’s losses under the at-risk rules (but beware that the activity may be passive). NOTE: The K-1 shows his proportional share of the loss. You will not need to further calculate the proportional loss as in the prior example.

Part 2:

Answer: B

Every PIG (passive activity gain) needs a PAL (passive activity loss) for the loss to be offset.

David’s losses will be suspended under passive activity rules because he has no passive activity gains to offset.

Question 40

Anna has salary of $50,000 and two investments, Limited Partnership Investment A and B. She does not materially participate in either investment. Her basis in the partnerships are: LLP A - $50,000; LLP B - $25,000.

LLP A had a $75,000 gain in the current year and LLP B had a $100,000 loss.

What is the net gain or loss for the two investments that will be recognized on the current tax return?

a) $3,000 loss
b) $25,000 loss
c) $0 gain or loss
d) $50,000 gain

Answer 40

Answer: D

The investments are passive activities. Therefore, the loss is limited to the at-risk amount and then to the passive activity income. The loss for LLP B is limited to $25,000 since that is the at-risk amount. It can then be netted against LLP A for a total of $50,000 gain ($75,000 – $25,000).

Question 41

Christian has the following investments:

• Publicly traded Limited Partnership A - $10,000 loss
• Publicly traded Limited Partnership B - $15,000 gain
• Nonpublicly traded Limited Partnership - $22,000 loss
• Nonpublicly traded partnership - $16,000 gain

Christian does not materially participate in these investments. Assuming Christian has the appropriate amount at risk to take any necessary losses what is the total suspended loss for the current year? a

) $1,000 suspended loss

b) $6,000 suspended loss
c) $10,000 suspended loss
d) $16,000 suspended loss

Answer 41

Answer: D

The nonpublicly traded partnerships can be netted together and the remainder is suspended. $22,000 – $16,000 = $6,000 suspended loss. The entire publicly traded partnership loss is suspended = $10,000. And the publicly traded gain is considered investment income = $15,000. The loss on Partnership A can carry forward until there is a gain from that partnership, or until you dispose of that partnership interest.

Question 42

What’s the difference between the Failure to File and Failure to Pay penalties?

Answer 42

Failure to File = Five% (up to 25%)

Failure to Pay = Point five% (up to 25%)

If over 60 days late, the minimum failure to file penalty is the smaller of $435 or 100% of the tax required to be shown on the return.

Question 43

When would a taxpayer be subject to the underpayment of estimated tax penalty?

Answer 43

Most people can avoid paying estimated tax if their withholding and credits equal 100% of the tax shown on the prior year’s return or 90% of the current year’s tax liability.

• For taxpayers with AGI above $150,000 ($75,000 MFS) they will pay estimated taxes based on 110% of prior year or 90% of current year by January 15th of the following year even though the full tax liability is due April 15th
• Taxpayers may not rely on this rule, however, if the taxpayer had a short (less than 12 months) taxable year for the previous year.
• In addition, a taxpayer does not have to pay estimated tax if the taxpayer had no tax liability for the previous year; the taxpayer was a US citizen or resident for the entire year; and the taxpayer’s tax year covered a 12-month period.

Question 44

John filed his tax return on April 15. At that time, he owed $900 on a total tax liability of $10,000, and he submitted a check for $900 with his tax return. Which of the following penalties will apply to John?

a) Failure to file.
b) Failure to pay.
c) Underpayment of estimated tax.
d) None of the above.

Answer 44

Answer: D

Answer A is incorrect because John filed his return on time. Answer B is not correct because John paid his tax liability when he filed his return. Answer C is not correct because John’s underpayment was only 9% of his total tax due, so he paid over 90% of his tax liability. Therefore, John is not subject to an underpayment penalty.

Question 45

What are the MACRS property classes and examples of each?

Answer 45

• 3 year: Tractors, rent-to-own property
• *5 year: Autos, computers, office equipment
• *7 year: Office furniture and fixtures
• 27.5 year: Rental home
• 39 year: Office building​

*These two categories are most likely to be tested.

Know that nonresidential real property and residential rental property use the mid-month convention.

• Under this convention, you treat all property placed in service or disposed of during a month as placed in service or disposed of at the midpoint of the month. This means that a one-half month of depreciation is allowed for the month the property is placed in service or disposed of.

Question 46

Robin purchased a computer for her office and paid $2,000. Using MACRS cost recovery and the above chart, how much depreciation can Robin recognize in the first year?

a) $500
b) $1,000
c) $400
d) $2,000

Answer 46

Answer: C

The computer that Robin purchased is 5-year property. Therefore, in the first year, Robin can deduct 20% of the cost of the computer or $400 ($2,000 x 20%).

Question 47

Kevin and Pete own and operate K&P, Inc., a manufacturer of custom speed motorcycles. This year they purchased a new metal cutting machine that cost $2,100,000. Assuming K&P, Inc. has taxable income of $3,250,000 after taking the maximum 179 deduction, how much was their taxable income before the deduction?

a) $3,760,000
b) $2,030,000
c) $4,300,000
d) $3,250,000

Answer 47

Answer: C

K&P, Inc. has sufficient taxable income before the 179 deduction since after the deduction tax-able income is still greater than zero so we do not need to worry about any threshold there. They placed in service $2,100,000 of property. Therefore, the maximum deduction of $1,050,000 will be used. If the 179 deduction was $1,050,000 then their taxable income before the deduction was $4,300,000.

Question 48

At the beginning of the current year, Ellie’s basis in her LLP interest was $150,000. At the end of the year, Ellie received a K-1 from the partnership that showed the following: - Cash withdrawal of $30,000 - LLP income of $17,500 - Dividend income of $5,000 - Short-term capital loss of $1,400 - Charitable contributions of $2,900 What is Ellie’s basis in her LLP interest at the beginning of the next year?

a) $31,400
b) $76,400
c) $138,200
d) $150,000

Answer 48

Answer: C

Ellie’s basis in her partnership interest is $138,200. Her original basis of $150,000 is increased by the LLP taxable income of $17,500 and the dividend income of $5,000. Her basis, however, is reduced by the cash withdrawal, short-term capital loss, and charitable contribution. There-fore, her basis is $138,200 ($150,000 + $17,500 + $5,000 - $30,000 - $1,400 - $2,900).

Question 49

What are the dividend-received deductions based on ownership percentages for a corporation?

Answer 49

Question 50

Hee Company (a C corporation) owns 15% of Haw Company. During the year, Haw Company paid a $45,000 dividend to Hee Company. Assuming that Hee Company does not receive dividends from any other corporation, how much will Hee Company’s dividends-received deduction be?

a) $6,750
b) $22,500
c) $36,000
d) $45,000

Answer 50

Answer: B

Hee will include the $45,000 of dividend income in its gross income, but will be entitled to a dividends-received deduction of $22,500 ($45,000 x 50%).

Question 51

What are the S Corporation requirements?

Answer 51

A corporation must meet all of the following requirements at all times for the “S” election to be initially and continually valid:

• An S corporation cannot have more than 100 eligible shareholders.
• Ownership of S corporation stock is restricted to individuals who are US citizens or US residents, estates, certain trusts, and charitable organizations.
  
  • An ESBT (Electing Small Business Trust) is one of the trusts that can own an S Corporation.
• The corporation must be an eligible corporation created under the laws of the United States or of any state.
• Insurance companies, Domestic International Sales Corporations (DISCs), and certain financial institutions are not eligible for S corporation status.
• The corporation is allowed only one class of outstanding stock.
  
  • An S corporation may have one class of stock, however, the one class of stock may have shares with voting rights and shares with no voting rights.

Question 52

What is a Personal Holding Company?

Answer 52

A personal holding company is defined in Internal Revenue Code section 452. Basically, a corporation is a personal holding company if both of the following requirements are met:

1. Personal Holding Company Income Test. At least 60% of the corporation’s adjusted ordinary gross income for the tax year is from dividends, interest, rent, and royalties.
2. Stock Ownership Requirement. At any time during the last half of the tax year, more than 50% in value of the corporation’s outstanding stock is owned, directly or indirectly, by 5 or fewer individuals.

Question 53

Which of the following entities provides limited liability for all owners?

1. Limited Partnership
2. Corporation
3. S corporation

a) 3 only.
b) 1 and 2 only.
c) 2 and 3 only.
d) 1, 2, and 3.

Answer 53

Answer: C

Limited partnerships only provide limited liability for limited partners. Limited partnerships are required to have at least one general partner, who has unlimited liability.

Question 54

Allison is a doctor who is investing in a new business that she expects to experience losses in the first year. Allison is concerned about protecting her personal assets. Which entity would you recommend?

a) Sole proprietorship.
b) S corporation.
c) C corporation.
d) Partnership.

Answer 54

Answer: B

An S corporation provides flow-through accounting so she can offset ordinary income with business losses. Option D is not appropriate because the question did not indicate that she has any partners.

Question 55

Pat owns 100% of PH, Inc. PH, Inc. owns 80% of RM, Inc. RM, Inc. pays dividends. Which of the following entities would benefit the most from RM’s dividend payments?

a) S corporation.
b) C corporation.
c) Sole proprietorship.
d) LLC.

Answer 55

Answer: B

C corporations are entitled to a dividends-received deduction of 100% if they own 80% or more of the company paying the dividend.