REG Missed Questions 2 Flashcards
Which of the following items would increase an S corporation’s accumulated adjustments account (AAA)?
A. Taxable interest income
B. Tax-exempt interest income
C. Nondeductible penalties
D. Shareholder distributions
Choice “A” is correct. Taxable interest income is a separately stated item that increases an S corporation’s AAA. The accumulated adjustments account (AAA) is the accumulated earnings and profits of the S corporation. AAA is increased by ordinary business income and separately stated income and gains. AAA is decreased by ordinary business losses, separately stated losses and deductions, nondeductible expenses (other than those related to tax-exempt income), and distributions. An S corporation may also have an other adjustments account (OAA), which is increased by tax-exempt income and decreased by nondeductible expenses related to tax-exempt income.
Gail and Mark James contributed to the support of their two children, Jack and Jill, as well as Mark’s mother, Betty. Jack is a 19-year-old full time student who earned $5,000 this year working at a coffee shop on campus. Jill is 24 years old and worked full-time as a librarian and earned $25,000. Jack comes home during the summer and holidays. Jill lives at home year-round. Betty lives in an apartment in town and received $2,000 in municipal bond interest, $6,000 in dividend income, and $4,000 in nontaxable Social Security benefits. Jack, Jill, and Betty are U.S. citizens and unmarried. Gail and Mark provided more than half of the support for Jack, Jill, and Betty. How many people qualify as dependents on Gail and Mark’s tax return?
A. Three
B. One
C. Two
D. Zero
Choice “B” is correct. Jack meets the CARES test for a qualifying child. Jill does not meet the CARES test for a qualifying child because she is 24 and not a full-time student. She fails the age limit test of CARES. Jill also does not meet the SUPORT test because she earns more taxable income than the gross income threshold amount (“U” for under that amount). Betty does not meet the CARES test because she fails the close relative and age limit tests. (The CARES test is for a qualifying child, not a qualifying relative.) Betty also fails the SUPORT test because her taxable income ($6,000) is not under the gross income threshold amount. Therefore, Gail and Mark James can claim one person as a dependent—Jack.
Which of the following is the overall limitation to the qualified business income (QBI) deduction?
A. Taxable income limitations based on filing status
B. Lesser of: 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of qualified property
C. Lesser of: 50 percent of the combined QBI deductions or 20 percent of the taxpayer’s taxable income in excess of net capital gain
D. Lesser of: the combined QBI deductions or 20 percent of the taxpayer’s taxable income in excess of net capital gain
Choice “D” is correct. Once the QBI deduction is calculated based on the taxpayer’s eligibility, the overall deduction is limited to the lesser of the combined QBI deductions or 20 percent of the taxpayer’s taxable income in excess of net capital gain.
Which of the following is a list of courts that are referred to as courts of original jurisdiction, or trial courts, for tax matters?
A. The U.S. District Court, the U.S. Court of Federal Claims, and the U.S. Court of Appeals.
B. The Tax Court, the U.S. District Court, and the U.S. Bankruptcy Court.
C. The Tax Court, the U.S. Court of Federal Claims, and the U.S. Court of Appeals.
D. The Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.
Choice “D” is correct. The courts of original jurisdiction for tax cases, i.e., the courts in which a taxpayer would first bring a lawsuit against the IRS, are the Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.
Jane is a widow whose spouse died on December 31, Year 1. Jane and her spouse did not have any children but Jane’s nephew, Phil, moved into her home when Jane’s spouse died and lived there throughout Year 1 and Year 2. Phil is 25 years old and has a part-time job but spends most of his time helping Jane. Phil’s taxable gross income for Year 2 was $10,000. Jane pays all the costs of maintaining the home and provides more than half of Phil’s support. What is Jane’s most advantageous filing status for Year 2?
A. Surviving spouse
B. Married filing jointly
C. Single
D. Head of household
Choice “C” is correct. Jane does not meet the qualifications for head of household, surviving spouse, or married filing jointly filing status in Year 2. She is unmarried so the only filing status she qualifies for is single.
In the current year, a self-employed taxpayer had gross income of $57,000. The taxpayer paid self-employment tax of $8,000, self-employed health insurance of $6,000, and $5,000 of alimony pursuant to divorce finalized in 2007. The taxpayer also contributed $2,000 to a traditional IRA. What is the taxpayer’s adjusted gross income for the year?
A. $40,000
B. $46,000
C. $50,000
D. $55,000
Choice “A” is correct. Adjusted gross income is gross income minus adjustments. Half of the $8,000 self-employment tax is an adjustment for AGI, as is the $6,000 self-employed health insurance, the $5,000 alimony, and the $2,000 contribution to a traditional IRA. Alimony paid pursuant to a divorce settlement executed on or before December 31, 2018, is deductible by the payor. Alimony paid pursuant to a divorce settlement executed after December 31, 2018, is not deductible. All of these amounts (total of $17,000) are subtracted from the $57,000 gross income to arrive at AGI of $40,000.
Max, a 19-year-old single taxpayer, works part time and goes to school part time. Maxʹs adjusted gross income (AGI) for the current year is $30,000. He made a $3,000 contribution to a Roth individual retirement account (IRA). Which of the following is a true statement about Maxʹs retirement savings contribution credit for the current year?
A. The credit is only available for contributions to a traditional IRA, not a Roth IRA.
B. Max is not eligible for the credit because he is not at least 21 years old by the end of the tax year.
C. Max is eligible for the credit even if he is a dependent of another taxpayer.
D. The credit is only available for $2,000 of Maxʹs contributions to a Roth IRA.
Choice “D” is correct. Only $2,000 of Maxʹs $3,000 Roth IRA contribution is eligible for the credit. The retirement savings contribution credit is a nonrefundable credit for contributions of up to $2,000 to either a traditional or Roth IRA by an eligible taxpayer.
Max is an eligible taxpayer because he is at least 18 years old by the end of the year, he is not a full-time student, and he is not a dependent of another taxpayer.
Merrill and Joe’s divorce was finalized in June of 2012. As part of the settlement, Joe received the following:
Alimony $3,000/per month
Child support $1,000/per month
Lump-sum property settlement payment $125,000
Payments began in July, 2012; however, Merrill only paid a total of $15,000 during the year. For the current year, what amount must Joe include in gross income on his individual income tax return?
A. $9,000
B. $140,000
C. $134,000
D. $15,000
Choice “A” is correct. Alimony received pursuant to a divorce agreement executed on or before December 31, 2018 is included in taxable gross income; child support is not. Alimony paid according to a divorce agreement executed after December 31, 2018, is neither taxable to the recipient nor deductible by the payor. Because this divorce was finalized in 2012, the alimony is included in gross income. Joe was to receive $3,000 per month in alimony for the remaining six months of the year (July - December), for a total of $18,000. Child support is non-taxable as are lump-sum property settlements made pursuant to a divorce. When total payments received do not equal the total due, the amounts are first allocated to child support. Thus, of the $15,000 paid by Merrill, $6,000 is first allocated to child support. The remaining $9,000 would constitute alimony and would be taxable income to Joe.
Dave and Pam Stevens contributed to the support of their three children, Lisa, Tanya, and Hannah, and Pam’s divorced mother, Ellen. For the current year, Lisa, a 26-year-old sales clerk, earned $27,000. Tanya, a 23-year-old, full-time college graduate student in accounting, earned $35,000 working for a CPA firm. Hannah, a 20-year old artist, earned nothing during the year, but is still aspiring to sell her first piece and has signed on with an art studio. Ellen received $10,000 in nontaxable social security benefits and $2,000 in dividend income. All are U.S. citizens and are over half supported by Dave and Pam. How many dependents do Dave and Pam Stevens have under the qualifying child and qualifying relative rules?
A. Zero
B. Three
C. Two
D. One
Choice “B” is correct. Based on the CARES (QC) and the SUPORT (QR) tests, Dave and Pam have three dependents.
Lisa: NO. Lisa fails the age limit for QC and exceeds the gross income limitation for QR.
Tanya: YES. Tanya meets all tests of QC. She is a full-time student under the age of 24 so she meets the age test.
Hannah: YES. Hannah meets all criteria for QR. She fails the age limit test for QC.
Ellen: YES. Ellen meets the gross income limitation for QR because the Social Security income is nontaxable and not included for the gross income test.
Tanya, Hannah, and Ellen all meet dependency requirements.
For the current year, Kelly Corp. had net income per books of $300,000 before the provision for federal income taxes. Included in the net income were the following items:
Dividend income from an unaffiliated domestic taxable corporation (taxable income limitation does not apply and there is no portfolio indebtedness) 50,000
Bad debt expense (represents the increase in the allowance for doubtful accounts)
80,000
Assuming no bad debt was written off, what is Kelly’s taxable income for the current year?
A. $250,000
B. $380,000
C. $330,000
D. $355,000
Choice “D” is correct.
Book net income $300,000
Nondeductible bad debt expense $80,000
Dividends-received deduction $(25,000)
355,000
A taxpayer reported the following in a tax year:
Salary $122,000
Capital gain dividends 3,700
Partnership short-term capital loss (6,300)
The taxpayer acquired the partnership interest during the year in exchange for a capital contribution of $2,750, and there were no additional items affecting the taxpayer’s basis in the partnership. What is the taxpayer’s adjusted gross income for the year?
A. $122,000
B. $122,950
C. $119,400
D. $122,700
Choice “B” is correct. The taxpayer’s adjusted gross income (AGI) for the year is $122,950. The short-term capital loss (STCL) from the partnership can only be flowed through for deduction on the partner’s individual income tax return to the extent of the partner’s tax basis in the partnership interest. In this case, the partner’s basis is the amount of his capital contribution of $2,750, so only $2,750 of the STCL is flowed through for deduction on his individual tax return. The remaining $3,550 loss ($6,300 − $2,750) is suspended until the partner’s basis is reinstated in future years.
Individual taxpayers are allowed to deduct up to $3,000 of net capital losses each year, after netting all the capital gains and losses for the year together. The $2,750 STCL from the partnership is offset against the LTCG dividends of $3,700, so the taxpayer has a net LTCG for the year of $950.
Salary $122,000
Capital gain dividends (LTCG) $3,700
STCL from partnership (2,750)
Net LTCG 950
AGI 122,950
Which of the following would preclude a taxpayer from deducting student loan interest expense?
A. The total amount paid is $1,000.
B. The taxpayer claims a dependent on his or her income tax return.
C. The taxpayer is married filing jointly with AGI of $135,000.
D. The taxpayer is single with AGI of $110,000.
Choice “D” is correct. $110,000 of AGI is above the current year student loan interest expense AGI limitation for a single taxpayer.
The Stevenson’s are filing married filing jointly, and their adjusted gross income was $58,250. Additional information is as follows:
Interest paid on their home mortgage $5,200
State taxes paid $2,000
Medical expenses in excess of AGI floor $1,500
Deductible contributions to IRAs $4,000
Alimony paid to Mr. Stevenson’s first wife (divorce finalized in 2015) $5,000
Child support paid for Mr. Stevenson’s daughter $5,100
What amount may the Stevenson’s claim as itemized deductions on their Schedule A?
A. $8,700
B. $13,800
C. $12,300
D. $7,200
Choice “A” is correct. Interest on a home mortgage, state taxes paid, and medical expenses in excess of the AGI floor are itemized deductions reported on Schedule A. Contributions to IRAs and alimony paid on a divorce executed prior to 2019 are adjustments to gross income to arrive at AGI. Child support is neither an adjustment nor an itemized deduction.
Home mortgage interest $5,200
State taxes paid $2,000
Medical expenses $1,500
Total itemized deductions $8,700
For Year 2, Quest Corp., an accrual basis calendar year C corporation, had an $8,000 unexpired charitable contribution carryover from Year 1. Quest’s Year 2 taxable income before the deduction for charitable contributions was $200,000. On December 12, Year 2, Quest’s board of directors authorized a $15,000 cash contribution to a qualified charity, which was made on January 6, Year 3. What is the maximum allowable deduction that Quest may take as a charitable contribution on its Year 2 income tax return?
A. $8,000
B. $20,000
C. $15,000
D. $23,000
Choice “B” is correct. C corporations are allowed a maximum charitable contribution deduction of 10 percent of taxable income before the following deductions:
Any charitable contribution;
The dividends-received deduction;
Any net operating loss carryback; and
Any net capital loss carryback.
Accrued charitable contributions not paid by the end of the year are deductible in the year of accrual if (i) the board of directors authorizes the contribution during the tax year and (ii) the accrual basis corporation pays the accrued amount by the 15th day of the fourth month (generally 3½ months) following the end of the tax year.
Any amount in excess of the “10 percent limitation” may be carried forward for five years.
For the current year, Jennifer has self-employment net income of $50,000 before any SEP IRA deduction and no other earned income for the year. The total amount of self-employment tax related to Jennifer’s earnings was $7,064. What is the maximum amount Jennifer may deduct for contributions to her SEP IRA for the year?
A. $66,000
B. $8,587
C. $10,000
D. $9,294
Choice “D” is correct. The maximum annual deductible amount for self-employed individuals to a SEP IRA is the lesser of $66,000 (2023) or 20 percent of net earnings. “Net earnings” is defined as net self-employment income minus 50 percent of self-employment (S/E) taxes.
Net self-employment income $50,000
50% of self-employment taxes (3,532)
[$7,064 × 50%]
Self-employment earnings before SEP IRA 46,468
Times 20% × .20
Calculated SEP IRA Deduction 9,294
The 20 percent of self-employment earnings is less than the maximum of $66,000 (2023), so the SEP IRA deduction is $9,294.
In the current year, an unmarried individual with modified adjusted gross income of $25,000 paid $1,000 interest on a qualified education loan entered into on July 1. How may the individual treat the interest for income tax purposes?
A. As a nondeductible item of personal interest.
B. As a $1,000 deduction to arrive at AGI for the year.
C. As a $500 deduction to arrive at AGI for the year.
D. As a $1,000 itemized deduction.
Choice “B” is correct. The $1,000 of qualified education loan interest paid in the year is reported as a deduction to arrive at AGI for the year. The taxpayer’s AGI of $25,000 is below the phase-out threshold for unmarried taxpayers, so the deduction is not phased out.
Jane is a widow whose spouse died on January 2, Year 1. Jane and her spouse did not have any children but Jane’s nephew, Phil, moved into her home when Jane’s spouse died and lived there the entire year. Phil is 25 years old and has a part-time job but spends most of his time helping Jane. Phil’s taxable gross income for Year 1 was $10,000. Jane pays all the costs of maintaining the home and provides more than half of Phil’s support. What is Jane’s most advantageous filing status for Year 1?
A. Single
B. Head of household
C. Surviving spouse
D. Married filing jointly
Choice “D” is correct. A taxpayer may file a married filing jointly tax return in the year that a spouse dies, regardless of when in the tax year the spouse died. There is no requirement that the taxpayer maintain a home for a dependent child or dependent relative. The taxpayer does not meet the qualifications for single, head of household, or surviving spouse filing status in Year 1.
Chris Baker’s adjusted gross income on her current year tax return was $160,000. The amount covered a 12-month period. For the next tax year, Baker may avoid the penalty for the underpayment of estimated tax if the timely estimated tax payments equal the required annual amount of:
I. 90% of the tax on the return for the current year paid in four equal installments.
II. 110% of prior year’s tax liability paid in four equal installments.
A. Neither I nor II.
B. II only.
C. Both I and II.
D. I only.
Choice “C” is correct. Both I and II.
I. Payment of 90% of the tax on the return for the current year avoids the penalty for underpayment of estimated tax.
II. Generally, payment of 110% of the prior year’s tax liability avoids the penalty for underpayment of estimated tax when the taxpayer’s AGI from the prior year exceeds $150,000. If the taxpayer’s AGI is $150,000 or less, payment of 100% of the prior year’s tax liability avoids the penalty for underpayment of estimated tax.
Note: Payment of the lesser of the two above will provide “safe harbor” to the taxpayer.
Dawn White’s adjusted gross income on her Year 1 tax return was $100,000. The amount covered a 12-month period. For the Year 2 tax year, the minimum payments required from White to avoid the penalty for the underpayment of estimated tax is:
A. 90% of the current tax on the return for the current year paid in four equal installments or 100% of the prior year’s tax liability paid in four equal installments.
B. 90% of the current tax on the return for the current year paid in four equal installments or 110% of the prior year’s tax liability paid in four equal installments.
C. 110% of the prior year’s tax liability paid in four equal installments only.
D. 100% of the prior year’s tax liability paid in four equal installments only.
Choice “A” is correct. The requirement is 90% of the current tax on the return for the current year paid in four equal installments or 100% of the prior year’s tax liability paid in four equal installments.
A real estate broker reported the following business income and expenses for the current year:
Commission income $100,000 Expenses: Auto rentals 2,000 Referral fees to other brokers (legal under state law) 20,000 Referral fees to nonbrokers (illegal under state law) 8,000 Parking fines 200
What amount should be reported as net profit on Schedule C, Profit or Loss from Business?
A. $69,800
B. $70,000
C. $77,800
D. $78,000
Choice “D” is correct. The taxpayer’s Schedule C net profit is $78,000.
The taxpayer may deduct ordinary and necessary business expenses, which include the auto rentals and referral fees to other brokers that are legal under state law. The illegal referral fees to nonbrokers and parking fines are nondeductible.
Commission income $100,000
Auto rentals (2,000)
Referral fees to other brokers (20,000)
Schedule C net profit $ 78,000
Daisy Dunn is a single, calendar-year, cash-basis taxpayer with no dependents. Daisy died on March 1, Year 1. Daisy earned $20,000 from her job and $500 of interest income from bank accounts in Year 1 before she died. Her estate received another $1,500 of interest from her bank accounts in Year 1 after her death.
What is Daisy’s taxable gross income on her Year 1 final federal income tax return?
A. $22,000
B. $20,000
C. $20,500
D. $0
Choice “C” is correct. The $20,000 wages and $500 interest earned and received before Daisy died should be included in her taxable gross income on her Year 1 final federal income tax return. The $1,500 of interest income received after Daisy’s death by her estate should be included on the estate’s Year 1 federal income tax return.
Which of the following can be subject to the net investment income tax?
A. A domestic C corporation.
B. An individual who is a resident of the United States.
C. A limited partnership.
D. A nonresident alien.
Choice “B” is correct. An individual who is a U.S. resident may be subject to the 3.8 percent net investment income tax on net investment income above statutory AGI threshold amounts.
Emmett loaned Baker $10,000. Baker filed for bankruptcy last year, and Emmett was notified that Emmett would receive $0.20 on the dollar. In the current year, Emmett received $1,500 as the final settlement. The loan is nonbusiness. How should Emmett report the loss?
A. $8,000 short-term capital loss last year and $500 ordinary loss in the current year.
B. $8,500 short-term capital loss in the current year.
C. $8,000 short-term capital loss last year and $500 capital loss in the current year.
D. $8,500 ordinary loss in the current year.
Choice “B” is correct. Emmett should report the loss as an $8,500 short-term capital loss in the current year. Nonbusiness bad debt losses are treated as short-term capital losses in the year that the debt becomes totally worthless. Since Emmett received the final settlement in the current year, the loss should be reported in the current year.
Alex and Myra Burg, married and filing joint income tax returns, derive their entire income from the operation of their retail candy shop. Their adjusted gross income was $50,000. The Burgs itemized their deductions on Schedule A. The following unreimbursed cash expenditures were among those made by the Burgs during the year:
Repair and maintenance of motorized wheelchair for physically handicapped dependent child
$ 300
Tuition, meals, and lodging at special school for physically handicapped dependent child in the institution primarily for the availability of medical care, with meals and lodging furnished as necessary incidents to that care
4,000
State income tax
1,200
Self-employment tax
7,650
Four tickets to a theatre party sponsored by a qualified charitable organization; not considered a business expense; similar tickets would cost $25 each at the box office
160
Repair of glass vase accidentally broken in home by dog; vase cost $500 5 years ago; fair value $600 before accident and $200 after accident 90
Fee for breaking lease on prior apartment residence located 20 miles from new residence 500
Security deposit placed on apartment at new location 900
Without regard to the adjusted gross income percentage threshold, what amount may the Burgs claim in their current year return as qualifying medical expenses?
A. $4,000
B. $300
C. $4,300
D. $0
Choice “C” is correct. $4,300 medical expenses.
Wheelchair repair 300
School for handicapped 4,000
Total 4,300
Mary purchased an annuity that pays her $500 per month for the rest of her life. She paid $70,000 for the annuity. Based on IRS annuity tables, Mary’s life expectancy is 16 years. If Mary dies after receiving 10 full years of the annuity payments, how is Mary’s annuity treated on her final tax return?
A. Deduct $43,749.60 as an itemized deduction.
B. Deduct $26,250.40 as an itemized deduction.
C. Deduct $70,000 as an itemized deduction.
D. No deduction for the annuity.
Choice “B” is correct. If Mary dies after receiving 10 full years of annuity payments, she will have received 120 payments (10 years × 12 months). Mary’s IRS life expectancy was 16 years (16 years × 12 months = 192 months). For the first 192 payments, Mary will have a return of capital of $364.58 ($70,000/192 months). Therefore, after 10 full years of payments she will have recovered $43,749.60 ($364.58 × 12 × 10) of the $70,000 investment in the annuity. The unrecovered portion ($70,000 – $43,749.60 = $26,250.40) can be deducted on Mary’s final tax return as an itemized deduction.
Roger Corp. had operating income of $300,000 after deducting $12,000 for charitable contributions made during the fiscal year, but not including dividends of $10,000 received from a 10 percent-owned domestic taxable corporation. How much is the base amount to which the percentage limitation should be applied in computing the maximum deduction for the charitable contribution?
A. $300,000
B. $322,000
C. $317,000
D. $312,000
Choice “B” is correct. The percentage threshold limit for charitable contributions for a corporation is 10 percent of adjusted taxable income. Total taxable income is calculated before the deduction of any charitable contributions, the dividends-received deduction, or any capital loss carryback. Thus, the $300,000 must be adjusted to add back the charitable contribution deduction of $12,000 plus the $10,000 of dividend income not included in the $300,000. The base equals $322,000.
Mark and Mary formed MM Inc. as an S corporation. Each contributed $50,000 in exchange for five shares of corporate stock. In addition, MM obtained a $60,000 loan from a local bank that was still outstanding at the end of the year. In MM’s first year of operation, it reported a loss of $20,000 and did not make any distributions to the shareholders. What is Mark’s basis in his MM shares at the beginning of the second year?
A. $70,000
B. $50,000
C. $40,000
D. $100,000
Choice “C” is correct. Mark’s initial stock basis of $50,000 is reduced by his 50 percent share of MM’s Year 1 ordinary loss. An S corporation shareholder does not include any S corporation debt in stock basis.
Initial contribution $ 50,000
Ordinary loss (50 percent) (10,000)
Tax basis in stock $ 40,000
Which of the following statements about the child and dependent care credit is correct?
A. The maximum credit is $600.
B. The credit is available for the cost of the care of a disabled spouse.
C. The child must be under the age of 18 years.
D. The child must be a direct descendant of the taxpayer.
Choice “B” is correct. The expenses for care of a spouse who is disabled and unable to take care of himself or herself are eligible for the credit, up to a maximum expenditure of $3,000.
A cash basis taxpayer should report gross income:
A. For the year in which income is either actually or constructively received, whether in cash or in property.
B. For the year in which income is either actually or constructively received in cash only.
C. Only for the year in which income is actually received in cash.
D. Only for the year in which income is actually received whether in cash or in property.
Choice “A” is correct. A cash basis taxpayer should report gross income for the year in which income is either actually or constructively received, whether in cash or in property.
Dreamscape, Inc., a widget retailer, had taxable income of $150,000 from operations during its taxable year. In addition, Dreamscape incurred a $35,000 loss from the sale of investment land, a capital asset. No other gains or losses were generated during the taxable year, nor had been in past years. In Dreamscape’s tax return for that year, what is the proper treatment of the $35,000 loss?
A. Use $3,000 of the loss to reduce the taxable income to $147,000 and carry the remaining $32,000 forward for 5 years.
B. Use $3,000 of the loss to reduce the taxable income of $147,000 carry the remaining $32,000 forward for 3 years.
C. Carry the $35,000 capital loss forward for five years.
D. The $35,000 capital loss can be used in the current year to reduce taxable income to $115,000.
Choice “C” is correct. Capital gains are taxed at the same rate as ordinary income for a corporation. However, capital losses can only be used to offset capital gains. Any amount not utilized in the year of generation can either be carried back 3 years to offset prior capital gains or carried forward for 5 years.
Where is the deduction for qualified business income (QBI) applied in the individual tax formula?
A. As an alternative to the standard deduction
B. As an adjustment to arrive at adjusted gross income
C. As a deduction from adjusted gross income separate from the standard deduction and itemized deductions
D. As an itemized deduction
Choice “C” is correct. The QBI deduction is taken from adjusted gross income (“below the line”). It is not part of the itemized deductions.
On January 2, Year 1, the Kanes paid $60,000 cash and obtained a $300,000 mortgage to purchase a home. In Year 4, they borrowed $20,000 secured by their home on a home equity line of credit and used the cash to pay bills and take a vacation. That same year they took out a $7,000 auto loan.
The following information pertains to interest paid in Year 4:
Mortgage interest on first loan $19,000
Interest on home equity line of credit $2,500
Auto loan interest $500
For Year 4, how much interest is deductible?
A. $19,000
B. $21,500
C. $19,500
D. $22,000
Choice “A” is correct. Interest on mortgages of up to $750,000 to buy, build, or substantially improve a home (the first loan) are fully deductible. Interest on home equity loans is only deductible if the proceeds are used to substantially improve the home. Interest for personal expenses such as auto loans and credit cards is not deductible. The total deduction is $19,000.
Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, Year 1, and incurred the following costs:
Legal fees to obtain corporate charter $41,000
Commission paid to underwriter $25,000
Other stock issue costs $10,000
Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In Year 1, what amount should Brown deduct for the organizational expenses?
A. $5,000
B. $6,200
C. $1,200
D. $8,600
Choice “B” is correct. Organizational costs are amortizable over a minimum period of 15 years (180 months). In addition, subject to a $50,000 total expenditure limitation, a $5,000 deduction is allowed in Year 1. Allowable costs in connection with the corporate organization are legal fees to obtain the corporate charter, necessary accounting services, expenses of temporary directors, and incorporation fees paid to the state. Organizational costs exclude stock issue costs and commissions paid to underwriters to help sell the shares. Only the legal fees of $41,000 qualify as organizational costs. $41,000 − $5,000 = $36,000/180 months = $200 × 6 months = $1,200 + $5,000 (expense in Year 1) = $6,200.
Smith made a gift of property to Thompson. Smith’s basis in the property was $1,200. The fair market value at the time of the gift was $1,400. Thompson sold the property for $2,500. What was the amount of Thompson’s gain on the disposition?
A. $0
B. $1,300
C. $1,100
D. $2,500
Choice “B” is correct. The general rule for the basis on gifted property is that the donee receives the property with a rollover cost basis (equal to the donor’s basis). An exception exists where the fair market value of the property at the time of the gift is less than the donor’s basis. That is not the case in this question; thus, the calculation of the gain on the disposition of the property is:
Amount realized $2,500
Basis $(1,200)
Gain recognized $1,300
he question below includes actual dates that must be used to determine the appropriate tax treatment of the transaction.
Fred and Wilma were divorced in 2017. Fred is required to pay Wilma $12,000 of alimony each year until their child turns 18. At that time, the payment will be reduced to $10,000 per year. In the current year, in accordance with the divorce agreement, Fred paid $6,000 directly to Wilma and $6,000 directly to the law school Wilma is attending. What amount of the payments received in the current year is income to Wilma?
A. $10,000
B. $0
C. $12,000
D. $6,000
Choice “A” is correct. Alimony pursuant to a divorce or separation agreement executed on or before December 31, 2018, is taxable to the recipient and deductible by the payor. Child support is not taxable to the recipient and not deductible by the payor. Because the total payment decreases to $10,000 once Fred and Wilma’s child turns 18, the $2,000 decrease is deemed child support. The fact that Fred pays the law school in accordance with the divorce agreement on Wilma’s behalf does not change the fact that $10,000 is considered alimony.
A beneficiary acquired property from a decedent. The fair market value at the date of the decedent’s death was $100,000. The decedent had paid $130,000 for the property. Estate taxes attributed to the property were $2,000. The beneficiary sold the property two years after receipt from the estate. What is the basis of the property for the beneficiary?
A. $102,000
B. $100,000
C. $132,000
D. $130,000
Choice “B” is correct. The basis of inherited property to the beneficiary is the fair market value of the property at the date of the decedent’s death (or the alternate valuation date, if the alternate valuation date is used for determining the value of the estate for estate tax purposes).
Kari Corp., a manufacturing company, was organized on January 2, Year 1. Its Year 1 federal taxable income was $400,000 and its federal income tax was $100,000. What is the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for Year 1 if Kari takes only the minimum accumulated earnings credit?
A. $300,000
B. $50,000
C. $150,000
D. $0
Choice “B” is correct. For the accumulated earnings tax, in this case, accumulated taxable income would equal taxable income ($400,000) minus federal income taxes ($100,000) minus the minimum accumulated earnings credit ($250,000) for manufacturing companies or $50,000.
Mock operates a retail business selling illegal narcotic substances. Which of the following item(s) may Mock deduct in calculating business income?
I. Cost of merchandise.
II. Business expenses other than the cost of merchandise.
A. Both I and II.
B. I only.
C. II only.
D. Neither I nor II.
Choice “B” is correct. A gain from an illegal activity is includible in income. To determine the gain, a deduction is permitted for cost of merchandise. Business expenses for operating an illegal business, other than the cost of merchandise, are not permitted as deduction.
Which of the following taxpayers may use the cash method of accounting?
A. A C corporation with annual gross receipts of $50,000,000.
B. A tax shelter.
C. A manufacturer.
D. A qualified personal service corporation.
Choice “D” is correct.
Rule: The general rule is that the accrual method of accounting will be required by tax shelters, large C corporations (average annual gross receipts over three-year period greater than $29 million) and manufacturers. The IRS has the authority to require that a taxpayer use a method of accounting to accurately reflect the proper income and expenses. Personal Service Corporations are permitted the use of the cash method.
American Corp. retained Baker, CPA, to conduct an audit of its financial statements to obtain a bank line of credit. American signed an engagement letter drafted by Baker that included a disclaimer provision. As a result of Baker’s failure to detect a material misstatement in American’s financial statements, the audit report contained an unmodified opinion. Based on American’s audited financial statements, National extended credit to American. American filed a petition in bankruptcy shortly thereafter. National sued Baker for damages based on common law fraud. What would be Baker’s best defense?
A. Baker lacked the intent to deceive.
B. Baker included a disclaimer provision in the engagement letter with American.
C. National was not in privity with Baker.
D. Baker acted with due diligence in conducting the audit.
Choice “A” is correct. In order to prove fraud, National must prove the five elements of fraud. These are a misrepresentation of a material fact, intent to deceive, actual and justifiable reliance on the misrepresentation, an intent to induce that reliance, and damages. A defense by Baker that there was no intent to deceive would be a valid defense against a claim of fraud.
Calculate the taxpayer’s qualified business income deduction for a qualified trade or business:
Filing status: Single
Taxable income: $100,000
Net capital gains: $0
Qualified business income (QBI): $30,000
W-2 wages: $10,000
A. $6,000
B. $15,000
C. $20,000
D. $5,000
Choice “A” is correct. $30,000 QBI × 20% = $6,000. W-2 wage and property limits do not apply to single taxpayers with taxable income before the QBI deduction below the taxable income threshold of $182,100 (2023).
An S corporation has two shareholders who are also employees of the corporation. Shareholder A owns 20 shares and shareholder B owns 90 shares. The total number of shares issued and outstanding is 2,000. The corporation pays the health insurance premiums for all its employees and families. The cost of family coverage is $5,300. The corporation pays for family coverage for both shareholders. Because the company paid for health insurance, which of the following amounts would be reported to Shareholder A as his income?
A. $0
B. $2,650
C. $4,240
D. $5,300
Choice “A” is correct. The value of fringe benefits such as health insurance is includable in the gross income of S corporation shareholders who own more than 2 percent of the S corporation’s stock (unless the S corporation does not deduct the cost of such benefits). In this case, Shareholder A only owns 1 percent of the S corporation’s stock (20 shares/2,000 shares = 1 percent). Thus, Shareholder A is not required to include the value of the health insurance in his gross income.
