Income Tax - All Quizzes and Test Questions Flashcards
The Tax Reform Act of 1986 was roughly revenue neutral because:
- It was supported by both Republicans and Democrats.
- It was not intended to raise or lower taxes.
- It divided the tax burden evenly between individuals and businesses.
- It made the tax rates equal across all tax brackets.
A. 2 only
B. 1 and 3
C. 2 and 3
D. 1, 2, and 4
The correct answer is A.
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.
Tad is eligible for a qualified dependent credit for his 70-year-old mother. In calculating her taxes, his mother may not claim an additional standard deduction for her age. True or False?
False. The mother can claim the additional standard deduction for her age.
Ted cashed in his life insurance policy when he found out he had a terminal illness. He had paid $15,000 in premiums and collected $50,000 from the insurance company. Ted is not required to include any of the proceeds in gross income.
True of False?
True. Because Ted has a terminal illness, he can receive the insurance proceeds of $50,000 as a nontaxable accelerated death benefit.
Which of the following taxes generates the largest percentage of gross collections for the Internal Revenue Service?
A. Corporate income tax.
B. Individual income tax.
C. Estate tax.
D. Employment tax.
B. Individual income taxes make up nearly 50% of the gross collections by the Internal Revenue Service.
Under which of the following circumstances will a taxpayer be subject to an accuracy-related penalty?
- If the taxpayer files an incorrect return and has failed to make a good faith effort to comply with the tax law.
- If the taxpayer understates his tax liability by more than 5 percent of the correct tax liability.
- If the taxpayer makes a substantial understatement associated with an estate or gift tax valuation.
A. 1 only
B.1 and 2
C. 2 and 3
D. 1 and 3
The correct answer is D.
A taxpayer will be subject to an accuracy-related penalty if he makes a substantial understatement of his tax liability, generally more than 10 percent of the correct tax liability and at least a $5,000 deficiency.
Claude and Daphne are trying to calculate their gross income for this year. Which of the following items should they include in their gross income?
- Child support payments in the amount of $15,000 received by Daphne from her ex-husband for the support of Daphne’s minor child Emile.
- $1,200 of dividends received by Claude and Daphne from Mudbugs, Inc., a corporation in which they own 200 shares of stock.
- Unemployment benefits in the amount of $800 received by Claude from the state of Louisiana.
- $3,000 that Daphne earned selling her homemade andouille sausage.
A. 4 only
B. 1 and 2
C. 2, 3, and 4
D. 1, 2, 3, and 4
Solution: The correct answer is C.
Option 1 is not correct because child support is not includible in gross income. All of the other options are included in gross income (dividend income, unemployment compensation benefits, and gross income from self-employment).
Ursula and her husband Boris were legally separated in January 2022, and their divorce became final on December 30, 2022. Ursula’s children lived with her for the first four months of 2022, but moved in with their father after Ursula was declared legally blind in April. Ursula did not contribute anything to the cost of maintaining the household when the children were living with her husband. Ursula is 40 years old. What filing status can Ursula use for her 2022 tax filing and what is her standard deduction?
A. Married Filing Jointly; $27,300
B. Head of Household; $21,150
C. Single; $14,700
D. Head of Household; $21,500
Solution: The correct answer is C.
Option C is correct; Ursula must use the Single filing status. In addition, she is entitled to one additional standard deduction because of her blindness. Therefore, her standard deduction for 2022 is $14,700 ($12,950 + $1,750).
- The filing statuses that you can use will depend on when your divorce is completed. If you complete your divorce on or before Dec. 31 (the final day of the tax year) then you cannot file a joint tax return. If the new year starts before your divorce becomes official, the IRS will still recognize you as married, and therefore allow you to file a joint return for the previous year.
Option A is incorrect because even though Ursula was married during 2022, she was not married as of the end of the year.
Options B and D are incorrect because Ursula does not qualify for the Head of Household filing status. Ursula did not maintain a household for a qualifying child for more than half of the year. Her children only lived with her for four months of the year and she did not pay for the cost of maintaining a household for them for the remainder of the year.
You are considered to have been married for the entire tax year if, on December 31, any of the following was true:
- You were legally married and living together as husband and wife, wife and wife, or husband and husband.
- You were legally married but living apart and have not made any action to legalize your separation.
- You were legally separated under an interlocutory decree of divorce, but your divorce has not been finalized.
Linwood files his tax return 65 days after the due date. Along with the return, Linwood remits a check for $6,000 which is the balance of the tax owed. Disregarding the interest element, Linwood’s total failure to file penalty is:
A. $90
B. $810
C. $900
D. $990
Solution: The correct answer is B.
Following the procedure set forth in Chapter 2, the penalty is determined as follows:
FTP= .5%/mo. up to 25%
FTF= 5%/mo. up to 25%.
FTF is reduced by FTP.
You round up (65 days = 3 months)
Which statement is true with respect to private letter rulings?
A. They cover facts applicable to a particular taxpayer.
B. They deal with completed transactions.
C. They are not binding on the IRS.
D. They are issued at the request of the IRS.
Solution: The correct answer is A.
All of the statements except A are false regarding letter rulings. Private letter rulings cover facts applicable to a particular taxpayer (option A), are issued at the request of the taxpayer (option D), deal with proposed transactions (option B), and binding on the IRS with respect to the requesting taxpayer and the particular transaction (option C).
Which of the following are requirements for satisfying the bona fide resident test necessary for excluding foreign earned income?
- The taxpayer must establish permanent quarters in the foreign country for himself and his family.
- The taxpayer may not return to the United States during the year.
- The taxpayer must intend to work in the foreign country for an indefinite period of time.
A. I only.
B. I and II only.
C. II and III only.
D. I and III only.
Which statement is false with respect to the U.S. Tax Court?
A. Appeals from the Tax Court are brought to the U.S. Court of Appeals.
B. The Court is located in Washington, D.C., but the judges hear cases around the country.
C. A taxpayer must pay the deficiency before litigating here.
D. The Court hears only tax cases.
Solution: The correct answer is C.
The taxpayer does not have to pay the tax before litigating in the U.S. Tax Court. The other options are true.
Which administraction of tax system does not let you appeal the decision? (U.S. Court of Federal Claims, Small Claims Division, Tax Court, U.S. District Court)
Small Claims Division
Administration of the Tax System Chart (memorize)
- U.S. District Court is the only trial by jury
- U.S. Federal Claims and U.S. District Court requires prepayment of Tax
- Cannot appeal small claims division
*
A surviving spouse will file a joint return for the year of death and write in the signature area:
“Filing as surviving spouse.” The spouse also can file jointly for the next two tax years if he or she has dependents and has not remarried. This special provision for qualified widows and widowers allows the surviving spouse to benefit from the advantages of a joint return, such as the higher standard deduction.
Which of the following events would produce a deductible loss?
A. Erosion of personal use land due to rain or wind.
B. Termite infestation of a personal residence over a several year period.
C. A delivery van used for business and destroyed in an auto accident.
D. A stolen diamond ring.
Solution: The correct answer is C.
A casualty loss may be taken for business assets.
Losses are only deductible if they are not covered by insurance.
Expenses incurred in a trade or business are deductible for AGI.
A. True
B. False
Solution: The correct answer is A.
Such expenses are deductible for AGI.
For the year 2022, personal casualty loss deductions are never allowed on Form 1040.
A. True
B. False
Solution: The correct answer is B.
Watch the use of absolutes. NEVER is an absolute.
TCJA provides for the use of the casualty loss rules if the area is deemed a federal disaster, making the fact pattern a false statement.
Which is the only court that allows a jury trial?
A. Appropriate U.S. Circuit Court of Appeals
B. U.S. District Court
C. U.S. Tax Court
D. U.S. Court of Federal Claims
Solution: The correct answer is B.
Toby, age 15, qualifies as a dependent of his grandmother. During 2022, Toby had interest income in the amount of $200 and earnings from a part-time job of $750. Toby’s taxable income is:
A.$0
B. $100
C. $650
D. $850
Solution: The correct answer is A.
Toby’s standard deduction of $1,150 ($750 + $400*) completely negates his gross income of $950 ($750 earned income + $200 interest income).
* 2022 Tax law change for kiddie tax - standard deduction is either $1,150 or earned income plus $400 (not to exceed the standard deduction for a single tax filer).
Which of the following is not an administrative source of tax law?
A. Revenue Ruling.
B. Treasury Regulations.
C. Decisions by the U.S. Tax Court.
D. Technical Advice Memoranda.
Solution: The correct answer is C.
In the case of a below-market loan between family members, if the imputed interest rules apply:
i. The borrower must recognize interest income.
II. The lender has interest income.
III. The lender is deemed to have made a gift.
IV. The borrower has interest expense.
A. Only I is true.
B. II, III, and IV are true but I is false.
C. I and II are false but III and IV are true.
D. All of the above are true.
Solution: The correct answer is B.
Which of the following can be claimed as a deduction for AGI?
A. Personal casualty losses
B. Investment interest expenses
C. Self-employment tax
D. Property taxes on personal use real estate
Solution: The correct answer is C.
One half of the self-employment is an adjustment to gross income.
(The investment interest expenses are a deduction FROM AGI - if you itemize)
Elton and Elsie are husband and wife and file a joint return for this year. Both are under 65 years of age. They provide more than half of the support of their two daughters, Karen (age 17) and Kristie (age 25). Kristie is a full-time medical student. Kristie receives a $5,400 scholarship covering her room and board at college. They furnish all of the support of Hattie (Elton’s grandmother), who is age 70 and lives in a nursing home. How many qualified dependent credits ($500) are Elton and Elsie potentially entitled to receive?
A. Two
B. Three
C. Four
D. Five
Solution: The correct answer is A.
Two: One for Karen, she is a qualifying child but has aged out at 17, and one for Hattie. Kristie is not a qualifying child—although a full-time student, she is not under age 24 and she does not meet the qualifying relative category due to the gross income test—the type of scholarship aid she receives is taxable. Hattie is not a member of the household but satisfies the relationship test.
To claim your child as your dependent, your child must meet either the qualifying child test or the qualifying relative test: To meet the qualifying child test, your child must be younger than you and either younger than 19 years old or be a “student” younger than 24 years old as of the end of the calendar year.
to claim child tax credit - kid must be under 16
Key Takeaways
- For tax year 2021, the Child Tax Credit is up to $3,600 or $3,000, depending on the age of your child. The Credit for Other Dependents is worth up to $500.
- The IRS defines a dependent as a qualifying child (under age 19 or under 24 if a full-time student, or any age if permanently and totally disabled) or a qualifying relative.
- A qualifying dependent can have income but cannot provide more than half of their own annual support.
- A taxpayer can’t claim a dependent if they are a dependent themselves, if the dependent files a joint tax return with a spouse (except in certain cases), or is claimed as a dependent on someone else’s tax return.
Cecilia and Landon DeFee purchased their primary residence in North Carolina this year, but still maintain a vacation property in the Smokey Mountains. Their home in N. Carolina was purchased for $450,000, and they paid $22,349 in interest the first year. The vacation property was purchased 5 years ago for $300,000 and they paid $14,795 in interest this year. The couple has no other itemized deductions. What is the mortgage interest deduction for Cecilia and Landon?
A. $10,000
B. $37,144
C. $24,800
D. $22,349
Solution: The correct answer is B.
Their itemized deductions exceed the standard deduction of $25,900 for 2022. Their housing acquisition costs are under the $750,000 cap from TCJA of 2017, and no additional equity loans or credit has been taken. They can deduct their full mortgage interest.
SALT (State and Local Taxes) is capped at $10,000
If the second home is considered a personal residence, you must file Form 1040 or 1040-SR and itemize deductions on Schedule A to claim the mortgage interest deduction.
In most cases, single filers and those married filing jointly can deduct all of their mortgage interest on up to $750,000 of mortgage debt. This rule applies to any personal residence, whether it’s your first or second home, or both
Emily, whose husband died in December of this year, maintains a household in which her dependent daughter lives. Which of the following is most likely to be her filing status for this year?
A. Single
B. Surviving spouse
C. Head of household
D. Married, filing jointly
Solution: The correct answer is D.
Since she is deemed married in the year of her husband’s death, she cannot file as single (choice A) or head of household (choice D). She does not qualify for surviving spouse status until the next year. Therefore, she is most likely to use the married filing jointly filing status.
Keith, age 12, has $10,000 in unearned income and $20,000 in earned income in 2022. How much will be taxed at the parent’s rate?
A. $0
B. $7,700
C. $9,350
D. $17,050
Solution: The correct answer is B.
Unearned $10,000
Earned Income $20,000
Total $30,000
Less SD (2022) ($12,950)
$17,050
At parent Rate $7,700 $10,000 unearned income – $2,300*
At kid’s rate $9,350
SECURE Act 2019 reverted the TCJA 2017 back to the pre-TJCA calculation. Amounts above the unearned income standard deduction will be taxed at the parent’s tax rate (no longer at the trust and estate rate).
* 2022 standard deduction as applies to unearned income of $1,150 and the amount of $1,150 taxed at the child’s rate
Under what circumstances is a taxpayer required to use a calendar year tax period?
A. If the taxpayer does not keep books or accounting records.
B. If the taxpayer just opened a new business.
C. If the taxpayer has a tax year of less than 12 months.
D. If the taxpayer receives reporting documents such as Forms W-2 and 1099.
Solution: The correct answer is A.
Option B is incorrect because there is no requirement for new businesses to use a calendar year tax period.
Option C is incorrect; a taxpayer may use a fiscal year tax period and have a tax year of less than 12 months in the first year.
Option D is incorrect; although most taxpayers who receive such documents use the calendar year tax period, the receipt of such documents does not in and of itself require them to do so.
Abner owned bonds that paid $750 of interest on the first day of January each year. Exactly one-third of the way through the current year, Abner gave the bonds to his brother, Brody. When Brody receives the $750 of interest on the first day of January next year, what amount will be included in Brody’s gross income next year?
A. $0
B. $250
C. $500
D. $750
Solution: The correct answer is C.
Remember, interest is paid after it is earned, so the amount received by Brody includes interest earned while the bonds were owed by Abner. Brody owned the bonds for two-thirds of the year. Therefore, he must report two-thirds of the interest in his gross income for the year in which the interest is received.
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. Cafeteria plans are authorized by Section 125 of the Internal Revenue Code.
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.
Hansel and Gretel, a married couple, manage apartments and they are required to live in the managers’ apartment as a condition of their employment. Instead of providing the apartment to Hansel and Gretel rent-free, the owner of the apartment building gives Hansel and Gretel a housing allowance of $600, which they use to pay rent on the managers’ apartment. Hansel and Gretel pay $600 per month in rent. If they did not live in the managers’ apartment, Hansel and Gretel could live in another apartment building where they would only pay $500 in rent. What amount, if any, must be included in Hansel and Gretel’s gross income?
A. $0
B. $100
C. $500
D. $600
Solution: The correct answer is A.
An employee is allowed to exclude from gross income the value of lodging furnished by an employer to the employee if the lodging is furnished (1) on the employer’s business premises, (2) for the convenience of the employer, and (3) the employee is required to accept the lodging as a condition of employment. It does not matter that Hansel and Gretel were paid a housing allowance, which they were then required to pay back to the employer for rent. Hansel and Gretel can exclude the entire value of their housing from their gross income.
Ian, a single taxpayer, received $15,000 of Social Security retirement benefits this year. He also received $16,000 of interest income. How much of Ian’s Social Security benefits must be included in his gross income?
A. $0
B. $7,500
C. $12,750
D. $15,000
Solution: The correct answer is A.
Since the total of Ian’s MAGI ($16,000) and one-half of his Social Security benefits (0.50 × $15,000 = $7,500) is less than the base amount ($25,000), none of his Social Security benefits are included in gross income.
Jessie, an unmarried taxpayer using the single filing status, received $16,000 of Social Security retirement benefits this year. Jessie also received $5,000 of interest income and $45,000 of income from her retirement plan during the year. How much of Jessie’s Social Security benefits must be included in her gross income?
A. $0
B. $8,000
C. $13,600
D. $16,000
Solution: The correct answer is C.
Since her MAGI ($50,000) plus one-half of her Social Security benefits (0.5 × $16,000 = $8,000) exceeds her adjusted base amount ($34,000), she must calculate her includible Social Security benefits using the formula 3 or 4 below.
- 0.85 × $16,000 = $13,600
- 0.85 × [$50,000 + (0.50 × $16,000) - $34,000] = $20,400 plus the lesser of the amount calculated using 1 and 2 below:
- 0.50 × $16,000 = $8,000
- 0.50 × [$50,000 + (0.50 × $16,000) - $25,000] = $16,500
The lesser amount is $8,000
The formula 4 total is $28,400 ($20,400 + $8,000)
The lesser of the formula 3 or 4 amounts is $13,600. Therefore, $13,600 of the Social Security benefits must be included in Jessie’s gross income.
Fiona is a highly compensated employee of GreatWorks, Inc. Which of the following fringe benefits would be taxable to Fiona?
A. Health insurance provided by GreatWorks to all employees.
B. Group term life insurance in the amount of $40,000 paid for by GreatWorks.
C. Dependent care assistance for the highly compensated employees of GreatWorks.
D. On-premises athletic facilities that may only be used by the managers and vice-presidents of GreatWorks.
Solution: The correct answer is C.
Dependent care assistance can only be excluded from a highly compensated employee’s gross income if it is provided on a nondiscriminatory basis. Answer d is not correct because access to athletic facilities can be provided on a discriminatory basis without causing inclusion in the employee’s gross income.
Kenny would like to make a deductible contribution to a Health Savings Account. Which of the following is/are a requirement in order for Kenny to be able to make such a contribution?
- Kenny must be eligible to establish a Health Savings Account.
- Kenny must have a high deductible health plan.
- Kenny must meet the deductible of his HDHP.
A. 1 only
B. 1 and 2
C. 2 and 3
D. 1 and 3
Solution: The correct answer is B.
Kenny is not required to meet the deductible of his high deductible health plan in order to make a deductible contribution to his HSA. However, he is required to be eligible to establish an HSA and to have a high deductible health plan.
Leon, age 71, is an active participant in his employer’s defined benefit plan, but he would also like to make a deductible contribution to a traditional IRA this year. Leon is married, files a joint return with his wife, and has an AGI of $111,000 in 2022. What is the maximum deductible contribution that Leon can make to a traditional IRA?
A. $700
B. $5,300
C. $6,300
D. $7,000
Solution: The correct answer is C.
The phaseout range for taxpayers who are active participants and use the married filing jointly filing status is $109,000 - $129,000 for 2022. Since Leon’s AGI is within this range, he may not make a full deductible contribution to a traditional IRA, but may make a reduced deductible contribution. Leon can contribute $6,000 plus $1,000 catch up. Therefore, Leon’s deductible contribution is reduced by $700 [$7,000 × (($111,000 - $109,000)/$20,000]. The maximum deductible contribution that Leon can make to a traditional IRA is $6,300.
SECURE Act 2019 removed the age maximum on contributions to Traditional IRAs. Leon can continue to contribute if he has sufficient earned income.
Tim and Janet were divorced. Their only marital property was a personal residence with a value of $100,000 and cost of $40,000. Under the terms of the divorce agreement, Janet would receive the house and Janet would pay Tim $10,000 each year for 5 years, or until Tim’s death, whichever should occur first. Tim and Janet lived apart when the payments were made to Tim. The divorce agreement, dated December 15, 2017 did not contain the word “alimony.” Which of the following is true?
A. Tim must recognize a $30,000 [$50,000 – 1/2($40,000)] gain on the sale of his interest in the house.
B. Tim does not recognize any income from the above transactions.
C. Janet is allowed to deduct $10,000 each year for alimony paid.
D. Janet is not allowed any alimony deductions.
Solution: The correct answer is C.
The $10,000 cash meets all of the requirements for alimony treatment. Although the circumstances suggest that Janet is paying Tim for his share of the marital property, the agreement must specify that the payments are not alimony to avoid alimony treatment.
Marge made a $60,000 interest-free loan to her son, Steve, who used the money to buy an automobile. Steve’s only sources of income were $25,000 from wages and $250 of interest on his checking account. The relevant Federal interest rate was 5%. Based on the above information:
A. Marge must recognize $250 of imputed interest income on the below market loan.
B. Marge must recognize $1,000 of imputed interest income on the below market loan.
C. Marge must recognize $3,000 of imputed interest income on the below market loan.
D. Marge is not required to impute any interest.
Solution: The correct answer is D.
The $100,000 exception would apply, so interest will need to be imputed to the lender if the Borrower’s net investment income exceeds $1,000. The lender will only impute the lesser of the Borrower’s net investment income or the AFR.
Marge is not required to recognize imputed interest income because Steve’s investment income is less than $1,000.
In Year 1, Ted purchased an annuity for $60,000. The annuity is to pay him $1,500 per month for the rest of his life. His life expectancy is 120 months. Which of the following is true?
A. Ted is not required to recognize any income until he has collected 40 payments (40 × $1,500 = $60,000).
B. If Ted collects 24 payments and then dies in Year 3, Ted’s estate should amend his tax returns for Year 1 and Year 2 and eliminate all of the reported income from the annuity for those years.
C. If Ted lives and collects on the annuity for 130 months, the amounts received in the last 10 months are excludible from his gross income.
D. For each $1,500 payment received in the first year, Ted must include $1,000 in gross income.
Solution: The correct answer is D.
The annuity exclusion formula is investment/expected return = $60,000/($1,500 × 120) = $60,000/$180,000 = .333. Therefore, when Ted collects $1,500, he must recognize $1,500 × (1 – .333) = $1,000 gross income.
Answer b. is incorrect. Instead of amending prior returns, Ted will be allowed to deduct a loss on his final return for the cost of the annuity less the amount previously excluded as a return of capital.
Iris, a widow, elected to receive the proceeds of a $100,000 face value life insurance policy on the life of her deceased husband in annual installments of $12,500 over the remainder of her life, estimated to be 10 years. Which of the following is true?
A. None of the payments received are included in gross income because their source is the life insurance policy.
B. All of the payments are included in Iris’s gross income because she paid nothing for the right to receive the payments.
C. Iris will not recognize income until the 9th year, after she has recovered her investment.
D. Iris must include $2,500 in gross income each year for the first 10 years she collects on the policy.
Solution: The correct answer is D.
The income portion of the first annuity payment received is $2,500 ($12,500 – $10,000 exclusion). The exclusion is calculated as follows:
($100,000/125,000) × $12,500 = $10,000
Roger, age 19, is a full-time student at State College and a candidate for a bachelor’s degree. During the year, he received the following payments:
State scholarship for ten months (tuition and books) $3,600
Loan from college financial aid office $1,500
Cash support from parents $3,000
Interest on CDs $1,700
Cash prize awarded in contest $500
Total: $10,300
What is Roger’s adjusted gross income for this year?
A. $1,700
B. $2,200
C. $5,800
D. $10,300
Solution: The correct answer is B.
$2,200 ($1,700 interest + $500 prize).
During the current year, Harrison sustained a serious injury in the course of his employment. As a result of the injury sustained, he received the following payments during the year:
Unemployment compensation $5,000
Worker’s compensation $6,500
Damages for physical personal injuries $5,000
Reimbursement from his employer’s accident and
health plan for medical expenses paid by Harrison $2,000
What is the amount to be included in Harrison’s gross income for the current year?
A. $2,000
B. $5,000
C. $6,500
D. $11,500
Solution: The correct answer is B.
The only item included in Harrison’s gross income is the unemployment compensation. All other payments received are specifically excluded from gross income.
Ridge is the manager of a motel. As a condition of his employment, Ridge is required to live in a room on the premises so that he would be there in case of emergencies. Ridge considered this a fringe benefit, since he would otherwise be required to pay $600 per month rent. The room that Ridge occupied normally rented for $60 per night, or $1,500 per month. On the average, 90% of the motel rooms were occupied. As a result of this rent-free use of a room, Ridge is required to include in gross income:
A. $0
B. $600 per month
C. $1,500 per month
D. $1,350 ($1,500 × .90 = $1,350)
Solution: The correct answer is A.
The room qualifies for the § 119 lodging exclusion.
If an income tax return is not filed by a taxpayer, there is no statute of limitations on assessments of tax by the IRS.
A. True
B. False
Solution: The correct answer is A.
Which of the following is a deduction from AGI (itemized deduction)?
A. Contribution to a traditional IRA
B. Roof repairs to a rental home
C. Mortgage Interest
D. Alimony payment made under a contract dated 12/1/13
Solution: The correct answer is C.
A, B, and D are deductions for AGI.
Which of the following statements regarding the deduction of costs associated with investigating the purchase of a new line of business is not correct?
A. Assuming the taxpayer is not currently engaged in business, if the new line of business is not purchased, no deduction is permissible.
B. If the new line of business is purchased and it is in the same line of business as the current trade or business operation, the cost of investigating the new business is fully deductible.
C. The ability to deduct the cost of investigating a new line of business is often overlooked by taxpayers.
D. If the new line of business is purchased and it is in a different line of business as the current trade or business operation, there is no way to recoup the costs of investigation.
Solution: The correct answer is D.
If the new line of business is purchased and it is in a different line of business as the current trade or business operation, the costs of investigation are recouped by capitalizing the expenses and amortizing it ratably over a 60-month period.
Olive’s daughter Polly suffers from a rare illness. During the current year, Olive drove Polly to see a specialist in another state 15 times. Each trip was 300 miles each way and required an overnight stay in a hotel that costs $70 per night. Olive’s AGI is $24,000. What is her medical expense deduction for the current year (assume the mileage rate is 16¢ per mile)?
A. $0
B. $690
C. $1,800
D. $2,490
Solution: The correct answer is B.
Olive may deduct 16¢ per mile (2021) for the travel associated with Polly’s medical care and may deduct up to $70 per night for lodging (limited to the lesser of $50 per eligible person or actual expense incurred). Therefore, the total medical expenses are $2,490 [(300 × 2 × 15 × $.16) + (15 × $70)]. However, Olive may only deduct the amount that exceeds 7.5% of her AGI in 2021. 7.5% of Olive’s AGI is $1,800, making her deductible amount (2,490 – 1,800) $690.
Taxpayer Certainty and Disaster Tax Relief Act of 2020 extends 7.5% of AGI to taxable years beginning after December 31, 2020.
In September of this year, Rudolph refinanced his home. Prior to refinancing, his only outstanding debt was the balance due on his original mortgage of $110,000. Rudolph needed some additional money to pay for his child’s college education and to take advantage of an investment opportunity, so upon refinancing, Rudolph took out a 30-year mortgage for $250,000. To reduce the interest rate on the mortgage, down to 5%, Rudolph paid $2,500 in points on refinance. Which of the following statements is correct?
A. Rudolph can deduct all of the mortgage interest paid on the note.
B. Rudolph can deduct the mortgage interest incurred on $110,000, plus a pro rata portion of the points paid on refinancing. The remaining interest is not deductible.
C. Rudolph can only deduct the mortgage interest incurred on $210,000.
D. Rudolph can only deduct the mortgage interest paid on $210,000 plus a pro rata portion of the points paid on refinancing.
Solution: The correct answer is B.
$110,000 of the refinanced amount continues to be treated as acquisition indebtedness since that was the previous balance of Rudolph’s mortgage.
Post TCJA, if you refinance under the amount of original indebtedness, you can continue the pre-TCJA rules, if you refinance more (as in this case) you need to follow the new rules. You can deduct the original indebtedness (110k) up to $750,000. A home equity can only be included if it is used to better the property. So under these rules, they can deduct interest on $110,000, the home equity was not used for a qualified reason and will not be deductible.
The pre TCJA would allow up to $100,000 in home equity for interest deductions, 40,000 would have not been deductible, leaving 210k that could have been deducted under the old rules
Since not all of the new mortgage is considered acquisition indebtedness, only a portion of the points paid on the refinance will be deductible.
Sammy owned a home in south Florida that was severely damaged by a small hurricane, no Federal disaster was declared. Sammy had purchased the home for $150,000, and the fair market value of the home prior to the hurricane was $500,000. His homeowners insurance policy had lapsed one month before the hurricane hit and Sammy had not obtained any other insurance. After the hurricane, the property had a fair market value of $0. Assuming that Sammy’s AGI was $115,000 this year, what is Sammy’s casualty loss deduction?
A. $0
B. $138,400
C. $138,500
D. 388,400
Solution: The correct answer is A.
Under TCJA, personal casualty losses unless located in a federally declared disaster area are not deductible. Business casualty losses are unchanged. Personal casualty losses in federally declared disaster areas are still subject to the calculation below unless the government grants relief.
Prior to the TCJA: Sammy’s casualty loss is valued at $150,000 which is his adjusted basis less insurance proceeds received (insurance proceeds in this case are zero). His economic loss (the fair market value before the event, $500,000 less the fair market value after the event, $0) is $500,000. Since Sammy had never paid tax on the $350,000 gain in the property, however, he cannot take a tax deduction for the economic loss. If Sammy had the property fully insured, he would have received the full $500,000 (less his deductible) from the insurance company. Sammy’s casualty loss of $150,000 must be reduced by $100 and the result is only deductible to the extent it exceeds 10% of AGI. The deductible portion of Sammy’s casualty loss is $138,400 ($150,000 - $100 - $11,500[10% of AGI]).
In the case of a gift loan of greater than $10,000 but less than $100,000, the imputed interest rules apply if the donee has net investment income of over $1,000.
A. True
B. False
Solution: The correct answer is A.
The imputed interest rules apply to gift loans. However, if the amount of the loan is for $100,000 or less, the imputed interest cannot exceed the borrower’s net investment income for the tax year. If net investment is $1,000 or less, it is considered to be $0.
Which of the following events would produce a deductible loss?
A. Erosion of personal use land due to rain or wind.
B. Termite infestation of a personal residence over a several year period.
C. A delivery van used for business and destroyed in an auto accident.
D. A stolen diamond ring.
Solution: The correct answer is C.
A casualty loss may be taken for business assets.
Which of the following authorized the first constitutional federal income tax?
A. Revenue Act of 1861
B. 16th Amendment
C. Revenue Act of 1916
D. None of the above
Solution: The correct answer is B.
Answer A is incorrect because although the Revenue Act of 1861 did impose a federal income tax, it was later found to be unconstitutional because Congress did not have the power to levy an individual income tax at that time. Answer B is correct because the 16th Amendment gave Congress the power to impose an individual income tax, but did not itself impose that tax. Answer C is incorrect because the Revenue Act of 1916 raised the rates previously imposed under the Revenue Act of 1913.
During the year, Rick had the following insured personal casualty losses (arising from a tornado, a Federally declared disaster). Rick also had $18,000 AGI for the year.
Fair Market Value
Asset Adjusted Basis Before After Insurance Recovery
A $500 $700 $300 $100
B $3,000 $2,000 -0- $500
C $700 $900 -0- $200
Rick’s casualty loss deduction is:
A. $400
B. $600
C. $1,000
D. $1,400
Solution: The correct answer is A.
Asset A $300
Asset B $1,500
Asset C $500
$2,300
Less: Statutory floor (100)
Less: AGI limitation (10% × $18,000) (1,800)
Casualty loss deduction 400
Remember the deduction is the lesser of ATB or decline in FMV less insurance proceeds.
Reminder, ONLY Federally declared disasters are eligible for casualty loss treatment after 12/31/17.
Note: $100 comes from ‘The limitations on the deduction for personal casualty losses do not end there. Two additional restrictions apply. First, a $100 floor must be deducted from each occurrence (Statuotory floor). Second, the loss is only deductible to the extent it exceeds 10% of AGI.’
Under which of the following circumstances is a trip outside the United States considered to be purely for business?
- The taxpayer does not have control over the timing or arrangements for the trip.
- The trip outside the United States lasts for less than seven days.
- Less than 50 percent of the time spent on the trip was personal.
- Vacation was not a primary consideration for the trip.
A.1 only
B. 2 and 3
C. 1, 2, and 4
D. 1, 2, 3, and 4
Solution: The correct answer is C.
A trip outside the United States is considered to be purely for business when less than 25 percent of the time spent on the trip was personal. All of the other statements regarding travel outside the United States are correct.
Proposed Regulations carry more weight than Temporary Regulations.
A. True
B. False
Solution: The correct answer is B.
Proposed Regulations have no legal precedence and are not binding on taxpayers until the regulation becomes final.
FICA Taxes and Self-employment income
The self-employment tax rate is 15.3%: 12.4% of that part goes to Social Security and 2.9% for Medicare. This rate applies to 92.35% of self-employment income within the SS wage base.
You can deduct half of the SE tax on your 1040
ex: You can deduct half of your self-employment tax on your income taxes. So, for example, if your Schedule SE says you owe $2,000 in self-employment tax for the year, you’ll need to pay that money when it’s due during the year, but at tax time $1,000 would be deductible on your 1040.
For income tax purposes, property can be categorized several ways (how is property held or whether prop is a capital asset, ordinary income asset of 1231 asset)
How property is held: personal use, investment/production of income, trade or business
Or
is prop a capital asset, ordinary income asset or 1231 asset (depreciable personal prop or real prop used for productive use in trade or biz or production of income)
Section 1231 Assets
Section 1231 Assets
- Section 1231 assets are (1) depreciable personal property or (2) real property used for productive use in a trade or business
- In addition to being depreciable property or real property used in a trade or business, the owner of the asset must have a long-term holding period for the asset (the owner must have held the asset for more than one year).
Technically, Section 1231 assets include:
- Depreciable personal property or real property used for productive use in a trade or business or for the production of income,
- Timber, coal, and Iron
- Livestock held for draft, breeding, dairy or sporting purposes,
- Un-harvested crops on land used in business, and
- Purchased intangible assets eligible for amortization (such as Goodwill).
Section 1231 assets (depreciable property held longer than one year)is sometimes subject to recapture IF that property is sold at a gain. There are two types of recapture - 1245 (peronsalty items like patents, copyrights, PCs, desks, machines, trucks, etc) and 1250 (real estate items - buildings.structures attached to lands) Lands are never depreciated, so its not subjec to recapture.
1245 recapture is subject to the depreciation taken. On the gain, the extent of Depreciation taken is subject to ordinary income rates, and the rest is taxed at (1231) capital rates.
1250 (real estate) - first recognize any accelerated depreciation as ordinary income (any depreciation taken greater than SL), 25% straightline depreciation, remaining is 1231 taxed at capital rates.
Remember “1245 comes before 1250, P (peronslaty) comes before R (real estate)” also the 1250 gain has the special 25% tax rate in there for SL depreciation
- Section 1231 assets are potentially subject to 1245 or 1250 recapture.
- Section 1245 depreciable tangible personalty property used in a trade or business or held for production of income is subject to recapture.
- Depreciable real property used in a trade or business or held for the production of income is subject to 1250 recapture.
when a TP disposes of depreciable real property (either 1245 or 1250) at a gain, the TP may have to recognize all or part of the gain as ordinary income under the deprecation recapture rules. Any reamined gain is a 1231 gain (preferential rates)
Capital Assets
-most personal use assets and move investment assets are capital assets
Section 1221 of the IRC defrines what is NOT a capital asset including:
- inventory
- depreciable property used in trade or biz (1231)
- copyrights and creative works
- accounts and notes receiveable
“All assets are capital assets except ACID”
Ordinary Income Assets
- assets that when sold, result in ordinary income to the owner of the asset
- Some 1221 listed asets that are not capital assets are ordinary income assets:
- -inventory
- -accounts receivable
- -creations in the hand of the creator
- copyrights in the hands of the creator
Purpose of Basis
allows taxpayers to recover the value of the assets used to purchase or aqcuire property
Cost Basis includes
-amount paid in cash, debt obligations, other property, or services. Also includes amounts paid for sales tax, freight, installaation, excist taxes, legal and accounting fees, revenue stamps, recording fees and real estate taxes
Adjusted Taxable Basis - Property Acquired by Nontaxable Exchange
-when property is acquired in an exchange, the newly acquired property will have a carry over basis if the property ix excnahged for property of equal value (no boot is paid)
- if prop is exchanged for a more valuable asset (and thus boot is paid) the new asset wil have a carryover basis plus any boot aid
- if opposite, (and boot is received) the new asset will havea carryover basis reduced by an boot received
Holding period for capital gains in inherited property is always
Answer: Long term
Basis of Gifted Property (Not Inhertied) 3 Rules
General rule -donee’s basis in the gifted property is same as donor’s basis (carried over)
First exception: FMV of gifted asset is less than the donor’s basis (loss property). Double Basis Rule applies
Gains - basis is still same as donor’s
Losses only - basis to the donee is the FMV of the property on date of gift
If sold at later and the amount realized is b/w the FMV of the date of the gift and the adjusted basis of the donor, no gain/loss is recognized.
Second Exception: when gift tax has been paid.If gift tax had been paid and an aset had appreciated in hands of the donor, then the portion of tax which is associated with cap appreciation is added to donor’s basis to determining the donee’s basis
Formula: {(Net Appreciation in Value of Gift/Value of Taxable Gift) x Gift Tax Paid]
Ex: Cathy rec’d gift from Darren on June 15 of this year (Darren had already transferred cash equal to annual exclusion to Cathy). The FMV of the gift on June 15 was $20K. Darren had a basis in the asset of $16K and paid gift tax of $800. Cathy’s basis in the gifted property is now $16,160.
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Basis of Gifted Prop
-Determingin Loss on the Sale of Gifed Property
- the basis of the property in the hands of the donee iw the lower of:
- -the donor’s basis, or
- the FMV of the property at the time of the gift
Holding Period:
General rule: donee’s holding period includes holding period of donor.
Exception: if double basis asset (FMV of gift is less than the donor’s basis) is sold for a loss, then the HP for donee starts on the date of the gift
Basis of Property Xferred b/w spouse in divorce
transfers b/w spouses incident to divorce are treated the same as gifts - in other words, carryover basis applies.
no gain or loss is recognized on a transfer bw spouses or former spouses incident to divorce (must occur within one year on date marriage legally ended).
250/500K exemption for gains on home sale
Can only exclude if its used as your PRIMARY RESIDENCE for at least 2 of the last five years
Related Party Transactions
- only affects transactions when there is a loss
- tranferor’s loss is forever lost, transferee takes asset with double basis rule (FMV for losses, transferor’s basis for gains). Holding period = date of the sale
Ex: Melanie purchased 100 shares of Lawncare inc. for $5,000 three years ago. Last week, she sold those shares to her sibling, Isaish, for $4,200. Isaish sells shares today for $4,300. Which of the following represents Isaidhs’ sale?
Answer:
Qualified Dividends are
- for stocks held 60 days or longer
- get preferential tax treatment
Exceptions to cap gains rates
- collectaibles are taxed at 28%
- unrecaptured Sectioj 1250 gain (straight line depreciation) is taxed at 25%
- Qualifying Small Biz Stock.
Gains must be _____ before they are _______
Gains must be realized before they are recognized for income tax purposes
Realized = sold
Recognized = taxed
Ordinary gains are fully taxable, and ordinary losses are fully deductible.
Capital gains and losses are subject to special tax treatment
Amount reazlied on sale/exchange of asset is the sum of:
cash rec’d pluys
FMV of property rec’d in the exchange, plus
liabilites shed
Recognition of gain occurs:
- when debt is relieved
- when money is “taken out of” an investmetn as a loan when they individual is not personally liable for the money
- net gifts ( transfers where donee agrees to pay gift tax
In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs. The canceled debt isn’t taxable, however, if the law specifically allows you to exclude it from gross income. These specific exclusions will be discussed later. (IRS website)
Examples of where gain/loss is reazlied, but not recognized (for tax purposes)
- like-kind exchanges of real property held for productive use or investment
- certain exchanges where cash received is quickly reinvested in similar property
- transfer of property to controlled corporation
- exchange for plans of coporate reorg
- transfer to, or distributions from, partnerships
- Losses generated on the sale or exchange of property that is used for personal purposes is disallowed for income tax purposes. Results in permanent loss of capital for tax payer.
- Loses are wash sales are disallowed (occurs when TP sells securities at a loss and acquires substantially similar securities with 30days before or after the date of the loss sale.
- Exam Tip: Index fund for index fund - wash sale rule applies.
- Index Fund for Managed Large cap fund - wash sale rules do not apply
Wash Sales
- Loses are wash sales are disallowed (occurs when TP sells securities at a loss and acquires substantially similar securities with 30days before or after the date of the loss sale.
- Exam Tip: Index fund for index fund - wash sale rule applies.
- Index Fund for Managed Large cap fund - wash sale rules do not apply
- If there is a wash sale, the entire loss is disallowed. But the new basis will be the disallowed loss + mkt price stock was bought again at
- Wash sale rules don’t apply to commodity futures contracts and foreign currencies
cap gains exlcusion - personal residence
you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home provides rules and worksheets. Topic No. 409 covers general capital gain and loss information.
Qualifying for the Exclusion
In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You’re eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. Generally, you’re not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home. Refer to Publication 523 for the complete eligibility requirements, limitations on the exclusion amount, and exceptions to the two-year rule.
Reduced exlucsion may be availible even if TP didn’t meet the ownership/used rule:
- change in employment (qualifed move for you and your spouse)
- change of health
- other unforeseen circumstances
if reduced exclusion is available, the amount excluded is based on the period of ownership between the last sale and the current sale (pro rate). (If joint owners owned for 18 months calc is (18/24 = .75 and then .75 x 500K = 375K)
*only qualified use qualies for exclusion - if you rent it out, you must do a calculation to exclude that from the exlusion. Pg./ 15 of book)
A loss resulting from worthless securities is deductible in year in which the securities
Answer: became completely worthless.
Tax Treatment of gains/losses summary chart
- gains and losses from capital asset transactions must be netted against each other by holding period
- if excess losses result, they are shifted to category carrying teh highest tax rate
- net capital losses are FOR AGI to the extend of $3K/yr. (excess losses are carried over to the next yr indefinetly
Can I use passive losses to offset capital gains?
Passive losses on the property that you still have are not “unsuspended” until you dispose of the property. You can use these losses to offset other passive income (i.e. Schedule E income, perhaps some Partnership income), but you cannot use it to offset the capital gain.
In addition to $3K of capital losses that are eligible to be offset against other income, another rule recatgeorizes capital losses on small business stock into ordinary losses
Section 1244: Single TP can deduct $50K ($100K if MFJ)
must be small biz coporation (less than $1 mln in total capital contributions plus paid-in capital)
Ex: In Yr 1, Sam invests in XYZ Corp, stock costing $150K. (Total XYZ stock outstanding is $800K). In Yr. 1, Sam sells all the stock for $65K. The stock is a Section 1244 stock.
Sam has following tax consequences:
$50K ordinary loss in YR 1.
$35K ST Capital loss ($3K deductible in YR 1)
$32K ST capital loss carry forward
Section 267 disallows losses bw related parties.
ONLY APPLIES TO LOSSES.
Related parties include: siblings, lineal descendants, ancestors, spouse
does not include: aunts/uncles, cousins, in-laws.
Losses disallowed reduce gains on subsequent disposition to an unrelated third party\
Ex: Colin sells to his son Briscoe 100 shares of XYZ stock for $8K. Collin’s basis was $10K. What are taxable consequences?
- Colin cannot recognize a realized loss of $2K
- Briscoes basis is $10K for gains and $8K for losses.
Exam Tip: Never gift or sell an asset to a related party when the donor’s basis is greater than the FMV of the asset
Bill owns 1,000 share of KMA stock. He bought it in 1998 for $40K ($40/sh). THe current FMV of the stock is $32K. Bill sells the KMA stock to his broter Jack hass for $32K. Jack later sells the KMA stock to his friend for $38,500 six months later. What are the tax consequences?
Bill has no gain or loss, Jack has no gain or loss.
This is Section 267.If the FMV is below the transerors’s basis, the transferees basis is FMV for losses and the transferors basis for gains. 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.
Main Benefit of Section 1231 (depreciable assets used for business held longer than a year
- gains from sale of 1231 asset are LTCG for tax purposes
- losses from sale of 1231 asset are ORDINARY LOSSES for income tax purposes
However, C Corps pay same rate of tax on ordinary income and cap gains. So generation of a 1231 gain will not restult in a tax benefit for the corporation.
Depreciation Recapture (1231 assets)
If TP disposes of depreciable prop at a gain, TP may have to treat all or some of the gain as ordinary income due to depre. recapture
Sole purpose of deprecation recapture is to ensure that, when an asset is sold, the TP receives his initial capital capital back tax free - no more, no less.
Section 1231 assets (depreciable property held longer than one year)is sometimes subject to recapture IF that property is sold at a gain. There are two types of recapture - 1245 (peronsalty items like patents, copyrights, PCs, desks, equipment, machines, trucks, etc) and 1250 (real estate items - buildings. structures attached to lands) Lands are never depreciated, so its not subject to recapture.
1245 recapture is subject to the depreciation taken. On the gain, the extent of Depreciation taken is subject to ordinary income rates, and the rest is taxed at (1231) capital rates.
If propety sold for amount equal to adjusted basis, no gain/loss realized, no depreciation recapture. Thus no tax consequences
If sold at a loss, ordinary loss*** and no deprecation recapture.
Exam Tip: 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.
Exam Tip: Any sale amount in excess of the original purchase prices of a Section 1245 asset is a Section 1231 gain.
Ex: Roscoe sells equipment used in his business for $18K. He had originaly purchased the equipment for $15K and had taken $7K of deprecation. What is the Section 1231 gain for Roscoe?
Answer: $3K.
7k = ordinary income (section 1245 recap)
3k = 1231 gain
1250 (real estate) - first recognize any accelerated depreciation as ordinary income (any depreciation taken greater than SL), 25% straightline depreciation, remaining is 1231 taxed at capital rates.
*currently all depreciation on real estate is taken on a straighe line basis.
Remember “1245 comes before 1250, P (peronslaty) comes before R (real estate)” also the 1250 gain has the special 25% tax rate in there for SL depreciation
- Section 1231 assets are potentially subject to 1245 or 1250 recapture.
- Section 1245 depreciable tangible personalty property used in a trade or business or held for production of income is subject to recapture.
- Depreciable real property used in a trade or business or held for the production of income is subject to 1250 recapture.
Note: land buildings are NOT 1245 property
*All 1245 and 1250 losses are ordinary losses
Nontaxable Exchanges
Nonrecognition Transactions
- “realized but not recognized” income
- like-kind exchanges
- principal residence
- investement real estae
- life insurance policies
Nontaxable vs. Tax-Free Transacations
- nontaxable transaction: realied gain/loss not currently recognized, recognition is postponed to a future date (carryover basis), holding period for new asset, depreciation recapture
- Tax Free Transaction: nonrecognition of gain is premanent
Like-Kind Exchanges (non-recognition for tax purposes
- 1031 Exchange.- provides for deferred taxation of gains associated with certain exchange trasnactions. Only real prop transacation will receive 1031 treatment.
*
When is a child a qualifying dependent for income taxes reasons?
The IRS defines a dependent as a qualifying child under age 19 (or under 24 if a full-time student) or a qualifying relative who makes less than $4,300 a year (tax year 2021). A qualifying dependent may have a job, but you must provide more than half of their annual support
What is a child’s standard deduction for 2022?
How does this apply to kiddie tax?
If you can be claimed as a dependent on another person’s tax return, your 2022 standard deduction is limited to the greater of $1,150 or your earned income plus $400 (again, the total can’t be more than the basic standard deduction for your filing status).
If a child has earned income, their standard deduction is the greater of earned income plus $400 (not to exceed the single tax filers standard deduction amount) or $1,150. If the earned income plus $400 is greater than $1,150 and the child has unearned income, up to $1,150 of the standard deduction can apply to the unearned income, and the remainder applies to the earned income
- The net unearned income of a child under the age of 19 or a full-time student under the age of 24 may be subject to income tax at the parent’s tax rates.
- The amount of unearned income subject to tax at the parent’s rate is called net unearned income (NUI).
- NUI is equal to unearned income less the sum of $2,300. ( NUI must exceed $2,300 to have a taxable consequence for the parents)
- The first $2,300 for 2022 of unearned income of a child is not taxed at the parent’s rate. If it is taxed, it will be at the child’s rate.
Ex: Steven, age 13 has earned income = $15,000 and $13,000 unearned income.
How much will be taxed at parent’s rate? Kid’s rate?
Answer: Taxable amount = $15,000 + $13,000 – $12,950 (2022) = $15,050
Parent’s Rate = $13,000 – $2,300 = $10,700 (under SECURE Act 2019 will be taxed at the parents tax rate)
Kid’s Rate = $15,000 – $11,800 = $3,200 plus $1,150 from unearned income (2300 less 1150) = $4,350
(Note: 11800 comes from the STD less the $1,150 that will be applied to unearned income of 2,300)
What is your SD if you can be claimed as a dependent on another’s TR?
If you can be claimed as a dependent on another person’s tax return, your 2022 standard deduction is limited to the greater of $1,150 or your earned income plus $400 (again, the total can’t be more than the basic standard deduction for your filing status).
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 $2,300.
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.
Taking Distributions from Annuity - Before Annuitization & After Annuitization
Annuities - taking distributions
Before Scheduled Start Date (take out payment before we annuitize)
*Key: remember, this is not as beneficial tax wise so we have the two rules
-
Issued Pre-82
FIFO (First In First Out)- FIFO looks at basis first. Ex: assume $50K in basis with earnings/growth of $100K. (Total balance of $150K. Distribution of $75K = 25K would be taxable to me
-
Issued Post-82
LIFO (Last In First Out)- LIFO looks at earnings first . Ex: assume $50K in basis with earnings/growth of $100K. (Total balance of $150K. Distribution of $75K = 75K would be taxable to me
- May be subject to 10% early withdrawal penalty.
On/After Annuitization
The exclusion ratio calculates how much of each annuity payment should be excluded from taxable income
- Exclusion Ratio/Exclusion Amt = (Investment/Exp return)
- Exlucsion Ratio applies until the term runs out (if term is for 15 years and he lives longer, the entire payment is taxable after that 15th year)
**If client fails to live untli end of term, they can eligible to receive a deduction FROM AGI that represnets the rmaining principle balance. (principal - (exluclded value x years lived). Pg. 57
Example: Thomas invested $100,000 in an annuity contract. Many years later, he annuitized the contract. The insurance company agreed to pay him $1,388.89 per month for 15 years. His expected return is $250,000.20 (15 years x 12 months x $1,388.89 per month).
The exclusion ratio is 0.40 ($100,000/$250,000) and the excluded amount is $555.56 for each payment received.
Life Insurance Premiums - What is included in taxable income?
Who can deduct premiums on TR?
Only employer can deduct life insurance premiums, EE have to include prem. in TI AFTER $50K in benefits.
An employer can deduct the total cost of Group Term Insurance provided to an employee. Up to $50,000 (face or death benefit amount) of group term life insurance for each employee may be excluded by the employee
Ex: Edward’s employer provides him with $80,000 of group term life insurance for which Edward pays none of the premiums. Edward is 56 years old at the end of the year. He can exclude the cost of the first $50,000 of coverage. He must include $154.80 ($30 thousand x $0.43 per thousand per month x 12 months) in his gross income. This amount is generally reported as part of the employee’s W-2 income. If Edward pays any amount toward the cost of the insurance coverage, the taxable amount will be reduced by the amount of the employee payment.
*.43 comes from the imputed income premium table where for age 55-59 the taxable amount is .43/1,000 in coverage
- Self-employment tax serves as FICA tax for self-employed taxpayers.
- Rate is 15.3%, base is net self-employment income, and deduction (FOR AGI) is allowed for 1/2 of self-employment tax.
- The IRS allows you to deduct 50% of your total self-employment tax on your tax return. (you can deduct 50% of the payroll taxes you paid on your TR)
SE Tax: 12.4 % OASDI, 2.9% Medicare
Remember there is an additional 0.9% medicare tax for high income self employed taxpayers on
A 0.9% Additional Medicare Tax applies to Medicare wages, self-employment income, and railroad retirement (RRTA) compensation that exceed the following threshold amounts based on filing status:
- $250,000 for married filing jointly;
- $125,000 for married filing separately; and
- $200,000 for all other taxpayers.
Example of the Self-Employment Tax
Contrary to what you may think, individuals typically pay self-employment tax on 92.35% of their net earnings—not on 100% of their full earnings.1 Here’s how it works.
Let’s say an individual runs a human resource consulting business and calculates their total net income for 2021 as $200,000 after business expenses are deducted. Their self-employment tax will be assessed on 92.35% of this amount $200,000 for a total of $184,700. This amount is above the capped limit for the Social Security portion of the self-employment tax. Therefore, Robin’s self-employment tax bill will be $23,063.50. We arrive at this figure as:
> ($142,800 x 12.4%) + ($184,700 x 2.9%)
> $17,707.20 + $5,356.30
When filing their 2021 income tax return, they can claim an above-the-line deduction for half of their self-employment tax, or $23,063.50 ÷ 2 = $11,531.75. In effect, they get a deduction on the “employer” portion (6.2% Social Security + 1.45% Medicare = 7.65%) of their self-employment tax.
What is the additional Medicare tax?
- An individual is liable for Additional Medicare Tax of .9% if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual’s filing status:
Filing Status
Threshold Amount
Married filing jointly$250,000Married filing separate$125,000Single$200,000Head of household (with qualifying person)$200,000Qualifying widow(er) with dependent child$200,000
- Additional Medicar Tax on investment income of 3.8% according to the same table above.
In general, net investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, and non-qualified annuities.
The Net Investment Income Tax is separate from the Additional Medicare Tax, which also went into effect on January 1, 2013. You may be subject to both taxes, but not on the same type of income. The 0.9 percent Additional Medicare Tax applies to individuals’ wages, compensation, and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income.
Basic Income Tax Formula
Remember QBI is a deduction from AGI (20% deduction)
The qualified business income deduction (QBI) is a tax deduction that allows eligible self-employed and small-business owners to deduct up to 20% of their qualified business income on their taxes. In general, total taxable income in 2021 must be under $164,900 for single filers or $329,800 for joint filers to qualify.
Self-employment tax (SE) is added to your income tax, after your income tax is calculated.
https://kb.drakesoftware.com/Site/Browse/15919/QBI-Deduction-Frequently-Asked-Questions?Keywords=ubi
If you are self-employed, only 92.35% of your earnings are subject to Social Security and Medicare taxes. So if you report $100,000 in income, you will only pay FICA (Federal Insurance Contributions Act) tax on $92,350 of it. This is referred to as the “self-employed multiplier of .9235.”
Example of the Self-Employment Tax
Contrary to what you may think, individuals typically pay self-employment tax on 92.35% of their net earnings—not on 100% of their full earnings.1 Here’s how it works.
Let’s say an individual runs a human resource consulting business and calculates their total net income for 2021 as $200,000 after business expenses are deducted. Their self-employment tax will be assessed on 92.35% of this amount $200,000 for a total of $184,700. This amount is above the capped limit for the Social Security portion of the self-employment tax. Therefore, Robin’s self-employment tax bill will be $23,063.50. We arrive at this figure as:
> ($142,800 x 12.4%) + ($184,700 x 2.9%)
> $17,707.20 + $5,356.30
When filing their 2021 income tax return, they can claim an above-the-line deduction for half of their self-employment tax, or $23,063.50 ÷ 2 = $11,531.75. In effect, they get a deduction on the “employer” portion (6.2% Social Security + 1.45% Medicare = 7.65%) of their self-employment tax.
Major Types of Taxes
Property (ad valorem) Taxes
- Property taxes are based on the value of the asset and are generally on realty or personalty.
Excise Taxes
- Restricted to specific items
- Examples: gasoline, tobacco, liquor (discourages bad behavior)
- Hotel occupancy tax
- Rental car surcharge
- Tax is levied on visitors who cannot vote and used to fund special projects.
General Sales Taxes
- Currently the jurisdiction of states and localities.
Severance Taxes
- Tax on natural resources extracted.
- Important revenue source for states rich in natural resources
- Oil, natural gas, etc.
- Death Taxes - Federal Estate Tax
Employment Taxes
-
FICA taxes
- Paid by both an employee and employer.
- In 2022, Social Security rate for employees is 6.2% on a maximum of $147,000 of wages (and a matching 6.2% for employers). In addition, the employee Medicare rate is 1.45% on all wages (also a matching 1.45% for employers).
- There is an excess Medicare tax of 0.9% on income over $200,000 ($250,000 MFJ).
- Self-employment tax serves as FICA tax for self-employed taxpayers.
Rate is 15.3%, base is net self-employment income, and deduction (FOR AGI) is allowed for 1/2 of self-employment tax.
-
FUTA (unemployment) taxes
- Provides funds for state unemployment benefits.
- Is administered jointly by states & Fed govt.
- Credit is allowed (up to 5.4%) for FUTA paid to the state.
- The tax is only paid by employer.
FTP vs. FTF
Failure to to file - five % per month up to 25% (F)
Failure to pay - .5% per month (up to 25%)
FTF is reduced by FTP
Round up on months (45 days late = 2 months)
Tax Statue of Limitations - For assessment of deficiency
Statue of Limitations
- Later of: 3 years form due date of return or filing date for IRS audit, whichever is later and 10 years SOL for IRS to collect tax
- 6 years if there was a material omission (25% of income not stated)
SOL does not apply to a false of fraduelntly filed TR. Unlimited SOL.
Only an ACE (Attorney, CPA or enolled agent) can represent a client during an IRS audit
Administration of the TaX System
Which does not allow you to appeal the decison? Answer: Small Claims Division
Does not require the TP to pay the tax before filing suit.. Answer: Small Claims Division, Tax Court
Which allows a trial by jury? U.S. District Court
US Tax Court - no prepayment of tax is necessary to bring claim to U.S Tax Court. Trial by jury is not available. Appeals are available
Small Tax Division of US Tax Court case dis for deficiencies under $50K (no appeal rights).
U.S. Court of Federals claims - sits only in Washington D.C. Only hears claims against the U.S. Tax deficiencies must be paid. Appeals are to U.S> Court of appea.s
US District Court - tax deficiencies must be paid. Only court that allows a jury trial
US Court of Appeals- 12 Circuit Court through the U.S.
Cash vs Accural TP
Cash - recognize income when it is RECIEVED. Most individuals and some businesses.
Constuction receipt doctrine: when income is readily availbable to thte TP, and that income is not subject to substantial limitations or restrictions, that income is deemed rec’d and should be taxed.
Accural - recognized income when it is EARNED.
Five Filing Statuses
- Single
-
MFJ
- TP and his/her spouse must be married on the last day of the year. Treated as if they were married the whole year.
- If TP spouse died during the yr and they did not remarry, TP can still file a joint return for that year of death
- the year when your divorce decree becomes final that you lose the option to file as married joint or married separate. In other words, your marital status as of December 31 of each year controls your filing status for that entire year.
- MFS
- HOH
- individual who are unmarried (or considered unmarried - abandoned by spouse) as of last day of taxable year.
- must have paid more than half the costs of keeping up his home, TP home was main home to children for more than half the year and the TP is eligible ot claim a credit children
-
Qualifying Widow with Qualified Child
- can file for two years following death of spouse
- child must live in house the whole year
- cannot be remarried
Additional Standard Deduction
`1*additional standard deduction amounts:
TP age 65 OR older or blind are entitled to an increased SD
$1,750 for individuals not married and not filing as qualifying widower
$1,400 for all other TP
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TP who are blind must file to receive the additional SD. IRS has age on file, but not blindness.
Ex: Albert is single, blind and Age 67. His SD is $16,450.
Ex: Martha is 72 years old and can be claimed as a dependent by her daughter.
- She has $3,000 of interest income during the current year.
- Her basic standard deduction is $1,150.
- Her total standard deduction is $2,900 ($1,150 basic standard deduction + $1,750 additional standard deduction for age).
2% AGI Floor
Deductions Not Subject to the 2% Floor (STILL Deductible):
- Gambling losses (to the extent of gambling income),
- Deduction for estate taxes imposed on IRD (income in respect of a decedent assets),
- Loss on the disposition of an annuity contract,
- Repayments of income (such as repayments of Social Security income when the taxpayer fails the earnings test).
Deductions Subject to the 2% Floor (NOT Deductible Under TCJA after 12/31/17):
- Unreimbursed employee business expenses (travel, journals, uniforms, union dues).
- Appraisal fees.
- Hobby expenses (to the extent of hobby income).
- Investment expenses (e.g., fees).
- Tax advice and preparation.
- Losses on terminated IRAs.
Itemized Deductions are reported on Schedule A
- Always a below the line (FROM AGI) deduction
- Several are subject to AGI floors/ceilings
Medical Expenses
Deductible
- Prescription Drugs
- Expenses Related to Diagnosis, Cure, & Treatment
- Health Insurance Premiums (after tax payouts)
- Capital Expenditures
- Nursing Home and Special Schools
- Travel and Lodging
Nondeductible
- Elective Cosmetic Surgery
- Dance Lessons
- Health Club Dues
- Marijuana
- Over-the-Counter Drugs
- General Health Items (e.g., vitamins)
Can deduct their total qualified unreimbursed medical care expenses that exceed 7.5% of the AGI if they itemize
- If reimbursed in the same year as the expense is paid:
- Reimbursement offsets medical expense.
- Amount deductible is excess of expenses over reimbursement.
- If reimbursed in the year after the medical expenses were paid:
- Reimbursement is income only to extent medical deduction was taken by taxpayer (tax benefit rule).
Up to 85% of your SS benefits can be taxed
Taxability based on TP’s MAGI (AGI not included SS benefits plus tax exempt int, int earned on savings bonds used for higher head, income earned in foreign country/PR
*memorize hurdle rates
- MAGI + one half SS benefit = below first hurdle, not taxable
-
MAGI + one-half SS benefit = b/w two hurdles
- lesser of:
- 50% of ss benefit OR
- 50% [MAGI + .50 (SS Benefits) - Hurdle 1]
- Greater than second hurdle = leser of 85% of SS benefit OR
- 85%[MAGI +.5(SS benfit) - Hurdle 2], plus lesser of
- $6K for MFJ or $4,500 for all other TP, or
- taxable amount under the 50% formula and only considering hurdle 1
Ex: Uli and Violet are married and have $30K of income. In addition the have SS benefits of $20K. What amount of their SS benefit must be included in their taxable income?
Answer: $4K.
Lesser of:
50% of SS benefit OR
50% [30,000 +.5(20,000) - $32,000] = $4,000
Ex: Yanni and Zelda, a married couple have income of $45K and social security benefits of $20K. What amount of their benefits must be included in their taxable income?
Answer: $15,350
Lesser of:
85% of benefits = $17K:
Or
.85[MAGI +.5(20,000) - 44,000] = $9,350 plus lesser of:
- $6K MFJ OR
- .5 (45K + 10K -32000) = $11,500
Must include $15,350 in TI
Below Market Returns
below market returns apply to term or demand loans that are gift loans, or tax avoidance loans.
- have special tax treatment - requires lender to impute the interest income that would have been earned had the lender made a bona fide interest-bearing market loan (called phantom income)
- -lender is considered to have made a gift to the borrower in the amt of the imputed int
- amt lender (donor) must impute as income for income tax purposes = amount of gift from the donor to the donee (borrower)
Deductions FOR AGI
- Alimony paid
- Alimony received under an Agreement dated after 12/31/18 is not deductible by the payor, nor includable by the payee.
- , Contributions to Traditional IRAs, pension, profit sharing plans, annuity plans
- Charitable contributions of cash to qualified charities ($300 or $600 MFJ)*
- Interest paid on student loans subject to limitations
- ½ self employment tax
- trade or business expenses
- Rental or royalty income expenses
- Losses from the sale of business property
- Qualified moving expenses
- Suspended for years 2018-2025
- Only deductible for Armed Forces moving to a permanent post.
- Self Employed Health Insurance and Retirement contributions
- health savings accounts
* TCDTR Act of 2020 for taxpayers that do not itemize in tax years 2020 and 2021
Deductions FROM AGI - Charitable Contributions
Overall, just remember usually 50% of AGI
Business Casualty Loss Example
Business and production of income losses (no insurance proceeds received). Not subject to $100 and 10% AGI floor.
*A business casualty, unlike a personal casualty, allows the taxpayer to take a deduction equal to the adjusted basis if there is a complete loss of property.
Ex: Beau owned a home in New Orleans that was severely damaged by a hurricane, declared a federal disaster. Beau had purchased the home for $200,000, and the fair market value of the home prior to the hurricane was $400,000. His homeowners insurance policy had lapsed one month before the hurricane hit and Beau had not obtained any other insurance. After the hurricane, the property had a fair market value of $90,000. Beau’s casualty loss is valued at $200,000 which is his adjusted basis less insurance proceeds received (insurance proceeds in this case are zero). His economic loss (the fair market value before the event, $400,000 less the fair market value after the event, $90,000) is $310,000, but Beau’s casualty loss is limited to his adjusted basis because his adjusted basis is less than the decline in the fair market value of the property. If Beau had the property fully insured, he would have received the full $310,000 (less his deductible) from the insurance company.
- Determine Loss
- The loss will always be the lesser of the decline in value AKA economic value ($400K - 0 = $400K) or the adjusted taxable basis AKA loss on casualty($350K - $300K from insure. = $50K)
- Adjusted for 10% of AGI.
- Adjust for $100 for old tax law
- Total deduction = $39,900
Alternative Minimum Tax (AMT)
applies to TP who take advantage of “items of tax preference”
TP is liable for the greater of his regular tax liability or the AMT
Designed primarily to temporarily change the timing of tax payments, although in some cases, imposition of the AMT results in a permanent increase in tax.
questions usually relate to calculating AMTI
For purposes of exam , we will Usually be adding in preference and adjustment items.
*AMT formula starts with regular taxable income.
If AMT tax number is higher than regular tax number, you use the higher number. A portion of that number will be considered regular tax, and the other AMT tax.
AMT continued
Summary:
State and Local Taxes - not deductible under AMT
Itemmized Deduciton Subject to 2% not deductible under AMT
For AMT purposes, you generally must depreciate (deduct) business assets over a longer period of time than you can for regular tax purposes. This creates a difference between regular tax depreciation and AMT depreciation
Itemized Deductions not allowed under AMT :
-SALT taxes (considerd an adjustment)
-preferences items
*percentage depletion
*intangible drilling costs
*int. on private activity bonds
Rental Property
Rental Losses - subject to passive loss rules
Personal Use - AKA diminimus use
- Rented for less than 15 days (AKA 14 days or less)
- Income is not taxable (rental expenses are not deductible)
- Mortgage interest and property taxes are 100% allowed on Schedule A
Rental Use Property -
- Rented for 15 days or more, and used personally less than or equal to the greater of 10% of rental or 14 days
- Include Income
- Expenses can be deducted
- Apportion expenses between personal use and rental use
- Rental use expenses are deductible beyond income (can deduct loss up to $25K, phased out at $150K)
- The personal apportionment of mortgage int. And property taxes are deductible on Schedule A, other personal expenses are non-deductible
Mixed Use
- Rented for 15 days or more, and used personally more than or equal to the greater of 10% of rental or 14 days
- Include Income
- Expenses can be deducted
- Apportion expenses between personal use and rental use
- Rental use expenses are NOT deductible beyond income - no loss for mixed use property
- The personal apportionment of mortgage int. And property taxes are deductible on Schedule A, other personal expenses are non-deductible
Rental Prop Decision Tree
*IRS requires allocation based on total days used
tax treatment of income and expenses of a primariuly rental vacastion hjome:
- rental income is included in gross income
- rental expenses are deductible FOR AGI
- -Rental income and expenses are reported on Schedule E
Schedule E
A Schedule E form is used as a supplement document that’s filed alongside a 1040 tax form to report any income or loss that you have incurred from rental real estate, royalties, partnerships, S corporations, estates or trusts.
At Risk Rules and Passive Activity Treatment
(3) Types of Income:
- active
- passive (at-risk rules apply BEFORE passive activity rules)
- portfolio
At-RIsk RUles: losses can only be deducted to the extent of the property/money at risk.
Ex: Mike invests $30K for a 40% int. in a GP. THe partnership produces $250K in losses. How much can Mike deduct?
Answer: $30K can deduct. $70K is suspended.
What Is a Suspended Loss?
A suspended loss is a capital loss that cannot be realized in a given tax year due to passive activity limitations. These losses are, therefore, “suspended” until they can be netted against passive income in a future tax year. Suspended losses are incurred as a result of passive activities, and can only be carried forward, known as a capital loss carryover
For example, assume an investor invests $15,000 in limited partnership (LP) units (a type of flow-through entity). The business structure of an LP is such that this investor shares the profits or losses of the business pro-rata with other partners and owners, as is characteristic of investing in flow-through entities.
Assume that the business goes downhill, and the investor’s share of the loss incurred is $19,000. Since they are only able to deduct their initial investment in the first year, they will have an excess amount of loss which will be suspended and carried forward. In this situation, their excess loss is their share in the limited partnership’s loss minus their initial investment (or $4,000). If this investor decided to put an additional $10,000 towards this investment the following year, this investor’s at-risk limit will be $6,000, because the suspended loss is then subtracted from the amount of the additional investment.
**Disposition of Passive Activities - after entire int. in a passive activity is disposed of, suspended losses from previous eyars are fully deductible against other income
*publicly traded partnerships cannot net against one another, but privately traded partnerships can (P. 89)
David invests in a LP and pays $250K for a 10% interest in the partnership. David receives a K-1 showing his share of the losses is $75K. This is his only investment. How much of the loss is suspended under the at-risk rules?
Answer: $0.
He has $250K at risk. He does not need to suspend any of the $75K loss.
How much of the loss is suspended under the passive activity rules?
Answer: $75K.
David’s losses will be suspended under passive activity rules because he has no passive activity gains to offset.
Understanding Suspended Losses
While many losses incurred in a given tax year can be deducted in the same year they occur, losses generated from passive activities can only be used to offset income or gains generated from other passive activities.
These rules, set forth by the Internal Revenue Service (IRS), are known as the Passive Activity Loss (PAL) rules. Investors are prevented from using losses incurred from income-producing activities in which they are not materially involved to offset ordinary income. Income from rental properties is generally considered passive, even if you materially participated in their management. However, if you qualify as a real estate professional, then your participation isn’t classified as passive.
dept
charitable donations deducition
60% of AGI deduction - cash
30% of AGI deduciton -LTCG stocks
Like-Kind Exchange
cannot be personal use property
amt formula
Peyton has a warehouse used in his business. He exchanges it for a storage building owned by Eli. (Peyton and Eli are unrelated). The basis of Peyton’s asset is $40,000 and he gives Eli $20,000 cash plus the asset in exchange for Eli’s asset, which is worth $36,000. Eli’s basis in his original asset is $10,000. What is Eli’s gain or loss?
- $20,000 gain recognized.
- $26,000 gain realized and recognized.
- $0 gain recognized.
- $0 loss recognized.
aotc vs llc
The American opportunity tax credit is:
- Worth a maximum benefit of up to $2,500 per eligible student.
- Only available for the first four years at an eligible college or vocational school.
- For students pursuing a degree or other recognized education credential.
- Partially refundable. People could get up to $1,000 back.
The lifetime learning credit is:
- Worth a maximum benefit of up to $2,000 per tax return, per year, no matter how many students qualify.
- Available for all years of postsecondary education and for courses to acquire or improve job skills.
- Available for an unlimited number of tax years.
- There are several differences and some similarities between the American Opportunity Tax Credit (AOTC), the Lifetime Learning Credit (LLC) and the deduction for tuition and fees. You can claim all three benefits on the same return but not for the same student or the same qualified expenses. See “No Double Benefits Allowed” for more information on claiming one or more education benefits.
- There is no limit on the number of years you can claim the credit. The credit is worth up to $2,000 per tax return. The LLC is a nonrefundable credit,
rental prop
