Module 2 Investment Vehicle Taxation, NII, Additional Medicare Tax and Education Planning

Question 1

Lauren has investment interest expense from her margin account of $9,000. She had municipal bond interest income of $3,000, corporate bond interest income of $5,000, and qualified dividends of $2,000. She has elected to use her available 15% capital gain tax rate on the dividends. What is her investment interest deduction?

A)
$7,000
B)
$9,000
C)
$12,000
D)
$5,000

Answer 1

d Lauren is limited to a $5,000 investment interest deduction or only the amount of taxable bond interest, which is her investment income. She may not offset qualified dividend income for which she elected the long-term capital gain rate, nor can she offset nontaxable municipal bond interest with an investment interest deduction.

LO 2.2.1

Question 2

Hardship withdrawals are only allowed from Section 401(k) plans if specifically stated in the plan document and typically for expenses including which of the following?

Vacation costs
Medical expenses
College tuition costs
Insurance premiums
A)
II and III
B)
I and III
C)
I and II
D)
II, III, and IV

Answer 2

a Hardship withdrawals are typically allowed for medical expenses, college tuition and fees, the purchase of a principal residence, burial expenses for a spouse or dependents, and to prevent eviction from one’s principal residence or foreclosure on the mortgage of such residence.

LO 2.4.1

Question 3

Which one of the following statements about life insurance products and their tax attributes is CORRECT?

A)
Deferred annuities owned by a corporation are eligible for tax-deferred accumulation.
B)
If a person purchased a life and 20-year term-certain immediate annuity at age 50, there would be no premature distribution penalty.
C)
Permanent life insurance owned by a pension plan is 100% income tax free to the beneficiary of the plan.
D)
Modified endowment contracts (MEC) do not provide a tax-free death benefit if the policyholder dies before age 59½.

Answer 3

b An immediate annuity is one that is purchased by a single payment (premium), where payments commence no later than one year from the contract date, and which provides for a series of substantially equal periodic payments (paid at least annually). As such, immediate annuities avoid the 10% premature withdrawal penalty. Death benefit tax status of a MEC is the same as for any other non-MEC contract. Non-death-benefit distributions from a MEC will most likely be taxable as ordinary income to the extent that the cash surrender value exceeds the investment in the contract. With some exceptions, annuity contracts owned by a corporation are not treated as an annuity for tax purposes; thus the annual increase in value is subject to income tax. Part of the death benefit paid from life insurance owned by a pension may be taxable. Normally, any amount in excess of the cash value will be treated as death proceeds from a life insurance policy, and amounts equal to the cash value will be treated as a pension plan distribution. Nonperiodic (lump-sum) distributions from deferred annuity contracts issued after August 14, 1982, are treated on a last-in, first-out (LIFO) basis—taxable earnings are first distributed.

LO 2.1.1

Question 4

Which of these is the threshold on earnings for the additional Medicare tax for a single taxpayer?

A)
$250,000
B)
$200,000
C)
Unlimited
D)
$127,200

Answer 4

b Single taxpayers are subject to the additional Medicare tax when earned income exceeds $200,000 in the tax year.

LO 2.3.1

Question 5

A taxpayer intends to use a home equity loan to obtain funds to purchase municipal bonds. Which of the following is CORRECT regarding the income tax implications of this scenario?

A)
None of these choices apply.
B)
The interest on the home equity loan is not deductible.
C)
The municipal bond interest becomes taxable.
D)
The interest on the home equity loan is fully deductible.

Answer 5

b The interest on the municipal bond continues to be tax exempt. There is no deduction allowed for the interest on funds borrowed to purchase tax-exempt securities.

LO 2.2.1

Question 6

Larry and Mary are married taxpayers filing a joint tax return. In 2023, their AGI is $360,000, and their investment income (included in the AGI) is $100,000. They have investment interest expense of $7,000 and state income taxes attributable to the investment income of $5,000. What is the amount of Medicare contribution tax that they must pay?

A)
$3,800
B)
$3,344
C)
$3,534
D)
$4,180

Answer 6

b They will pay the 3.8% Medicare contribution tax on $88,000. This is the lesser of the net investment income ($100,000) or the AGI in excess of the threshold amount ($360,000 – $250,000, or $110,000). The net investment income is the investment income of $100,000, reduced by the allowable investment expenses of $12,000. In this situation, all $88,000 of the net investment income is subject to the Medicare contribution tax. Larry and Mary will pay a $3,344 Medicare contribution tax (3.8% on $88,000).

LO 2.3.1

Question 6

Your client is contemplating the sale of some of her holdings in her employer’s stock. The stock was acquired in four separate purchases as follows:

Purchase Date Shares Cost Per Share Cost
June 1, 1997 200 $10 $2,000
June 1, 1999 200 $18 $3,600
June 1, 2001 200 $12 $2,400
June 1, 2007 200 $20 $4,000
Total 800 $12,000
What is the least amount of gain she would be required to report if she sold 500 shares for $12,500?

A)
$500
B)
$3,700
C)
$4,300
D)
$5,000

Answer 6

b

To minimize the taxable gain, we would choose the shares with the highest cost basis. Thus we would sell the 200 shares that have a basis of $20 each, 200 of the $18 basis shares, and 100 of the $12 basis shares. This gives an aggregate basis of $8,800, resulting in a (long-term capital) gain of $3,700. The ability to use specific identification was not impacted by the Tax Cuts and Jobs Act (TCJA).

LO 2.1.3

Question 7

Which one of the following does NOT correctly state a characteristic of a commercial annuity?

A)
An annuity is a contract in which investments are made in exchange for a promise of regular frequent payments for the rest of a taxpayer’s life or for a fixed period of time.
B)
An annuity payment is generally part return of capital and part interest payment.
C)
With an annuity, there is a maximum annual contribution per year, which is adjusted yearly for inflation.
D)
Annuity contracts may vary regarding the payment time period and the frequency of the payments.

Answer 7

c. There is no set maximum annual contribution that may be made to a commercial annuity.

LO 2.1.2

Question 7

Gabe files as married filing jointly with his wife, Monica. It is September of the current year and his year- to-date compensation working at Jack Sprat, Inc., is $225,000 for this last payroll period. How much of his compensation is subject to payroll tax withholding for the additional Medicare tax so far this year?

A)
$0
B)
$200,000
C)
$25,000
D)
$225,000

Answer 7

c. Even though taxpayers who file as married filing jointly do not incur the additional Medicare tax until their income exceeds $250,000, employers are required to begin withholding the tax when an employee first has compensation exceeding $200,000, disregarding the employee’s filing status. The 0.9% tax is withheld on the excess above $200,000, in this case $25,000.

LO 2.3.1

Question 7

Three years ago, Myla received a gift of 100 shares of public utility stock from her aunt. The fair market value of the stock on the date of the gift was $20 per share. Her aunt had purchased the stock six years earlier at $6 per share. Myla sold this stock for $24 per share last week.

What was Myla’s basis in the stock when she sold it?

A)
$20 per share
B)
$24 per share
C)
$6 per share
D)
$14 per share

Answer 7

c

The only time that the gifted asset takes the sale price as the basis is when the fair market value on the date of the gift is less than the donor’s basis and the asset is sold at a price between the fair market value on the date of the gift and the donor’s basis.

LO 2.1.3

Question 8

All of the following deductions are allowable in arriving at adjusted gross income except

A)
qualifying contributions to Keogh-qualified and self-employed tax-advantaged plans.
B)
student loan interest (limited).
C)
alimony paid.
D)
100% of self-employment tax paid.

Answer 8

d

The deduction for self-employment tax paid is generally limited to the calculated employer share, or 50%, not 100%.

LO 2.4.1

Question 8

Ryan and Jeanie Hill are married and file a joint income tax return. Their AGI (without the student loan interest deduction) is $115,000. They properly claim their son, Anthony, a full-time student, as a dependent. Anthony has incurred student loan debt over the years and is the sole borrower on the loans. Ryan and Jeanie made all the student loan payments during the year and paid $3,100 of student loan interest in the current year. Anthony’s AGI (without the student loan interest deduction) is $8,000.

Which of the following is CORRECT regarding the student loan interest deduction?

A)
Anthony may deduct $2,500 of student loan interest.
B)
Ryan and Jeanie may deduct $3,100 of student loan interest.
C)
Ryan and Jeanie may deduct $2,500 of student loan interest.
D)
No one may deduct the student loan interest.

Answer 8

d

The maximum student loan interest deduction is $2,500 for a given year. However, the deduction may only be taken by the taxpayer legally obligated to make the payments. In addition, a taxpayer who may be claimed as a dependent on another’s return may not claim the student loan interest deduction.

LO 2.4.1

Question 9

Which of the following rates apply to qualified dividends that fall above the $553,850 (2023) taxable income breakpoint for a married couple filing jointly (MFJ)?

A)
15%
B)
25%
C)
20%
D)
28%

Answer 9

c

Qualified dividends (and net long-term capital gains) that fall into the taxable income above $553,850 (for MFJ) are taxed at a 20% rate.

LO 2.2.2

Question 10

Rob Buckingham has an investment interest expense carryforward of $3,500 from a prior tax year. For the current tax year, he has an AGI of $75,000, $4,000 of investment interest expense, and $9,500 of investment income. He has investment adviser’s fees of $5,000. How much investment interest expense, if any, may Rob deduct in the current tax year?

A)
$4,000
B)
$3,500
C)
$6,000
D)
$7,500

Answer 10

d

Investment interest expense is deductible up to the amount of investment income. The investment income is $9,500. Rob has total investment interest expense of $7,500. All of that is currently deductible.

LO 2.2.1

Question 10

James and Julie are a married couple filing jointly. For the 2023 tax year, they have a taxable income of $400,000. Included in the taxable income is $35,000 of net long-term capital gains from the sale of securities and $15,000 of qualified dividends.

At what tax rate will their net capital gains and qualified dividends be taxed?

A)
25%
B)
0%
C)
20%
D)
15%

Answer 10

d

The long-term capital gains and qualified dividends are taxed at 15%. The long-term capital gains and qualified dividends fall into the taxable income range of $89,250 to $553,850 (2023) for a married couple filing jointly.

LO 2.2.2

Question 11

Ken Brandt (a single taxpayer), age 28, holds the following securities:

Stock Purchase Date Fair Market Value Cost Basis
ABC (300 shares) Oct. 3, 2004 $12,200 $5,500
DEF (500 shares) Feb. 15, 2022 $22,600 $15,600
GHI (100 shares) June 2, 2007 $4,350 $6,250
LMN (700 shares) Dec. 9, 2021 $19,360 $28,560
XYZ small-cap fund (500 shares) Oct. 20, 2012 $1,200 $3,700
VWL (750 shares, §1244) July 17, 2006 $4,050 $115,600
Bonds Purchase Date Fair Market Value Cost Basis
EE savings bonds May 1, 2013 $8,500 $6,000
Ken wants to sell the XYZ fund shares to lock in the $2,500 loss, but he is also considering buying 500 shares of the same fund the following week because he believes that the value is going to increase significantly over a period of years. As his planner, what can you accurately tell Ken about this scenario?

A)
The loss would be a fully deductible capital loss.
B)
The basis in the newly acquired shares would be the amount paid for those shares, increased by the $2,500 disallowed loss.
C)
He should wait a minimum of 60 days after the sale to repurchase the shares so that the loss may be recognized.
D)
If he purchases shares in Alpha Growth Mutual Fund within 30 days after sale of the old shares, the $2,500 loss would be disallowed.

Answer 11

b

The wash sale rule disallows a loss if substantially identical securities are purchased before 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the amount of the disallowed loss. Securities from a different issuer or obligor generally are not considered substantially identical.

LO 2.1.3

Question 11

Which of the following benefits provided by an employer is taxable to its employees?

A)
A company car is used for personal mileage by an employee.
B)
Meals provided on the employer’s premises that allow employees to attend a job related education seminar.
C)
Undergraduate and graduate education assistance, up to a maximum of $5,250.
D)
Expenses for qualifying work-related education of the self-employed.

Answer 11

a

Personal use of a company car is a taxable fringe benefit. The other education benefits listed are specifically excluded by the Code.

LO 2.4.1

Question 11

Five years ago, Greg Young, age 55, purchased a deferred annuity that is estimated to pay him $900 per month for the rest of his life, beginning at age 65. His investment in the contract was a one-time payment of $150,000. The assumed rate of return on the contract is 4%.

Which one of the following is an income tax implication of the deferred annuity for Greg?

A)
Withdrawals in a nonperiodic distribution are first allocated to the tax-free investment in the annuity.
B)
The annuitized distribution amount consisting of Greg’s investment in the contract is a tax-free return of capital.
C)
Tax-free nonperiodic distributions are allowed for education or family illness.
D)
Earnings within the annuity are taxable in full each year to Greg as ordinary income.

Answer 11

b

A nonperiodic distribution or withdrawal from a post-August 13, 1982, annuity contract is treated on a last-in, first-out (LIFO) basis. In other words, to the extent that the cash surrender value exceeds the investment in the contract, taxable interest income is treated as being withdrawn first. There are no provisions that allow for a tax-free withdrawal for education or illness. The earnings on the investment in a commercial annuity are deferred—there is no current taxation on the earnings within the contract as long as an individual is the owner (or treated as an owner) of the contract.

LO 2.1.2

Question 12

Charles wants to invest $20,000 to generate income taxable at the capital gain rates and not at ordinary income tax rates. He will hold any investment for at least 18 months. Which of the following investments would achieve Charles’s goal?

Buy an office building and rent space to others.
Buy stock in a Fortune 500 company.
Purchase a quality artwork with appreciation potential.
Purchase a speedboat for personal use only.
A)
II and IV
B)
II and III
C)
I and III
D)
I, II, III, and IV

Answer 12

b

Statements II and III are correct. Any qualified dividends on the stock will be taxed at LTCG rates. A sale of the stock or the investment painting after the 18-month holding period will generate either a LTCG or a LTCL depending on the sale price. Rental income is taxed at the ordinary income tax rate. A speedboat for personal use will not generate any income and will likely decrease in FMV 18 months later.

LO 2.2.2

Question 12

John Wallace is the beneficiary of a $300,000 insurance policy on his wife’s life. John elects to receive $25,000 per year for 15 years rather than receive a lump sum. Of the $25,000 received each year,

A)
$25,000 is excluded.
B)
$25,000 is taxable.
C)
$20,000 per year is taxable.
D)
$20,000 is tax free.

Answer 12

d

The proceeds received under a settlement option are treated as an annuity for income tax purposes. We would thus calculate the exclusion amount for the annuity. The $300,000 death proceeds are divided by the 15-year payout to provide $20,000 per year that is tax free. The remaining $5,000 per year is taxable interest income.

LO 2.1.1

Question 12

You are working with new financial planning clients, Dan and Patrice Harden, on educational funding issues for their three dependent children. Dan and Patrice will file jointly this year, as they have always done, and anticipate an AGI of $110,000. Their oldest child, Ben, age 23, is in his first year of graduate school studying to be a pharmacist. Ben graduated from college in three years, so the American Opportunity Tax Credit was claimed for three years of Ben’s education. Their middle child, Margaret, age 19, had a conviction for felony drug possession last year. She’s “cleaned up her act” and will be a full-time student at a community college this year. Their youngest child, Francis, age 7, is a good kid who wants to be a doctor when he grows up.

Which of the following statements concerning educational tax credits and incentives is CORRECT?

Ben and Margaret would each qualify for the American Opportunity Tax Credit (AOTC).
Ben and Margaret would each qualify for the Lifetime Learning Credit.
Dan and Patrice may make a contribution to a Coverdell account for Francis.
Only Ben would qualify for the Lifetime Learning Credit.
A)
II only
B)
II and III
C)
I and III
D)
III and IV

Answer 12

b

Ben and Margaret both qualify for the Lifetime Learning Credit. The Lifetime Learning Credit may be claimed for graduate studies, and may be claimed for a child with a felony drug conviction. Note that the Lifetime Learning Credit would allow a total of $10,000 of education expenses to be utilized on Dan and Patrice’s tax return. (The Lifetime Learning Credit limitation of $10,000 is applied per return, whereas the AOTC limitation of $2,500 is per student.) The parent(s) who claims a child as a dependent is entitled to take the tax credit for the educational expenses of the child. The AGI is under the phaseout thresholds for the Lifetime Learning Credit. Even though the AOTC may generally be claimed for four years, Ben does not qualify for the AOTC because it may not be claimed for graduate work, only the first four years of undergraduate work. The AOTC may not be claimed for a child who has a felony drug conviction, so Margaret does not qualify for the AOTC. Dan and Patrice may make a Coverdell contribution for Francis, because their AGI does not exceed the phaseout limit of $190,000 to $220,000 for a married couple filing jointly. (The AGI limitations will be provided on the examination.)

LO 2.4.1

Question 13

Your clients, Jason and Marcela, have a 6-year-old daughter, Michelle. They want to start a savings plan for Michelle's college education. You are convinced that a Section 529 plan is the best option for Michelle's college education. What can you accurately tell Jason and Marcela about the 529 plan? A) The maximum annual contribution to a 529 plan is currently $17,000. B) Jason and Marcela would be able to change the investment mix within a particular 529 plan only once per year. C) There is ordinary income treatment and a 10% penalty on all 529 distributed funds that Michelle doesn’t use for education. D) Qualified higher-education expenses include tuition, fees, books, special needs services, and room and board if Michelle is at least a half-time student.

Answer 13

d The $17,000 amount is the annual gift tax exclusion amount. While there is generally no annual maximum contribution, gifts of up to five times the annual gift tax exclusion may be made in a single year, essentially without gift tax implications. Funds not used for education may be rolled over to another beneficiary who is a family member. In addition, the ordinary income treatment and penalty would apply only to the earnings distributed. The investment mix within a 529 plan may be changed twice per calendar year. Qualified higher-education expenses (QHEE) include tuition, fees, books, equipment necessary for enrollment, and special needs services. In addition, room and board expenses are QHEE for a student who is at least half time. Expenses for the purchase of computer or peripheral equipment (printer, modem, etc.), computer software, or internet access and related services may also be treated as qualifying expenses if they are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. Distributions of up to $10,000 annually may also be used for elementary and secondary school, as a result of the Tax Cuts and Jobs Act (TCJA). LO 2.4.1

Question 13

Maxwell Gates is about to begin receiving payments from a deferred fixed annuity that he purchased many years ago. His investment in the annuity contract was $30,000. He is to receive $375 per month for the rest of his life. His current life expectancy, based on IRS tables, is 10 years. What amount, if any, of each monthly payment is excludable by Maxwell? A) $150 B) $125 C) $250 D) $0

Answer 13

The investment of $30,000 divided by the total expected return of $45,000 ($375 per month × 12 months × 10 years) gives an exclusion ratio of 0.667, which is multiplied by the $375 payment to equal an exclusion of $250. LO 2.1.2

Question 13

Which one of the following statements regarding education provisions is CORRECT? A) The annual contributions to a Coverdell account may not exceed $2,000 per donor. B) Higher-education expenses for the Section 529 plan may include expenses for a computer, software, and internet access. C) The American Opportunity Tax Credit applies to undergraduate and graduate courses at an accredited, Title IV institution. D) Qualifying expenses for the American Opportunity Tax Credit (AOTC) include tuition, books, supplies, and room and board.

Answer 13

b Qualifying expenses for the AOTC do not include room and board. The AOTC may only be used for the first four years of undergraduate or vocational courses. Qualified higher-education expenses for Section 529 purposes include tuition, books, fees, and equipment for enrollment at an eligible educational institution; expenses for special needs services; and room and board costs for students who are at least half-time. In addition, expenses for the purchase of computer or peripheral equipment (printer, modem, etc.), computer software, or internet access and related services may be treated as qualifying expenses if the equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. The annual contributions to a Coverdell account may not exceed $2,000 per beneficiary. LO 2.4.1

Question 14

Jill purchased stock four years ago for $15,000. The stock had a fair market value (FMV) of $13,000 on the last day of the prior year. If Jill sells the stock for $16,000 six months later, what is her recognized gain or loss? A) $1,000 short-term capital gain (STCG) B) $0 C) $1,000 long-term capital gain (LTCG) D) $4,000 LTCG

Answer 14

Because Jill sold the stock after four years, her holding period is long term and her gain is $1,000 ($16,000 − $15,000). LO 2.1.3

Question 15

Your client, Kurt, has a child, Bryce, who is about to begin college full time in the fall. Bryce has a felony drug conviction. He has heard of some of the education incentives built into the Code and has asked you to give him some information regarding the education incentives. Which of the statements are CORRECT regarding the education incentives? If Kurt purchased EE bonds and placed them into a Uniform Gift to Minors Act (UGMA) account or a Uniform Transfers to Minors Act (UTMA) account for Bryce, there is no possibility of the bonds qualifying for the education exclusion. Bryce would be ineligible for the American Opportunity Tax Credit. If Bryce has a Coverdell Education Savings Account, distributions would be allowable to cover his room and board expenses. The American Opportunity Tax Credit would be allowable on expenses incurred for textbooks and room and board. A) I and IV B) II and III C) III and IV D) I, II, and III

Answer 15

d There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds, or unless they are held jointly with the purchaser's spouse. The student is ineligible for the American Opportunity Tax Credit if he has a felony drug conviction. Room and board is an allowable expense for distributions from a Coverdell account. Neither the American Opportunity nor Lifetime Learning Credit are allowed for room and board expenses. LO 2.4.1

Question 16

John Prentice owns 100 shares of Quantum Inc., a publicly held corporation. He receives a stock dividend of 10 shares of Quantum Inc. when the fair market value (FMV) of the stock is $10 per share. John originally paid $20 per share for the 100 shares of stock. Approximately what is John's new basis in each share of stock after the stock dividend? A) $19 B) $18 C) $20 D) $17

Answer 16

b The effect of the stock dividend is to "dilute" the basis in the previously owned shares by establishing basis in the new shares. John now owns 110 shares with an aggregate basis of $2,000. This equals an approximate basis of $18 per share. LO 2.2.2

Question 17

Your client, Albert, purchased a life insurance policy. He wants you to determine if it is a modified endowment contract (MEC) for tax purposes. To be classified as a MEC, a policy must have which of the following qualities? Be a life insurance policy under state law Meet either the cash value accumulation test or the guideline premium and cash value corridor test Be a contract that was entered into on or after June 21, 1988 Fail to meet the seven-pay test A) I and II B) III and IV C) I, II, III, and IV D) I, II, and III

Answer 17

c To be classified as a MEC, a policy must encompass all of the choices: be a life insurance policy under state law; meet either the cash value accumulation test or the guideline premium and cash value corridor test; be a contract that was entered into on or after June 21, 1988; and fail to meet the seven-pay test. LO 2.1.1

Question 18

Mike has interest and short-term capital gain income of $9,000 in the current tax year. He paid broker commissions on security purchases of $1,000, paid $1,800 for investment adviser fees, and had $8,500 of investment interest expense. His AGI is $225,000. What amount of investment interest expense may be deducted as an itemized deduction? A) $7,700 B) $8,000 C) $6,200 D) $8,500

Answer 18

d Investment interest expense is deductible up to the amount of net investment income, which is $9,000. The net investment income is simply the investment income (interest and short-term capital gains) of $9,000. Remember that the investment adviser fees are not deductible. The commissions are not a deductible item. The commissions increase the basis of the securities upon purchase and reduce the gain realized upon sale. LO 2.2.1

Question 18

Terry and Jan are married taxpayers filing a joint tax return. Their AGI is $265,000, and their net investment income (included in the AGI) is $70,000. What is the amount, if any, of the Medicare contribution tax? A) $2,660 B) $15,000 C) $0 D) $570

Answer 18

d The answer is $570. ($265,000 – $250,000 = $15,000. $15,000 × 3.8% = $570.) LO 2.3.1

Question 18

At a recent client meeting, you discovered that your client, Stan, utilized a home equity loan of $100,000 to obtain funds to purchase municipal bonds. This is the only home equity loan that Stan has. Which of the following is CORRECT regarding the income tax implications of this scenario? A) The interest on the home equity loan is fully deductible, but the interest on the municipal bonds becomes taxable. B) The interest on the home equity loan is not deductible, and the interest on the municipal bonds becomes taxable. C) The interest on the home equity loan is not deductible, and the interest on the municipal bonds remains tax exempt. D) The interest on the home equity loan is fully deductible, and the interest on the municipal bonds remains tax exempt.

Answer 18

c The interest on a home equity loan is not deductible unless the proceeds are used to build, purchase, or renovate a residence. LO 2.2.1

Question 18

Which of the following statements regarding the 0.9% additional Medicare tax is NOT correct? A) The tax is calculated on all income in excess of the taxpayer’s threshold based on filing status. B) If a taxpayer expects to have income above the threshold for the taxpayer’s filing status when combined with a spouse’s income and/or any self-employment income, the taxpayer may ask for additional federal income tax withheld by the employers. C) The tax is in addition to the 2.9% Medicare tax that is assessed on the taxpayer’s compensation and self-employment income. D) The tax is paid by the employee only; it has no employer contribution.

Answer 18

a An individual is liable for the additional Medicare tax if the individual taxpayer's wages, other compensation, or self-employment income (combined with a spouse if filing as married filing jointly) exceeds the thresholds for the taxpayer's filing status. LO 2.3.1

Question 19

Victoria Glass has $6,500 of investment interest expense and net investment income of $6,000 in the current tax year. She paid broker's commissions of $1,000 during the tax year. How much investment interest expense, if any, may Victoria deduct in the current tax year? A) $5,000 B) $6,500 C) $6,000 D) $5,500

Answer 19

c Investment interest expense is deductible only to the extent of net investment income. LO 2.2.1

Question 19

John and Sheryl are married taxpayers filing a joint tax return. In 2023, their AGI is $360,000, and their investment income (included in the AGI) is $80,000. They have investment interest expense of $9,000. What is the amount, if any, of Medicare contribution tax that they must pay? A) $4,180 B) $0 C) $3,040 D) $2,698

Answer 19

d They will pay the 3.8% Medicare contribution tax on $71,000. This is the lesser of the net investment income ($71,000) or the AGI in excess of the threshold amount ($360,000 – $250,000, or $110,000). The net investment income is the investment income of $80,000, reduced by the allowable investment expenses of $9,000. In this situation, all $71,000 of the net investment income is subject to the Medicare contribution tax. John and Sheryl will pay a $2,698 Medicare contribution tax (3.8% on $71,000). LO 2.3.1

Question 19

Alicia is age 16 and her total income was $3,000 in bank interest in 2023. Her parents' marginal tax rate is 24%. What is her total tax on the interest? (Round the answer to the nearest dollar.) A) $245 B) $585 C) $1,700 D) $720

Answer 19

a Alicia is in the 10% marginal tax bracket. $1,250 is eliminated by her standard deduction for unearned income. The next $1,250 is taxed 10%, generating tax of $125. The remaining $500 is taxed at her parents' marginal rate of 24%, or $120. Therefore Alicia's total tax due is $245. LO 3.2.1

Question 20

Which of the following statements regarding the dividends-received deduction is CORRECT? The amount of the dividends-received deduction is based on the percentage owned of the dividend-paying corporation by the corporation receiving the dividend. The dividends-received deduction is specific to corporations. A) II only B) I only C) Both I and II D) Neither I nor II

Answer 20

Both of these statements are correct. LO 2.2.2

Question 20

Under the modified endowment contract (MEC) rules, which of the following is NOT considered a distribution from the MEC? A) Dividends retained by an insurer to pay premiums B) Loans taken as cash or used to pay premiums C) Withdrawals from the contract D) Dividends received as cash

Answer 20

a Dividends retained by the insurer to pay premiums are not treated as distributions from a MEC. LO 2.1.1

Question 21

Ron Phillips, age 43, and Sandy Phillips, age 41, are married with two children, Michael, age 12, and Victoria, age 8, who has been blind since her birth. Ron is an architect and general partner with XYZ partnership. Sandy is self-employed as an attorney and works out of a home office. Her home office is exclusively and regularly used for business, and the home office is her principal place of business. Their information for the tax year 2023 is as follows: Adjusted gross income: $217,300 Itemized deductions (including qualified residential mortgage interest, taxes paid, and charitable contributions): $33,000 Early in the current year, Sandy's father died. Sandy is the sole beneficiary of her father's entire estate. The estate is presently in the probate process. Sandy's mother, Lisa, age 68, has moved in with them but provides her own support. She was married to Sandy's father when he died earlier this year. This is Ron's second marriage. He makes monthly support payments to his former wife and his daughter. Because both Ron and Sandy are considered self-employed, they make quarterly estimated tax payments each year to cover both their income tax and self-employment tax obligations. Assume that in 2023, Sandy inherits land with a fair market value (FMV) of $500,000 from her father's estate and $200,000 in death benefits from a life insurance policy on her father's life. Based on the information provided in the case scenario for Ron and Sandy Phillips, how much must Sandy include in gross income as a result of receiving these amounts? A) $500,000 B) $0 C) $700,000 D) $200,000

Answer 21

b Inheritances and life insurance proceeds paid because of death are both excluded from gross income. LO 2.1.1

Question 21

Kerri, a single taxpayer who itemizes deductions, incurred $5,000 in management fees relating to her taxable investments. Her AGI is $100,000, which includes $20,000 of investment income. How much investment expense (Section 212 expense) can she deduct for this year? A) $0 B) $4,000 C) $2,000 D) $5,000

Answer 21

a Investment expenses other than investment interest expenses are not deductible. LO 2.2.1

Question 22

Which of the following is NOT a form of an annuity? A) Variable annuity B) Selective annuity C) Fixed annuity D) Deferred annuity

Answer 22

b A selective annuity is not a recognized category of annuities.

Question 22

Ken Brandt (a single taxpayer), age 28, holds the following securities: Stock Purchase Date Fair Market Value Cost Basis ABC (300 shares) Oct. 3, 2004 $12,200 $5,500 DEF (500 shares) Feb. 15, 2022 $22,600 $15,600 GHI (100 shares) June 2, 2007 $4,350 $6,250 LMN (700 shares) Dec. 9, 2021 $19,360 $28,560 XYZ small-cap fund (500 shares) Oct. 20, 2012 $1,200 $3,700 VWL (750 shares, §1244) July 17, 2006 $4,050 $115,600 Bonds Purchase Date Fair Market Value Cost Basis EE savings bonds May 1, 2016 $8,500 $6,000 Assume Ken incurs $7,500 of college expenses in the current year. If Ken redeems the EE bonds to pay these expenses, what are the tax consequences? A) A portion of the interest may be excluded. B) There is insufficient information given to determine the tax consequences. C) All accrued interest is taxable in the current year. D) All the interest may be excluded.

Answer 22

c The exclusion for interest on EE bonds redeemed to pay for qualifying higher-education expenses applies only to bonds purchased by an individual age 24 or older. Ken is 28 years old; the bonds were purchased approximately seven years ago, when Ken was approximately age 21. LO 2.4.1

Question 23

Which of the following are qualified interest expense deductible in arriving at an individual's AGI? Student loan interest Mortgage interest on a loan acquired for a personal residence in 2023 for $600,000 Interest on home equity loan indebtedness to buy an automobile Investment interest expense A) I, II, III, and IV B) II and III C) IV only D) I only

Answer 23

d Only item I, student loan interest, is deductible in arriving at an individual's AGI. Statements II and IV are incorrect and are deductions from AGI. Statement III is not a deductible expense. Home equity loan interest is not deductible for AGI and is only deductible from AGI to the extent the proceeds are used for home acquisition or improvement and not personal expenses. LO 2.2.1

Question 23

Bob and Norma are married and have two dependent children. If the couple file their Form 1040 as married filing jointly and have taxable income of $70,000, what is their tax rate for qualified dividends in 2023? A) 15% B) 0% C) 20% D) 25%

Answer 23

b Because Bob and Norma made less than $89,250 in 2023, they will use the 0% tax rate for qualified dividends. LO 2.2.2

Question 24

Jim Jannsen purchased a deferred variable annuity several years ago. His investment in the annuity contract was $48,000. His current life expectancy, based on IRS tables, is 20 years. During the current year, he received annuity payments totaling $5,400. What amount of the annuity payments is taxable to Jim? A) $2,400 B) $3,000 C) $5,400 D) $0

Answer 24

b The investment in the contract ($48,000) is divided by the life expectancy (20 years) to equal the amount of the variable annuity excluded ($2,400 per year). Thus, of the $5,400 received, $2,400 is excluded, and the remaining $3,000 is taxable. LO 2.1.2

Question 24

Which one of the following is accurate regarding the Lifetime Learning Credit? A) Qualified higher-education expenses typically include tuition, books, and supplies. B) The credit may only be used during the first four years of postsecondary education. C) The maximum credit of $2,000 is per student. D) The maximum credit of $2,000 is per tax return.

Answer 24

d The maximum credit of $2,000 is per tax return. LO 2.4.1

Question 25

Lindsey is age 2 and her total income was $4,000 in qualified dividends in 2023. Her parents are in the 12% marginal tax bracket. What is her total tax on the dividends? A) $0 B) $216 C) $585 D) $600

Answer 25

a Because these are qualified dividends, they qualify for long-term capital gains rates. Lindsey's taxable unearned income is calculated as follows: $4,000 − $1,250 (2023) standard deduction − $1,250 taxed at the child's rate = $1,500 taxed at her parents' marginal rate. Therefore, her tax rate on the qualified dividends received is 0%. LO 3.2.1

Question 26

A lump-sum payment of the proceeds of a life insurance policy that is made to the beneficiary upon the insured's death A) is typically taxable. B) is taxable if from a modified endowment contract (MEC). C) is generally exempt from income taxation. D) is taxable if the proceeds exceed the net investment in the policy.

Answer 26

c The lump-sum proceeds of a life insurance policy paid to a beneficiary at the death of the insured are exempt from income taxation. LO 2.1.1

Question 27

Jeff is the beneficiary of a $150,000 policy on the life of his mother. Jeff encounters severe financial hardship and thus sells the policy to an unrelated party, Tony, for $40,000. Tony subsequently pays premiums on the policy of $10,000. Upon the death of Jeff's mother, what amount must Tony include in gross income? A) $0 B) $150,000 C) $100,000 D) $110,000

Answer 27

c In a situation where the policy is received in exchange for valuable consideration, the excluded amount is limited to the consideration paid ($40,000) plus the future premiums paid ($10,000). LO 2.1.1

Question 27

Which of the following is a CORRECT statement regarding the wash sale rules? A) The wash sale rules do not apply to dealers. B) Small differences in the maturity dates of bonds will not cause them to be classified as substantially identical. C) The wash sale rules do not apply to sales and investments in mutual funds. D) Basis is generally decreased by the amount of the loss that is disallowed on a wash sale.

Answer 27

a The wash sale rules do not apply to taxpayers who are brokers or dealers of financial instruments. LO 2.1.3

Question 28

In 2013, Jack Meyers, a married taxpayer filing jointly, purchased U.S. Series EE savings bonds for $4,000. During 2023, when Jack was 40 years old, he redeemed the bonds to help pay for his dependent son's college tuition. The accrued value at the time of redemption was $5,000. Assume Jack pays $9,200 of tuition expenses during the year. The 2023 AGI is $100,000. What are the tax consequences upon the redemption of the bonds? A) A portion of the interest may be excluded. B) All accrued interest is taxable in the current year. C) There is insufficient information given to determine the tax consequences. D) All the interest may be excluded.

Answer 28

d The exclusion begins to phase out at an AGI of approximately $140,000 ($137,800) for joint filers for 2023. The phaseout information will be provided on the examination. The other requirements for exclusion of the interest are also met: purchased by an individual 24 years of age or older, redeemed to pay for qualifying higher-education expenses of a dependent, taxpayer, or spouse. The other limitation, EE redemption proceeds greater than qualified expenditures, does not apply here. LO 2.4.1

Question 29

Theresa is a single taxpayer. In 2023, her AGI is $235,000, including a net long-term capital gain of $44,000. What is the amount, if any, of Medicare contribution tax that she must pay? A) $0 B) $1,672 C) $1,330 D) $2,880

Answer 29

c She will pay the 3.8% Medicare contribution tax on $35,000. This is the lesser of the net investment income ($44,000) or the AGI in excess of the threshold amount ($235,000 – $200,000, or $35,000). Theresa will pay a $1,330 Medicare contribution tax (3.8% on $35,000). LO 2.3.1

Question 30

On what form are capital gains and losses calculated? A) Schedule B B) Schedule A C) Schedule D D) Schedule C

Answer 30

c Schedule D is used to calculate capital gains and losses. Schedule A is used to itemize deductions. Schedule B is used to report interest and ordinary dividends. Schedule C is used to calculate profit or loss from business. LO 2.1.3

Question 30

Winona Fischer has a single premium whole life policy issued in 1989 on which she wants to take out a loan. Which one of the following would be the tax treatment on such a borrowing? A) There would be no taxes on the loan because only dividends from whole life policies are taxable. B) There would be taxes on the loan because it is not for a business purpose. C) There would be taxes on the loan to the extent that the cash value immediately before the distribution exceeded ’s the investment in the contract. D) There would be no taxes on the loan because loans on life insurance policies are not taxed.

Answer 30

c Any single premium whole life policy issued after June 21, 1988, is a modified endowment contract (MEC) because it fails the seven-pay test. Borrowing is treated as a distribution; thus there is ordinary income to the extent that the cash surrender value exceeds the investment in the contract. In other words, a distribution from a MEC is treated on a last-in, first-out (LIFO) basis. LO 2.1.1

Question 31

Which of the following is a form of an annuity? A) Fixed annuity B) Quick annuity C) Selective annuity D) Sustained annuity

Answer 31

a Selective, quick, or sustained annuities are not recognized categories of annuities. Fixed, variable, immediate, and deferred are all categories of annuities. LO 2.1.2

Question 32

Terry and Jan are married taxpayers filing a joint tax return. Their AGI is $310,000, and their net investment income (included in the AGI) is $90,000. What is the amount of the Medicare contribution tax for the current tax year? A) $2,280 B) $5,180 C) $3,420 D) $4,180

Answer 32

a $310,000 – $250,000 = $60,000. $60,000 × 3.8% = $2,280. $60,000 < $90,000. LO 2.3.1

Question 33

Which of the following statements correctly describes the method for calculating the exclusion ratio for a fixed annuity? A) The number of expected payments is divided by the investment in the annuity contract. B) The investment in the annuity contract is divided by the number of expected payments. C) The investment in the annuity contract is divided by the total expected return. D) The total expected return is divided by the investment in the annuity contract.

Answer 33

c The exclusion ratio for a fixed annuity contract is not calculated by dividing the total expected return by the investment in the contract. It is calculated by dividing the investment in the contract by the total expected return. LO 2.1.2

Question 34

This year, Ken sold several securities that left him with the following types of gains and losses: Long-term capital gain: $8,000 Short-term capital gain: $1,800 Long-term capital loss: $2,200 Short-term capital loss: $1,000 What is the net capital gain or loss on Ken's security sales? A) Net long-term loss of $1,400 B) Net long-term gain of $2,640 C) Net long-term gain of $5,800 and net short-term gain of $800 D) Net long-term gain of $2,320 and net short-term gain of $800

Answer 34

c The long-term gain and loss are netted, leaving a long-term gain of $5,800. Short-term gains and losses are netted, leaving a short-term gain of $800. These are left separate due to the disparate tax treatment of short-term versus long-term gains. LO 2.1.3

Question 34

Gary Anderson bought 1,000 shares in a mutual fund for $30 per share. Later that year, the fund declared a dividend of $2.50 per share. Gary elected to have dividends from the fund reinvested to purchase additional shares at $28 per share. Gary has a capital loss carryforward from a prior year and would like to maximize the use of the carryforward. What is the maximum amount of taxable gain Gary can incur if he later sells all the shares for $33 per share? A) $500 B) $5,000 C) $3,447 D) $3,000

Answer 34

c The difference between the sales price of the shares held and the basis of the shares held determine gain. The maximum gain would involve the sale of the 89.29 shares obtained with the distribution reinvestment and 1,000 of the original shares. The basis of the 89.29 shares is $2,500, and the basis of the other shares is $30,000, for a total of $32,500. Compared to the sale price of $35,947 (rounded), there is a gain of $3,447. LO 2.1.3

Question 34

Larry and Mary are married taxpayers filing a joint tax return. In 2023, their AGI is $360,000, and their investment income (included in the AGI) is $100,000. They have investment interest expense of $7,000 and state income taxes attributable to the investment income of $5,000. What is the amount of Medicare contribution tax that they must pay? A) $3,344 B) $3,800 C) $3,534 D) $4,180

Answer 34

a Explanation They will pay the 3.8% Medicare contribution tax on $88,000. This is the lesser of the net investment income ($100,000) or the AGI in excess of the threshold amount ($360,000 – $250,000, or $110,000). The net investment income is the investment income of $100,000, reduced by the allowable investment expenses of $12,000. In this situation, all $88,000 of the net investment income is subject to the Medicare contribution tax. Larry and Mary will pay a $3,344 Medicare contribution tax (3.8% on $88,000). LO 2.3.1

Question 35

Gary received a bequest of 100 shares of XYZ stock from a relative who died on March 1, 2023. The relative bought the stock at a total cost of $5,500. The value of the 100 shares of XYZ stock was $5,750 on March 1. Its value rose to $6,250 on July 1, 2023, on which day Gary sold it for $6,250, incurring expenses for the sale of $250. The taxable gain on the sale would be A) a $250 short-term capital gain. B) a $500 long-term capital gain. C) a $250 long-term capital gain. D) a $500 short-term capital gain.

Answer 35

c Explanation The amount realized on the sale is $6,000 (sale price of $6,250 reduced by the selling expenses of $250). This is compared to the fair market value (FMV) ($5,750) on the date of death, which is the recipient's basis. This generates a $250 gain. The issue then becomes one of holding period. The holding period of an asset acquired from a decedent is deemed to be long term. Thus, Gary has a $250 long-term capital gain. LO 2.1.3

Question 36

Michelle has investment income (interest and dividends) of $23,000 in the current tax year. She paid broker's commissions of $2,000 on stock purchases and had $40,000 of investment interest expense. What amount, if any, of investment interest expense may be deducted as an itemized deduction? A) $0 B) $23,000 C) $42,000 D) $40,000

Answer 36

b Explanation Michelle's interest expenses exceed her net investment income, so she can deduct only $23,000 because she can deduct these expenses only up to the net investment income amount. If her expenses were less than her net investment income, the entire investment interest expense would be deductible. LO 2.2.1

Question 36

Which of these statements regarding capital gains is CORRECT? A) Net short-term gains are subject to a taxpayer’s ordinary income tax rate. B) A maximum rate of 28% applies to long-term gain on collectibles. C) All of the above. D) Net long-term capital gains are subject to a 0% tax rate if a single filing taxpayer’s taxable income is below $44,625 (2023).

Answer 36

c Net long-term capital gains (and qualified dividends) are subject to a 0% tax rate if the taxpayer's taxable income is below $44,625 (for a single taxpayer, in 2023). The breakpoints will be provided on the exam. Net short-term gains are subject to a taxpayer's ordinary income tax rate. A maximum rate of 28% applies to long-term gain on collectibles. LO 2.1.3

Question 37

Larry has owned 100 shares of Positive Publishing Inc. stock since September 15, 2019. His basis in the 100 shares is $15,000. Larry sold these shares on March 15, 2023, for $12,500. After hearing a positive earnings report for the Positive Publishing stock, he purchases 100 more shares on April 11, 2023, for $13,000. What is the basis in the shares purchased on April 11, 2023? A) $13,000 B) $10,500 C) $15,500 D) $25,500

Answer 37

c The sale at a loss and the subsequent repurchase of substantially identical shares within a period of 30 days before 30 days after the date of the loss sale results in a wash sale. This causes a disallowance of the loss. The basis of the newly acquired security is increased by the amount of the disallowed loss from the wash sale. The $2,500 disallowed loss is added to the $13,000 purchase price to give a basis of $15,500. LO 2.1.3

Question 37

Which one of the following is CORRECT regarding the American Opportunity Tax Credit? A) The credit may be taken for a student who is in his fifth year of undergraduate education. B) The maximum tax credit is $2,500 per tax return. C) Qualified higher-education expenses include books, supplies, and reasonable room and board expenses. D) The maximum tax credit is $2,500 per student.

Answer 37

d The maximum tax credit is $2,500 per student. LO 2.4.1

Question 38

Leslie Howard purchased a deferred variable annuity several years ago. Her investment in the annuity contract was $50,000. Her current life expectancy, based on IRS tables, is 20 years. During the current year, she received annuity payments totaling $4,100. What amount of the annuity payments is excludable by Leslie? A) $0 B) $1,600 C) $2,500 D) $4,100

Answer 38

c The annual exclusion for a variable annuity is the investment in the contract ($50,000) divided by the life expectancy (20 years) to equal $2,500 per year. Thus, of the $4,100 received, $2,500 is excluded, and the remaining $1,600 is taxable. LO 2.1.2

Question 38

Garret has the following items of income: $1,500 of interest income, $2,800 of qualified dividend income (he has not decided whether to have it taxed at the ordinary or capital gain rate), and a salary of $100,000. Which of these are classified as portfolio income? A) Interest income, dividend income, and salary B) Salary only C) Interest income and dividend income D) Interest income only

Answer 38

c Interest and dividends are portfolio income. Salary is active income. LO 2.2.2

Question 38

Fred has investment income (interest and dividends) of $9,000 in the current tax year. He paid $1,000 in broker commissions on security purchases and $1,800 in investment adviser fees, and he has incurred $8,500 of investment interest expense. His AGI was $25,000. What amount of investment interest expense may be deducted as an itemized deduction? A) $6,200 B) $9,000 C) $7,700 D) $8,500

Answer 38

d Investment interest expense is deductible up to the amount of Fred's investment income. Because there is only $8,500 of investment interest expense, it is completely deductible. LO 2.2.1

Question 39

Which one of the following is a characteristic of a variable annuity contract? A) The amount of the payments varies according to the investment performance of the underlying assets. B) A fixed annuity payment is guaranteed upon payment of flexible premiums. C) The annuitant pays now for future fixed or variable payments. D) Variable annuity contracts are not tax advantaged, unlike other annuity contracts.

Answer 39

a The payments on a variable annuity contract are determined by the performance of the assets in which the contract is invested. There is no minimum guaranteed payment, nor is there a maximum. LO 2.1.2

Question 39

Four years ago, Mark received a gift of 500 shares of common stock from his grandfather. The fair market value of the stock on the date of the gift was $335 per share. His grandfather had purchased the stock three years earlier at $425 per share. Mark sold this stock for $200 per share last week. What was Mark's basis in the stock when he sold it? A) $335 per share B) $425 per share C) $200 per share D) $225 per share

Answer 39

a When the fair market value on the date of the gift is less than the donor's basis in the asset and the sale price is less than the fair market value on the date of the gift, then the fair market value on the date of the gift is used as the donee's basis. LO 2.1.3

Question 39

Pam paid $31,000 in premiums on an endowment life insurance policy with a face value of $90,000. In the current year, upon reaching age 70, Pam received the face value of the policy. For tax purposes, how much income, if any, will Pam report? A) $59,000 B) $31,000 C) $90,000 D) $0

Answer 39

a The cancellation of the endowment policy causes taxation on the difference between the amount received, the cash surrender value, and the investment in the contract, the premiums paid. LO 2.1.1

Question 40

Marge had net earnings from self-employment of $260,000 in 2023. What is her total self-employment tax? A) $30,308 B) $26,828 C) $29,691 D) $32,950

Answer 40

Marge's 2023 self-employment tax is calculated as follows: Self-employment income $260,000 Less $260,000 × 0.0765 ($19,890) Equals net earnings $240,110 Less 2023 taxable wage base ($160,200) Equals SE income subject to Medicare tax $79,910 Multiplied by 0.029 × 0.029 Equals Medicare portion of SE tax $2,317 Add $160,200 × 0.153 $24,511 Total self-employment tax $26,828 LO 2.3.1

Question 40

Your clients, John and Mary Voight, spoke recently to their insurance agent regarding the purchase of a single premium whole life policy. The agent indicated that the policy would be a modified endowment contract. The Voights were unsure what that meant. Which of the following describe a modified endowment contract? Meets the requirements of a life insurance contract under state law Was entered into (or substantially modified) on or after June 21, 1988 Fails to meet the "seven pay test" Meets the guideline premium and corridor test or the cash value accumulation test A) I, II, III, and IV B) II and III C) II, III, and IV D) I, II, and III

Answer 40

a Statements I through IV are all elements of the IRC definition of a modified endowment contract. The contract fails to meet the seven-pay test if the cumulative amount paid under the contract at any time in the first seven years is greater than the seven net level annual premiums that would have been paid under a seven-pay, paid-up contract. LO 2.1.1

Question 41

How are qualified dividend distributions taxed? A) Qualified dividends can only be taxed at the LTCG rate if the underlying stock has been held for a year plus one day. B) None of these. C) Qualified dividends are generally taxed at the 20%/15%/0% long-term capital gain (LTCG) rates. D) Qualified dividends are taxed as short-term capital gain (STCG).

Answer 41

c Qualified dividend distributions are eligible for the same 20%/15%/0% rate as long-term capital gains. Most dividends declared by a corporate board of directors of a domestic corporation are considered qualified dividends and are permitted the preferential rate. LO 2.2.2

Question 41

Which one of the following is an exception to the general rule that life insurance proceeds are excluded from income? A) The transfer for value rule B) The cash guideline premium rule C) The cash value accumulation rule D) The corridor rule

Answer 41

a The only exception to the general rule that life insurance proceeds are excluded from income is the transfer for value rule, which applies when a life insurance contract is transferred for valuable consideration. LO 2.1.1

Question 42

Which of the following statements correctly describes the method for calculating the exclusion amount for variable annuity payments? A) The investment in the annuity contract is divided by the total expected return. B) The number of expected payments is divided by the investment in the annuity contract. C) The total expected return is divided by the investment in the annuity contract. D) The investment in the annuity contract is divided by the number of expected payments.

Answer 42

d Explanation The exclusion ratio for a fixed annuity contract is calculated by dividing the investment in the contract by the total expected return. For a variable annuity, the exclusion amount is calculated by dividing the investment in the contract by the number of expected payments. LO 2.1.2

Question 43

Which of the following are deductions from AGI? Qualifying alimony paid to a former spouse Child support paid to a former spouse Investment interest expense incurred by an individual State and local income taxes paid A) III only B) III and IV C) II and IV D) I, II, and III

Answer 43

b \ Explanation Child support is not deductible. Alimony, if it meets certain tests, is an above the line deduction for AGI. Investment interest expense and State and Local Taxes are below the line deductions from AGI. LO 2.2.1

Question 44

Which of the following statements is CORRECT? A) A shareholder who receives a Schedule K-1 from an S corporation must calculate and pay self-employment tax on the income. B) Self-employed individuals, such as a sole proprietor or general partner in a partnership, generate self-employment income and must pay both portions of the FICA (Federal Insurance Contributions Act) payroll tax. C) A general partner reports the income from the Schedule K-1 form provided by the partnership on Schedule C of Form 1040. D) A sole proprietor must pay the 0.9% Additional Medicare Tax on all net self-employment income.

Answer 44

b Self-employed individuals, such as a sole proprietor or general partner in a partnership, generate self-employment income. In turn, such individuals must pay both portions of the FICA (Federal Insurance Contributions Act) payroll tax. A general partner reports the income from the Schedule K-1 form provided by the partnership on Schedule E of Form 1040. A shareholder who receives a Schedule K-1 from an S corporation does not pay self-employment tax on the income. The Additional Medicare Tax of 0.9% also applies to self-employed individuals who have a combined income greater than $200,000 if single and $250,000 if MFJ. The tax is levied on the net earnings from self-employment of the sole proprietor or partner and consists of the gross income derived from any trade or business, less allowable deductions attributable to this trade or business (generally Schedule C); or the taxpayer's distributive share of the ordinary income or loss of a partnership (not an S corporation) engaged in a trade or business (Schedule K-1). LO 2.3.1

Question 45

Which one of the following statements is true regarding nonperiodic distributions from an annuity contract prior to the annuity start date, issued after August 13, 1982? A) A nonperiodic distribution is taxed on a FIFO basis if proceeds are used to pay a student loan. B) A nonperiodic distribution is prorated equally between a tax-free return of principal and a taxable interest payment. C) A nonperiodic distribution is taxed first as a taxable interest payment until the interest payments are completely exhausted and then as a tax-free return of principal. D) A nonperiodic distribution is first considered a tax-free return of principal and then a taxable interest payment.

Answer 45

c A nonperiodic distribution is taxed under the exclusion ratio rules. LO 2.1.2

Question 46

Fred and April Johnson are married and file a joint income tax return. Their AGI (without the student loan interest deduction) is $103,000. They properly treat their son, Bill, a full-time student, as a dependent. Bill has incurred student loan debt over the years and is the sole borrower on the loans. Bill paid $3,100 of student loan interest in the current year. His AGI (without the student loan interest deduction) is $11,000. Which one of the following is CORRECT regarding the student loan interest deduction? A) No one may deduct the student loan interest. B) Bill may deduct $3,100 of student loan interest. C) Bill may deduct $2,500 of student loan interest. D) Fred and April may deduct $2,500 of student loan interest.

Answer 46

a The maximum student loan interest deduction is $2,500 for a given year. However, the deduction may only be taken by the taxpayer legally obligated to make the payments. In addition, a taxpayer who may be claimed as a dependent on another's return may not claim the student loan interest deduction. LO 2.4.1

Question 46

In 1987, Greg Gorman purchased a single premium whole life insurance policy. What is the tax implication to Greg if he borrows the interest from the policy's accumulated cash value to pay his current year's medical expenses? A) Greg will be required to report the amount borrowed as income, but he will not be allowed a medical expense deduction. B) Greg will be required to report the amount borrowed as income and will be allowed a medical expense deduction. C) Greg will not be required to report the amount borrowed as income and will not be allowed a medical expense deduction. D) Greg will not be required to report the amount borrowed as income, but he will be allowed a medical expense deduction.

Answer 46

d Explanation Amounts borrowed from a single premium policy issued before June 21, 1988, are nontaxable; thus, the earnings would not be taxable. A medical expense deduction will be allowed regardless of the source of the funds because the payment will be for a valid medical expense. If the amounts were borrowed from a single premium policy issued on or after June 21, 1988 (a modified endowment contract), they would be taxable on a last-in, first-out basis. LO 2.1.1

Question 47

For two years, Lisa Carson was able to pay the premiums on her whole life policy without borrowing. For the past two years, she has borrowed from the cash value of her whole life policy to pay the premiums. Last year, she paid $95 of interest on the funds she borrowed. What are the tax implications in this situation? A) The interest expense is not tax deductible because it does not exceed $100. B) The interest is deductible because Lisa is in the business of continuing her insurance and the interest is deductible business interest expense. C) The interest expense is not tax deductible. D) The interest expense is tax deductible because it does not exceed $100.

Answer 47

c The interest expense is not tax deductible because interest on a loan incurred to purchase personal life insurance protection is considered personal interest, which is not deductible. Personal loan interest is not tax deductible, regardless of whether the lender is a bank or a life insurance company. LO 2.1.1

Question 47

Cash value life insurance is often structured like an investment vehicle. However cash value life insurance contains important features that shelter the inside buildup from taxation. Which of the following will NOT be considered when determining whether a policy can maintain its tax favored status? A) The cash value accumulation test B) The death benefit C) The earned premium test D) The guideline premium and corridor test

Answer 47

c Without a death benefit, a contract does not meet the legal definition of life insurance. There are currently two tests—only one of which must be met—in order to classify a product as life insurance for federal income tax purposes: (1) the cash value accumulation test and (2) the guideline premium and corridor test. There is no earned premium test. LO 2.1.1

Question 48

Which of the following statements correctly defines inside buildup as it refers to life insurance? A) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-preferred basis. B) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-deferred basis. C) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-free basis. D) During the insured’s lifetime, the accumulations of cash value within a policy grow on a tax-annuitized basis.

Answer 48

b Accumulations of cash value within a life insurance policy grow on a tax-deferred basis during the insured's lifetime. LO 2.1.1

Question 48

In 1992, John Idler purchased a single premium whole life insurance policy. In the current year his medical expenses are $15,000 and his AGI is $75,000. What is the tax implication to John if he borrows the interest from the policy's accumulated cash value to pay his current year's medical expenses? A) John will be required to report the amount borrowed as income and will be allowed a medical expense deduction. B) John will not be required to report the amount borrowed as income, but he will be allowed a medical expense deduction. C) John will be required to report the amount borrowed as income, but he will not be allowed a medical expense deduction. D) John will not be required to report the amount borrowed as income and will not be allowed a medical expense deduction.

Answer 48

a Amounts borrowed on a single premium whole life policy issued on or after June 21, 1988 (a MEC), are taxable on a last-in, first-out basis; thus, the earnings would be taxable. A medical expense deduction will be allowed regardless of the source of the funds, since the payment would be for a valid medical expense. LO 2.1.1

Question 49

Which of the following statements regarding the use of life insurance inside a retirement plan is CORRECT? A) The premiums paid are NOT a taxable benefit to the employee. B) The premiums paid are a taxable benefit to the employee. C) The premiums paid are a taxable benefit to the employer. D) If the employee dies prematurely, the survivors will receive no benefits.

Answer 49

b\ \ The premiums paid are a taxable benefit to the employee. The main benefit to the employee is in the event of their premature demise, their survivors will still receive ample retirement benefits. LO 2.1.1

Question 50

Matthew Brady, age 67, purchased a deferred annuity in January 1982 for $50,000. In the current year, when the surrender value was $125,000, Matthew took a nonperiodic distribution of $75,000. Which one of the following statements correctly describes the income tax consequences of the distribution? A) $50,000 is taxable, $25,000 is tax free. B) $50,000 is tax free, $25,000 is taxable. C) $75,000 is tax free. D) $75,000 is taxable income.

Answer 50

b The pre-August 14, 1982, annuity retains first-in, first-out (FIFO) treatment. Thus, the basis of $50,000 is treated as being withdrawn first and is tax free. The remaining $25,000 is taxable. If this were a post-August 13, 1982, contract, it would be treated on a last-in, first-out (LIFO) basis. LO 2.1.2

Question 50

Which one of the following is a characteristic of a fixed annuity contract? A) Fixed annuity contracts are not tax advantaged, unlike other annuity contracts. B) The annuitant pays now for future fixed or variable payments. C) If a corporation owns the annuity contract, the earnings are not tax deferred. D) The buyer may choose among a handful of investment options.

Answer 50

c With a fixed annuity contract, there is no ability to select the investment options; the payments are fixed. Fixed annuity contracts are generally tax advantaged (tax deferred), unless a corporation owns the annuity contract, in which case the earnings are currently taxable. Such is also the case with a variable annuity. LO 2.1.2

Question 51

Several years ago, Allison Colbert purchased a deferred fixed annuity. The cost of the annuity was a single payment of $40,000. The annuity will provide monthly payments of $275. At the time the annuitized distributions are to begin, Allison's life expectancy will be 25 years. How much of each payment will be excluded from taxation? A) $133 B) $142 C) $206 D) $57

Answer 51

a Allison is expected to receive $82,500 ($275 × 12 × 25). Her investment in the contract ($40,000) is then divided by the total expected return ($82,500) to determine the excludable portion of each payment. The exclusion ratio is the $40,000 divided by $82,500, which equals 48.48%. 48.48% of $275 = $133 excludable from each payment. LO 2.1.2

Question 51

Which one of the following statements is CORRECT concerning capital gains and losses? A) Excess capital losses are carried forward for up to five years. B) Net capital losses are deductible up to $3,000 annually. C) Net capital gains are always taxed at a maximum rate of 28%. D) Net capital gains are always taxed at a flat rate of 15%.

Answer 51

b Net long-term capital gains (LTCG) (from other than unrecaptured Section 1250 income and collectibles) are taxed at rates of 0%, 15%, or 20%. For married couples filing jointly, the 0% long-term capital gain rate ends at $89,250 of taxable income. For long-term capital gains falling between the $89,250 breakpoint and $553,850 of taxable income (again, for married couples filing jointly), the rate is 15%. For long-term capital gains falling into taxable income levels above $553,850 (MFJ), the rate is 20%. The table shows the breakpoints for LTCG and qualified dividend preferential rates. LTCG Rates Based on Taxable Income Filing Status 0% rate 15% rate 20% rate Single Under $44,625 $44,626–$492,300 Over $492,300 Head of household Under $59,750 $59,751–$523,050 Over $523,050 Married filing jointly Under $89,250 $89,251–$553,850 Over $553,850 Estates and trusts Under $3,000 $3,001–$14,650 Over $14,650 Special rates apply to the sale of real estate or collectibles—25% (the maximum rate for gain attributable to straight-line depreciation on real estate), or 28% (maximum rate in the case of collectibles). Net capital losses, the capital losses remaining after netting against capital gains, are deductible up to $3,000 per year with an indefinite carryforward. LO 2.1.3

Question 51

Adrian Brown owned 500 shares of XYZ growth and income fund. She has become increasingly dissatisfied with the performance of the fund and, upon the advice of a friend, decided to execute a "telephone transfer" and switch the balance in the fund to the XYZ intermediate bond fund. Which one of the following describes the tax effect of such a strategy? A) No gain or loss will be recognized by the taxpayer, and the basis in the new fund will be the same as that of the old fund. B) No gain or loss will be recognized by the taxpayer, but the basis of the new fund will be reduced by any deferred gain or increased by any unrecognized loss. C) Gain or loss will be recognized by the taxpayer on the redemption of the old fund. D) Any loss will be recognized by the taxpayer, but any gain will be deferred through a reduction in the basis of the new fund.

Answer 51

c A telephone transfer is the same as a sale or other taxable redemption of the fund. Therefore, gain or loss will be recognized based on the difference in the redemption proceeds and the basis in the shares redeemed. This is true even if the transfer is made between two funds in the same fund family. LO 2.1.3

Question 52

Your client, Elaine Dell, is near the highest tax bracket and is contemplating several investments. She is, however, concerned about minimization of her federal income tax liability on the income from the investment. Which of the following investments would produce income that would be taxed at the lowest potential tax rate? A) A utility stock with a high dividend yield B) A certificate of deposit C) A zero coupon bond D) A corporate bond fund

Answer 52

a Qualified dividends are generally taxed at a 15% rate (or 20% for taxpayers with higher income levels). All of the other options produce interest income, which is taxable as ordinary income, at the marginal rate of the taxpayer. LO 2.1.3

Question 52

Ann Hamilton owns 500 shares in the XYZ S&P 500 Index Fund. The basis of her investment in this fund is $4,500, while the fair market value is only $2,000. She wants to sell her shares to "lock in" the $2,500 loss, but she is considering buying 500 shares of the GRC Small-Cap Index ETF the following week because she believes that the value is going to increase significantly over a longer period. As her planner, what can you accurately tell Ann about this scenario? A) The basis in the newly acquired shares would be the amount paid for those shares, increased by the $2,500 disallowed loss. B) She should wait a minimum of 61 days after the sale to repurchase the shares so that the loss may be recognized. C) If the loss were disallowed, the basis in the newly acquired shares would be decreased by the disallowed loss. D) The loss would be a fully deductible capital loss.

Answer 52

d The wash sale rule disallows a loss if substantially identical securities are purchased prior to 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the amount of the disallowed loss. The S&P 500 mutual fund should not be substantially identical to the small-cap ETF because the funds track very different indices and because of the difference in the way ETFs trade compared with mutual funds. LO 2.1.3

Question 52

Bruce and Melissa Parish, married taxpayers filing jointly, have the following items related to their investments during the current tax year: Investment interest expense $5,000 Interest income $2,500 Short-term capital gains $1,000 Investment adviser's fees $1,250 Commissions paid on stock purchase $200 Adjusted gross income $60,000 What is the Parishes' allowable investment interest expense deduction for the current year? A) $3,450 B) $3,250 C) $3,500 D) $5,000

Answer 52

c Investment interest expense is limited to the taxpayer's net investment income of $3,500. LO 2.2.1

Question 53

Which one of the following statements is incorrect regarding investment interest expense? A) Interest paid or accrued to purchase or carry tax-exempt investments is not deductible. B) Net investment income is the taxpayer’s investment income—typically interest, nonqualified dividends, and short-term capital gains. C) Investment interest expense is deductible up to the amount of the net investment income. D) Excess investment interest expense cannot be carried forward into succeeding tax years.

Answer 53

d Excess investment interest expense can be carried forward into succeeding tax years. Investment interest expense is deductible up to the amount of net investment income. The interest on funds borrowed to purchase tax-exempt investments is not deductible. The net investment income is typically interest, nonqualified dividends, and short-term capital gains. Long-term capital gains and qualified dividends may be included at the taxpayer's election, but the taxpayer must forgo the preferential tax rates on these items. LO 2.2.1

Question 53

Tom Bell has investment income (interest) of $8,000 in the current year. He paid $1,200 in investment adviser fees and had $7,000 of investment interest expense. His AGI is $35,000. What amount of investment interest expense may be deducted in the current year as an itemized deduction? A) $7,000 B) $6,800 C) $8,000 D) $6,500

Answer 53

a Investment interest expense is deductible up to the amount of investment income. The investment income is the interest income of $8,000. However, the deduction cannot exceed the actual investment interest expense of $7,000. LO 2.2.1

Question 54

Michelle Will has interest income of $23,000 in the current tax year. She paid brokers' commissions of $2,000 on stock purchases and had $40,000 of investment interest expense. What amount, if any, of investment interest expense may be deducted as an itemized deduction? A) $33,000 B) $23,000 C) $21,000 D) $0

Answer 54

The deduction for investment interest expense ($40,000) is limited to net investment income ($23,000). The remaining portion ($17,000), however, can be carried forward into future years. Note that the broker's commissions are not deductible, nor considered an expense when calculating net investment income. LO 2.2.1

Question 55

For the current tax year, Bob Phillips, an individual taxpayer filing a joint return, has $50,000 of investment interest expense and $20,000 of net investment income (interest and dividends). Bob's AGI is $200,000. How much investment interest expense, if any, may Bob deduct in the current tax year? A) $0 B) $20,000 C) $21,000 D) $50,000

Answer 55

b Investment interest expense is deductible up to the amount of net investment income. The problem tells us that the net investment income is $20,000; thus that is the maximum deduction. The fact that the dividends are included in the net investment income indicates that the taxpayer elected to include them in investment income and is forgoing the preferential rates associated with qualified dividends. The AGI has no bearing on the answer. LO 2.2.2

Question 56

Sheila, a single taxpayer, has taxable income of $520,000. Included in the taxable income is $50,000 of qualified dividends. At what rate(s) will her qualified dividends be taxed? A) 15% only B) 20% only C) 15% and 20% D) 25% only

Answer 56

c The qualified dividends straddle the $492,300 breakpoint (for 2023). Thus, a portion fall into the $44,626 to $492,300 range and are taxed at 15%. The dividends above the $492,300 breakpoint are taxed at 20%. LO 2.2.2

Question 57

Samantha received the following dividends in 2023 from her portfolio: Ordinary dividends from HOT stock, a publicly traded company Dividends from Sky High Realty and Trust, a publicly traded REIT Life insurance dividends from her whole life policy Qualified dividends from BET stock, a publicly traded company Which of the above is NOT considered taxable? A) I and II B) II and IV C) IV only D) III only

Answer 57

d Life insurance dividends are considered a return of premium paid (provided the cumulative dividends received over the life of the policy do not exceed the basis in the policy) and thus are not taxable. The other choices listed are taxable. Qualified dividends are eligible for long term capital gains rates. REIT dividends may qualify for a QBI deduction but nonetheless will still be taxable. LO 2.2.2

Question 58

Lindsey is age 2 and her total income was $2,500 in qualified dividends in 2023. What is the tax on the dividends at Lindsey's rate? A) $0 B) $95 C) $115 D) $30

Answer 58

a Lindsey is in the 10% marginal income tax bracket. She can use the long-term capital gains tax rate on qualified dividends received. At her income and filing status, the capital gain tax rate is 0%. LO 2.2.2

Question 58

Which one of the following is NOT subject to the Medicare contribution tax? A) Qualified dividends B) Income from a nonperiodic distribution from an annuity C) Qualified Roth distributions D) Long-term capital gains

Answer 58

c Qualified Roth distributions are not subject to the Medicare contribution tax. Only taxable items, such as net capital gains, net rental income, annuity income and dividends, for example, are subject to the Medicare contribution tax. LO 2.3.1

Question 59

Which of the following taxpayers may owe the additional Medicare tax of .9% in 2023? Brad and Jane file jointly and have combined wages of $288,000. Terry's only income in 2023 is from his investments and totals $290,000. Jack has earned $150,000 in compensation from his employment at Bland Foods Inc. Lisa, whose filing status is head of household, is self-employed and has self-employment income of $225,000. A) I only B) IV only C) I and IV D) I, II, and III

Answer 59

c Statements I and IV are correct. The additional Medicare tax rate is .9%. An individual is liable for the additional Medicare tax if the individual taxpayer's wages, other compensation, or self-employment income (combined with a spouse if filing as married filing jointly) exceeds the thresholds for the taxpayer's filing status of a combined income greater than $200,000 if single/head-of-household or $250,000 if married filing jointly. Choice II is incorrect. Because Terry has no wage income, the Additional Medicare tax of .9% cannot apply. However, Terry is subject to the separate Net Investment Income tax of 3.8%. LO 2.3.1

Question 60

Terry and Jan are married taxpayers filing a joint tax return. In 2023, their AGI is $310,000, and their net investment income (included in the AGI) is $90,000. What is the amount of their Medicare contribution tax for 2023? A) $3,420 B) $4,180 C) $2,280 D) $0

Answer 60

c Terry and Jan will pay the 3.8% Medicare contribution tax on $60,000. This is the lesser of the net investment income ($90,000) or the AGI in excess of the threshold amount ($310,000 – $250,000, or $60,000). In this situation, only $60,000 of the net investment income is subject to the Medicare contribution tax and calculates to $2,280 ($60,000 × 0.038). LO 2.3.1

Question 61

Clare is a single taxpayer. In 2023, her AGI is $235,000, including a net long-term capital gain of $50,000. What is the amount, if any, of Medicare contribution tax that she must pay? A) $1,330 B) $1,900 C) $0 D) $570

Answer 61

a She will pay the 3.8% Medicare contribution tax on $35,000. This is the lesser of the net investment income ($50,000) or the AGI in excess of the threshold amount ($235,000 – $200,000, or $35,000). In this situation, only $35,000 of the net investment income is subject to the Medicare contribution tax. Clare will pay a $1,330 Medicare contribution tax (3.8% on $35,000). LO 2.3.1

Question 62

Your client Sally, age 30, is designing an educational investment program for her 8-year-old son. She expects to need the funds in about 10 years when her AGI will be approximately $70,000. She wants to invest at least part of the funds in tax-exempt securities. Which of the following investment(s) may yield tax-exempt interest on her federal return if the proceeds were used to finance her son's education? Treasury bills EE bonds GNMA funds Zero coupon Treasury bonds A) II and III B) I, III, and IV C) III and IV D) II only

Answer 62

d Proceeds from EE savings bonds may be exempt if the proceeds are used for qualified higher-education expenses of the taxpayer, spouse, or dependent. There is an AGI phaseout, which is $91,850–$106,850 (2023) for a single taxpayer. (The actual phaseouts are provided on the exam.) All the other options generate currently taxable income. The Treasury bills and GNMA funds both produce taxable income on the federal return (Treasury bill interest would typically be tax exempt on her state return). The zero Treasury also produces taxable income each year as the amortized discount is added to taxable income, even though no cash income is received. LO 2.4.1

Question 63

Tim Jones is single, 21 years old, and in his third year of college. He has an AGI of $35,000 and receives no support from his parents. The college is a Title IV institution where students are eligible to receive federal financial aid, and Tim is pursuing an undergraduate degree in criminal justice. When Tim was 13, his parents established a Uniform Transfers to Minors Act (UTMA) for him, and funded it with EE savings bonds. When Tim was a freshman, he was convicted of a felony drug possession charge. Which one of the following is CORRECT regarding Tim's situation? A) Tim qualifies for the American Opportunity Tax Credit. B) Tim may redeem the EE bonds potentially tax free if the proceeds are used for his qualifying education expenses. C) Tim could use both the American Opportunity Tax Credit and the Lifetime Learning Credit in the same year. D) Tim qualifies for the Lifetime Learning Credit.

Answer 63

d Tim qualifies for the Lifetime Learning Credit. His AGI is under the phaseout range. He is pursuing a degree at an eligible institution. The felony drug conviction would preclude the use of the American Opportunity Tax Credit but not the Lifetime Learning Credit. There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds or unless they are held jointly with a spouse. A bond that has been gifted to another taxpayer does not qualify for the exclusion. The American Opportunity Tax Credit and the Lifetime Learning Credit may not be claimed in the same year for the same student.

Question 64

Seven years ago, Karen Price purchased U.S. EE savings bonds for $5,000. During the current year, when Karen was 27 years old, she redeemed the bonds to help pay for her graduate school tuition. The accrued value at the time of redemption was $7,000. Assume Karen incurs $11,000 of tuition expenses in the year. What are the tax consequences upon the redemption of the bonds? A) A portion of the interest may be excluded. B) All the interest may be excluded. C) All accrued interest is taxable in the current year. D) The income on the bonds is generally subject to state income taxes.

Answer 64

c The exclusion for EE bond interest redeemed to pay for qualifying higher-education expenses applies only to bonds purchased by an individual age 24 or older, and held in that person's name, or jointly with a spouse. Karen is 27 years old; the bonds were purchased 7 years ago, when Karen was approximately 20. Because Karen does not qualify for the exclusion of the interest income because she was not age 24 or older at the time of purchase. All the interest is taxable in the year the bonds are redeemed. Remember that the interest of EE bonds is deferred until maturity, unless an election has been made to have the interest taxed each year as it accrues. Also, the interest income from EE bonds (and other federal government obligations) is generally not subject to state income tax. LO 2.4.1

Question 65

Eight years ago, Joan Allen, a married taxpayer filing jointly, purchased U.S. Series EE savings bonds for $6,000. She titled the bonds jointly with her husband, Hank. During the current year, when Joan was 35 years old, they redeemed the bonds to help pay for Joan's graduate school tuition. The accrued value at the time of redemption was $8,000. Their AGI for 2023 is estimated to be $100,000. Assume Joan incurs $8,000 of tuition expenses during the year. What are the tax consequences upon the redemption of the bonds? A) All accrued interest is taxable in the current year. B) The interest is taxable at both state and federal levels. C) All the interest may be excluded. D) A portion of the interest may be excluded.

Answer 65

c The EE bond exclusion (for educational purposes) is phased out (for married couples filing jointly) between $137,800 and $167,800 of AGI in 2023. There is no exclusion available when AGI exceeds $167,800. It is not necessary to memorize the exact phaseout amounts because they will be provided on the exam. To qualify for the exclusion, the bonds must be purchased by an individual age 24 or older and held in that person's name, or jointly with a spouse. EE bonds are not taxable at the state level. LO 2.4.1

Question 66

Which one of the following is CORRECT regarding the Coverdell Education Savings Account? A) Deductible contributions of up to $2,000 may be made per beneficiary. B) Distributions may be tax free even if made for K-12 expenses. C) Distributions may be tax free only if made for a full-time student. D) Room and board may be covered with a tax-free distribution only if the student is full-time.

Answer 66

b The predominant benefit of the Coverdell ESA is distributions may also be used to pay for K-12 expenses. This is unlike the 529 plan which is designed primarily to pay for college expenses (Note: a limited amount of $10,000 may now be withdrawn from a 529 for K-12 expenses). LO 2.4.1

Question 67

Which of the following benefits that Claudia has received from her employer can be excluded from taxation? A) $5,000 of graduate education assistance. B) An athletic membership at a local club valued at $1,500 per year. C) A year-end bonus. D) A company car that she uses for personal vacations.

Answer 67

a Undergraduate and graduate education assistance is excluded from an employee's income in any one year period, up to a maximum of $5,250. The other options are fully taxable. LO 2.4.1