Module 4 Tax Implications of Special Circumstances Flashcards
What could you advise a client, concerning taxation, if a premarital agreement initiates a transfer of funds?
You would be better off with a transfer for consideration, which would likely not be taxed.
If a gift transfer is made, one spouse would likely have considerable income added.
A)
Both I and II
B)
Neither I nor II
C)
I only
D)
II only
b
The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party).
LO 4.1.2
Jan and Martha have one child, age 8, who is in day care while they work outside of the home. During the current year, they spent $3,900 on qualifying child care expenses. Their AGI is $44,908. What is the amount of the child care credit that they may claim?
A)
$200
B)
$600
C)
$780
D)
$1,050
b
The child care credit is based on qualifying expenditures of up to $3,000 per child, up to $6,000 for two or more children. The qualifying expenditures are multiplied by an applicable percentage of 20% (for taxpayers with an AGI of $43,000 or more). For the student, it is important to remember the $3,000 for one child, $6,000 for two or more children, and the 20%. It is highly unlikely that the CFP Board would test a child care credit calculation where the AGI is less than $43,000.
LO 4.2.1
Terry has just been divorced. He is asking his planner, Marianne, for recommendations of amending his financial plan given his newly single status. Which of the following actions should Marianne take?
Marianne should review the beneficiary designations on Terry’s life insurance policies to be certain the beneficiaries are in line with his wishes post-divorce.
Marianne should ask for any documentation on property settlements and other court-ordered financial transactions.
Marianne should inquire whether a qualified domestic relations order was issued by the court and obtain a copy to ascertain its effect on Terry’s financial plan.
Marianne should inform Terry that the transfer-for-value income tax rule makes the transfer of any life insurance policies a taxable event.
A)
I, II, and III
B)
I and IV
C)
III only
D)
II and IV
a
Statement IV is incorrect. The transfer-for-value income tax rule does not apply in situations when a life insurance policy is transferred from one spouse to another as a result of a property settlement.
LO 4.2.3
Which of the following is necessary for a premarital agreement to be valid and enforceable?
A)
It cannot have been signed under duress.
B)
Signatories cannot be greater than 37½ years apart in age.
C)
It cannot include complete disclosure of the assets of both parties.
D)
It must include contractual obligations about who is responsible for house cleaning.
a
A premarital agreement cannot be signed under duress. The age disparity of the signatories is not in and of itself relevant. It must include full disclosure of assets. It cannot include contractual obligations, such as who is responsible for house cleaning.
LO 4.1.2
Which of the following is the main reason for a premarital agreement?
A)
It financially protects the parties if the death of one occurs, particularly the one who has more assets.
B)
It financially protects the parties if the death of one occurs, particularly the one who has fewer assets.
C)
It financially protects the parties in a divorce, particularly the one who has fewer assets.
D)
It financially protects the parties in a divorce, particularly the one who has more assets.
d
Explanation
A premarital agreement financially protects the parties in a divorce, particularly the one who has more assets.
LO 4.1.2
Which of the following statements regarding child support payments is CORRECT?
They are nontaxable to the payee.
They are nondeductible by the payor.
A)
Both I and II
B)
Neither I nor II
C)
II only
D)
I only
Child support payments are nontaxable to the payee and nondeductible by the payor.
LO 4.2.3
Lois and Clark recently divorced. Clark was ordered to pay child support and alimony. Clark works as a police officer at the local precinct. Lois expressed concern that he may be killed in the line of duty. Therefore, the judge has ordered him to obtain a life insurance policy. Which of the following is true?
A)
Clark must be the owner of the policy.
B)
Clark must pay the life insurance premiums in addition to alimony.
C)
Clark can treat the premiums as alimony.
D)
Clark should claim he is uninsurable because of his profession.
c
Explanation
Some states require alimony payors to obtain life insurance. Clark can include the money he spends on life insurance as part of his overall alimony payment. Lois has the insurable interest and therefore should be the owner of the policy. Although Clark’s premiums may be higher due to his profession, his profession will not prevent him from becoming insured.
LO 4.2.2
Ron, age 43, and Sandy, 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 spouse and his daughter.
Because both Ron and Sandy are considered to be self-employed, they make quarterly estimated tax payments each year to cover both their income tax and self-employment tax obligations.
Assume Ron’s ex-spouse successfully petitions the court to require Ron pay their daughter’s private school tuition of $1,000 per month for the nine months of the school year. How much can Ron deduct on his income tax return for these payments?
A)
$4,500
B)
$0
C)
More information is needed
D)
$9,000
b
This is additional child support and is not tax deductible.
LO 4.2.3
If approved by a valid court, the assets divided and transferred by a qualified domestic relations order (QDRO) are
A)
nontaxable.
B)
gift taxable.
C)
sometimes taxable.
D)
fully taxable.
a
If approved by a court of competent jurisdiction, the transfer of assets incident to a divorce is not taxable.
LO 4.2.2
Paul was divorced from his spouse, Patricia, late last year. As part of the property settlement agreement, Paul agreed to transfer his interest in a residential real estate tract to Patricia. Paul’s cost basis in this real estate tract was $50,000. The tract was appraised at a fair market value of $100,000 at the time of its transfer to Patricia. Which of the following income tax implications is true of Paul’s transfer of the real estate to Patricia?
A)
Paul’s basis in the real estate is carried over to Patricia for income tax purposes.
B)
Patricia receives a basis in the real estate equal to the fair market value at the time of transfer.
C)
Paul is allowed a deduction equal to the excess of the fair market value over the basis in the property.
D)
Paul must recognize the gain on the real estate at the time of transfer at ordinary income rates.
a
A transfer of property incident to divorce is tax free. The transferee takes a carryover basis in the asset.
LO 4.2.3
Which of the following statements regarding the tax implications of divorce is NOT correct?
A)
Any transfer of property between spouses incident to a divorce is always income tax free.
B)
As a result of divorce, the custodial parent may list the children as a dependents unless there is a written agreement to the contrary.
C)
Child support payments are taxable to the payee and deductible by the payor.
D)
The transfer-for-value income tax rule does not apply when a life insurance policy is transferred from one spouse to another as a result of a property settlement.
c
Child support payments are nontaxable to the payee and nondeductible by the payor. All other choices are correct.
LO 4.2.3
Lowell and Thelma Jordan are married and will file a joint return for the current tax year. Lowell and Thelma are contributing to their respective 401(k) plans through their employers. They have provided you with the following information.
Lowell’s salary (after 401(k) contributions) $75,000
Thelma’s salary (after 401(k) contributions) $50,000
Alimony payments to Lowell’s ex-spouse $24,000
Net long-term capital loss $7,000
Property taxes $2,000
IRA contribution—Lowell $6,500
IRA contribution—Thelma $6,500
Lowell’s divorce was finalized in 2015. Based on the information given, what is their adjusted gross income for the current tax year?
A)
$81,000
B)
$85,000
C)
$118,000
D)
$83,000
b
The salaries of $125,000 reduced by the $24,000 of alimony payments equals $101,000. This is further reduced by $3,000 of net capital losses. Remember that only $3,000 of net capital losses are deductible in a given year, with an indefinite carryforward of the excess. The $13,000 of IRA contributions is also deductible. Even though both spouses are active participants in company-maintained retirement plans, their MAGI (AGI without the IRA contributions) is only $98,000. This is under $116,000—the beginning of the phaseout range for married couples filing jointly, where both spouses are active participants. The property taxes are an itemized deduction and do not affect the AGI.
LO 4.2.3
Ruth and Doug divorced last year. They have two children, ages 7 and 9. Their divorce decree states that Ruth has custody of both children. There is no written agreement for listing the children as dependents on their returns. However, Doug provides 75% of the child support, amounting to $15,000 per year. Based on this information, which parent is entitled to show the children as dependents on their income tax returns?
A)
Ruth, because she has custody and there is no written agreement that Doug could claim the children
B)
Doug, because he provides at least $1,200 per year for the children’s support and Ruth cannot prove she contributes more than this amount
C)
Ruth, because the court awarded her custody of the children
D)
Doug, because he provides over half of the child support
a
The parent with custody for a greater portion of the year is treated as providing more than half of a child’s support, where the child receives more than half of his total support for the year from either or both parents who are divorced.
LO 4.2.3
Lisa owns a fourplex in which she lives and rents out two of the other three units for $1,200 per month each. Her parents, who are both age 70 and retired, live in the fourth unit and do not pay Lisa any rent. Residents pay their own utilities. Lisa has asked her financial planner how this arrangement with her parents will affect her income tax return. What should her planner tell her?
A)
The planner needs to know how much this rent makes up the total support of her parents and if any other amounts are paid for their care and support by Lisa before making any recommendations.
B)
The $14,400 of forgone rent constitutes support, and Lisa may use the head of household filing status.
C)
Living rent-free with their daughter does not mean she is providing any support to them.
D)
Because the parents are not the planner’s clients, a determination cannot be made.
a
To make a determination on whether or not Lisa’s parents are her dependents, the planner needs complete information of how much Lisa has paid, if anything, in addition to the forgone rent for their support and what percentage that is of her parents’ total support.
LO 4.2.1
Carl and Rita are legally separated on December 31 this year. Carl earned $50,000 this year, and Rita earned $95,000. They live in a common law state and have no dependents. They have come to a tax preparer to determine how they must file their income taxes this year. What does the planner tell them?
A)
They must each file as MFS, each reporting their own income.
B)
They must each file as single, each reporting their own income.
C)
They may file as MFJ as they were not legally separated until the end of the year.
D)
They must each file as single, each reporting $60,000 (half of the total of $120,000) in income.
b
Single (S) filing status is used for an unmarried, legally separated, or divorced individual who does not qualify for any other filing status.
LO 4.2.3
Which of the following elements is NOT required for alimony?
The divorce agreement must specify that the payments are alimony.
The payor and payee are not members of the same household at the time the payments are made.
There is no liability to make the payments after the payee’s death.
The payments are not for the support of the payor’s children.
A)
I only
B)
I, II, and IV
C)
II, III, and IV
D)
II and III
a
Statement I is correct. It is not necessary to specify that payments are alimony. However, the divorce agreement cannot specify that the payments are not alimony.
LO 4.2.3
Which of the following is CORRECT concerning married individuals filing a joint income tax return?
Legally married spouses may file a joint return even though one spouse has no income or deductions.
Legally married spouses’ tax years must begin on the same date.
Legally married spouses are not legally separated under a decree of divorce or separate maintenance on the last day of the calendar year.
Neither legally married spouse is a nonresident alien at any time during the year.
A)
I, II, and IV
B)
IV only
C)
I, II, III, and IV
D)
II and III
c
Explanation
All statements are required for legally married spouses to file a joint income tax return.
LO 4.1.1
Ed was divorced from his spouse, Julie, in 2018. Julie received custody of their only child, Sally, age 5. Ed was ordered to pay $2,500 of alimony and child support per month to Julie until Sally reaches age 18. At that time, the payments are to decrease to $1,000 per month. What portion of each payment is deductible by Ed as qualifying alimony?
A)
$0
B)
$2,500 of each payment
C)
$1,500 of each payment
D)
$1,000 of each payment
d
Explanation
Amounts tied to a contingency or the occurrence of an event relating to the child are presumed to be nondeductible child support. Thus, $1,500 is tied to the child’s reaching age 18 and would not be deductible. The remaining $1,000 per month is deductible alimony.
LO 4.2.3
Haley’s great-grandmother, Sylvia, lives in her own home, but Haley provides direct support for her. Sylvia uses $4,200 of her Social Security income (her only income) for her own support, including paying her Medicare premiums. Haley can document that she paid $6,550 in support for Sylvia. Haley is a single taxpayer. Can she list Sylvia as a dependent and claim head of household filing status?
A)
Yes, Sylvia’s Social Security is nontaxable and is not used in the support test.
B)
No, Sylvia does not live with Haley, so she fails as a qualifying relative.
C)
No, Sylvia used Social Security benefits for some of her own support.
D)
Yes, Sylvia satisfies all of the criteria for a qualifying relative.
d
Sylvia satisfies all of the criteria for a qualifying relative. The income test is satisfied because she has no taxable income. The support test is satisfied because the money she used for her own support was less than 50% of her total support. A great-grandmother is a direct ancestor of a taxpayer and is a relative that does not have to live in the same household as the taxpayer.
LO 4.2.1
What could you advise a client, concerning taxation, if a premarital agreement initiates a transfer of funds?
You would be better off with a transfer treated as a gift, which would likely not be taxed.
If a transfer for consideration is made, one spouse would likely have considerable income added.
A)
Neither I nor II
B)
I only
C)
Both I and II
D)
II only
c
Explanation
The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party).
LO 4.1.2
When filing as married filing separately, which of the following are true?
If one spouse itemizes deductions, the other spouse must also itemize.
The couple avoids joint and several liability for the other spouse’s return.
Married filing separately is usually more advantageous for a couple than married filing jointly.
A)
I and II
B)
I, II, and III
C)
III only
D)
II only
a
Explanation
As an alternative to filing jointly, married individuals may file separate returns. This is known as married filing separately (MFS), and, in a few cases, the individuals may derive some tax benefit. However, the filing of returns MFS is usually not advantageous for married individuals.
LO 4.1.1
Which of the following is necessary for a valid and enforceable premarital agreement?
A)
There should be full disclosure of each party’s net worth prior to signing.
B)
The agreement needs to be orally agreed upon.
C)
Only one party needs to agree on the terms.
D)
It must specify alimony payments to be provided upon divorce of the parties.
a
Explanation
To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party’s financial situation. It may not be used to regulate an award of alimony.
LO 4.1.2
ustin was divorced in February 2023. As part of the divorce decree, Justin is paying $3,000 per month in child support and alimony to his ex-spouse, Casey. When his youngest child becomes 18, this payment will be reduced to $1,000. Justin would like to know the tax implications of the child support and alimony he is paying. After evaluating Justin’s circumstances, what should you tell Justin regarding the tax treatment of these payments?
None of the payments are taxable income to his ex-spouse.
Justin may deduct the alimony but not the child support.
A)
II only
B)
Neither I nor II
C)
I only
D)
Both I and II
c
Child support is not deductible by the payor or taxable to the payee, and, beginning in 2019, the tax treatment is the same for alimony.
LO 4.2.3
Max has taxable income of $80,000 from wages and will list his mother as a dependent on his tax return. Max will take the standard deduction this year. He wants to file on as simple an income tax form as he can. Which form will fit Max the best?
A)
Form 1040NR
B)
Form 990
C)
Form 709
D)
Form 1040
Max can use the 1040. 990 is for nonprofits. 709 is for gift tax. 1040NR is for nonresident aliens.
LO 4.2.1
Herman and Clarisse are married and come to you for tax advice. Herman is a U.S. citizen and Clarisse is not. What can you tell them about options for filing their taxes?
Clarisse can elect to file taxes as a nonresident or as a resident alien.
If filing as a resident alien, Clarisse will only need to fill out Form 1040NR.
If filing as a resident alien, Clarisse and Herman will need to pay taxes on all of their income (worldwide).
This will create an immigration benefit for Clarisse.
A)
I and III
B)
I only
C)
II, III, and IV
D)
II and IV
If married to a U.S. citizen or resident alien, the nonresident alien can elect to be treated as a resident alien for tax purposes only. Tax status does not necessarily reflect immigration status. If this election is made, the couple must pay U.S. taxes on their worldwide income. In this situation, the nonresident alien spouse should obtain an Individual Tax Identification Number (ITIN). Depending on their individual situation and intentions, they may apply for a Social Security number with the Social Security Administration.
LO 4.1.1
Lucy’s son, Alex, has been severely disabled since he was a small child. He has just turned 22, and Lucy provided all of his support until this year when he was placed in an extended care facility. With increased expenses not covered by insurance, Lucy will have to split his support. Lucy will provide one-third of the support, and Alex’s grandmother will pay one-third, with Alex’s aunt paying the final third. Because this is a new situation this tax year, Lucy has come to her financial planner to understand who can list Alex on their tax return for the purposes of filing status and possible credits. What does the planner tell Lucy?
A)
While one of the taxpayers may list Alex as a dependent in an agreed upon year, no tax credits would be available to that taxpayer.
B)
No one can list Alex on their return because no one has paid more than half of Alex’s support.
C)
The three relatives are free to agree among themselves who will list Alex on their return.
D)
Only Lucy, as his mother, can list Alex on her return.
c
Eligible taxpayers are generally free to agree among themselves who will list an individual as a dependent and who will claim any available credits when an individual can be claimed by more than one taxpayer.
LO 4.2.1
Which of the following is necessary for a premarital agreement to be valid and enforceable?
A)
It may be holographic.
B)
The agreement may be oral or in writing.
C)
Both signatories must utilize the same attorney.
D)
It must be in writing.
d
Explanation
To be valid, a prenuptial agreement must be in writing, witnessed, and reviewed by an attorney. Each party should obtain independent counsel.
LO 4.1.2
Floyd is a single U.S. citizen and the sole support of his father, Jacob, who is a qualifying relative. What filing status is best for Floyd to use this year?
Single
Head of household
A)
II only
B)
I only
C)
Both I and II
D)
Neither I nor II
a
Explanation
Only statement II is correct. Because Floyd’s father can be listed as his dependent on his tax return, Floyd should use the head of household filing status.
LO 4.2.1
As part of a 2022 divorce decree, Patrick was required to transfer all of his existing life insurance policies to his former spouse, Marlene. She became the owner and beneficiary of the policies. Patrick is now required to continue making the premium payments on all of the policies. How will the life insurance premium payments be treated?
A)
They are included as income.
B)
They are considered alimony.
C)
They are included as tax deductions.
D)
They are included as taxable income on Marlene’s return.
b
When a taxpayer transfers ownership and control of life insurance policies to a former spouse, any premium payments that the taxpayer makes on those policies are considered alimony to the ex-spouse.
LO 4.2.3
Which of the following statements regarding married couples who file joint tax returns is NOT correct?
A)
When spouses file jointly, each spouse is liable for only one-half of the tax due.
B)
Spouses who file a joint return have joint and several liability for the payment of any tax due.
C)
Spouses may file a joint return even if one spouse has no income.
D)
The law provides for innocent spouse relief, which may excuse one spouse for the failure of the other spouse’s tax obligation.
a
Spouses who file a joint return have joint and several liability for the payment of any tax due. This means each spouse is responsible for the entire tax liability and not just one-half.
LO 4.1.1
Which of the following statements concerning alimony is CORRECT?
A)
No payments except cash can be considered alimony.
B)
Payments to maintain property used by the payee spouse, but owned by the payor spouse, qualify as alimony.
C)
Cash payment of the payee spouse’s mortgage made by the payor spouse as required by the divorce or separation instrument qualifies as one-half alimony.
D)
Payments made with respect to jointly owned property are considered one-half alimony.
d
Cash payment of the payee spouse’s mortgage, rent, tuition, or tax liability made by the payor spouse as required by the divorce or separation instrument may qualify as alimony. Payments to maintain property used by the payee spouse, but owned by the payor spouse, do not qualify as alimony, even if required under the instrument. Payments made with respect to jointly owned property are considered one-half alimony. These property-related expenditures may include mortgage payments, real estate taxes, and homeowners insurance.
LO 4.2.2
Colin and Lucy are meeting with their financial planner, Jorge, before the tax year ends to discuss changes in their situation. In March of this year, Lucy’s father, Curtis, was diagnosed with dementia and required placement in a nursing home. Colin and Lucy paid for about half of his expenses until his death in December of this year. They would like to know what tax relief they may have for supporting Curtis this year. What does Jorge tell the couple?
A)
The couple can take a partial tax credit for Curtis this year.
B)
The couple is assured of at least being able to list Curtis on their tax return this year.
C)
Because they paid for only half of his nursing home expenses for Curtis, the couple is not entitled to the dependent care credit on their tax return.
D)
Jorge should ask for documentation to establish Curtis’ income, the amounts spent on his own support, and how much the couple spent before he can provide any recommendations.
d
Explanation
Jorge cannot provide any answers to Colin and Lucy until he has more documentation to support his recommendations.
LO 4.2.1
Legally married spouses may file a joint return
A)
if neither spouse is a nonresident alien at any time during the year.
B)
even if their tax years do not begin on the same date.
C)
if separated by a divorce decree, but the divorce is not final.
D)
only if both spouses have income or deductions.
a
Legally married spouses may file a joint return (even though one spouse has no income or deductions) if their tax years begin on the same date; they are not legally separated under a decree of divorce or separate maintenance on the last day of the calendar year; and neither is a nonresident alien at any time during the year.
LO 4.1.1
Which of the following taxpayers may use the married filing jointly filing status?
A married couple, even though one spouse did not have any income during the tax year
A married couple that is legally separated on the last day of the tax year if they share custody of a dependent child
A married couple that is legally separated on the last day of the tax year
A married couple that is not legally separated on the last day of the tax year
A)
II and IV
B)
I and IV
C)
I, II, and IV
D)
I, II, and III
b
A married couple may file a joint return even though one spouse has no income or deductions if they are not legally separated or divorced on the last day of the tax year.
LO 4.2.2
Nicholas and Ashley are married and file a joint tax return. Nicholas earns $80,000 annually, and Ashley earns $90,000 each year. What percentage of the tax liability does each spouse owe?
A)
100% for each spouse
B)
An amount based on each spouse’s percentage of income
C)
50% for each spouse
D)
Ashley has the highest salary; therefore, she owes 100%
a
Under the rule of joint and several liability, each spouse owes 100% of the tax liability, no matter who earned the income or in what proportion.
LO 4.1.1
Keith was divorced from Barbara in 2018. Barbara received custody of their two children. Keith was ordered to pay $1,000 per month to Barbara until the youngest child reaches age 18. At that time, the payments are to decrease to $400 per month. What portion, if any, is deductible by Keith as qualifying alimony?
A)
$0
B)
$1,000
C)
$500
D)
$400
d
A total of $600 is tied to an occurrence or contingency related to a minor child—the child reaching age 18. Thus, this amount is presumed to be nondeductible child support.
LO 4.2.3
Which of the following is necessary for a valid and enforceable premarital agreement?
A)
It must specify alimony payments to be provided upon divorce of the parties.
B)
There should be full disclosure of each party’s net worth prior to signing.
C)
The agreement needs to be orally agreed upon.
D)
It can be used to facilitate a divorce.
b
To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party’s financial situation. It may not be used to regulate an award of alimony or facilitate a divorce.
LO 4.1.2
Which of the following payments between divorced spouses is considered entirely child support?
Mark must pay his daughter’s private school tuition until she graduates high school.
Sarah must pay her ex-spouse, Norman, $1,000 per month for five years or until he remarries. Norman has custody of their 15-year-old son.
Lucius is required to pay $5,000 per month to Anna, his child’s mother, until the child is age 18.
Jason is required to pay Lisa $3,000 per month until their daughter is 18, after which the payment is reduced to $1,400 per month.
A)
I and III
B)
IV only
C)
III and IV
D)
I only
a
Statements I and III are correct. Statement II is alimony because the condition does not relate to the child. Statement IV is both alimony and child support because only part of the payment is related to contingency related to the child.
LO 4.2.3
Ed was divorced from his spouse, Julie, in 2018. Julie was granted custody of their only child, Sally, age 5. Ed was ordered to pay $2,500 per month to Julie until Sally reaches age 18. At that time, the payments are to decrease to $1,200 per month. What portion of each payment, if any, is deductible by Ed as qualifying alimony?
A)
A total of $1,300 of each payment is deductible by Ed.
B)
None of each payment is deductible by Ed.
C)
A total of $1,200 of each payment is deductible by Ed.
D)
All of each payment is deductible by Ed.
c
Explanation
In a divorce decree, any amount tied to the happening of a contingency or an event related to a minor child is deemed to constitute nondeductible child support. In this situation, $1,300 is tied to Sally turning 18. Thus, only the remaining $1,200 is considered to be alimony.
LO 4.2.3
Barbara and Morgan were divorced last year and have a child age 13. The court ruled that Barbara must pay Morgan $2,000 per month to cover both alimony and child support. The divorce decree states that 70% of each payment is allocated for child support and the payments must last for five years. Based on this information, which of the following statements is CORRECT?
A)
Barbara can deduct $600 per month as child support.
B)
Barbara can deduct $1,400 per month as child support.
C)
Barbara cannot take a deduction.
D)
Barbara can deduct $1,400 per month as alimony.
c
Explanation
Beginning in 2019, alimony payments are no longer deductible by the payor.
LO 4.2.3
Which of the following statements regarding items of gross income is CORRECT?
Alimony or separate maintenance payments are includible in the gross income of the payee and are deductible for income tax purposes from the gross income of the payor if the divorce was finalized prior to January 1, 2019.
Child support payments are includible in the gross income of the payee and are deductible for income tax purposes from the gross income of the payor.
A)
I only
B)
Neither I nor II
C)
Both I and II
D)
II only
a
Payments for child support are not deductible by the payor and are not included in gross income for the payee.
LO 4.2.3
Abby and her father, Ryan, live together in Abby’s home. Ryan is bedridden, and Abby must pay a caregiver to provide meals and other assistance to Ryan during the day so Abby can go to work downtown. Abby pays $5,000 annually for this service. Ryan has no income, and Abby is his full support. What tax relief may be available to Abby for the expenses of caring for her father?
Child and dependent care credit
A greater standard deduction amount
A)
Both I and II
B)
Neither I nor II
C)
I only
D)
II only
a
Abby is entitled to both the standard deduction amount for the head of household filing status and the child and dependent care tax credit, subject to the limits based on Abby’s AGI.
LO 4.2.1
In 2023, Alice provided over half the support of her son, Mike, age 20, who is a full-time college student. Assuming all of the other qualifying child tests are met, what is the maximum age that Mike can be a full-time student and still qualify to be listed as Alice’s dependent?
A)
23
B)
21
C)
19
D)
18
a
Mike must pass an age test (meet one of the following): (1) under age 19 at the close of the tax year, or (2) is a full-time student and under age 24 at the close of the tax year.
LO 4.2.1
Which of the following must be true for someone to be claimed as a dependent for another taxpayer?
A dependent may not have more than $4,700 (2023) of gross income.
The taxpayer must provide over 50% of the dependent’s support.
A person who dies during the year may not be identified as a dependent.
Social Security payments are always included in the dependent’s gross income.
A)
II and IV
B)
III and IV
C)
I and II
D)
I only
c
A dependent may not have more than $4,700 (2023) of gross income. Social Security income is excluded from the test if that is the elder’s only source of income. The taxpayer must also provide over 50% of the dependent’s support to claim them. Coincidentally, as long as all the tests are met, a person who dies during the year may still be identified as a dependent.
LO 4.2.1
Mavis and Bennet are married and file jointly. Mavis earns $30,000 and Bennet earns $70,000. What percentage of the tax liability does each spouse owe?
A)
100% for each spouse
B)
Depends on the percentage of income
C)
50% for each spouse
D)
Bennet earns the most, so he owes 100%
a
Under the rule of joint and several liability, each spouse owes 100% of the tax liability, no matter who earned the income or in what proportion.
LO 4.1.1
Michael was divorced after 12 years of marriage and recently died. He had two dependent children, ages four and six, who are cared for by their mother. He was currently, but not fully, insured under Social Security at the time of his death. The benefits that his survivors are entitled to include which of the following?
A lump sum death benefit of $255
A children’s benefit
A divorced spouse’s benefit
A parent’s benefit for deceased workers’ parents who are over the age of 62
A)
III and IV
B)
I, II, and III
C)
I and II
D)
I, II, III, and IV
c
A lump sum death benefit of $255 is payable to the surviving spouse or children of the deceased worker if he was fully or currently insured. The children’s benefit is payable because Michael was either currently or fully insured. The mother of the children would be entitled to a benefit because she is caring for Michael’s children who are under the age of 16. However, that is not called the divorced spouse benefit. It is the surviving spouse caring for a dependent child benefit. The parents are not entitled because Michael was not fully insured. Statements III and IV are benefits only available under fully insured status.
LO 4.2.3
If Gloria, after divorce, wants to change the beneficiary of a trust that names her spouse as beneficiary to her daughter, which of the following is true?
If the trust document does not allow the beneficiary to be removed, a new trust must be created.
If a new trust is created, a new beneficiary can be easily named.
Assets in an original trust can be decanted to a new trust.
A)
I only
B)
II and III
C)
I and III
D)
I, II, and III
c
Some trust documents do not allow the beneficiary to be removed. In this case, the original grantor may be able to create a new trust. The trustee of the old trust could then decant the assets to the new trust. However, this arrangement presupposes the agreement of the disinherited spouse.
LO 4.2.2
After a divorce, a planner should encourage a client to
A)
name the estate as the beneficiary.
B)
review existing life insurance policies and update the beneficiaries.
C)
encourage the client to cancel all existing life insurance policies and start over.
D)
name minor children as the primary beneficiaries.
b
Planners should not assume divorcees updated their life insurance after a divorce. In fact, failing to remove a former spouse as a life insurance beneficiary is a common mistake. If the policy is not changed, the insurance company has a contractual obligation to pay the former spouse. Canceling a policy is generally ill advised because the client may no longer be insurable. Naming a minor as beneficiary can create a very complicated legal situation that could prevent the child from receiving the payout. If the client names the estate as a beneficiary, the payout will not be released until after the probate process, which can take months or years to complete.
Arlene, who is 75 years old and single, is listed as a dependent on her son’s tax return. During the current year, she received $1,700 interest on a savings account, $1,000 of interest income from municipal bonds, and $11,000 of Social Security benefits. She also earned $1,250 from a part-time job. What is Arlene’s gross income?
A)
$14,950
B)
$5,700
C)
$2,950
D)
$13,950
c
Explanation
The interest income on the savings account and the earned income from the part-time job are included in Arlene’s gross income. The interest income earned on the municipal bond is tax exempt and is excluded from her gross income. Her gross income is equal to $2,950 ($1,700 + $1,250). The Social Security benefits will not be included in her gross income.
LO 4.2.1
Which of the following ways would make a premarital agreement valid and enforceable?
A)
An orally executed agreement
B)
Both oral and written agreements
C)
A written agreement with any one of the parties signing
D)
A written agreement with signatures of both parties
d
To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party’s financial situation. It may not be used to regulate an award of alimony.
LO 4.1.2
hich of the following statements regarding installment payments pursuant to a divorce is CORRECT?
It is usually in the best interest of the recipient of the funds to spread the amount of payments over as many years as possible to take advantage of the time value of money.
It is usually in the payee’s best interest to immediately receive as much money as possible rather than receiving payments over a longer period.
A)
Neither I nor II
B)
Both I and II
C)
II only
D)
I only
c
A common issue that arises in the settlement of divorce proceedings is how payments are best structured in resolution of marital obligations. As a general rule, it is usually in the best interest of the payor to spread the amount of payments over as many years as possible to take advantage of the time value of money. Alternately, the payee’s best interests are served by immediately receiving as much money as possible rather than receiving payments over a longer period.
LO 4.2.2
Reese and Belinda are married taxpayers who will file separately in 2023. What is the gross income threshold that will trigger filing an income tax return for Reese or Belinda?
A)
$20,800
B)
$27,700
C)
$13,850
D)
$14,250
c
Married individuals who file separately must file if income equals or exceeds the standard deduction amount for a single taxpayer ($13,850 in 2023).
LO 4.1.1
Legally married spouses may file a joint return
A)
if separated by a divorce decree, but the divorce is not final.
B)
even if one spouse is a nonresident alien.
C)
even if their tax years do not begin on the same date.
D)
even if one spouse does not have income or deductions.
d
Legally married spouses may file a joint return (even though one spouse has no income or deductions) if their tax years begin on the same date; they are not legally separated under a decree of divorce or separate maintenance on the last day of the calendar year; and neither is a nonresident alien at any time during the year.
LO 4.1.1
Andrew and Lillian are meeting with their financial planner, Marcus, before the tax year ends to discuss changes in their situation. In March of this year, Lillian’s mother, Janice, suffered a stroke and required placement in a nursing home. She did not have the funds to pay for it, and it fell to the couple to support her stay until her death in November of this year. They would like to know what tax relief they may have for supporting Janice this year. What does the planner tell the couple?
A)
Marcus should ask for documentation to establish Janice’s income, the amounts spent on her own support, and how much the couple spent before he can provide any recommendations.
B)
The couple is assured of at least being able to take a tax credit for Janice this year.
C)
The couple can take a partial tax credit for Janice this year.
D)
Because they paid nursing home expenses for Janice, the couple is entitled to the dependent care credit on their tax return.
a Marcus cannot provide any answers to the Andrew and Lillian until he has more documentation to support his recommendations.
LO 4.2.1
Which form should a nonresident alien file, if they earned income during the taxable year and if not electing to be a resident?
A)
Form 1040
B)
Form 706
C)
Form 1040NR
D)
Form 1041
c
If they earned U.S. income during the year, nonresident aliens must file Form 1040NR. However, if married to a U.S. citizen or resident alien, the nonresident alien can elect to be treated as a resident alien for tax purposes only. Tax status does not necessarily reflect immigration status. If this election is made, the couple must pay U.S. taxes on their worldwide income. In this situation, the nonresident alien spouse should obtain an Individual Tax Identification Number (ITIN). Depending on their individual situation and intentions, they may apply for a Social Security number with the Social Security Administration.
LO 4.1.1
Amanda and Matt were divorced in January 2023 and have one 11-year-old son. The court ruled that Amanda must pay Matt $4,000 per month to cover both alimony and child support. The divorce decree states that 70% of each payment is allocated for child support, and these payments must be made for seven years. Based on this information, which of the following statements is CORRECT?
A)
Amanda can deduct the $4,000 per month as child support and alimony payment.
B)
Amanda cannot deduct the alimony or the child support she pays Matt.
C)
Amanda can deduct $2,800 per month as child support.
D)
Amanda can deduct $1,200 per month as alimony.
b
Child support is not deductible, and, beginning in 2019, alimony payments are not deductible by the payor.
LO 4.2.3
Which of the following payments between divorced spouses is NOT considered only child support?
Mark must pay his daughter’s private school tuition until she graduates high school.
Sarah must pay her ex-spouse, Norman, $1,000 per month for five years or until he remarries. Norman has custody of their 15-year-old son.
Lucius is required to pay $5,000 per month to Anna, his child’s mother, until the child is age 18.
Jason is required to pay Lisa $3,000 per month until their daughter is 18, after which the payment is reduced to $1,400 per month.
A)
IV only
B)
I and II
C)
II and IV
D)
I and III
c Explanation
Statements II and IV are correct. Statement II is alimony because the condition does not relate to the child. Statement IV is both alimony and child support because only part of the payment is related to contingency related to the child.
LO 4.2.3
Which of the following legally married couples may file a joint (MFJ) income tax return?
David and Jack whose tax years began on the same day
Marvin and Alicia who are legally separated on the last day of the calendar year
Janice and Juan; Juan was a nonresident alien for only the first three months of the year
Sylvia and Marilyn who married on New Year’s Eve this year
A)
I and IV
B)
III and IV
C)
I and II
D)
II and IV
a Only couple I and IV may file a joint income tax return. Marvin and Alicia were legally separated on the last day of the year and are ineligible. Because Juan was a nonresident alien for part of the year, Janice and Juan are also ineligible to use the MFJ filing status.
LO 4.1.1
As part of a divorce decree, a judge has ordered Judy, 44, to give Alex, 36, half of her IRA. This transfer can be best described as
A)
qualified domestic relief order.
B)
a domestic relations order (DRO).
C)
a qualified domestic relations order (QDRO).
D)
subject to the 10% early withdrawal penalty.
b
This is properly known as a domestic relations order because an IRA is not a qualified plan. If Judy instead were ordered to withdraw from her 401(k), it would become a qualified domestic relations order.
LO 4.2.2
Pat’s son, Alex, has been severely disabled since he was a small child. He has just turned 22, and Pat has provided all of his support until this January when he was placed in an extended care facility. With the increased expense not covered by insurance, Pat must split his support with Alex’s paternal grandmother and his aunt who have provided the other two-thirds equally. Because this is a new situation this tax year, Pat has come to her financial planner to understand who can list Alex on their tax return for the purposes of filing status and possible credits. What does the planner tell the Pat?
A)
No one can list Alex on their return because no one has paid more than half of Alex’s support.
B)
The three relatives are free to agree among themselves who will list Alex on their return.
C)
While one of the taxpayers may list Alex as a dependent in an agreed upon year, no tax credits would be available to that taxpayer.
D)
Only the Pat, as his mother, can list Alex on her return.
b
Eligible taxpayers are generally free to agree among themselves who will list an individual as a dependent and who will claim any available credits when an individual can be claimed by more than one taxpayer.
LO 4.2.1
Your client was divorced in 2017. Your client’s ex-spouse has custody of their 10-year-old daughter. During the current tax year, your client made alimony payments of $12,000 paid to contractors and maintenance workers for upkeep of the ex-spouse’s house. In addition, the client paid child support payments of $6,000 to the ex-spouse. Your client’s adjusted gross income before any deductions for the listed expenses was $175,000. What is the appropriate amount of the alimony deduction on your client’s current-year federal income tax return?
A)
$18,000
B)
$12,000
C)
$0
D)
$6,000
b
Payment made by the payor spouse to a third party as a result of a divorce or separation instrument can be alimony. Cash payment of the payee spouse’s mortgage, rent, tuition, or tax liability made by the payor spouse as required by the divorce or separation instrument may qualify as alimony. The child support payments are nondeductible by the payor and are not includible by the recipient.
LO 4.2.3
Colin and Lucy are meeting with their financial planner, Mark, before the tax year ends to discuss changes in their situation. In March of this year, Lucy’s mother, Joyce, suffered a stroke and required placement in a nursing home. She did not have the funds to pay for it and it fell to the couple to support her stay until her death in November of this year. They would like to know what tax relief they may have for supporting Joyce this year. What should Mark tell the couple?
A)
Because they paid nursing home expenses for Joyce, the couple is entitled to the dependent care credit on their tax return.
B)
The couple is assured of at least being able to list Joyce on their tax return this year.
C)
Mark should ask for documentation to establish Joyce’s income, the amounts spent on her own support, and how much the couple spent before he provides any recommendations.
D)
The couple can take a partial tax credit for Joyce this year.
c
Mark cannot provide any answers to Colin and Lucy until he has more documentation to support his recommendations.
LO 4.2.1
Lacey is a single taxpayer. Lacey’s aunt, Blanche, has come to live with her after it was determined she could no longer live independently. She is physically challenged and needs full-time care. Blanche’s parents set up a trust for her that supplies all of her support, including paying for in-home care and all medical bills. Lacey wants to know how this will affect her income tax situation. What does the planner tell her?
A)
Blanche is a qualifying relative.
B)
Lacey may list Blanche as a dependent on her income tax return.
C)
Lacey and Blanche will both file as single.
D)
Lacey’s filing status changes to head of household.
c
Because the trust pays for all of Blanche’s support, Lacey’s income tax return is unaffected. Both Lacey and Blanche will file as single.
LO 4.2.1
Which of the following is NOT a requirement to be met in order to deduct alimony payments for a divorce finalized in 2018?
A)
The legal document or state law must require that payments will stop after the recipient spouse dies.
B)
Payments must be in cash.
C)
Payments must be equal in each year of the agreement.
D)
The parties must not file a joint tax return at the time of payment.
c
All of the options are requirements except the payments must be equal each year of the agreement. However, unequal and declining payments can trigger the alimony recapture rules.
LO 4.2.3
Jack and Melissa, who are both age 49, are married and file jointly for federal income tax purposes. What amount must their total gross income meet or exceed to require the couple to file a federal income tax return in 2023?
A)
$26,800
B)
$27,700
C)
$20,800
D)
$13,850
b
Married individuals who file jointly are not required to file unless their combined gross income equals or exceeds the basic standard deduction amounts, $27,700 in 2023.
LO 4.1.1
In 2023 Mason is working with his attorney and his CFP® professional on the final documents concerning his divorce from Kristen. The sources for the cash and property for Kristen have been identified and are to be received by Kristen over eight years. If alimony payments are specified to continue after Kristen’s death, which of the following statements regarding such payments is CORRECT?
A)
The payments are not considered alimony.
B)
The alimony is a deductible expense.
C)
The total future amounts become taxable income.
D)
The alimony is both deductible by Mason and is taxable income to Kristen.
a
If the payments are scheduled to be paid beyond the death of the payee, the payments are generally not deductible and are no longer considered alimony but a disguised property settlement. Other requirements that must be met for the alimony to be deductible are that the payments be in cash and pursuant to a divorce or separation agreement.
LO 4.2.3
Ted and Sophie are divorcing in 2023, and Sophie is questioning her planner about the tax impact of the financial aspects of the divorce decree. Ted will be paying alimony to Sophie for the next four years unless she remarries first. Ted will pay child support to Sophie for their only son, Mark, until he reaches age 18. Sophie and Mark will continue to live in the family home, and Ted’s interest in the home will be transferred to Sophie. Which of the following statements concerning the income tax implications of Ted and Sophie is NOT correct?
A)
The child support payments are not taxable income to the recipient and are nondeductible by the payor.
B)
When the family home is transferred to Sophie, it does not affect her income.
C)
The planner notes a $20,000 reduction between payments in year one and payments in year two and tells Sophie the couple will not be subject to the alimony recapture rules.
D)
The alimony received by Sophie is deductible as an itemized deduction on her income tax return in the year Ted pays it.
d
Alimony is not (and never has been) an itemized deduction. For 2023 divorce agreements, alimony is not an above-the-line deduction for the payor nor taxable income to the payee.
LO 4.2.3
Which of the following married couples may file their federal income tax return using the married filing jointly (MFJ) status?
A)
Paul and Josie will be married next year on New Year’s Day.
B)
Terry and Edie divorced last year but did not move into separate homes until November of this year.
C)
Sara has income for the tax year but Jack does not.
D)
Mark and Beth are both self-employed and have different fiscal years to accommodate their businesses.
c
Because Mark and Beth have different fiscal years to accommodate their businesses, their tax years do not begin on the same date, and they may not file as MFJ. In order to use the MFJ status, a couple must be legally married on the final day of the tax year.
LO 4.1.1
Which of the following taxpayers may use the married filing jointly filing status?
A married couple, even though one spouse did not have any income during the tax year
A married couple that is legally separated on the last day of the tax year if they share custody of a dependent child
A married couple that is legally separated on the last day of the tax year
A married couple that is not legally separated on the last day of the tax year
A)
I, II, and III
B)
II and IV
C)
I, II, and IV
D)
I and IV
d A married couple may file a joint return even though one spouse has no income or deductions if they are not legally separated or divorced on the last day of the tax year.
LO 4.1.1
When spouses who are legally married use the married filing jointly filing status, what is their liability for the combined income tax owed?
A)
Each spouse has joint and several liability for payment of the entire tax.
B)
Each spouse has liability for the tax due in proportion to their earnings reported on the return.
C)
Each spouse owes 50% of the tax due.
D)
A nonworking spouse has no liability for the tax owed.
a
When filing in this manner, spouses have joint and several liability for the payment of tax, meaning each spouse is responsible for the entire tax and not just half.
LO 4.1.1
Ron, age 43, and Sandy, 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 current tax year 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 spouse and his daughter.
Because both Ron and Sandy are considered to be self-employed, they make quarterly estimated tax payments each year to cover both their income tax and self-employment tax obligations.
Based on the information provided in the case scenario, which of the following statements regarding Lisa’s income tax filing status is CORRECT?
A)
Lisa may file married filing jointly.
B)
Lisa must file a single return.
C)
Lisa may file as head of household.
D)
Lisa must file married filing separately.
a
Because Lisa’s spouse died earlier in the year, she may use married filing jointly status. She cannot use the head of household filing status because she does not maintain a household for a qualifying child or relative.
LO 4.1.1
What important information could you tell your nonresident client (married to a U.S. citizen) about electing to be treated as a resident alien for tax purposes?
You will need to pay taxes only on your U.S. income.
You will need to pay taxes on your worldwide income.
This will create an immigration benefit.
You should obtain an individual taxpayer identification number (ITIN) or Social Security number.
A)
II, III, and IV
B)
I and IV
C)
I only
D)
II and IV
d
If married to a U.S. citizen or resident alien, the nonresident alien can elect to be treated as a resident alien for tax purposes only. Tax status does not necessarily reflect immigration status. If this election is made, the couple must pay U.S. taxes on their worldwide income. In this situation, the nonresident alien spouse should obtain an Individual Tax Identification Number (ITIN). Depending on their individual situation and intentions, they may apply for a Social Security number with the Social Security Administration.
LO 4.1.1
Which of the following are characteristics of a valid and enforceable premarital agreement?
It may be orally executed by the parties that are affected.
There should be a full and complete disclosure of each party’s net worth prior to signing.
It may be used to regulate an award of alimony upon divorce of the parties.
There should be a written agreement with the willingly executed signatures of both parties.
A)
II and IV
B)
I and II
C)
II and III
D)
III and IV
a
To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party’s financial situation. It may not be used to regulate an award of alimony.
LO 4.1.2
Which of the following is necessary to include in a premarital agreement?
A)
Financial resources and net worth of the less wealthy party
B)
Intentions to facilitate a divorce
C)
Financial resources and net worth of both parties
D)
Financial resources and net worth of the more wealthy party
c
To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party’s financial situation. It may not be used to regulate an award of alimony.
LO 4.1.2
Which of the following would result in higher taxation of one party with a premarital agreement?
A)
Transfer under the agreement is treated as an estate
B)
Transfer under the agreement is treated as a gift
C)
Transfer for consideration is made
D)
Transfer for premarital is made
c
The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party).
LO 4.1.2
John and Karen will spend $7,000 on day care for their two children (ages 9 and 10) in the current tax year. These expenses were incurred to allow both John and Karen to work outside the home. Their adjusted gross income is estimated at $138,000. What is the amount, if any, of child care credit to which they are entitled?
A)
$1,400
B)
$480
C)
$1,200
D)
$960
c
The maximum amount of qualifying expenditures on which the credit may be based is $3,000 per child, or $6,000 for two or more children. This is multiplied by 20% for taxpayers with an AGI greater than $43,000. Thus, $6,000 × 20% = $1,200.
LO 4.2.1
Max and his mother, Lucy, live together in his home. Lucy is bedridden, and Max must pay a caregiver to provide meals and other aid during the day so he can leave the house and work. He pays $5,000 annually for this service. His mother has no income, and he is her full support. What tax relief may be available to Max for the expenses of caring for his elderly mother?
A greater standard deduction amount
Child and dependent care credit
A)
II only
B)
Both I and II
C)
I only
D)
Neither I nor II
b
Max is entitled to both the standard deduction amount for the head of household filing status and the child and dependent care tax credit, subject to the limits based on Max’s AGI.
LO 4.2.1
Now that their parents have died, Joseph is assuming the responsibility for the care of his 25-year-old disabled sister. Joseph has told his financial planner there is a trust for his sister to provide funds sufficient for her to live in an assisted-living facility or to reimburse him for the cost of an at home caregiver and his sister’s other expenses if she stays in his home. He would prefer for his sister to live with him but does not want to cause her any problems with tax issues on any income she gets if she does. His sister is adamant that she does not want to be anyone’s dependent. What advice can the planner give to Joseph?
If his sister’s income from the trust is paying for all of her needs, then she is not a dependent on anyone’s income tax return.
If Joseph’s sister lives in an assisted-living facility, she cannot be a dependent of Joseph.
A)
II only
B)
I only
C)
Neither I nor II
D)
Both I and II
b
Statement I is correct. If all of his sister’s support is paid for by funds she receives from the trust, she cannot be a dependent of Joseph. Statement II is incorrect. Simply not living with Joseph does not preclude him from listing his sister as a dependent. If Joseph provided more than half of the support for his sister, he would be allowed to list her as a dependent and take any tax credits that may be available.
LO 4.2.1
Max is a widower who provides a home for himself and his dependent six-year-old daughter, Lucy. He has hired an individual to pick his daughter up from school each day, bring her home, cook dinner, and perform some housekeeping services until he gets home four hours later. He pays $1,600 per month for the service. How will this affect Max’s income tax return?
Max may be entitled to a child and dependent care credit.
Max qualifies to list Lucy on his income tax return as a dependent.
Because Lucy attends school during the day, the child or dependent care credit is not available.
Max must allocate the $1,600 per month between child care and housekeeping services.
A)
II only
B)
II, III, and IV
C)
I and II
D)
I and IV
c
School attendance does not affect the availability of the credit. The $1,600 in expenses incurred each month to enable Max to work outside the home do not have to be divided between child care and housekeeping services.
LO 4.2.1
Trudy is a single taxpayer. Her Aunt Diane has come to live with her after it was determined she could no longer live independently. She is physically challenged and needs full-time care. Diane’s deceased parents set up a trust for her that supplies all of her support, including paying for in-home care and all medical bills. Trudy wants to know how this will affect her own income tax situation. What does the planner tell her?
A)
Trudy may list Diane as a dependent on her tax return.
B)
Trudy’s filing status changes to head of household.
C)
Diane is Trudy’s qualifying relative.
D)
Trudy must file as single.
d
Because the trust pays for all of Diane’s support, Trudy’s income tax return is unaffected and she will file as single.
LO 4.2.1
Macy, age 22 and disabled, has been living with her older brother, Leon, since last December when their parents died in an auto accident. Leon has been providing all of her support as her share of the life insurance benefit was put into a trust for her college education. Leon is asking his planner about Macy’s status as a qualifying relative because her life insurance benefit was $250,000. He hopes to use the head of household status this year. What does the planner tell him?
A)
Only the trust can list Macy as a dependent on its return.
B)
Even though Leon supported Macy, Leon cannot list her as a dependent because her insurance benefit was so large.
C)
Because Leon provided all of Macy’s support this year, he may claim her as a dependent.
D)
Leon cannot list Macy as a dependent and claim head of household status.
c
Because Leon provided all of Macy’s support this year, he can claim her as a dependent and claim head of household status.
Which of the following must be true in order for an adult child or elderly parent to be claimed as a dependent for another taxpayer?
A dependent may not have more than $4,700 (2023) of gross income.
The taxpayer must provide over 75% of the dependent’s support.
A person who dies during the year may be identified as a dependent.
Social Security payments are always included in the dependent’s gross income.
A)
III and IV
B)
I and III
C)
I and II
D)
II and IV
b
An adult dependent (i.e., not a “qualifying child”) may not have more than $4,700 (2023) of gross income. Social Security income is excluded from the test if that is the elder’s only source of income. The taxpayer must also provide over 50% of the dependent’s support to claim them. Coincidentally, as long as all the tests are met, a person who dies during the year may still be identified as a dependent.
LO 4.2.1
As part of the property settlement after Lori and Gordon divorced, Gordon transferred ownership of a life insurance policy to Lori. Lori is the beneficiary of the policy, and Gordon is the insured. Which of the following statements regarding the property settlement is CORRECT?
The transfer of the life insurance policy is subject to the transfer-for-value rule.
The death proceeds of the policy will be income tax free at Gordon’s death.
A)
Both I and II
B)
II only
C)
I only
D)
Neither I nor II
b
Statement I is incorrect; the transfer-for-value rule does not apply when a life insurance policy is transferred from one spouse to the other under a property settlement incident to divorce. Statement II is correct.
LO 4.2.2
Which of the following statements regarding installment payments pursuant to a divorce is CORRECT?
It is usually in the best interest of the payor to spread the amount of payments over as many years as possible to take advantage of the time value of money.
It is usually in the payee’s best interest to immediately receive as much money as possible rather than receiving payments over a longer period.
A)
I only
B)
Neither I nor II
C)
Both I and II
D)
II only
c
A common issue that arises in the settlement of divorce proceedings is how payments are best structured in resolution of marital obligations. As a general rule, it is usually in the best interest of the payor to spread the amount of payments over as many years as possible to take advantage of the time value of money. Alternately, the payee’s best interests are served by immediately receiving as much money as possible rather than receiving payments over a longer period.
LO 4.2.2
As part of their divorce decree, Judy, age 44, was forced to split her 401(k) with Alex, age 36. Alex received a check in April for $100,000 from the custodian. Alex put the proceeds into a one-year CD account at the local bank. As a result, Alex will
A)
not have to pay ordinary income tax on the $100,000.
B)
have to pay ordinary income tax on the $100,000.
C)
not have to pay income tax, but Judy will owe gift tax.
D)
have to pay ordinary income tax on the $100,000 plus a 10% early withdrawal penalty.
b
Although the transfer itself is tax free, Alex should roll the assets distributed from Judy’s 401(k) within 60 days into his own IRA or retirement plan. Because he failed to do so, he owes ordinary income tax on the entire distribution. When incident to a divorce, qualified domestic relations orders (QDROs) are however not subject to gift tax or early withdrawal penalties.
LO 4.2.2
Lois, age 29, and Clark, age 31, recently divorced. Lois is taking custody of their three children ages four, two, and one. Clark will pay alimony and child support of $1,000 per month. They live in a state that requires alimony payors to obtain a life insurance policy. Clark obtained a group term life policy for $50,000 through his employer to meet this obligation. Clark’s lawyer claims this satisfies his legal obligation. Which of the following should a financial planner recommend to Lois?
A)
She should inquire if she can take loans against the cash value for future college tuition payments.
B)
She should demand his employer increase the coverage.
C)
She should demand an increase in coverage and request a permanent policy.
D)
She should accept the settlement as adequate.
c
Clark is underinsured given his legal obligations. Lawyers are not financial planners and generally are not trained to calculate life insurance coverage needs. Consequently, they often settle for an amount of life insurance that is too low. Term policies do not have cash value. If Clark leaves his employer, the term policy will most likely be canceled, which would compel Lois to take Clark back to court.
LO 4.2.2
Which of the following statements concerning alimony is CORRECT?
A)
No payments except cash can be considered alimony.
B)
Payments to maintain property used by the payee spouse but owned by the payor spouse do not qualify as alimony.
C)
Cash payment of the payee spouse’s mortgage made by the payor spouse as required by the divorce or separation instrument qualify as one-half alimony.
D)
Payments made with respect to jointly owned property are considered full alimony.
b
Cash payment of the payee spouse’s mortgage, rent, tuition, or tax liability made by the payor spouse as required by the divorce or separation instrument may qualify as alimony. Payments to maintain property used by the payee spouse, but owned by the payor spouse, do not qualify as alimony, even if required under the instrument. Payments made with respect to jointly owned property are considered one-half alimony. These property-related expenditures may include mortgage payments, real estate taxes, and homeowners insurance.
LO 4.2.3
Jack and Emily are legally separated on December 31 this year. Jack earned $40,000 this year, and Emily earned $80,000. They live in a common law state and have no dependents. They have come to a tax preparer to determine how they must file their income taxes this year. What does the planner tell them?
A)
They must file as single, each reporting $60,000 (half of the total of $120,000) in income.
B)
They may file as MFJ as they were not legally separated until the end of the year.
C)
They must file as single, each one reporting their own income.
D)
They must file as MFS, each reporting their own income.
c
Single (S) filing status is used by an unmarried, legally separated, or divorced individual who does not qualify for any other filing status.
LO 4.2.3
Bob and Bonnie were divorced in 2016. As a result of a court order, Bob pays Bonnie $700 per month in alimony. He makes each month’s payment with a money order. Earlier this year, Bonnie moved in with Bob, and they now share a two-bedroom apartment. Which of the following statements is accurate concerning the alimony payments by Bob?
A)
The payments are not deductible because the payments must be in cash.
B)
The payments are not deductible because the taxpayers are living together at the time of payment.
C)
The payments are deductible because they are equal each year of the agreement.
D)
The payments are deductible because they are being made as a result of a court order.
b
The requirement that the payments be in cash means that the payments may not be in the form of property. Payments are not necessarily deductible just because they are a result of a court order; there are other requirements that must be met as well. One of those requirements to have qualifying alimony is that the taxpayers must not be living together at the time of payment. The payments do not need to be equal each year. However, unequal and declining payments can trigger the alimony recapture (excess front-loading) rules.
LO 4.2.3
Dan and his spouse, Gina, are getting divorced. Dan has an IRA with a balance of $400,000. Part of the balance was rolled over from his 401(k). He claims the IRA is a gift because it was funded predominantly with cash gifts from his parents during their 15-year marriage. Gina does not have a retirement account. Which of the following is correct?
A)
Because the IRA was funded with gift money, it is treated as separate property. Gina has no claim to the funds.
B)
Gina can only claim a portion of the IRA if they live in a community property state.
C)
Gina can request a domestic relations order and, if granted, claim a portion of the IRA funds.
D)
Qualified plans are exempt from property settlements in a divorce.
c
Gina can request a domestic relations order and submit a claim for a portion of the IRA funds. By law, IRAs and 401(k)s can only be funded with earned income. For this reason, Dan’s claim that the IRAs were funded with gift money is an implausible defense. Qualified plans and IRAs may be divided in a property settlement, whether the parties reside in a community property or common law state.
LO 4.2.3
Larry and Pam are married and will file a joint return for the 2023 tax year. Pam is an active participant in a company-maintained retirement plan, but Larry is not. They have provided you with the following information. Pam’s divorce was finalized in 2018.
Larry’s salary $120,000 Larry’s IRA contribution $6,500
Pam’s salary $65,000 Pam’s IRA contribution $6,500
Alimony payments to Pam’s ex-spouse $9,600
Itemized deductions $15,000
Based on the information given, what is their taxable income for the 2023 tax year?
A)
$89,900
B)
$141,200
C)
$100,900
D)
$107,400
b
The $185,000 in salaries is reduced by the alimony payment of $9,600 and Larry’s IRA contribution of $6,500 to give an AGI of $168,900. The AGI is reduced by the greater of the itemized deductions ($15,000) or the standard deduction ($27,700 in 2023) to leave $141,200. Pam’s IRA contribution is nondeductible because the MAGI exceeds the phaseout range of $116,000 to $136,000. Because the MAGI is less than $218,000, Larry may still deduct his full IRA contribution. Note that the MAGI ($175,400 in this situation) is the AGI computed without regard to the IRA deduction itself. The AGI phaseout limits for active participants will be provided on the exam.
LO 4.2.3
Brent and Sheila are married and will file a joint return. They have provided you with the following information.
Brent’s salary $80,000
Sheila’s salary $65,350
Alimony payments to Brent’s ex-spouse $20,000
Brent’s child support paid $12,000
Itemized deductions $13,000
Brent’s divorce from his prior marriage was finalized in 2016. Based on the information given, what is their taxable income for the 2023 tax year?
A)
$111,250
B)
$87,450
C)
$97,650
D)
$110,850
c
The $145,350 in salaries is reduced by the alimony payment of $20,000 to give an AGI of $125,350. The AGI is reduced by the greater of the itemized deductions ($13,000) or the standard deduction ($27,700 in 2023) to equal $97,650. The child support paid is not a deductible item.
LO 4.2.3
Ron, age 43, and Sandy, 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 spouse and his daughter.
Because both Ron and Sandy are considered to be self-employed, they make quarterly estimated tax payments each year to cover both their income tax and self-employment tax obligations.
Ron’s divorce decree specifies that the payment made to his former spouse is $300 per week until his former spouse dies, at which point payments will continue to be made to her estate until her daughter is age 18. Based on the information provided in the case scenario for Ron and Sandy, what amount per week is considered to be alimony?
A)
$0
B)
$300
C)
$150
D)
$50
b
If there is an obligation to continue to make payments after the death of the ex-spouse, the payments are not treated as alimony.
LO 4.2.3
Which of the following statements regarding alimony paid under a 2023 divorce agreement is CORRECT?
A)
Alimony may be paid in either cash or property.
B)
Alimony is deductible by the payor spouse, and includible in income by the payee spouse, to the extent that the payment is contingent on the status of the divorced couple’s children.
C)
Alimony payments must terminate on the death of the payee spouse.
D)
The divorced couple may be members of the same household at the time the alimony is paid.
c
Payments to former spouses are no longer deductible and are considered alimony only if
the payments are made in cash (and not property);
the decree does not specify that the payments are not alimony for federal income tax purposes;
the payor and payee are not members of the same household at the time that the payments are made; and
there is no liability to make the payments for any period after the death of the payee.
LO 4.2.3
Paul was divorced from his spouse, Pat, late in 2023. As part of the property settlement agreement, Paul agreed to transfer his interest in a residential rental property to Pat in exchange for release of marital claims. Paul’s cost basis in this real estate tract was $50,000. The tract was appraised at a fair market value of $100,000 at the time of its transfer to Pat. Which of the following is an income tax implication of Paul’s transfer of the real estate tract to Pat?
A)
Pat receives a basis in the real estate equal to the fair market value at the time of transfer.
B)
Paul’s basis in the real estate is carried over to Pat for income tax purposes.
C)
Paul is allowed a deduction equal to the excess of the fair market value over his basis in the property.
D)
Paul must recognize the gain on the real estate at the time of transfer as ordinary income.
b
When there is a transfer of property incident to divorce, the basis simply carries over to the other spouse. The transfer is not a taxable event. Pat will likely owe capital gains tax when disposing of the property.
LO 4.2.3
Ruth and Doug divorced last year. They have two children ages seven and nine. Their divorce decree states that Ruth has custody of both children. There is no written agreement for listing the children as dependents on Ruth’s or Doug’s income tax returns. However, Doug provides 75% of the child support, amounting to $15,000 per year. Based on this information, which parent is entitled to list the children as dependents for income tax purposes?
A)
Ruth, because she has custody and there is no written agreement stating Doug could list the children on his return
B)
Ruth, because the court awarded her custody of the children
C)
Doug, because he provides over one-half of the child support
D)
Doug, because he provides at least $1,200 per year for the children’s support and Ruth cannot not prove she contributes more than this amount
a
The parent with custody for a greater portion of the year is treated as providing more than one-half of a child’s support. In these circumstances, however, Ruth could potentially sign IRS Form 8332 which would constitute a written agreement that would allow Doug to claim their two children as dependents on his tax return in the current year.
LO 4.2.3
Gary has just divorced. He is asking his planner, Ruth, for recommendations of amending his financial plan given his newly single status. Which of the following recommendations should Ruth make?
Gary should review the beneficiary designations on his life insurance policies to be certain the beneficiaries are in line with his wishes post-divorce.
Ruth should ask for any documentation on property settlements and other court-ordered financial transactions.
Ruth should inquire whether a qualified domestic relations order was issued by the court and obtain a copy to ascertain its effect on Gary’s financial plan.
Ruth should inform Gary that the transfer-for-value income tax rule makes the transfer of any life insurance policies a taxable event.
A)
II and IV
B)
I, II, and III
C)
III only
D)
I and IV
b
Statement IV is incorrect. The transfer-for-value income tax rule does not apply in situations when a life insurance policy is transferred from one spouse to another as a result of a property settlement.
LO 4.2.3
