Income Tax Fundamentals and Calculations - Review Questions

Question 1

Susan is a sole-proprietor with self-employment earnings of $180,000. Susan has no other sources of wage or salary income. Calculate Susan’s self-employment taxes due.

Answer 1

($180,000 × .9235) + $0 > $168,600

1) SE earnings × .9235 × .029 = Medicare tax

 $180,000 × .9235 × .029 = $4,821

2) ($168,600 − $ W-2 wages) × .124 = OASDI tax

 ($168,600 − $0) × .124 = $20,906.00

3) Add steps 1 and 2 for total SE tax due

 $4,821 + $20,906.00 = $25,727

 Susan’s SE tax is $25,727

Question 2

Susan is a sole-proprietor with self-employment earnings of $160,000. In addition, Susan has W-2 wages of $30,000 from a part time position as a bartender on the weekends. Calculate Susan’s self-employment taxes due.

Answer 2

($160,000 × .9235) + $30,000 > $168,600]

1) SE earnings × .9235 × .029 = Medicare tax

$160,000 × .9235 × .029 = $4,285.04

2) ($168,600 − $ W-2 wages) × .124 = OASDI tax

($168,600 − $30,000) × .124 = $17,186.40

3) Add steps 1 and 2 for total SE tax due

$4,285.04 + $17,186.40 = $21, 471 (rounded)

Susan's SE tax is $21, 471 (rounded)

Question 3

Susan is a sole-proprietor with self-employment earnings of $60,000. In addition, Susan has W-2 wages of $30,000 from a part time position as a bartender on the weekends. Calculate Susan’s self-employment taxes due.

Answer 3

($60,000 × .9235) + $30,000 ≤ $168,600]

1) SE earnings × .9235 × .153 = SE Tax

$60,000 × .9235 × .153 = $8,477.73

Susan’s SE tax is $8,478

Question 4

June Higgins, a single taxpayer, has the following itemized deductions:

Home mortgage interest $5,218
Charitable contributions $2,200
State income taxes $9,120
Gambling losses (to extent of winnings) $1,500
Property taxes $7,480

What is the amount of the allowable itemized deductions for 2024?

1) $18,918
2) $17,418
3) $24,018
4) $25,518

Answer 4

1) $18,918

All of these itemized deductions are allowable except that taxes (from all sources) are limited to $10,000.

$5,218 + $2,200 + $1,500 + $10,000 = $18,918

Question 5

For 2024, Jane had self-employment income of $140,000. Additionally, Jane worked part time teaching at a local college and earned $60,000 of W-2 wages.

Calculate Jane’s self-employment tax (rounded to the nearest dollar).

1) $17,215
2) $16,174
3) $12,047
4) $11,765

Answer 5

If the self-employment income times 92.35% added to the W-2 wages exceeds the OASDI limit ($168,600 for 2024 ), then you must calculate the Medicare and OASDI portion separately. $140,000 × .9235 × .029 = $3,749 (Medicare portion). $168,600 (OASDI limit) − $60,000 (W-2 wages) = $108,600. Now multiply that amount by the OASDI rate of 12.4%. $108,600 × .124 = $13,466 (OASDI portion). Add the two components together: $13,466 + $3,749 = $17,215.

Question 6

Jason earned $68,000 of self-employment wages. Additionally, he received a cash distribution of $35,000 from a 10% interest in an S-Corporation. Calculate Jason’s self-employment tax for 2024.

1) $ 9,240
2) $ 9,608
3) $10,027
4) $14,553

Answer 6

If the self-employment income times 92.35% added to the W-2 wages exceeds the OASDI limit ($168,600 for 2024), then you must calculate the Medicare and OASDI portion separately. In this case, there are no W-2 wages and the self-employment income is only $68,000. Therefore, you can calculate using the combined OASDI and Medicare rate (15.3%). $68,000 × .9235 × .153 = $9,608. Please note that a distribution from an S-Corporation is not subject to self-employment tax.

Question 7

A taxpayer having a marginal tax bracket of 24% has an itemized deduction of $4,000. What is the amount of a tax credit that would generate the same reduction in income tax liability?

1) $ 520
2) $ 960
3) $ 4,000
4) $16,667

Answer 7

2) $ 960

To calculate an equivalent tax credit of an itemized deduction you multiply the deduction by the marginal tax bracket. $4,000 × .24 = $960.

Question 8

In 2024, John and Mary file jointly and have a marginal tax bracket of 35%, although their average tax rate is 27%. Their son, age 16, has W-2 wages of $3,400 and $3,000 of interest income from a taxable bond fund. How much of the son’s income will be taxed using his parents’ tax rates?

1) $ 0
2) $ 400
3) $ 500
4) $ 2,100

Answer 8

2) $ 400

Any unearned income exceeding $2,600 is taxed using the parents’ marginal tax rates. $3,000 − $2,600 = $400.

Question 9

For the current year, John and Mary file jointly and have a marginal tax bracket of 35%, although their average tax rate is 27%. Their son, age 16, has W-2 wages of $3,400 and $3,000 of interest income from a taxable bond fund. What is the son’s total tax liability?

Choose the best answer.

1) $ 128
2) $ 285
3) $ 355
4) $ 530

Answer 9

3) $ 355

The son’s standard deduction is the greater of either $1,300 or $3,850 (Earned income + $450), not to exceed the otherwise allowable amount of $14,600. Therefore, the son’s taxable income is ($3,400 + $3,000 − $3,850) $2,550. Of this amount, $400 is taxable using the parents’ tax rates ($400 × .35) = $140 (rounded). The remaining $2,150 ($2,550 − $400) is taxable at the child’s rate ($2,150 × .10) = $215. The two amounts added together equal the son’s liability ($140 + $215) = $355

Question 10

To compute the tax base for AMT, tax preferences must be _____ to taxable income.

Answer 10

Added

To compute the tax base for the alternative minimum tax (AMT), the tax preferences designated in Section 57 must be added to taxable income.

Question 11

Jane Jenkins, a single taxpayer, has the following itemized deductions:

Home mortgage interest (first mortgage) $17,200
Charitable contributions $4,000
State income taxes $8,155
Deductible gambling losses $1,900
Property taxes $1,845
Deductible Margin Interest $4,100
Jane’s AGI for the current year is $245,400. Under the regular tax method Jane is allowed itemized deductions of $37,200. Please note the TCJA of 2017 now limits all tax deductions to a maximum of $10,000 (Under the regular method).

What amount of itemized deductions, if any, would be allowed for purposes of the AMT?

Choose the best answer.

1) $21,200
2) $23,100
3) $25,300
4) $27,200

Answer 11

4) $27,200

All of the above items are deductible under AMT except for taxes (of any kind). $17,200 + $4,000 + $1,900 + $4,100 = $27,200

Question 12

Tom and Julie Munson are married and file a joint income tax return. They have one dependent son, Ross. They have estimated their regular tax to be $15,434 for the current year. Tom and Julie included the following items in calculating their regular tax liability.

Abbreviated Tax Return:

Adjusted gross income - $158,500
Itemized deductions (detailed below) - $48,500
Taxable income - $110,000

Other Issues:

Bargain element on the exercise of an ISO - $30,000
Income from reclass of Completed Contract method to Percentage of Completion method - $14,000

Detail of Itemized Deductions:

Home mortgage interest - $24,000
Property taxes - $6,700
Charitable contributions - $14,500
State Income Tax - $3,300

Using the above example, what is the Munson’s alternative minimum taxable income (AMTI)?
Choose the best answer.

1) $122,000
2) $133,000
3) $154,000
4) $164,000

Answer 12

4) $164,000

Here is what you need to figure out the Munson’s alternative minimum taxable income (AMTI)

Start with taxable income, add preference items and adjustments:

$110,000 Taxable Income

+ $30,000 Bargain Element of an ISO
+ $14,000 Percentage of Completion Adjustment
+$6,700 Property Taxes (not allowed under AMT method)
+$3,300 State Income Tax (not allowed under AMT method)
AMTI = Alternative Minimum Taxable Income = $164,000

OR

Start with AGI $158,500

+ $30,000 Bargain Element of an ISO
+ $14,000 Percentage of Completion Adjustment
- $24,000 Home mortgage interest
- $14,500 Charitable contributions
AMTI = Alternative Minimum Taxable Income = $164,000

Question 13

What are the most common characteristics of taxpayers who are subject to the AMT?

Answer 13

First, taxpayers who have materially invested in real estate before January 1, 1999 are likely candidates for the AMT because they will have a large positive adjustment caused from the differences in depreciation. Second, taxpayers who use credits to reduce their regular tax liability may well be subject to AMT because only certain tax credits can reduce the AMT. Third, taxpayers who have very large itemized deductions, primarily from large state and local taxes, may be subject to AMT because state and local taxes are not deductible for AMT purposes.

Question 14

Marcia Washington, a single taxpayer, has the following itemized deductions:

Home mortgage interest $ 9,920
Charitable contributions $ 4,000
State income taxes $ 5,155
Deductible gambling losses allowed $ 900
Property taxes $ 3,890
Deductible Margin Interest $ 3,100
Marcia’s AGI for 2023 is $345,870. Under the regular tax method Marcia is allowed itemized deductions of $26,965.

What amount of itemized deductions, if any, would be allowed for purposes of the AMT?

1) $9,920
2) $13,920
3) $17,020
4) $17,920

Answer 14

4) $17,920

All of these deductions are allowed under the AMT method except for income taxes and property taxes.

Question 15

Which of the following statements is incorrect?

1) Exclusions permanently increase the alternative minimum taxable income (AMTI).
2) Deferrals are AMT items that form the basis of an AMT credit.
3) Deferrals cause a temporary increase in AMT liability, and will reverse over time.
4) An exercise without the sale of an ISO (Incentive Stock Option) in the same tax year is an example of an AMT exclusion.

Answer 15

4) An exercise without the sale of an ISO (Incentive Stock Option) in the same tax year is an example of an AMT exclusion.

An exercise of an ISO without selling the stock is an example of an AMT deferral. This is a temporary exposure to AMT and will reverse over time by the formation of an AMT credit.

Question 16

Your client, who is in the 35% marginal tax bracket, has just exercised an ISO (Incentive Stock Option) and will definitely be paying tax under the AMT method this year. What is the best advice you can give your client in regard to income and deductions? To the extent possible:

1) The client should defer income and defer deductions
2) The client should accelerate income and accelerate deductions.
3) The client should defer income and accelerate deductions.
4) The client should accelerate income and defer deductions.

Answer 16

4) The client should accelerate income and defer deductions.

AMT has marginal tax rates of 26% and 28% which are lower than 35% so accelerating income into the AMT year and deferring deductions to a marginal tax year of 35% will minimize tax over a two-year period.

Question 17

Dick and Jane Murphy are married and file a joint income tax return. They have one dependent son, Ian. They have estimated their regular tax to be $19,200 for the current year. Dick and Jane included the following items in calculating their regular tax liability.

Abbreviated Tax Return
Adjusted gross income $150,000
Itemized deductions (detailed below) $39,750
Taxable income $110,250

Other Issues
Bargain element on the exercise of an ISO $28,000
Income from reclass of Completed Contract
method to Percentage of Completion method $12,800

Detail of Itemized Deductions
Home mortgage interest $23,150
Property taxes $ 3,000
Charitable contributions $ 7,500
State Income Tax $ 6,100
What is the alternative minimum taxable income (AMTI)?

1) $120,405
2) $135,100
3) $160,150
4) $185,420

Answer 17

3) $160,150

AMTI can be calculated one of two ways:

AGI plus preference items less allowable itemized deductions, or
Taxable income plus preference items plus disallowed itemized deductions.

Therefore:

$150,000 + ($28,000 + 12,800) – (23,150 + 7,500) = $160,150
$110,250 + ($40,800) + ($3,000 + $6,100) = $160,150

Question 18

Complete the following statement: An AMT Credit can be used____.

anytime the AMT liability exceeds the regular tax liability.

1) only in the year, the credit was created.
2) only when the deferral items from which it was created reverse.
3) only when the AMT liability is less than the regular tax liability.

Answer 18

3) only when the AMT liability is less than the regular tax liability.

Question 19

Robert and Doreen are married filing jointly and have calculated their 2024 AMTI to be $1,293,300. How much of an AMT exemption do they have available after the phaseout calculation?

Choose the best answer.

1) $114,650
2) $5,400
3) $92,250
4) $79,100

Answer 19

1) $114,650

The MFJ 2024 is $133,300 and begins to phase out at $1,218,700. For every dollar above $1,218,700, 25% is lost. Therefore, $1,293,300 − $1,218,700 = $74,600 × 25% or $18,650 is lost leaving $133,300 − $18,650 or $114,650 remaining.

Question 20

In 1992 Ellen purchased a house for $60,000 to use as her personal residence. She paid $12,000 and borrowed $48,000 from the local savings and loan company. In 1995 she paid $10,000 to add a room onto the house. In 1997 she paid $625 to have the house painted and $800 for built-in bookshelves. As of January 1 of the current year she has reduced the mortgage to $44,300. What is her basis for the house?

Choose the best answer.

1) $70,800
2) $60,000
3) $58,800
4) $55,100

Answer 20

1) $70,800

$60,000 + $10,000 + $800 = $70,800. Most property is acquired by purchase and therefore its initial basis is the cost of the property. Capital additions increase the basis.

Question 21

On January 1 of the current year, the Orange Corporation issues $500,000 of 11%, 20-year bonds for $480,000. Determine the amount of original issue discount, if any?

Answer 21

There is no original discount since the discount of $20,000 is less than $25,000 (.0025 × $500,000 × 20 ).

The OID is considered zero if the amount of discount “is less than ¼ of 1% of the stated redemption price at maturity, multiplied by the number of complete years to maturity”

Question 22

The basis of property received as a gift is generally the same as the ___________ basis.

Answer 22

Donor’s

The basis of property received as a gift is generally the same as the donor’s basis

Question 22

Ruben and Sandra are married and live in Louisiana, a community property state. They jointly own real property with an adjusted basis of $300,000. When the property has a FMV of $500,000, Ruben dies leaving all of the property to Sandra. What is her adjusted basis in the property?

Choose the best answer.

1) $300,000
2) $400,000
3) $500,000
4) $550,000

Answer 22

3) $500,000

Both her portion and Ruben’s portion get a step up in basis to $500,000 because they are in a community property state.

Question 23

Are all realized gains and losses recognized for tax purposes?

Answer 23

It is sometimes incorrectly believed that all realized gains and losses are recognized for tax purposes. Although most realized gains are recognized, some realized losses are not. For example, losses on the sale or exchange of property held for personal use cannot be recognized.

Question 24

To calculate adjusted basis, you take initial basis and ___ the capital additions and subtract capital recoveries.

Answer 24

Add

To calculate adjusted basis, you take initial basis and add the capital additions and subtract capital recoveries

Question 25

If an investor does not specify when securities are being sold, the LIFO method will be used.

Choose the best answer.

True
False

Answer 25

False

If an investor does not specify when securities are being sold, the FIFO method will be used. With this method, the stock sold or exchanged is presumably from the first acquired lots. While LIFO is a bona-fide accounting method for inventory valuation, LIFO per say does not exist for the sale of capital assets (LIFO is really a subset of the specific identification method).

Question 26

In 20X2, Jose purchased 100 shares of common stock in Black Corporation for $5,280. In 20X3, Black declared a stock dividend of 1 share of its common stock for each 10 shares held. This year, Black’s common stock split 2 for 1 at a time when the FMV was $80 a share. What is Jose’s basis in each of his shares of the Black Corporation stock if both distributions were tax-free?

Choose the best answer.

1) $80 per share
2) $48 for 110 shares and $0 for additional shares
3) $52.80 for 100 shares and $0 for all additional shares
4) $24 per share

Answer 26

4) $24 per share

$5, 280/ (100+10+110 shares) = $24

Question 27

Four years ago, Diana Jackson purchased a warehouse for her retail business at a cost of $290,000. She paid $6,000 in legal fees associated with the acquisition. She paid $14,500 to renovate the loading dock. She has paid $29,000 for property taxes and $22,500 for utilities during the four years. She has taken cost recovery deductions of $28,000. What is Diana’s current adjusted basis in the warehouse?

1) $256,000
2) $262,000
3) $282,500
4) $311,500

Answer 27

3) $282,500

Her original cost, plus the legal fees, plus the renovation, less the cost recovery equals her adjusted basis. ($290,000 + $6,000 +14,500 - $28,000 = $282,500). Please note that the property tax and utilities are expenses and do not affect capitalization and the basis.

Question 28

Six months ago, Jim’s Aunt Beatrice gave Jim 1,000 shares of ABC stock. At the time of the gift, the fair market value (FMV) was $40,000. Beatrice had bought the stock seven years ago for a total cost of $18,000. There were no gift taxes paid on the gift at the time of the transfer. If Jim sold the stock today for a total price of $15,000, what is the taxable gain to Jim and is it a long-term or short-term gain?

1) $3,000 loss, long-term
2) $3,000 loss, short-term
3) $25,000 loss, long-term
4) $25,000 loss, short-term

Answer 28

1) $3,000 loss, long-term

Since the FMV was greater than the donor’s basis at the time of the transfer, the donee takes the donor’s basis as well as the donor’s holding period.

Question 29

Ten months ago, Jim’s Aunt Beatrice gave Jim 1,000 shares of DEF stock. At the time of the gift, the fair market value (FMV) was $30,000. Beatrice had bought the stock seven years ago for a total cost of $38,000. There were no gift taxes paid on the gift at the time of the transfer. If Jim sold the stock today for a total price of $44,000, what is the taxable gain to Jim and is it a long-term or short-term gain?

1) $6,000 gain, long-term
2) $6,000 gain, short-term
3) $14,000 gain, long-term
4) $14,000 gain, short-term

Answer 29

1) $6,000 gain, long-term

Since the FMV was less than the donor’s basis at the time of the transfer, the donee takes the donor’s basis (and donor’s holding period) only if the asset is sold for more than the donor’s basis. In this case $44,000 is greater than $38,000 so the gain is $6,000 and the holding period is long-term.

Question 30

Five months ago, Jim’s Aunt Beatrice gave Jim 2,500 shares of GHI stock. At the time of the gift, the fair market value (FMV) was $69,000. Beatrice had bought the stock ten years ago for a total cost of $19,000. Beatrice paid $20,000 in gift taxes at the time of the transfer, and in so doing, took advantage of the full $18,000 annual exclusion. If Jim sold the stock today for a total price of $77,000, what is the taxable gain to Jim and is it a long-term or short-term gain?

1) $38,000 gain, long-term
2) $38,400 gain, long-term
3) $39,763 gain, long-term
4) $39,763 gain, short-term

Answer 30

2) $38,400 gain, long-term

Since the FMV ($69,000) was more than the donor’s basis at the time of the transfer ($19,000), the donee takes the donor’s basis (and the donor’s holding period). In this case, however, the donee will get the benefit of an additional basis due to the gift taxes that were paid by the donor ($20,000). The taxable gift (FMV $69,000 − $18,000 annual exclusion) is $51,000. The appreciation of the gift ($69,000 − $19,000) = $50,000. The appreciation is then divided by the taxable gift ($50,000/$51,000) which is a factor of 98%. The factor percentage times the gift taxes paid ($20,000 × .98) equals $19,600. That amount is then added to the donor’s original basis of $19,000 for a total basis to the donee of $38,600, which generates a long-term gain of $38,400 ($77,000 − $38,600).

Question 31

Eight months ago, Jim’s Aunt Beatrice gave Jim 1,000 shares of XYZ stock. At the time of the gift, the fair market value (FMV) was $32,000. Beatrice had bought the stock seven years ago for a total cost of $35,000. Beatrice paid $6,400 in gift taxes at the time of the transfer, and in so doing, took advantage of the full annual exclusion. If Jim sold the stock today for a total price of $45,000, what is the taxable gain to Jim and is it a long-term or short-term gain?

1) $3,600 gain, long-term
2) $3,600 gain, short-term
3) $10,000 gain, long-term
4) $10,000 gain, short-term

Answer 31

3) $10,000 gain, long-term

Since the FMV was less than the donor’s basis at the time of the transfer, the donee takes the donor’s basis (and donor’s holding period) only if the asset is sold for more than the donor’s basis. In this case, $45,000 is greater than $35,000 so the gain is $10,000 and the holding period is long-term. Please note that even though gift taxes were paid by the donor, they do not apply in this case because at the time of the gift the FMV was less than the donor’s basis, i.e. no appreciation in the asset.

Question 32

Non-business bad debt losses are deducted as a ____ ____capital loss.

Answer 32

short-term

Bad debt losses from non-business debts are deductible only as short-term capital losses. It is only deductible in the year in which the debt becomes totally worthless.