Income Tax Planning | Lesson 2: Basic Income Tax Flashcards
Matthew had the following income and expenses for the current year: • Salary - $30,000 • State of Nevada bond interest - $4,000 • Gift of property from his uncle - Fair market value: $30,000; Uncle's basis: $3,000 • Student loan interest - $5,000 • Medical expenses - $6,000 • Roth IRA contribution - $2,000 Calculate Matthew's AGI for the current year. a) $19.000 b) $25.000 c) $27,500 d) $31.500
Answer: C
Salary of $30,000 - $2,500 student loan interest = $27,500. The State of Nevada BondS are municipal bonds and are not taxable. The gift is not taxable. The medical expenses are itemized deductions. The Roth IRA contribution is not deductible. Student loan interest is only deductible up to $2,500.
Madison had the following income and expenses in the current year.
• Salary - $22,000
• Child support received - $6,000
• Alimony received from 2016 divorce- $10,000
• Personal injury award from an auto accident. She lost the use of her left hand and was awarded damages of $200,000. She also received $50,000 in punitive damages and $30,000 for mental distress, of which $5,000 was used for counseling.
• Paid property tax of - $3,000
• Paid personal residence interest of - $9,000
Calculate Madison’s gross income for the current year.
a) $82,000
b) $95.000
c) $107,000
d) $285.000
Answer: C
Salary of $22,000 + Alimony of $10,000 + $50,000 in punitive damages and $25,000 in mental distress = $107.000.
Child support is not taxable. The personal injury award is not taxable; however, the punitive damages are. The award for mental distress is only excluded to the extent the money was used to pay medical bills. The property tax and residence interest are itemized deductions. Alimony is taxable since the agreement is pre 12/31/18.
Mark had an awful year. He recently learned that his wife, Abigail embezzled $300,000 from her employer this year. The employer has not yet identified the embezzlement, and Abigail has no intention of paying it back. After this occurred, Mark went into a deep depression and began using illegal drugs. For a short time, Mark sold illegal drugs to maintain his habit. He estimates that he earned roughly $40,000 selling drugs. However, he spent $30,000 manufacturing them and $2,000 in bribes to police officers. After a run-in with a local gang, Mark decided he better straighten up. He and Abigail began couples counseling to work on their problems. Although it cost them $7,000 in medical expenses, Mark determined why Abigail had resorted to embezzlement. She had been gambling on the weekends and had lost $250,000. She claims the thrill of winning kept her in the game, although she only won $2,500. Assuming Mark and Abigail file married filing jointly, what is their AGI?
a) $42,500
b) $53.500
c) $312,500
d) $340,000
Answer: C
$300,000 in embezzled funds + $40,000 in illegal drug sales - $30,000 in cost of goods sold + 2,500 in gambling winnings = $312,500. For illicit drug business, he must include the income, but he may deduct the cost of goods sold. The bribes are against public policy and may not be deducted.
Olivia provided support for the following individuals. She provided greater than 50% of their support unless otherwise noted.
• Her 10-year-old son lived in her home for three months out of the year. For the remainder of the time, he was enrolled in a boarding school for exceptionally bright individuals and lived in the school’s dorm.
• Her 25-year-old daughter lived in the home for the entire year. She is enrolled at the local university and is a full-time student. She earned $1,500 completing online paid surveys.
• Her ex-husband lived in the home for the entire year. They were divorced on January 15, but they have maintained a civil relationship for the sake of their children. He does not work.
• Olivia’s mother is currently living in an assisted living facility. Olivia pays for 25% of her support, and Olivia’s sister pays for the other 25%. Olivia’s mother provides the remaining 50%. Olivia and her sister agree that allows Olivia to claim the mother as a dependent if she qualifies.
How many of the above can be claimed for the child tax credit or family tax credit on Olivia’s 1040?
a) 0
b) 1
c) 2
d) 4
Answer: C
The ten-year-old son would qualify for the $2,000 child tax credit. The 25-year-old daughter qualifies for the $500 family tax credit. The family credit can include children over the age of 17 who are college students and others who meet the definition of dependent. Taxpayers nor spouses can count towards these credits. Olivia’s mother would not count; she does not meet the definition of dependent since Olivia is not providing 50% of her living expenses. Ex-spouses cannot be claimed as dependent family members.
Ethan, age 17, had a total income of $20,000 for 2022 - $10,000 was from his paper route, $3,000 was from local city bonds, and $7,000 was dividends from investments. How much of his income will be taxed to him at his rate?
a) $1.900
b) $2,300
c) $10.000
d) $18.850
Answer: A
$10,000 + 7,000 = $17,000 in gross income. The local bonds are municipal bonds and are not taxable. His standard deduction is the greater of $1,150 or earned income plus $400 limited to $12,950; in this case, $10,400 is his standard deduction. Step 1 - work with the unearned income: $7,000 - the $1,150 standard deduction for unearned income, leaving $5,850. The next $1,150 of unearned income is taxed at the child’s rate (single tax filer rate), leaving $4,700 taxed at the parent’s rate (SECURE Act 2019).
Step 2 - work with the earned income: $10,000 - the remaining standard deduction of $9,250 (10,400 - $1,150 used against unearned income), leaving $750 taxed at the child’s rate. In total, Ethan will have $10,400 ($1,150 + 9,250) of the standard deduction, $1,900 ($1,150 + 750) taxed at the child’s rate, and $4,700 taxed at the parent’s rate.
Daniel is a cash-basis taxpayer. Which of the following items must be included in his gross income calculation for the current year?
a) Earnings from Series EE bonds.
b) Business income earned on Dec. 15 of the current year. The client mailed a check on December 29 of the current year. The check arrived in Daniel’s mailbox on January 2 of the following year.
c) Business sale to customer made on Oct. 15. Daniel extended the payment date, and the client has yet to pay the sales price.
d) Original issue discount on the bonds for the current year.
Answer: D
Earnings on EE bonds can be delayed until redeemed or matured. Since he is a cash-basis taxpayer, Daniel does not have to include the business income until the year in which the check is received. The account receivable will not be incorporated until paid. The original issue discount must be included in the current year’s income.
Anthony made a loan to his daughter Sophie. The applicable federal rate for this type of loan is 5.5%. Anthony has a net investment income of $30,000, while Sophie has a net investment income of $900. The loan was for $50,000 so that Sophie could make the down payment on her new home. Anthony is charging Sophie 2% interest on the loan. Which of the following is correct?
a) The interest on the loan will not be imputed!
b) The interest on the loan will be imputed at 5.5% of the loan.
c) The interest on the loan will be imputed at 3.5% of the loan.
d) The interest on the loan will be imputed at a maximum of $900.
Answer: A
Since the loan is less than $100,000 and Sophie has an investment income of less than $1,000, interest is not required to be imputed.
Elizabeth purchased an annuity in 2016. She paid $75,000 for the annuity. She will now receive a life annuity of $1,000 per month. Elizabeth is expected to live for I0 years. Which of the following is true?
a) She will include $625 of each payment for the entire annuity payment.
b) She will include $375 of each payment until the total basis has been excluded.
c) She will exclude 100% of each payment until the total basis has been excluded.
d) She will include $250 of each payment until the total basis has been excluded.
Answer: B
Elizabeth’s annuity payment will be partially included in her income until she has utilized all of her capital. The inclusion formula is (Expected Total Payment - Basis)/Expected Total Payment) x Monthly Payment =
Inclusion amount.
[($120,000 - $75,000) ÷ ($1,000 x 12 x 10)] x $1,000 = $375
She will continue to include this amount until the entire basis has been excluded. At that point, she will include 100% of each payment.
Joseph and Alexis had the following income and expenses for the year:
• Joseph had a salary of $75,000
• Joseph’s employer provides him with a group term life insurance policy for two times his salary. The policy premium paid by the employer is $150 per year. Table 1 amount is $0.10.
• Alexis had a salary of $10,000 and unemployment compensation of $18,000.
• Alexis won $1,500 on a game show.
What is Joseph and Alexis’ joint gross income?
a) $86.500
b) $94,620
c) $104.620
d) $104,650
Answer: C
All items will be included in the income. The premium on the insurance policy will be included as follows: [($75,000 x 2) - $50,000] ÷ 1,000 x .10 x 12 = $120 inclusion. The amount the employer actually pays is irrelevant.
$75.000 + $120 + $10,000 + $18,000 + $1,500 = $104,620
Sarah had the following losses in the current year (no disaster declaration by the President):
• Termite damage to her home. The fair market value of the house before the damage was $250,000. The fair market value after the damage was $225,000. Sarah’s basis on the property is $200,000.
• Her car was broken into, and they stole her camera. The camera had a basis of $1,500 and a fair market value of $1,000. She received $200 in insurance proceeds.
• There was a fire on Sarah’s boat. The fire caused a $10,000 decline in value. Sarah’s basis on the property was 6,000. Sarah received $1,000 in insurance proceeds.
Sarah’s AGI is $30,000. What is her available casualty loss for the current year?
a) $0
b) $2.700
c) $27,600
d) $31.300
Answer: A
The termite damage is, by statute, not a casualty loss.
Without a disaster declaration, casualty losses are no longer deductible (TCJA2017).
Alyssa, a self-employed CFP professional, wanted to go to Hawaii for vacation. Being very creative, she decided to schedule several business meetings while she was there to deduct the expense as a business trip. She left her home on Friday, organized three business meetings for the following Wednesday, and returned home the following Monday. Which of the following is true?
a) She cannot deduct it as a business expense.
b) She can deduct one night of a hotel and one day of meals as a business expense.
c) She can deduct all travel, one night of a hotel, and one day of meals as a business expense.
d) She can deduct all travel, hotel, and meals as a business expense.
Answer: B
This trip is domestic. Therefore, the travel is only deductible if the trip is primarily for business. This trip is for pleasure; therefore, the travel is not deductible. The one night in a hotel and the one day of meals will be deductible since she did work for one day.
Tyler has lived and worked in Florida for 30 years. He was divorced recently and decided he needed a change of scenery. He applied for and was offered a job in California. Tyler had the following expenses related to the move:
• House hunting expenses - $5,000
• Moving truck service - $12,000
• Driving his car from Florida to California - $1,000 (the trip was 1,500 miles)
Lodging en route - $800
• Lodging at a hotel in California while he was unpacking - he couldn’t take the mess! - $300
• Meals en route - $250
• New driver’s license in California - $35
• Ticket for speeding en route - $250
Tyler’s new employer reimbursed him for $10,000 in moving expenses. Tyler’s salary for the year was $200,000. What is Tyler’s AGI?
a) $195.365
b) $196.200
c) $200,000
d) $210,000
Answer: D
The house-hunting expenses, lodging while unpacking, meals, new driver’s license, and ticket for speeding was never deductible. Per TCJA, moving expenses are no longer deductible, so the reimbursement must be included in income. Since the employer reimbursed him for $10,000 of the expenses, he must include that in his income. Thus, his AGI is $210,000 ($200,000 + $10,000).
Natalie and her husband James have been married for 25 years. They have three children, Chloe, age 18; John, age 16; and Brianna, age 8. Natalie and James have a combined salary of $150,000. During the year, the family had the following expenses:
• Brianna attends a private boarding school for gifted children. She has an extremely high IQ. The cost of the school is $40,000 and includes lodging and meals.
• John had an illegal drug problem during the year. He attended a drug rehabilitation program that cost $5,000.
• Chloe gave birth to a baby named Nathan, after Chloe’s grandfather. The cost of the delivery was $9,000. The baby’s father has not been involved; Natalie and James provide all of the support for the new baby.
• After Nathan was born, the family spent $600 on bottled water to mix with formula, $2,000 on a diaper service, and $200 on nonprescription drugs
What are Natalie and James’ taxable income for 2022?
a) $111,700
b) $111.950
c) $113.000
d) $124.100
Answer: D
This question is complicated because you must determine whether they can itemize or use the standard deduction. The school was not medically necessary.
If they select the standard deduction, their taxable income would be $150,000 - $25,900 = $124,100.
Jason was injured in an accident. He now has quadriplegia. He installed an elevator in his home to reach the second floor. The elevator cost was $10,000, and the increase in value attributable to the elevator was $4,000. He also had exit ramps built, the hallways widened, and bathroom fixtures lowered for $20,000. The increase in value of the home was $1,000. Jason’s income for the year is $25,000. What is Jason’s available deduction for medical expenses?
a) $0
b) $23.500
c) $24,125
d) $27,500
Answer: C
Capital improvements can be deducted as a medical expense. The general rule is that the cost less the increase in value of the home is an eligible deduction. However, certain expenditures that allow a physically disabled person to live independently are not reduced by increasing the home’s value. This includes exit ramps, widening of hallways, and lowering of bathroom fixtures but not elevators. Thus the medical deduction is: ($10,000 - $4,000 + 20,000) - (7.5% x25,000) = $24,125
Lauren has a salary of $50,000. She made an eligible contribution to her HSA. She had a casualty loss when her home was destroyed by fire. And she incurred medical expenses for a weight-loss program because she was morbidly obese. Which of the following is true?
a) The contribution to the HSA is an above-the-line deduction.
b) The casualty loss is an above-the-line deduction.
c) The medical expense is an above-the-line deduction.
d) She does not have any above-the-line deductions
Answer: A
The contribution to the HSA is an above-the line-deduction. The other expenses are itemized deductions, also referred to as below-the-line deductions.
