Income Tax Flashcards
What is the primary advantage of using the Section 179 Deduction over other cost recovery methods?
A.By deducting more currently, total tax liability is reduced and the present value of cash flows is increased.
B.The maximum Section 179 limit allows a business to deduct more up front.
C.Section 179 reduces the depreciation on most assets to only three years.
D.Depreciation applies only to business assets, whereas Section 179 applies to business and personal assets.
Solution: The correct answer is A.
Section 179 is an upfront business deduction, up to $1,250,000 (2025) that can be used by businesses to reduce tax liabilities. It’s possible to reduce Section 179 deduction to zero, depending how much is placed into service. If too much is placed into service, Section 179 would not have any advantages over other methods of depreciation.
Sara’s daughter Tara completed her senior year of college in the current year. Sara paid $5,000 in qualified education expenses for Tara in the current year. Sara is a MFJ taxpayer and has an AGI of $50,000 for the current year. What, if any, education credit will provide Sara the highest credit and how much is that credit?
A.Sara is not eligible to claim an education credit.
B.American Opportunity Tax Credit in the amount of $2,500.
C.Lifetime Learning Credit in the amount of $1,000.
D.Lifetime Learning Credit in the amount of $2,000.
Solution: The correct answer is B.
Option “B” is correct because the American Opportunity Tax Credit will provide a credit of $2,500 = 100% of the first $2,000 of expenses and 25% of the next $2,000 of expenses.
Option “C” is incorrect, because although the LLC may provide Sara a credit equal to 20% of her qualified education expenses, or $1,000, she would choose the American Opportunity tax credit - she cannot claim both.
Option “D” is incorrect because Sara would need to have paid $10,000 in qualified education expenses in order to claim the maximum Lifetime Learning Credit of $2,000.
The Tax Reform Act of 1986 was roughly revenue neutral because:
A.It was supported by both Republicans and Democrats.
B.It was not intended to raise or lower taxes.
C.It divided the tax burden evenly between individuals and businesses.
D.It made the tax rates equal across all tax brackets.
E.All of the choices.
Solution: The correct answer is B.
A piece of tax legislation is considered revenue neutral when it is expected to neither raise nor lower the total amount of taxes to be collected.
Issued when the Treasury feels that guidance must be provided quickly to taxpayers.
A.Temporary Regulations
B.Proposed Regulations
C.Final Regulations
D.Revenue Rulings
Temporary Regulations
Issued at the request of an individual taxpayer.
A.Revenue Procedures
B.Private Letter Rulings
C.Determination Letter
Private Letter Rulings
Federal tax legislation generally originates in what body?
A.Internal Revenue Service
B.Senate Finance Committee
C.House Ways and Means Committee
D.Senate floor
House Ways and Means Committee
Eva is a widow, age 74 and blind, who is claimed as a dependent by her son. During the year, she received $4,800 in Social Security benefits, $1,200 in bank interest, and $2,900 in cash dividends from stocks. Eva’s taxable income for 2025 is:
A.$4,100 – $1,350 – $4,000 = No taxable income
B.$8,900 – $4,000 = $4,900
C.$4,100 – $1,350 – $2,000 = $750
D.None of the choices
Solution: The correct answer is A.
Although Eva has no earned income, she is entitled to a minimum regular standard deduction for dependents of $1,350 (2025). She also is allowed additional standard deductions for age and blindness of $4,000 ($2000 + $2,000) in 2025. At this level of income, the Social Security benefits are a nontaxable exclusion.
Which of the following is a credit that reduces the amount of tax calculated on taxable income?
Dependent credit.
Child tax credit.
Earned income credit.
Credit for estimated tax payments.
A.I only.
B.I and III only.
C.II and III only.
D.I, II, III and IV only.
Solution: The correct answer is D.
All of the items are credits against the calculated tax on taxable income.
Which item may be cited as a precedent?
A.Regulations
B.Temporary Regulations
C.US Tax Court decision
D.All of the choices
Solution: The correct answer is D.
A characteristic of the statute of limitations is:
A.A three-year statute of limitations applies to all tax returns.
B.A different statute of limitations applies to tax refunds and deficiencies.
C.A six-year statute of limitations applies if gross income is understated by more than 20%.
D.There is a six-year statute of limitations on assessments of tax if a fraudulent return is filed.
Solution: The correct answer is B.
The three-year statute of limitations applies to timely filed returns reporting substantially proper amounts of income and deductions . The statute of limitation is not the same for refunds and deficiencies. A six-year statute of limitations applies to returns understating income in excess of 25 percent. If a fraudulent return is filed for a particular year, the statute of limitations never expires.
Which, if any, of the following correctly describes the kiddie tax for the current year?
A.Only applies to children who are age 19 or under during the tax year.
B.Would not apply if the only income earned by the child is interest on municipal bonds.
C.Any amount of unearned income can trigger the tax.
D.Its application relieves the minor from having to file a tax return.
E.None of the choices.
Solution: The correct answer is B.
No income shifting occurs when the income is nontaxable (municipals).
Choice A is incorrect. The child may be under age 24 and a full time student and still be subject to the Kiddie Tax.
Choice C is incorrect. Unearned income must exceed $2,700 in 2025.
Choice D is incorrect. Unless the parent(s) elect to include the unearned income on their own return, the child will have to file a return.
Katie has the following children:
(1) Matt, age 22, a full time student with unearned income of $3,300
(2) Bill, age 19, not a student with earned income of $27,000
(3) Steven, age 14, a student with unearned income of $1,000 and earned income of $3,000
(4) Robert, age 3, in pre-school with unearned income of $3,000.
Which child meets the criteria for kiddie tax (i.e., will have some income taxed at the parent’s rate for the current year)?
A.Matt and Robert
B.Steven and Robert
C.Steven, Robert and Bill
D.Steven, Robert, Bill, and Matt
Solution: The correct answer is A.
For the 2025 tax year, Matt and Robert meet the criteria.
Matt is a full-time student under 24 and has unearned income exceeding $2,700.
Bill does not meet the criteria. He is 19 and not a student.
Steven does not meet the criteria either. Despite being 14, he has less than $2,700 in unearned income.
Robert meets the criteria because of his age, and he has unearned income of more than $2,700.
A characteristic of FUTA is that:
A.It is imposed on both employer and employee.
B.It is imposed solely on the employee.
C.Compliance requires following guidelines issued by both state and Federal regulatory authorities.
D.It is applicable to spouses of employees but not to any children under age 18.
E.None of the choices.
Solution: The correct answer is C.
FUTA is imposed only on the employer. Since the administration of FUTA is shared by Federal and state governments, employers must comply with the rules issued by each.
Which of the following statements correctly describes the cash receipts and disbursements method of accounting?
A.Income is reported as it is earned and expenses are reported as they are incurred.
B.The cash receipts method is the most difficult accounting method to understand.
C.A taxpayer who uses the cash method for reporting most items may use a different method for reporting self-employment income.
D.Reporting of income and expenses is subject to the all events test.
Solution: The correct answer is C.
Options a and d describe the accrual method of accounting, not the cash receipts and disbursements method of accounting. Option b is incorrect; the cash receipts method is generally the easiest method of accounting to understand and the simplest to use. Income items are reported for the tax year in which they are received in cash and expenses are deducted in the year they are paid with cash.
Under what circumstances will a child be treated as the qualifying child of a noncustodial parent?
I. The parents are divorced.
II. The child receives over one-half of their support from the noncustodial parent.
III. The child is in the custody of the one parent for more than half the year.
IV. The custodial parent signs a statement that he will not claim the child for the year and the noncustodial parent attaches the statement to his return.
A.I only.
B.I, II and III only.
C.II, III and IV only.
D.I, II, III and IV.
Solution: The correct answer is D.
All of the options are requirements that must be met in order for a child of divorced parents to be treated as a qualifying child of the noncustodial parent. The purpose is for child credit. There are no more exemptions for dependents.
Joe and Bonnie were divorced. Their only marital property was a personal residence with a fair market value of $850,000 and a cost of $525,000. Under the terms of the divorce agreement dated 2016, Joe would get the house and Joe would pay Bonnie $75,000 each year for 6 years, or until Bonnie’s death, whichever comes first. Joe and Bonnie lived apart when the payments were made to Bonnie. The divorce agreement did not contain the word “alimony.” Joe paid the $450,000 to Bonnie over the six year period. Then, Joe sold the house for $1,200,000. How much total alimony may Joe deduct?
A.$0
B.$75,000
C.$450,000
D.$1,200,000
Solution: The correct answer is C.
The $75,000 Bonnie receives each year is alimony because it is a cash payment arising out of a divorce agreement, the agreement does not specify that the payments are not alimony, Bonnie and Joe are not members of the same household, and the payments cease upon the death of Bonnie. Therefore, Joe deducts $75,000 each year and Bonnie must include $75,000 each year in gross income. So the total alimony is $450,000. The transfer of the personal residence to Joe is not taxable.
Carin, a widow, elected to receive the proceeds of a $100,000 life insurance policy on the life of her deceased husband in 10 installments of $15,000 each. Her husband had paid premiums of $75,000 on the policy. Over the life of the installment contract, Carin must include in gross income:
A.$0
B.$50,000
C.$75,000
D.$100,000
Solution: The correct answer is B.
The interest element of $50,000 ($150,000 – $100,000) is included in Carin’s gross income.
In which of the following venues is a jury trial available for tax controversies?
A.U.S. Tax Court.
B.U.S. Tax Court, Small Claims Division.
C.U.S. District Court.
D.U.S. Court of Federal Claims.
Solution: The correct answer is C.
A jury trial is only available in tax controversies adjudicated by the U.S. District Court. Only bench trials are available in the other venues.
Cary invested $100,000 in an annuity contract. This year, Cary annuitized the contract. The insurance company agreed to pay Cary $520.83 per month for 20 years. Assume that Cary receives eight payments this year. Using this information, how much must Cary include in gross income this year?
A.$833.33
B.$3,333.31
C.$4,164.64
D.$6,249.96
Solution: The correct answer is A.
$520.83 × 240 = (100,000.00/124,999.20) = 80%
80% exclusion; 20% inclusion
($520.83 × 12 × 20%) × (8/12) = 833.33
Laureen lends her sister Jill $50,000 for cosmetic surgery. Laureen has $2,000 of investment income and Jill has $300 in investment income. How much must Laureen impute in interest income?
A.$0
B.$300
C.$1,700
D.$2,000
Solution: The correct answer is A.
Since the loan is <$100,000 and the borrower’s investment income is less than $1,000, the amount of imputed interest income is $0.
Under the terms of a divorce agreement made January 1, 2019, Lanny was to pay his wife Joyce $2,500 per month in alimony and $500 per month in child support. For a twelve-month period, Lanny can deduct from gross income (and Joyce must include in gross income):
A.$0
B.$6,000
C.$30,000
D.$36,000
Solution: The correct answer is A.
The $500 per month for child support was never deductible by Lanny. Alimony paid under divorce contracts post 12/31/2018 not deductible by payor nor includible by payee
Section 119 excludes the value of employer provided meals from the employee’s gross income:
A.Whenever the employer pays for the meal and it’s for the convenience of the employee.
B.When the meals are provided to the employee on the employer’s premises as a convenience to the employee.
C.When the meals are provided to the employee on the employer’s premises for the convenience of the employer.
D.All of the choices
Solution: The correct answer is C.
Peggy is an executive for the Tan Furniture Manufacturing Company. Peggy purchased furniture from the company for $7,000. The price Tan ordinarily charges a wholesaler is $8,500. The retail price of the furniture was $12,000, and Tan’s cost was $8,000. The company also paid for Peggy’s parking space in a garage near the office. The parking fee was $1,200 for the year. All employees are allowed to buy furniture at a discounted price comparable to that charged to Peggy. However, the company does not pay other employees’ parking fees. Peggy’s inclusion in gross income from the above is:
A.$0
B.$1,000
C.$1,200
D.$3,800
Solution: The correct answer is B.
The furniture purchases were under a “qualified employee discount” plan, but the exclusion is limited to the employer’s gross profit. Because Peggy purchased the furniture for $7,000 when the employer’s cost was $8,000, she must include $1,000 of the discount in gross income. The parking space is a qualified transportation fringe and is not required to be available to all employees (i.e., can be provided on a discriminatory basis).
Red, Inc. provides group term life insurance to the employees of the company. Susan, a highly paid vice-president, received $250,000 of coverage for the year at a cost to Red, Inc. of $2,800. The Uniform Premiums (based on Susan’s age) are $8 a year for $1,000 protection. How much of this must Susan include in gross income this year?
A.$1,600
B.$2,000
C.$2,240
D.$2,800
Solution: The correct answer is A.
$250,000 – $50,000 = $200,000 (because of the 50,000 exclusion)
$200,000 ÷ 1,000 = 200 units of coverage
Therefore, the employee’s income is the amount from the IRS table ($8 × 200 = $1,600).
Which of the following statements regarding cafeteria plans is not correct?
A.A cafeteria plan must offer at least three nontaxable benefits.
B.A cafeteria plan is a written plan under which the employee may choose to receive either cash or taxable benefits as compensation or qualified fringe benefits that are excludable from wages.
C.Commonly included benefits are group term life, medical reimbursement, disability benefits, and dependent care assistance.
D.A cafeteria plan is appropriate when employee benefit needs vary within the employee group.
Solution: The correct answer is A.
A cafeteria plan must offer at least one taxable benefit, usually cash, and one qualified nontaxable benefit. All of the other statements regarding cafeteria plans are correct.
Which of the following individuals can make contributions to Heidi’s HSA?
A.Heidi’s employer.
B.Heidi’s aunt.
C.Heidi’s ex-husband.
D.All of the above.
Solution: The correct answer is D.
Heidi’s employer, as well as any other person (including her aunt and her ex-husband) can make contributions to Heidi’s HSA.
Which of the following are deductions for AGI?
Qualified moving expenses
Unreimbursed employee business expenses
Alimony paid under a pre-12/31/2018 agreement
A.Only I and III
B.I, II, and III
C.III only
D.Only I and II
Solution: The correct answer is C.
Saul is divorced(under a 2010 agreement), under age 65, and has gross income of $50,000. His deductible expenses are as follows:
Alimony - $12,000
Charitable contributions - $2,000
Contribution to a traditional IRA - $3,000
Interest on home mortgage and property taxes on personal residence - $7,000
State income tax - $2,200
What is Saul’s AGI?
A.$19,800
B.$30,000
C.$35,000
D.$38,000
E.$42,000
Solution: The correct answer is C.
Saul’s AGI is calculated as follows:
Gross income $50,000 less deductions for AGI:
Alimony $12,000 & IRA $3,000 = ($15,000)
AGI $35,000
Expenses such as charitable contributions, home mortgage interest, property taxes, and state income taxes are generally itemized deductions (below the line) and do not reduce AGI.
Which of the following are deductions for AGI?
Medical expense exceeding 7.5% of AGI
Casualty loss due to wind damage
IRA deduction for a single tax filer with $50,000 AGI
A.Only I and III
B.I, II, and III
C.III only
D.Only I and II
Solution: The correct answer is C.
TCJA 2017 suspended personal casualty loss deductions for 2018 - 2025. Medical expense is below the line.
Which of the following statements is true regarding an HSA?
A.HSA contributions for the current tax year must be completed by December 31st.
B.Similar to an IRA, individuals age 50 or older are entitled to a catch-up contribution of $1,000 per year.
C.If a self-employed individual makes a contribution to their own HSA, that contribution is not taken into account when calculating net earnings from self-employment.
D.Contributions to HSAs are not required to be spent or forfeited at the end of each tax year, allowing taxpayers to accumulate an emergency fund available for future health care expenses only.
Solution: The correct answer is C.
C is true. If a self-employed individual makes a contribution to their own HSA, that contribution is not taken into account when calculating net earnings from self-employment. The contribution to the HSA is subject to employment tax.
A is false - HSA contributions can be made at any time during the tax year and up to the typical tax filing deadline.
B is false - HSA catch-up contributions can be made by those age 55 or older.
D is false - HSAs can be used for health care expenses as well as non-medical expenses (although taxes and/or a 20% penalty may apply).
Kristie, a full-time 3rd-grade teacher, spent $500 out of pocket in 2025 for classroom supplies, books, disinfectant, and math flashcards. How much can Kristie deduct on her 2025 taxes for the supplies?
A.$500 as an above-the-line adjustment
B.$300 as an above-the-line adjustment plus $200 as an unreimbursed employee business expense
C.$500 as an unreimbursed employee business expense
D.$300 as an above-the-line adjustment
Solution: Correct answer is D.
Teachers in elementary and secondary schools (K-12), principals, aides, and counselors may deduct up to $300 (in 2025) of out-of-pocket expenses as an adjustment to gross income.
A is incorrect. $500 exceeds the $300 maximum above-the-line adjustment
B and C are both incorrect. Expenses in excess of the $300 above-the-line max may not be treated as an unreimbursed business expense during the 2018-2025 tax years.
Match the following deductions with their correct description.
Bad Debts
A.$100,000 ordinary loss for married filing jointly, excess is capital loss ($50,000 for single filers).
B.Assumed worthless at year-end of realization.
C.If business and accrual, ordinary loss. If personal, specific write off and short-term capital loss.
D.Not deductible except as casualty losses.
Solution: The correct answer is C
Match the following deductions with their correct description.
Section 1244 Stock
A.$100,000 ordinary loss for married filing jointly, excess is capital loss ($50,000 for single filers).
B.Assumed worthless at year-end of realization.
C.If business and accrual, ordinary loss if personal, specific write off and short-term capital loss.
D.Not deductible except as casualty losses.
Solution: The correct answer is A.
To encourage investment in small business enterprises, Congress enacted Section 1244 of the IRC, which allows the first $50,000 of losses ($100,000 for taxpayers who are married filing jointly), per year, on Section 1244 stock to be classified as an ordinary loss instead of a capital loss. Any additional loss incurred on the stock would still qualify as a capital loss. Section 1244 only applies to losses, not gains, so any long-term gains on the sale of the stock will still be taxed at the favorable long-term capital gains tax rate.
Question
Match the following deductions with their correct description.
Net Operating Losses
A.Ratably written off.
B.In year paid, amortized over 60 months, or capitalized.
C.Carryforward to offset against 80% of income in future year.
Solution: The correct answer is C.
Match the following deductions with their correct description.
Research and experimental expenditures
A.Ratably written off.
B.In year paid, amortized over 60 months, or capitalized.
C.Back 2 and forward 20 years, can elect forward only.
Solution: The correct answer is B.
Tom operates an illegal drug-running operation and incurred the following expenses:
Salaries - $75,000
Illegal kickbacks - $20,000
Bribes to border guards - $25,000
Cost of goods sold - $160,000
Rent - $8,000
Interest - $10,000
Insurance on furniture and fixtures - $6,000
Utilities and telephone - $20,000
Which of the above amounts reduces his taxable income?
A.$0
B.$160,000
C.$279,000
D.$324,000
E.None of the choices.
Solution: The correct answer is B.
Cost of goods sold of $160,000 is treated as a negative item in calculating gross income rather than as a deduction. For a drug dealer, all other deductions are disallowed.
Robyn rents her beach house for 60 days and uses it for personal use for 30 days during the year. The rental income is $6,000 and the expenses are as follows:
Mortgage interest - $9,000
Real estate taxes - $3,000
Utilities - $2,000
Maintenance - $1,000
Insurance - $500
Depreciation (rental part) $4,000
Using the IRS approach, total expenses that Robyn can deduct on her tax return associated with the beach house are:
A.$0
B.$6,000
C.$8,000
D.$12,000
E.None of the choices.
Solution: The correct answer is D.
Since the property is classified as personal/rental use, the general rule is that the deductible expenses cannot exceed the gross income. Thus, under the general rule, the deductible expenses would be limited to $6,000. However, this ceiling does not apply to expenses that otherwise would be deductible as itemized deductions. Consequently, all of the mortgage interest and real estate taxes can be deducted ($9,000 + $3,000 = $12,000).
All of the following are incorrect regarding Net Operating Losses (NOL) EXCEPT:
A.A taxpayer is entitled to apply the NOLs against prior-year income for at least 2 years.
B.NOLs can be carried forward and may be used against up to 80% of income annually.
C.Unused NOLs can be carried forward for 20 years for the full amount of income.
D.None of the above.
Solution: The correct answer is B.
The question is looking for the true statement.
Choice A is a false statement. Based on the TCJA, as of 2018 NOLs can no longer be carried back.
Choice C is a false statement. You can carry forward indefinitely.
Choice D is a false statement. Not all answer options are true statements.
Lisa owns a condo in Hilton Head that she rents during the busy season (April-August). Her and her family use the condo all of March, September and one week during October. The condo generates $40,000 in rental income and she incurs $55,000 in expenses (mortgage interest, real estate taxes, brokerage fees, and miscellaneous expenses) associated with the rental activity, which of the following statements is correct?
A.There will be no increase in Lisa’s taxable income for the year.
B.Lisa will report a $15,000 loss on the property for tax purposes this year.
C.The $15,000 loss on the property is suspended under the passive activity rules.
D.By increasing Lisa’s AGI, the inclusion of the income could result in the loss of some of Lisa’s otherwise allowable itemized deductions.
Solution: The correct answer is A.
This is a mixed-use property, since the property was rented out for more than 14 days, and Lisa used the property for more than 14 days. Therefore, Lisa must include the rental income, but is permitted to deduct expenses to the extent of the income generated from the activity as a production of income expense, which directly offsets gross income (is an above the line deduction). Therefore, there will be no increase in Lisa’s AGI or taxable income for the year. The $15,000 of additional expenses that would otherwise have generated a loss is not deductible, so there is no loss that can be suspended under the passive activity rules.
Newman purchased a home in Los Angeles, CA for $750,000 using a variable rate mortgage. When interest rates increased, he could no longer afford the payments and was forced to sell the house for $650,000. Which of the following statements correctly describes the income tax consequences of this transaction?
A.Newman can reduce his adjusted gross income by the amount of his loss, $100,000.
B.Newman can reduce his adjusted gross income by $3,000 this year.
C.Newman will carry forward a $97,000 short-term capital loss.
D.Newman’s AGI will not be affected in any way by the loss.
Solution: The correct answer is D.
The home is a personal use asset. It was not purchased for investment or production of income. While Newman did suffer an economic loss on the home, he is not entitled to take any part of the loss as a tax deduction since the home was a personal use asset.
Grape Corporation purchased a machine in December of the current year. This was the only asset purchased during the current year. The machine was placed in service in February of the following year. No assets were purchased in the following year. Grape Corporation’s cost recovery would begin:
A.In the current year using a mid-quarter convention.
B.In the current year using a half-year convention.
C.In the following year using a mid-quarter convention.
D.In the following year using a half-year convention.
E.None of the choices.
Solution: The correct answer is D.
Cost recovery begins the year the equipment is placed into service. Machinery follows half-year convention per MACRS tables.
In the current year, Chee gives stock (basis of $36,000; fair market value of $30,000) to his nephew and pays a gift tax of $3,000 on the transfer. The nephew’s basis in the stock is:
A.$0 for gain and $0 for loss.
B.$30,000 for gain and $30,000 for loss.
C.$36,000 for gain and $30,000 for loss.
D.$36,300 for gain and $30,300 for loss.
E.None of the choices.
Solution: The correct answer is C.
The donee’s gain basis of $36,000 is the same as that of the donor. The donee’s loss basis of $30,000 is the lower of the donor’s adjusted basis or fair market value on the date of the gift. The gift tax paid is only proportionally added based on the appreciation when the asset is gifted to the donor.
Five years ago, Bailey purchased 200 shares of Circus Clowns, Inc. for $4,000. Bailey recently gifted those shares of stock to his son Barnum. The value of the 200 shares of stock on the date of the gift was $2,000. Which of the following statements is correct?
A.If Barnum subsequently sells the shares of Circus Clowns, Inc. for $4,750, the basis used to calculate his gain or loss will be $4,000.
B.If Barnum subsequently sells the shares of Circus Clowns, Inc. for $4,750, the basis used to calculate his gain or loss will be $1,000.
C.If Barnum subsequently sells the shares of Circus Clowns, Inc. for $1,600, the basis used to calculate his gain or loss will be $4,000.
D.If Barnum subsequently sells the shares of Circus Clowns, Inc. for $1,600, he will not have any gain or loss.
Solution: The correct answer is A.
Gain Rule (Carryover Basis): If the fair market value (FMV) at the time of the gift is higher than the donor’s original cost basis, the donee takes the donor’s basis.
Loss Rule (Lower FMV Basis): If the FMV at the time of the gift is lower than the donor’s basis, the donee has a dual basis:
For gains, use the donor’s original basis.
For losses, use the FMV at the time of the gift.
Abigail was an original investor in, and owns a 25% interest in, Decorate Your Dream LLC, a home decorating company. Abigail paid $50,000 for her interest. This year, Decorate Your Dream did very well and had a profit of $100,000. However, no distributions were made. What is Abigail’s basis in her interest in Decorate Your Dream at the end of this year?
A.$25,000
B.$50,000
C.$75,000
D.$100,000
Solution: The correct answer is C.
Abigail’s original cost basis is increased by her share of the profits. Therefore, her original cost basis of $50,000 is increased by $25,000. If there had been a distribution, this would have reduced Abigail’s adjusted basis in her interest in the company.
Victor and Vivian have a very diverse family. Which of the following children would not be a qualifying child for the purpose of claiming the child tax credit in the current year?
A.Vivian’s granddaughter, who turned 4 in the current year and lives with Victor and Vivian for more than half of the year.
B.Victor’s brother, who turned 16 in the current year and lives with Victor and Vivian for more than half of the year.
C.Victor and Vivian’s daughter, who turned 17 in the current year and does not provide more than half of her support.
D.Victor and Vivian’s son, who was born on October 21 of the current year.
Solution: The correct answer is C.
Individuals who reach the age of 17 during the tax year are not eligible to be qualifying children for the purpose of the child tax credit. All of the other children are eligible to be qualifying children.
Sara’s daughter Tara completed her senior year of college in the current year. Sara paid $5,000 in qualified education expenses for Tara in the current year. Sara is a single taxpayer and has an AGI of $50,000 for the current year. Tara has a felony drug conviction. What, if any, education credit should Sara claim and how much is the credit?
A.Sara is not eligible to claim an education credit.
B.American Opportunity Credit in the amount of $2,500.
C.Lifetime Learning Credit in the amount of $1,000.
D.Lifetime Learning Credit in the amount of $2,000.
Solution: The correct answer is C.
Option b is incorrect because the American Opportunity Credit cannot be claimed if someone has a felony drug conviction. Option d is incorrect because Sara would need to have paid $10,000 in qualified education expenses in order to claim the maximum Lifetime Learning Credit of $2,000. Option c is correct; Sara is eligible to claim the Lifetime Learning Credit and her credit is equal to 20% of her qualified education expenses, or $1,000.
Payments for employment-related care that are made to relatives of the taxpayer may qualify for the credit for child and dependent care expenses. Which of the following payments does not qualify?
A.Payments for employment-related care made to the taxpayer’s aunt.
B.Payments for employment-related care made to the taxpayer’s 21-year-old daughter (who is not a dependent of the taxpayer).
C.Payments for employment-related care made to a qualifying dependent of the taxpayer.
D.Payments for employment-related care made to taxpayer’s 17-year-old niece.
Solution: The correct answer is C.
Payments for employment-related care made to a dependent of the taxpayer do not qualify for the credit for child and dependent care expenses. All of the other options are qualifying payments.
This year, Marc, Inc. placed into service a machine that costs $220,000. What is the maximum Section 179 expense that Marc, Inc. could take for this tax year assuming they had taxable income before the deduction of $100,000?
A.$100,000
B.$120,000
C.$220,000
D.$520,000
Solution: The correct answer is A.
There is no “placed into service phase out” applicable here because the amount is below the placed into service limit. However, there is a limitation based on taxable income. The section 179 expense cannot create a loss. Thus, only 100,000 can be taken in the current year and the remaining 120,000 will be carried forward to be utilized in future years.
Donna sells stock in Martin Corporation to her brother David. Donna purchased the stock four years ago for $3,000 and the current fair market value of the stock is $1,800. David paid Donna $1,800 for the stock. Which of the following statements is correct regarding the tax consequences of this transaction?
A.If David subsequently sells the stock to an unrelated party for $3,500, he will realize a gain of $1,700.
B.If David subsequently sells the stock to an unrelated party for $1,600, he will realize a loss of $1,400.
C.If David subsequently sells the stock to an unrelated party for $2,200, he will have no gain or loss.
D.If David subsequently sells the stock to an unrelated party for $3,500, he will have no gain or loss.
Solution: The correct answer is C.
Which of the following is a capital asset?
A.The bicycle of a 10-year old child. The child purchased the bicycle with money inherited from an aunt.
B.The tools used by a self-employed carpenter.
C.The lots owned by a company that is in the business of buying and reselling residential building lots.
D.A “mint” set of 1985 coins owned by a coin dealer and that is for sale on his website.
E.None of the choices.
Solution: The correct answer is A.
The bicycle is a personal use asset and, therefore, a capital asset. The manner in which the child acquired the bicycle is not relevant. All of the other items are excluded from being a capital asset under § 1221.
Albert purchased a tract of land for $140,000 in 20x1 when he heard that a new highway was going to be constructed through the property and that the land would soon be worth $200,000. Highway engineers surveyed the property and indicated that he would probably get $180,000. The highway project was abandoned in 20x5 and the value of the land fell to $100,000. What is the amount of loss Albert can claim in 20x5 if the land was sold for $100,000 in 20x6?
A.$40,000
B.$60,000
C.$80,000
D.$100,000
E.None of the choices.
Solution: The correct answer is E.
Neither gain nor loss is recognized by Albert associated with the perceived fluctuations in the value of the land. The requisite identifiable event (i.e., sale or other disposition) has not occurred.
NOTE: the land was sold in year 6, Albert can not claim the loss for year 5.
Which of the following assets held by a manufacturing business is not a § 1231 asset?
A.Inventory
B.A machine used in the business and held more than one year
C.A factory building used in the business and held more than one year
D.Land used in the business and held more than one year
E.All of the choices
Solution: The correct answer is A.
Inventory is an ordinary asset.
Copper Corporation sold machinery for $27,000 on December 31 of the current year. The machinery was purchased several years ago for $30,000 and had an adjusted basis of $21,000 at the date of the sale. For the current year, what should Copper Corporation report?
A.Ordinary income of $6,000
B.A § 1231 gain of $3,000 and $3,000 of ordinary income
C.A § 1231 gain of $6,000
D.A § 1231 gain of $6,000 and $3,000 of ordinary income
E.None of the choices
Solution: The correct answer is A.
The recognized gain from the disposition of the machinery is $6,000 ($27,000 sale price – $21,000 adjusted basis). Since the recognized gain is less than the depreciation taken of $9,000 ($30,000 cost – $21,000 adjusted basis) and the asset is depreciable equipment used in a business, § 1245 depreciation recapture applies.
When assets subject to recapture are gifted, which of the following is true?
A.If the donor used the asset in a trade or business and depreciation was allowed, any recapture potential will be retained by the donor.
B.If the asset was personal property, the donee’s gain will be taxed at ordinary income (to the extent of depreciation taken).
C.If the gifted asset was real property, the straight-line depreciation will be taxed at the unrecaptured Section 1231 gains rate.
D.None of the above are true.
Solution: The correct answer is B.
Which of the following is not a disallowed loss?
A.Losses on the sale of personal use assets.
B.Losses on the subsequent sale of property gifted or sold to a related party when its fair market value is less than the original owner’s adjusted basis.
C.Loss from a wash sale.
D.Capital losses in excess of $3,000.
Solution: The correct answer is D.
Up to $3,000 of capital losses may be recognized against forms of income other than capital gains in any one tax year. However, if a taxpayer has capital losses in excess of $3,000, these losses are not disallowed, but are carried over to future tax years.
In 20x1, Cindy invested $100,000 for a 25% interest in a limited liability company (LLC) involved in an activity in which she is a material participant. The LLC reported losses of $340,000 in 20x1 and $180,000 in 20x2 with Cindy’s share being $85,000 in 20x1 and $45,000 in 20x2. How much of the losses can Cindy deduct?
A.$0 in 20x1, $0 in 20x2
B.$85,000 in 20x1, $0 in 20x2
C.$85,000 in 20x1, $15,000 in 20x2
D.$85,000 in 20x1, $45,000 in 20x2
E.None of the choices
Solution: The correct answer is C.
Cindy’s losses are not subject to the passive activity loss rules in either year because she is a material participant. However, the at-risk rules limit her losses to $100,000 over the period ($85,000 in 20x1 and $15,000 in 20x2).
Which of the following decreases a taxpayer’s at-risk amount?
A.Cash and the adjusted basis of property contributed to the activity.
B.Amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as security property not used in the activity.
C.Taxpayer’s share of amounts borrowed for use in the activity that is qualified nonrecourse financing.
D.Taxpayer’s share of the activity’s income.
E.None of the choices
Solution: The correct answer is E.
