Sample Exam 2 Flashcards
Which of the following statements concerning the tax rules applicable to investment interest is correct?
A) The amount deductible for investment interest in a given tax year is always the amount of the taxpayer’s net investment income for that year.
B) Investment income is defined as the sum of gross income from property held for investment plus capital gain realized from the disposition of property held for investment purposes.
C) Investment expenses are all deductible expenses, including interest expense, that are connected with the production of the taxpayer’s investment income.
D) If the amount of investment interest is greater than the taxpayer’s net investment income for the year, the excess investment interest may be carried forward to future tax years for deduction until the carryover is fully used up.
The answer is (D). (A) is incorrect because the amount of the taxpayer’s net investment income is a limitation on the amount deductible if the amount of investment interest exceeds the amount of the taxpayer’s net investment income. However, if the amount of investment interest is less than the amount of the taxpayer’s net investment income, the deduction is equal to the amount of investment interest for the year. (B) is incorrect because investment income generally includes the sum of gross income from property held for investment plus gain other than capital gain attributable to the disposition of property held for investment purposes. Capital gain may, at the election of the taxpayer, be included in the calculation of investment income. However, any capital gain included in the calculation is not eligible for the lower maximum income tax rates on long-term capital gain of individual taxpayers. The same rule applies to dividend income that is eligible for the special lower tax rates on qualified dividends. (C) is incorrect because investment expenses are all deductible expenses, other than interest expense, that are connected with the production of the taxpayer’s investment income.
Which of the following nontaxable sales and exchanges operate to disallow the recognition of certain realized losses exclusively?
A) like-kind exchanges of property
B) exchanges of insurance contracts
C) sale of a personal residence
D) wash sales
The answer is (D). (A) and (B) are incorrect because nontaxable like-kind exchanges of property defer recognition of gain or loss, and exchanges of insurance contracts defer recognition of gains. (C) is incorrect because the gain realized on the sale of a personal residence is excluded from gross income in the amount provided by the Internal Revenue Code.
Which of the following types of property is a capital asset?
A) the taxpayer’s inventory or other property held primarily for sale to customers in the ordinary course of the taxpayer’s business
B) depreciable or real property used in the taxpayer’s business
C) publicly traded stocks and bonds owned by investors
D) accounts or notes receivable acquired in the ordinary course of business for services rendered
The answer is (C). (A), (B), and (D) are incorrect because the taxpayer’s inventory or other property held primarily for sale to customers in the ordinary course of the taxpayer’s business, depreciable or real property used in the taxpayer’s business, and accounts or notes receivable acquired in the ordinary course of business for services rendered are specifically excluded from the definition of a capital asset in the Internal Revenue Code.
Which of the following statements concerning Treasury actions related to federal income taxation is correct?
A) Treasury regulations have often been overturned by the courts.
B) When a court holds a Treasury regulation invalid, the IRS may not continue to enforce the regulation against other taxpayers until it has been rewritten.
C) Unlike Treasury regulations, revenue rulings are not binding on IRS officials.
D) Determination letters are not issued about unclear points of law.
The answer is (D). (A) is incorrect because the courts seldom overturn Treasury regulations. (B) is incorrect because when a Treasury regulation is held to be invalid by a court lower than the U.S. Supreme Court, the IRS may continue to enforce it against other taxpayers. (C) is incorrect because revenue rulings are binding on officials of the IRS.
Which of the following transfers of a life insurance policy for consideration would leave the entire death proceeds paid tax exempt?
A) a transfer from an insured who is a shareholder in a closely held corporation to a fellow shareholder
B) a transfer from an insured who is an employee of a corporation to the corporation
C) a transfer of existing policies between the two owners of the stock in a corporation to fund a buy-sell agreement on a cross-purchase basis
D) a transfer from an insured who is a partner in a partnership to either another partner or the partnership itself
The answer is (D). (A), (B), and (C) are incorrect because a transfer from an insured who is a shareholder in a closely held corporation to a fellow shareholder, a transfer from an insured who is only an employee of a corporation to the corporation, and a transfer of existing policies between the two owners of the stock in a corporation to fund a buy-sell agreement on a cross-purchase basis are not exceptions to the transfer-for-value rule in the Internal Revenue Code.
Which of the following expenses would generally be deductible as a nonbusiness (production of income) expense prior to 2018 and the enactment of the Tax Cuts and Jobs Act?
A) the costs of acquiring, perfecting, or defending a taxpayer’s legal title to real property
B) legal fees or other costs directly attributable to tax planning or tax advice
C) fees for drafting a simple will
D) legal fees associated with a divorce
The answer is (B). (A) is incorrect because a nonbusiness expense must be a current expense. The costs of acquiring, perfecting, or defending a taxpayer’s legal title to property are included in the taxpayer’s capital investment and thus are not a current expense. (C) is incorrect because fees for drafting a simple will are essentially a personal expense and therefore nondeductible. (D) is incorrect because marriage is not fundamentally an income-producing activity in the eyes of the law and thus legal fees and other costs associated with a divorce are generally nondeductible.
Which of the following identifies an item of income that is not included in determining the taxpayer’s gross income?
A) a deduction
B) an exclusion
C) an exemption
D) a tax credit
The answer is (B). (A) is incorrect because a deduction is an item of expense. (C) is incorrect because an exemption is an arbitrary amount that is granted to taxpayers under the law to help reduce the net cost of their personal expenses. (D) is incorrect because a tax credit is a dollar-for-dollar reduction in the actual tax owed.
Which of the following statements concerning the standard deduction is correct?
A) A special standard deduction amount applies to taxpayers who are dependents.
B) The amount of the standard deduction remains the same from year to year until it is changed by Congress.
C) If a single taxpayer is aged 65 or older and/or legally blind, he or she is entitled to a deduction equal to twice the regular standard deduction.
D) Taxpayers with income above certain levels are subject to a phaseout of their standard deduction.
The answer is (A). (B) is incorrect because the amount of the standard deduction is indexed annually for inflation. (C) is incorrect because if a single taxpayer is aged 65 or older and/or legally blind, he or she is entitled to an amount in addition to the standard deduction, but the total is less than twice the regular standard deduction. (D) is incorrect because the standard deduction is not subject to phaseout rules.
Maggie is 65 years old and is owner and annuitant under an annuity contract that will begin this year, making annuity payments of $9,000 per year for life with 10 years certain. If Maggie’s investment in the contract she has owned for 9 years is $100,000, her life expectancy under the regulations is 20 years, and the actuarial value of the 10-year guarantee is $6,000, what is the amount of the annuity payment that could be excluded from Maggie’s gross income each year?
A) $4,504
B) $4,700
C) $5,000
D) $5,172
The answer is (B). (A), (C), and (D) are incorrect because the amount of the annuity payment that could be excluded from Maggie’s gross income each year is $4,700 computed as follows: Investment in contract – Value of guarantee = $100,000 – $6,000 = $94,000 Expected return = $9,000 × 20 years = $180,000 Amount of payment that can be excluded = ($94,000÷$180,000) × $9,000 = $4,700
Which of the following statements concerning the kiddie tax is correct?
A) The kiddie tax applies only if a child is aged 12 or older at the end of the tax year.
B) Under the kiddie tax, the child’s net unearned income in excess of $2100 is taxed at the trust and estate tax rates for the year.
C) The kiddie tax applies only to income generated by an asset received from the child’s parents.
D) Only unearned income from assets transferred to the child during the past 5 years including the current tax year is subject to the kiddie tax.
The answer is (B). (A) is incorrect because the kiddie tax applies only if a child is under, not over, a specified age, and that age is higher than 12. (C) is incorrect because the kiddie tax generally applies to income generated by an asset, regardless of from whom the child received the asset. (D) is incorrect because the kiddie tax applies, regardless of when any income-producing assets were transferred to the child.
Sam paid his wife alimony of $50,000 in the first postseparation year, $30,000 in the second postseparation year, and $20,000 in the third postseparation year. Each year, Sam deducted the amount of the payment on his tax return, and his wife included the payment as gross income on her tax return. Which of the following statements concerning this situation is correct, assuming the divorce decree was entered into prior to January 1, 2019?
A) Sam will have to include $10,000 in his income in the third postseparation year for an excess alimony payment in the first year.
B) Sam will have to include $10,000 in his income in the third postseparation year for an excess alimony payment in the second year.
C) Because the payments in the second and third postseparation years equal the $50,000 paid in the first year, there is no excess alimony payment that Sam must include as income in the third postseparation year.
D) Sam’s wife will have to include $35,000 as income in her return for the third postseparation year.
The answer is (A). (B) is incorrect because Sam will not have to include any income in the third postseparation year for an excess alimony payment in the second year. There was no excess alimony payment in the second postseparation year, because the alimony payment that year ($30,000) was less than the third-year payment ($20,000) plus $15,000. (C) is incorrect because Sam will have to include $10,000 in his income in the third postseparation year for an excess alimony payment in the first year. This amount is determined by averaging the second- and third-year payments ($25,000), adding $15,000, and subtracting the total ($40,000) from the first-year payment of $50,000. (D) is incorrect because when there is an excess alimony payment, it is included as income in the payer’s (Sam’s) third postseparation year tax return and deducted from the payee’s (wife’s) third postseparation year tax return.
Suppose Diana sells real property that she has used in her business for 3 years. If her adjusted basis in the property is $20,000, which of the following statements concerning income tax treatment of the sale is (are) correct?
I. If she sells the property for $15,000, the $5,000 loss will be deductible from her ordinary income without regard to the capital loss limitations.
II. If she sells the property for $25,000, the $5,000 gain will be eligible for treatment as a long- term capital gain, unless she is subject to recapture of Sec. 1231 losses from prior years.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
The answer is (C). Both I and II are correct because this is Sec. 1231 property.
Which of the following statements concerning the deduction of insurance premiums as medical expenses is (are) correct?
I. Although premiums paid for group medical insurance are deductible, premiums paid for individual health insurance policies are not deductible.
II. Although expenses for qualified long-term care services are deductible as medical expenses, premiums for qualified long-term care insurance contracts are not deductible.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
The answer is (D). I is incorrect because premiums paid for both individual and group health insurance policies are deductible as medical expenses. II is incorrect because both qualified long-term care expenses and premiums for qualified long-term care insurance contracts (subject to a premium deduction limit) are eligible for the medical expense deduction.
