Section 2: Income & Assets Unit 5: Investment Income and Expenses Flashcards
Question ID: 94849664 (Topic: Interest Income)
Marissa is a cash-basis taxpayer who earns interest and dividends during the current year on several investments:
$500 interest from a certificate of deposit.
$15 interest from a savings account.
$240 dividend from a mutual fund.
$1,750 of dividends from stocks.
Marissa reinvested the $500 in interest into a new CD along with the maturing principal. The earnings from the mutual fund are also not distributed and are used to purchase additional shares. The dividends from the corporate stock are also reinvested. Based on this information what amount of income must Marissa report on her current year tax return, and how should it be reported?
A. $515 in interest income and $1,990 in dividends must be reported on Schedule B.
B. $515 in interest income and $1,990 in dividends must be reported on Schedule D.
C. $15 in interest income and $1,990 in dividends must be reported on Schedule B.
D. Since all the amounts were reinvested, none of the income is taxable.
Correct Answer Explanation for A:
All the amounts must be reported as taxable income. Marissa must report $515 in interest income and $1,990 in dividends on Schedule B. Cash-method taxpayers must generally report interest income in the year in which they actually or constructively receive it. Even if the earnings are reinvested, the interest or earnings must still be reported as income in the year received.
Question ID: 94849720 (Topic: Interest Income)
Interest received on a certificate of deposit (CD) is:
A. Taxable only when withdrawn.
B. Partially taxable.
C. Tax-exempt.
D. Fully taxable.
Correct Answer Explanation for D:
Interest received on a certificate of deposit (CD) is fully taxable when it is earned. A certificate of deposit (CD) is a timed deposit sold by banks and other financial institutions that have a specific, fixed term usually at a fixed interest rate. The bank will send a 1099-INT for interest exceeding $10 paid during the year.
Question ID: 94849594 (Topic: Interest Income)
Nash withdrew $10,000 from a one-year, deferred interest certificate of deposit. He had to pay an early withdrawal penalty of two months’ interest, which totaled $112. Nash also earned $19 of interest from his other savings account during the year. What is the correct treatment of these transactions?
A. He must report the $19 as interest income. The early withdrawal penalty is not deductible.
B. He is allowed to subtract the penalty from the interest he earned during the year. Therefore, he is not required to report the interest.
C. He must report the $19 as interest income and he can claim the $112 penalty amount as an adjustment to income.
D. He must report the $19 as interest income. He can claim the $112 penalty amount if he itemizes deductions on Schedule A.
Correct Answer Explanation for C:
Nash must report the $19 as interest income. He can claim the $112 penalty amount as an adjustment to income. Taxpayers can adjust their income by deducting penalties they paid for withdrawing funds from a deferred interest account before maturity.
Question ID: 94849645 (Topic: Interest Income)
Leyla is your tax client. She received the following items during the current year:
$600 of income reported on Form-OID.
$200 of interest earned on a certificate of deposit (the amounts were not withdrawn).
$7,000 from a prior year installment sale ($5,000 was a return of principal and $2,000 was interest).
$500 earned on a savings bond.
$2,100 of qualified dividends.
She had no other income during the year. How much interest income must Leyla report on her tax return?
A. $8,100
B. $7,700
C. $3,300
D. $4,800
Correct Answer Explanation for C:
The answer is calculated as follows:
$2,000 interest on installment sale
+ $500 savings bond interest
+ $200 interest on certificate of deposit
+ $600 OID interest
= $3,300 reportable interest
The amounts that constituted a return of principal on the installment sale ($5,000) are not considered income. The $2,100 of qualified dividends is taxed as dividend income, not as interest income.
Question ID: 94849610 (Topic: Dividend and Distribution Income)
Dustin purchased stock five years ago for $3,000. During the tax year, he received a nondividend distribution of $550. How should this be reported?
A. Dustin must report the $550 as a long-term capital gain.
B. Dustin must report the nondividend distribution as dividend income.
C. Dustin must reduce the basis of his stock by $550.
D. Dustin must report the nondividend distribution as interest income.
Correct Answer Explanation for C:
Dustin must reduce his stock basis by $550. A nondividend distribution reduces the basis of a taxpayer’s stock. It is not taxed until the basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of the taxpayer’s investment in the stock of the company. When the basis of the stock has been reduced to zero, the taxpayer must report any additional nondividend distributions received as a capital gain.
Question ID: 94849695 (Topic: Dividend and Distribution Income)
Two years ago, Nadira bought 100 shares of Great Lakes Inc. stock for $10,000. On January 29, 2023, she received a non-dividend distribution of $6,000 from the company. On December 15, 2023, she received another non-dividend distribution of $5,000. What is the proper tax treatment for the second non-dividend distribution?
A. She must report a long-term capital gain of $1,000.
B. The amount is not taxable until she disposes of the stock.
C. She does not need to report the distribution because it is not taxable.
D. She must report a taxable distribution of $5,000.
Correct Answer Explanation for A:
She must report a long-term capital gain of $1,000. Distributions that are not paid out of earnings and profits are non-dividend distributions. Non-dividend distributions are considered a recovery or return of capital and therefore are generally not taxable. However, these distributions reduce the taxpayer’s basis. The first distribution reduces her stock basis to $4,000 ($10,000 - $6,000). Once basis is reduced to zero, any additional distributions are capital gains and are taxed as such. The first $4,000 of the December $5,000 distribution reduces Nadira’s basis to zero. She then must report a long-term capital gain of $1,000. Non-dividend distributions are reported on Form 1099-DIV.
Question ID: 94849543 (Topic: Dividend and Distribution Income)
Which of the following statements is correct regarding the holding period for qualified dividends?
A. The taxpayer must hold the stock for 121 days, including the ex-dividend date.
B. The taxpayer must hold the stock for more than 60 days during the 121-day period that begins 60 days after the ex-dividend date.
C. The taxpayer must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
D. The taxpayer must hold the stock for 60 days, not including the ex-dividend date.
Correct Answer Explanation for C:
Qualified dividends are given favorable tax treatment. However, a taxpayer must hold the dividends for the required period of time in order to qualify for these preferred tax rates. He must generally have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the date following the declaration of a dividend. When figuring the holding period for qualified dividends, the taxpayer should count the number of days he held the stock and include the day he disposed of the stock. The date the taxpayer acquires the stock is not included in the holding period.
Interest Income is generally reported to the taxpayer on Form 1099-INT if the amount of interest is >$___ for the year.
If taxable interest income exceeds $____, the taxpayer must report the int on Schedule ___.
Interest Income is generally reported to the taxpayer on Form 1099-INT if the amount of interest is >$10 for the year.
If taxable interest income exceeds $1,500, the taxpayer must report the int on Schedule B, Interest and Ordinary Dividends.
Nondividend Distribution tax treatment
First treated as a return of capital, so the basis in the stock is lowered.
Once basis is lowered to $0, any additional distributions are CAP GAINS.
Reported in Box 3 of Form 1099-DIV.
NKE deeclalres a year-end stock dividend. Sharon is a shareholder and prior to the dividend, she owns 100 shares. Her basis is $5,000. Sharon receives a dividend of 100 additional shares. After the dividend, she owns 200 shares. What is her new basis in each individual share?
After the dividend, Sharon owns 200 shares and her over basis in the shares does not change (it is still $5,000). But, her new basis in each individual share is $25/share. ($5k/200 = $25). She does not have any taxable income as a result of the stock dividend.
Cap gain distributions from a mutual fund are always treated as _____
long-term, regardless of the holding period.
Constructive dividends
May be considered dividends and therefore taxable to the shareholders and non-deductible to the corporation (c-corp)
