Tax 3 Flashcards
1
Q
Freda purchased a stereo system for her son Wes, age 16. The stereo was placed in Wes’ room and is used exclusively by him. Freda also purchased a new sports car in her own name, that was used 90% of the time by Wes. Which of the cost of these items may be considered as support in determining whether Freda may claim Wes as a dependent?
Both the stereo and the car qualify as support because of the use test.
Neither the stereo nor the car qualify as support because the car is Freda’s and the stereo is diminimus.
The stereo does not qualify for support but the car does because he uses it 90% of the time.
The stereo qualifies for support, but the car does not even though it is de minimus.
A
Solution: The correct answer is D.
The stereo system purchased and GIVEN to Wes qualifies as support. Because the car was not GIVEN to Wes (although he is allowed to use it) it will not be considered support. However, maintenance costs, such as gas and insurance that the taxpayer provides for his use of the car will qualify as support.
2
Q
<p>In which of the following venues is a jury trial available for tax controversies?The U.S. Tax Court.The U. S. Tax Court, Small Claims Division.A U. S. District Court.The U.S. Court of Federal Claims.All of the above.</p>
A
<p>Solution: The correct answer is C.A jury trial is only available in tax controversies adjudicated by the U.S. District Court. Only bench trials are available in the other venues.</p>
3
Q
<p>Leona is 68 years old and single. What is the least amount of adjusted gross income that will require Leona to file a tax return for 2020?$7,900$12,405$14,055$15,350</p>
A
<p>Solution: The correct answer is C.Leona must file a tax return if her adjusted gross income is $14,050 or more for the current year ($12,400 basic standard deduction + $1,650 additional standard deduction for age). Any amount GREATER THAN $14,050 will cause taxes to be filed. Keep in mind this question is looking for the LEAST amount that would cause her to file.</p>
4
Q
Which of the following decreases a taxpayer’s at-risk amount?
Cash and the adjusted basis of property contributed to the activity.
Amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as security property not used in the activity.
The taxpayer’s share of amounts borrowed for use in the activity that is qualified non-recourse financing.
Passive losses which are used against passive income from another source.
A
Solution: The correct answer is D.
Options “A,” “B” and “C” all increase the at risk amounts.
5
Q
To what extent may the rental losses of an active participant be deducted against active and passive income?
$25,000 of losses from rental property income may be deducted against ordinary income.
The taxpayer must be considered “active” in that they participate in the general management and decision making of the property.
The $25,000 is reduced $1 for every $2 over an AGI limit of $100,000.
When the AGI reaches $150,000, the deduction is lost and must be treated as regular passive income.
I and II only.
II and III only.
II, III and IV only.
All of the above.
A
Solution: The correct answer is D.
$25,000 of losses from rental property income may be deducted against ordinary income. The taxpayer must be considered “active” in that they participate in the general management and decision making of the property. Also, the $25,000 is reduced $1 for every $2 over an AGI limit of $100,000. When the AGI reaches $150,000, the deduction is lost and must be treated as regular passive income.
6
Q
Standard Deduction for someone over 65 using the single or HOH status
A
$1,650 for being 65 or over
7
Q
The classifications of income are:
Active Income. Earned Income. Unearned Income. Portfolio Income. Passive Income.
II, III, IV and V only.
I, II and III only.
I, IV and V only.
All of the above.
A
Solution: The correct answer is C.
The classifications of income are active, passive and portfolio. Earned income is a subset of active income while unearned income may be either a passive or portfolio income.
8
Q
Ned, a college professor, owns a separate business in which he participates during the current year. He has one employee who works part-time in the business. Which of the following statements is correct?
If Ned participates for 120 hours and the employee participates for 120 hours during the year, Ned does not qualify as a material participant.
If Ned participates for 95 hours and the employee participates for 5 hours during the year, Ned probably does not qualify as a material participant.
If Ned participates for 500 hours and the part-time employee participates for 520 hours during the year, Ned still qualifies as a material participant.
If Ned participates for 600 hours and the part-time employee participates for 1,000 hours during the year, Ned nevertheless qualifies as a material participant.
A
Solution: The correct answer is D.
The rules for material participation are: 1. More than 500 hours of participation 2. Taxpayer is the only one who substantially participates 3. Taxpayer spends greater than 100 hours in the tax year and no one else spends more 4. Taxpayer has materially participated in any 5 of the previous 10 years 5. The activity is a personal services activity and the individual has materially participated in any 3 prior years 6. Taxpayer participates 100 or more hours in this activity and total participation in all such activities exceeds 500 hours A is incorrect because he would be a material participant. The rule is > 100 hours and no one spends more. They can spend the same, but not more. (#3) B is incorrect because he is the only one who substantially participates (#2) C is incorrect because he needs to spend more than 500 hours or at least the same as the highest working person to be a material participant. (#1, #3) D is correct because he spent more than 500 hours (#1)
9
Q
<p>On January 1st of this year, Linda sold a piece of land she had had for years to George. Linda's basis in the land was $75,000 and she sold it for $100,000. It was agreed that George would pay Linda $10,000 as a down payment and would make installment payments of $10,000 for the next 9 years plus 10% interest. His second payment was due and payable December 31 of this year. What is Linda's tax consequence of this transaction this year?$20,000 of ordinary income$20,000 of long term capital gain$2,500 of long term capital gain and $9,000 of ordinary income$5,000 of long term capital gain and $9,000 of ordinary income</p>
A
<p>Solution: The correct answer is D.George is paying her $100,000. Her amount invested is $75,000. Therefore, over 10 years, her total profit will be $25,000 or $2,500 per year except for the down payment. There are two payments at the end of the year.An interest payment of 10% × $90,000*=$9,000 (ordinary income). The second payment, $10,000, consists of $2,500 capital gain and $7,500 of return of basis.*Recall the amount paid was $100,000 less a down payment of $10,000, so $90,000 was outstanding.</p>
10
Q
Standard Deduction for a blind person
A
$1,650 for being blind
11
Q
Assuming an asset is sold for a gain, when would Section 1250 ordinary income occur?
Depreciable property is sold at a gain.
Depreciable property is sold regardless of whether there is a gain or loss.
Straight line depreciation is used on real property subject to ACRS.
Real property subject to ACRS and accelerated depreciation was used.
A
Solution: The correct answer is D.
Section 1250 gain applies to the realized gain on real property where the accelerated method was used. The gain is the excess of accelerated over straight line (ACRS). Section 1250 gain is taxed as ordinary income. Under current law (MACRS), only straight line depreciation of real property is used.
12
Q
Which of the following distributions of IRC Section 1245 recapture property may result in the immediate recapture of some or all of previous depreciation deductions?
A distribution by a partnership to one of its partners.
A non-simultaneous like-kind exchange.
A disposition at death.
A sale for an interest-bearing note.
A
Solution: The correct answer is D.
Section 1245 recapture is applied to the sale of depreciated assets. Option “A” is incorrect because the distribution is a property distribution and not a sale. Option “B” is incorrect because there is no “sale” as part of a like-kind exchange. Option “C” is incorrect because the property transferred at death is not classified as a sale. Option “D” is correct because it is a sale, regardless for cash, notes, either or both.
13
Q
Cash Basis VS Accrual Method
A
Cash basis is recognized as income when received. (check is received by the taxpayer.)
The accrual accounting method recognizes expenses when the legal liability to pay arises. This usually occurs when the invoice is received.
14
Q
During the current tax year, Sam Malone had $10,000 of passive income from a publicly traded limited partnership. He also has a non-publicly traded limited partnership which generated a $10,000 passive loss. How much of the passive loss is deductible by Sam during the current tax year?
$0
$1,000
$3,000
$10,000
A
Solution: The correct answer is A.
Income from a publicly traded limited partnership may not be offset by any other passive losses.
15
Q
<p>As a direct result of the rules under TCJA 2017, qualifying dividends will be treated in which manner:Qualifying dividends are taxed in the same way as capital gains at an 18% rate for those in the 28% and higher marginal tax bracket.Qualifying dividends are taxed at a newly instituted 5% tax rate.The taxation on dividends have not been impacted under TCJA.Qualifying dividends are taxed at set dollar breakpoints.</p>
A
<p>Solution: The correct answer is D.Under prior law, the capital gain breakpoints were related to the tax breakpoints. Under TCJA the capital gain breakpoints are at set dollar amounts not corresponding to the current tax brackets. See provided tax tables posted in the Tax inflation Numbers section of online learning system.</p>
16
Q
Which of the following is not a requirement of the individual real estate investor exception to the passive activity loss rules?
The taxpayer must materially participate in the activity.
The taxpayer must own at least 10% of the value of the real estate.
The taxpayer must have an AGI of less than $150,000.
The taxpayer must actively participate in the activity.
A
Solution: The correct answer is A.
The taxpayer is not required to materially participate in the activity, but the taxpayer must actively participate in the activity. Material participation requires substantial, continuous involvement in the operation of the activity. Active participation means that the taxpayer participates in making management decisions concerning the property, but is not substantially and continuously involved in the operation of the activity.
17
Q
During the year, Myrna furnished more than 50% of the support for the following persons: Butch, Myrna’s husband, who has no income and does not file a return. Wallace, Myrna’s cousin, who does not live with her. Brad, Myrna’s father-in-law, who does not live with her. Dawn, Myrna’s 18 year old daughter who is a full time student. Presuming all other requirements for qualified dependent are met, on a separate return, how many qualified dependent credits may Myrna claim?
One.
Two.
Three.
Four.
A
Solution: The correct answer is B.
Butch, the husband, is not a qualified dependent, as a he is not eligible to be treated that way. Cousins do not meet the relationship test.
The fact that the father-in-law does not live with Myrna does not automatically disqualify him a dependent, if he meets all the other qualifying relative requirements, as stated, Myrna can claim the qualified dependent credit for him.
Myrna’s daughter is over 17 and ineligible for the qualifying child credit of $2,000 but, as a full time student, she will qualify as a qualified dependent for the $500 credit.
18
Q
<p>What is the marginal income tax rate?The tax rate applied to the last dollar of taxable income earned.The lowest tax rate a taxpayer can pay.The tax rate on business profit (margin).The average tax rate for an individual.</p>
A
<p>Solution: The correct answer is A.The marginal tax rate is the tax rate applied to the last dollar earned.</p>
19
Q
Which of the following taxpayers can use the standard deduction?
Zeke, who files a separate return from his wife Yasmine. Yasmine itemizes deductions on her return.
Xavier, who is a nonresident alien.
William, who files a tax return for less than 12 months because he changed his annual accounting period.
Violet, who is a non-citizen spouse but files MFJ.
A
Solution: The correct answer is D.
Only answer D describes a taxpayer who is permitted to use the standard deduction. All of the other taxpayers are required to itemize their deductions.
20
Q
Bonnie and Manuel are married. He paid $100,000 for their home five years ago. Its fair market value was $150,000 when Manuel died. What is Bonnie’s basis in the home after Manuel’s death if the home was held as community property and Manuel left his half to Bonnie?
$50,000
$75,000
$125,000
$150,000
A
Solution: The correct answer is D.
Upon the death of either spouse in a community property state, both halves of community property are stepped to the fair market value regardless of who inherits the decendant’s half.
21
Q
<p>Which of the following is a true statement regarding a current Net Operating Loss (NOL)?A NOL generally can be carried back two years prior to the loss year.A NOL can only offset up to 80% of the current year's income.A NOL deduction is available the year the loss occurs.An affirmative election must be made to forgo the carryback period.</p>
A
<p>Solution: The correct answer is B.NOL losses currently cannot be carried back but they can be carried forward, (except for select agricultural or insurance filers). However, the NOL can only offset 80% of the current year's income for years after 12/31/17.</p>
22
Q
Alberto (age 65) and Stephanie (age 58) are raising their grandson, Jackson, who is blind and qualifies as their dependent. What is Alberto and Stephanie’s standard deduction in 2020 if they file a joint income tax return?
$24,800
$26,100
$26,450
$27,400
A
Solution: The correct answer is B.
In 2020 the standard deduction for a married couple is $24,800. Since Alberto is 65 years of age or older he may also take an additional standard deduction of $1,300. $24,800 + $1,300 = $26,100. Their grandson’s blindness or being a dependent has no bearing on their standard deduction.
23
Q
Homer and Marge have been unable to have a baby. They decided last year that adoption would be the best choice for them. They adopted, Maggie, a 4 year old child this year. They paid $15,000 in qualifying adoption expense for the current year. Their MAGI is $170,000 and their tax due before the application of the qualified adoption credit is $11,000. What is Homer and Marge’s available adoption credit for the current year?
$9,000.
$11,000.
$13,570.
$15,000.
A
Solution: The correct answer is B.
They are limited to the least of a) qualifying adoption expenses (15,000), b) adoption credit of $14,300 for 2020, or c) amount of tax due ($11,000). The adoption credit is not refundable.
24
Q
Under what circumstances will the child of divorced parents be treated as the qualifying child of the noncustodial parent?
The parents are legally divorced and not living in the same household.
The child receives over one-half of his support for the year from his parents.
The child is in the custody of the parents for more than half the year.
The custodial parent signs a statement that he will not claim the child as a dependent for the year and the noncustodial parent attaches the statement to his return.
I only.
I, II and III only.
II, III, and IV only.
I, II, III, and IV only.
A
Solution: The correct answer is D.
All of the options are requirements that must be met in order for a child of divorced parents to be treated as a qualifying child of the noncustodial parent.
25
Scary Berries, Inc. is a C corporation that specializes in carving berries into frightening images. The company’s primary profit generation is the sale of berries and they generate $4 million in annual revenue on average. What accounting method may Scary Berries, Inc. utilize for tax purposes?
Cash basis
Accrual basis
Either cash or accrual
Units of production
Solution: The correct answer is B.
Since Scary Berries generates its income from inventory (the berries) they must file under the accrual basis even though their revenues are under the $25 million accrual basis.
26
Which of the following is not an ordinary income asset?
Literary compositions in the hands of the author.
Depreciable property or real property used in a trade or business.
Notes receivable from a trade or business.
Stock in trade held for sale to customers in the ordinary course of business.
Solution: The correct answer is B.
Depreciable property or real property used in a trade or business is a Section 1231 asset, not an ordinary income asset. All of the other options are ordinary income assets.
27
Which of the following credits are fully refundable?
```
The Earned Income credit.
The American Opportunity credit.
Lifetime Learning credit.
Child Tax credit.
Adoption credit.
```
I, IV and V only.
I only.
I and V only.
None of the choices.
Solution: The correct answer is B.
The Earned Income credit is refundable; able to create a negative tax liability. The American Opportunity credit and Child tax credit may be partially refundable.
28
A client sold an apartment building last year for $100,000, paying a sales commission of $5,000 plus $2,500 closing costs. The building originally cost $80,000 20 years ago. Total straight line depreciation of $40,000 had been taken. The building had a mortgage of $60,000 which was assumed by the buyer. What is the purchaser's cost basis?
```
$70,000
$92,500
$100,000
$107,500
$160,000
```
Solution: The correct answer is C.
The cost basis to a purchaser is the acquisition cost plus any other costs associated with purchasing the property or making it useful for service. The buyer paid $100,000. The question indicates that it was the seller and not the buyer who paid the sales commission and the closing costs. Therefore, the buyer's basis is only the acquisition costs of $100,000. Cash $40,000 plus mortgage $60,000.
29
Pat invests $150,000 for a 10% interest in a limited partnership. He receives a K-1 with his loss at $80,000. How much of his loss is suspended?
$0.
$8,000.
$15,000.
$80,000.
Solution: The correct answer is D.
To determine whether any of the losses are suspended you must first apply the at-risk rules, then the passive loss rules. The amount at risk is the basis of $150,000. Since the loss is less than the amount at risk, none of the loss is suspended due to the at-risk rules. In applying the passive loss rules, the passive loss is limited to the amount of passive income for the year. Since there is no passive income for the year, none of the loss may be recognized and the $80,000 loss is suspended.
30
Maria and Orlando are married taxpayers who file their income tax return jointly. They have asked you to explain to them how the current law will affect their 2020 tax filing. You tell them:
Their standard deduction is $24,800.
Their deduction is 200% of a single tax filer.
The maximum taxable income in the 22% bracket for MFJ filers will be twice the amount as for single filers.
I only.
I and II only.
II and III only.
I, II and III.
Solution: The correct answer is D.
The deduction for joint filers is 200% of a single tax filer, thus addressing the marriage penalty which was extended for 2020.
31
Tikia, Inc. is filing their corporate income tax return for last year with a tax-year end of September 29. What is their tax accounting period?
Fiscal
Calendar
Part-year
52-53 week
Solution: The correct answer is D.
A fiscal year ends on the last day of a month other than December. A calendar year ends on the last day of December. A partial-year is for a time span less than 1 year. A 52-53 week year ends on a specified day of the week (such as Friday) that occurs in the last week of the last month of the tax year.
32
John, Jay and Jeff each have an ownership interest in Three Guys Burgers, Inc. Based on the following information, which of them is/are considered to have materially participated in the conduct of the Three Guys Burgers business this year?
John dedicated more than 500 hours this year to Three Guys Burgers.
Jay devoted 150 hours to Three Guys Burgers this year.
Jeff devoted 115 hours to Three Guys Burgers this year, but also devoted more than 100 hours to several other similar activities, for a total of 520 hours in all of the activities combined.
I only.
II and III only.
I and III only.
I, II and III.
Solution: The correct answer is C.
Jay has not materially participated. Although Jay devoted more than 100 hours to the activity, he did not devote more hours than anyone else because John worked at Three Guys Burgers for more than 500 hours. Jeff is also a material participant because he devoted more than 100 hours to the activity and also devoted more than 100 hours to several other similar activities, for a total of more than 500 hours in all of the activities combined.
33
Tab owns an apartment building and a DVD rental business. He participates for approximately 600 hours in the apartment building operations and approximately 1,000 hours in the DVD rental activity. Which of the following statements is correct?
Both the apartment building and the DVD rental businesses are passive activities.
Neither the apartment building nor the DVD rental business is a passive activity.
The DVD rental business is a passive activity, but the apartment building is not.
The apartment building is a passive activity, but the DVD rental business is not.
Solution: The correct answer is D.
Rental real estate is by definition a passive activity, therefore, the apartment rental business is passive. The DVD rental business is not a passive activity in that DVD rentals are short-term. To be considered as passive activities, other rental activity of goods and equipment must be long-term. According to code, short-term is defined as less than seven days.
34
Under the accrual method of accounting, the taxpayer (seller) recognizes income when:
The bill is received by the buyer.
The goods are accepted by the buyer.
The goods are loaded on the truck at the seller's facility.
The seller writes and sends the invoice after sending the goods.
Solution: The correct answer is D.
The accrual accounting method recognizes income when the taxpayer has a right to collect. This occurs usually after the completion of a job and in no case later than when the invoice is prepared and sent.
35
Maria Blue spent $12,000 in day care services for her 4 children to allow her to work. If her adjusted gross income is $100,000, how much is her dependent care credit?
$1,200
$2,400
$6,000
$12,000
Solution: The correct answer is A.
The dependent care credit is not phased out and provides a credit of 20% on up to $3,000 per qualifying child with a maximum of $6,000 for two or more children. Therefore her credit is $1,200 = $6,000 × 0.20.
36
Kelly and Terry are separated and in the process of divorce so they are going to file their income tax return for last year separately. Kelly made a large number of charitable contributions from her own separate checking account at the end of last year so she wants to file using itemized deductions. What are Terry’s options assuming Kelly files using itemized deductions?Terry may utilize the standard deduction or itemized deduction, whichever is less.Terry may utilize the standard deduction or itemized deduction, whichever is greater.Terry must utilize the standard deduction.Terry must utilize itemized deductions.
Solution: The correct answer is D.A married individual who files a separate return (married filing separately filing status) cannot use a standard deduction if that person’s spouse itemizes deductions.
37
The holding period of property acquired by gift may begin on:
The date the property was acquired by the donor only.
The date of gift only.
Either the date the property was acquired by the donor or the date of the gift.
Some other date.
Solution: The correct answer is C.
A person receiving a gift has a holding period of the donor plus the donee if at disposition he uses the gain basis. However, the holding period for a gift utilizing the loss basis (where a double basis rule applies) starts the holding period at the date of the gift.
38
Cash Basis VS Accrual Method
CASH
- Cash basis is recognized as income when received. (check is received by the taxpayer.)
- Cash-basis taxpayers will recognize the income in the year that the payment is actually or constructively received.
ACCRUAL
- The accrual accounting method recognizes expenses when the legal liability to pay arises. This usually occurs when the invoice is received.
- Accrual-basis taxpayers must recognize the income in the year the services or goods are provided.
- The accrual accounting method recognizes income when the taxpayer has a right to collect.
- C corporations must use the Accrual method
- Partnerships with corporations as owners must use the accrual method
- S corporations are not required to use the accrual method of accounting
39
Wilma is married to Herb, who abandoned her five years ago. She has not seen or communicated with him since June of that year. She maintains a household in which she and her two young dependent children live. Which of the following statements about Wilma's filing status in this year is correct?
Wilma can use the rates for single taxpayers for this year.
Wilma can file a joint return with Herb for this year.
Wilma can file as a head of household for this year.
Any of the above.
Solution: The correct answer is C.
Wilma meets the "abandoned spouse" rules. Therefore, she can file as a head of household. Otherwise, her filing status would be married, filing separately. Head of Household required that the taxpayer pay for more than 50% of the upkeep of the home in which the qualifying individuals reside. The qualifying individuals need not be dependents of the taxpayer.
40
Michelle's husband passed away in January this year. She does not remarry and still maintains a residence for herself and her son who is 10 years old. When she is filing her tax return for this year she may file as:
Single
Married filing jointly
Married filing separately
Qualifying widower
I only
IV only
II and III only
II, III, and IV only
Solution: The correct answer is C.
(I) Since Michelle’s spouse died during the year she is considered married for the year. (II) and (III) Since Michelle is considered married for the full year (she was married but her spouse died during the year and she did not remarry) she may file MFS or MFJ. (IV) She does not currently qualify for filing qualifying widower since this status applies for the 2 years following the year of a spouse’s death.
41
One of the five tests which must be met to qualify as a dependent is:
The dependent has no income.
The taxpayer contributed over 50% of the dependent's support.
The dependent must be under 23 years old.
The dependent must not be required to file an income tax return.
Solution: The correct answer is B.
The five dependency tests are: 1) Gross Income Test, 2) Support Test, 3) Member of Household or Family Member Test, 4) Citizenship Test (U.S., Canada or Mexico), and 5) Joint Filing Test.
42
Karen and Tom are married filing jointly taxpayers with 3 children. Their MAGI is $85,000. What is the maximum amount of the child tax credit that could be refundable to Karen and Tom?
$0.
$2,000.
$4,200.
$6,000.
Solution: The correct answer is C.
They have 3 children. The child tax credit is $2,000 per child against their tax obligation, up to $1,400 ($4,200 for the three children) per child can be refundable if there is no tax obligation due.
43
During the current year, Martin, an unmarried taxpayer residing in Montgomery County, collected $200 interest on U.S. government bonds, $600 on Montgomery County school bonds, and $500 interest on a state condemnation award. He also received $60 in dividends on Ford Co. Common stock. His gross taxable income from the above is:$1,360$760$560$260
Solution: The correct answer is B.Interest on Montgomery County school bonds is excluded under Section 103. Gross income is $200 + $500 + $60 = $760.
44
One of the five tests which must be met to qualify as a dependent for a qualifying relative is:
Gross income of the dependent.
The ability of the dependent to provide for their own care.
The age of the dependent.
Whether the dependent owes income taxes from a previous year having filed single.
Solution: The correct answer is A.
The five dependency tests are: 1) Gross Income Test, 2) Support Test, 3) Not a qualifying child, 4) Citizenship Test (U.S., Canada or Mexico), and 5) Joint Filing Test.
45
Donna Bella, whose AGI is $250,000, also has passive income of $125,000 and passive losses of $150,000. She uses $125,000 of her passive losses to offset the passive income and the rest is subject to suspension. She has come to you today to find out which of the following ideas is the best possibility for reducing her current tax liability.
An investment in an oil by-product and natural gas limited partnership generating losses.
An investment in an activity producing credits.
An investment in rental real estate as an active participant designed to generate losses.
An investment in limited partnership historic district rehab project producing both credits and passive losses.
Solution: The correct answer is B.
In this case, more losses are not required at all. Rather, credits only are needed to improve the client’s tax position.
46
Eloise is an unmarried elderly woman who lives alone in a small apartment. Eloise is only able to provide 6% of her own support. The remainder of her support is provided by the following people: 10% of her support is provided by her oldest son Frank. 22% of her support is provided by her daughter Gertrude. 30% of her support is provided by her son Henry. 32% of her support is provided by her friend Irene. Which of these individuals is eligible to claim Eloise as a dependent?
Irene can claim Eloise as a dependent because she provides more support than anyone else.
Frank can claim Eloise as a dependent because he is the oldest son.
Henry can claim Eloise as a dependent, but only if Gertrude signs an appropriate statement.
None of these individuals may claim Eloise as a dependent.
Solution: The correct answer is C.
Option "A" is not correct; Irene may not claim Eloise as a dependent because she does not meet the relationship test as a qualifying relative. Option "B" is not correct; Frank has not provided more than 10% of Eloise's support, so he is not a qualifying person. Either Gertrude or Henry may claim Eloise as a dependent because they each provided more than 10% of Eloise's support and together they provided more than 50% of her support. In order for one of them to claim Eloise as a dependent, however, the other must sign a statement agreeing not to claim an exemption for Eloise for this year.
47
One of the five tests which must be met to qualify as a dependent is:
Whether the dependent files a joint return that year.
That the dependent owes taxes from a previous year.
Will the dependent owe taxes this year.
The unearned income reported by the dependent.
Solution: The correct answer is A.
The five dependency tests are: 1) Gross Income Test, 2) Support Test, 3) Member of Household or Family Member Test, 4) Citizenship Test (U.S., Canada or Mexico), and 5) Joint Filing Test.
48
Standard Deduction for someone over 65 MFJ
$1,300
49
Blake is a CFP® professional and prepares tax returns for his clients. He prepared his brother’s income tax return for $1,000 and he willfully neglects to include $30,000 of income since his brother did not receive a 1099 for consulting work. Blake is aware that his brother earned the $30,000 but fails to report it since he doesn’t believe the IRS will catch the understatement of income. The additional tax on this $30,000 of income would have been $7,500. How much of a penalty may Blake be subject to for the understatement of income?
None, but his brother will be subject to penalties.
$3,750
$5,000
$7,500
Solution: The correct answer is C.
The preparer penalty for willful or reckless conduct is the greater of $5,000 or 50% of the income derived by the preparer for the return. In this case, he charged his brother $1,000.
50
Which of the following income(s) is/are NOT subject to Social Security tax?Rental real estate income.Small part-time repair shop income as a proprietor.Shareholder's share of S corporation's income in excess of salary.Income of an individual working as an independent contractor.I, II and III only.I and III only.II and IV only.II, III and IV only.
Solution: The correct answer is B.(Options "I" and "III"). Neither income from rental real estate nor S corporation distributions are subject to self-employment taxes.Option "I" - Income from rental real estate is not subject to self-employment taxes.Option "II" - This implies there is no employee status, and therefore, if services are being provided then the individual's income from those services will be subject to self-employment taxes.Option "III" - A shareholder's distributive share of S corporation profits is recognized as ordinary income and not subject to self-employment taxes.Option "IV" - Income from work as an independent contractor is subject to self-employment tax.
51
Josie is 17 years old and qualifies as a dependent for her parents. Josie earned $4,200 in wages and $900 in interest income during the current year. What is Josie's basic standard deduction for the current year?
$4,200.
$4,550.
$5,100.
$6,350.
Solution: The correct answer is B.
Josie's basic standard deduction is equal to her earned income plus $350. Therefore, her basic standard deduction is $4,550.
52
The Tax Reform Act of 1986 was roughly revenue neutral because:It was supported by both Republicans and Democrats.It was not intended to raise or lower taxes.It divided the tax burden evenly between individuals and businesses.It made the tax rates equal across all tax brackets.II only.I and III only.II and III only.I, II, and IV only.
Solution: The correct answer is A.A piece of tax legislation is considered revenue neutral when it is expected to neither raise nor lower the total amount of taxes to be collected.
53
Lucy and Lou are married and normally file a joint return. Under which of the following circumstances are they required to file a tax return?If Lucy is 64 and Lou is 66 and their gross income is $26,000.If Lucy and Lou are both 35 and have one dependent and their gross income is $24,000.If Lucy is 64 and Lou is 64, Lou is blind, and their gross income is $26,000.None of the above.
Solution: The correct answer is C.The MFJ standard deduction is $24,800 and the additional standard deduction for 65 and over is $1,300.In option "A", their total standard deduction is ($24,800 + $1,300) = $26,100.In option "B", their standard deduction is $24,800.In option "C", their standard deduction is $24,800. Lou may benefit from an additional $1,300 additional standard deduction for blindness upon filing. A return must be filed to claim the ASD for blindness. The IRS will know your age, but not that you are blind.
54
Under the accrual method of accounting, the taxpayer (buyer) recognizes expenses when:
The goods leave the seller's warehouse.
The seller accepts the buyer's purchase order.
The buyer receives the seller's invoice.
The buyer first uses the goods.
Solution: The correct answer is C.
The accrual accounting method recognizes expenses when the legal liability to pay arises. This usually occurs when the invoice is received.
55
Ginger, age 21 and a full-time student for a degree at State University, qualifies as a dependent on her parents' return. During the summer, she earned $5,500 from a part-time job. Her only other income consisted of $950 interest on a savings account. What is Ginger's taxable income for the current year?$0$600$1,100$5,500
Solution: The correct answer is B.The standard deduction for Ginger is the greater of $1,100 or $350 plus earned income but not to exceed the normal standard deduction. Therefore $350 + $5,500 = $5,850 so it is not limited in 2020. The total income is $5,500 + $950 = $6,450. Taxable income is $6,450 - $5,850 = $600.
56
Linus (age 64) and Karen (age 63) are raising their granddaughter, Marie, who qualifies as their dependent. Marie is blind. Linus and Karen file a joint return in the current year. What is their standard deduction?
$24,800
$26,100
$26,450
$27,000
Solution: The correct answer is A.
Linus and Karen's standard deduction is $24,800. They are not age 65 or older so they don't receive an additional standard deduction. They do not receive an additional standard deduction for Marie's blindness because additional standard deductions for age and blindness are allowed only for the taxpayer and spouse, and not for their dependents.
57
Which of the following creates potential Section 1245?
Amortization of goodwill.
Immediate expense deduction under Section 179.
The sale of tangible personalty used in a trade or business at a gain.
There is Section 1231 loss from the property's disposition.
Solution: The correct answer is C.
Depreciable property includes equipment, patents, copyrights and other intangibles. Option "A" is incorrect because goodwill is amortized. Option "B" is incorrect because Section 1245 is not applied to Section 179 expensing. Option "D" is incorrect because a Section 1231 is applied to gains recognized after recapture.
58
Ford's federal income tax return was due on April 15 of the current year, but Ford did not file his return or pay his taxes until June 30 of the current year. Ford's unpaid tax balance during this period was $400. What is the total penalty that will be imposed on Ford for his failure to file and failure to pay?
$60.
$215
$400.
$435.
Solution: The correct answer is C.
The failure to file penalty is 5% of the unpaid tax balance for each month or part thereof that the tax return is late (up to 25% of the unpaid tax balance). Therefore, Ford's failure to file penalty is $60 (3 months × $400 × 5%). However, if a tax return is filed more than 60 days late (as it is in Ford's case), the minimum failure to file penalty is the lower of $435 or 100% of the tax due.
Therefore, Ford's failure to file penalty is actually $400 (100% of taxes due) Ford is also subject to a failure to pay penalty of 0.5% per month or part thereof. Therefore, Ford's failure to pay penalty is $6 (3 months × $400 × 0.5%). Note that the failure to file penalty is reduced by the failure to pay penalty. Therefore, Ford's total penalty is $400 ($400 failure to file penalty - failure to pay= $394, plus $6 failure to pay penalty).
59
Which of the following is not a requirement that must be satisfied in order for a legally married taxpayer to use the head of household filing status?
The taxpayer must file a separate tax return from the spouse.
The taxpayer must furnish over one-half of the cost of maintaining the household.
The spouse must not be a member of the household during the last six months of the tax year.
The taxpayer must be legally separated from the spouse.
II only.
IV only.
III and IV only.
I, II and III only.
Solution: The correct answer is B.
The taxpayer is not required to be legally separated from the spouse in order to qualify as an abandoned spouse and use the head of household filing status. All of the other options are requirements for qualifying as an abandoned spouse.
60
Alexander Dumas has a salary of $80,000, dividends of $20,000 and limited partnership income of $15,000. This year, he also invested in an equipment-leasing partnership where he is not a material participant. His initial investment included $50,000 cash and a non-recourse note for $60,000. What is the maximum tax deduction Alexander may take on the equipment leasing investment this year?
$0
$15,000
$35,000
$50,000
Solution: The correct answer is B.
This is a passive activity. His deduction is equal to his limited partnership income from other sources to the extent he is at risk. The maximum investment deduction may not exceed the cumulative investment income. The $60,000 non-recourse note is irrelevant to answering this question. This question also assumes that the investment occurred in the current tax year.
61
If an individual who may otherwise qualify as a dependent does not spend funds that he or she has received (i.e., social security, wages), what is the IRS position regarding these unexpended amounts in terms of their application to the support test and their inclusion in being applied to the gross income test?
Income received but not spent is applicable to the gross income test but not the support test.
Income received but not spent is not applicable to the gross income test nor to the support test.
Income received but not spent is applicable to the gross income test and to the support test.
Income received but not spent is not applicable to the gross income test but is applicable to the support test.
Solution: The correct answer is A.
Income received but not spent is applicable to the gross income test but not the support test.
To claim someone as a dependent you have to provide at least 50% of their support. If the child has income that just goes into savings or spent on miscellaneous fun items instead of being used toward paying their bills (housing, clothing, food, etc.), while you are paying their bills, then you are supporting them. The income counts as gross income for the child, but it is not support unless they use it to support themselves.
62
In year 1 Justin earns $700 from delivering papers for a newspaper company and he is treated as self-employed. In year 2 the newspaper company hires him as an employee and pays him $700 as W-2 income with no federal or state income tax withholding. Does Justin have to file a tax return in either year?Year 1: Yes Year 2: YesYear 1: No Year 2: YesYear 1: Yes Year 2: NoYear 1: No Year 2: No
Solution: The correct answer is C.The rule is that a taxpayer must file if he has greater than or equal to $400 of net earnings from self-employment. If the taxpayer does not have self-employment income there is no requirements to filing unless your income exceeds the standard deduction and personal exemption ($0 for 2018 - 2025) for that year.
63
Noah has been working part-time through college and earned $20,000 last year with a total federal income tax liability of $1,200. This year he will earn $100,000 with an expected income tax liability of $15,000. What is the lowest amount of tax withholding Noah should have to meet the safe harbor rules?$1,200$12,000$13,500$15,000
Solution: The correct answer is A.He has two choices: 100% of last year’s tax liability or 90% of this year’s tax liability. Last year’s income tax liability was $1,200 and 90% of this year is $13,500. Therefore, the lowest amount that of tax withholding that needs to be met is $1,200.
64
Section 1245 recapture does not apply to business equipment held for 17 months or longer if:
The property was destroyed by fire and the insurance recovery exceeds the property's adjusted basis.
The property was sold for a gain but was depreciated using straight-line depreciation rather than MACRS.
The property was acquired, depreciated, and exchanged for a less valuable asset where the buyer of the asset paid additional cash in the exchange.
The property was abandoned as worthless.
Solution: The correct answer is D.
Option "A" is incorrect because if the insurance proceeds exceed the property's adjusted basis, the excess is considered a sale and any portion of gain attributable to depreciation will be subject to Section 1245 recapture.
Option "B" is incorrect because Section 1245 recovery occurs any time a gain results from the reduction of basis due to depreciation.
Option "C" is incorrect because Section 1245 applies to gain resulting from a reduced basis due to depreciation.
Option "D" is correct. Property sold or abandoned below the basis adjusted by depreciation is not subject to Section 1245 recapture because either not all depreciation was taken or there was more likely a loss rather than a gain. For 1245 recapture to occur there must be a gain over the basis.
65
Paul (age 35) and his wife Stacey (age 33) are married with three young children. They both work outside the home. Paul is a corporate executive with Wellstar and Stacey is an executive assistant with a small local company. Paul fully participates in his company’s qualified retirement plan by contributing $19,500 of his salary, which is matched 100% up to 3% of compensation. Stacey’s employer does not offer a retirement plan. In addition, during the year they had the following items of income and expense:Paul’s gross salary: $150,000Stacey’s gross salary: $32,000Stacey’s cash gift to her mother: $5,000Interest from a joint savings account: $100Federal income taxes withheld from paychecks: $30,000State income taxes withheld from paychecks: $12,000Charitable contributions made: $4,400Mortgage interest for home: $11,100Real Estate Taxes on home: $6,000Contribution to Paul’s traditional IRA: $6,000Contribution to Stacey’s traditional IRA: $6,000What is Paul and Stacey’s taxable income?$124,100$131,100$134,100$139,600
Solution: The correct answer is B.150,000 Paul's gross salary+32,000 Stacey's gross salary182,000+ 100 Interest182,100-19,500 His 401K for 2020162,600-6,000 Her IRA (his is not deductible)156,600 AGI-10,000 State Income Tax Withheld & RE taxes (capped at $10,000)-11,100 Qualified mortgage interest-4,400 Charitable131,100 Taxable IncomeItemized deductions equal $25,500 versus the standard deduction of 24,800 in 2020
66
Two years ago, Bill purchased stock in Pinkley Corporation (the stock is not small business stock) for $1,000. In the current year, the stock became worthless. During the current year, Bill also had an $8,000 loss on small business stock (Section 1244) purchased two years ago, a $9,000 loss on a non-business bad debt, and a $5,000 long-term capital gain. What should Bill report this year?$4,000 long-term capital loss and $9,000 short-term capital loss.$3,000 long-term capital loss and $10,000 long term loss carry forward.$8,000 ordinary loss; $3,000 short-term capital loss and a $2,000 short-term capital loss carryover.$8,000 ordinary loss and $5,000 short-term capital loss.
Solution: The correct answer is C.The non-business bad debt is treated as a short-term capital loss. The loss on worthless stock held for more than one year is a long-term capital loss. The loss on small business stock Section 1244 is recognized as an ordinary loss not subject to the capital loss rules. Note the following calculation: $5,000 (long-term capital gain) - $1,000 (long-term capital loss worthless stock) = $4,000. From this amount, subtract $9,000 (non-business bad debt expense - short-term capital loss) to obtain a net short-term loss of ($5,000.) However, the maximum annual capital loss deduction is net $3,000.
67
Which of the following is a tax credit that reduces the tax due on taxable income?
Qualified dependent credit.
Child tax credit.
Earned income credit.
Credit for estimated tax payments.
I, II and III only.
II and III only.
I, II, III and IV only.
III, and IV.
Solution: The correct answer is C.
The "Qualified dependent credit" is new under TCJA and applies to qualified dependents and/or qualifying children 17 and over. It is limited to $500. The "child tax credit" applies to qualifying children under age 17 and was expanded under TCJA to $2,000 per child, with the possibility of up to $1,400 per child being refundable. The "earned income credit" is a credit against the calculated tax, available to those with very low income, predominantly from earnings (wages) and it is a refundable credit. The CFP exam considers the prepayment of tax, through withholding and/or estimated tax payments, as credits as well since they also reduce the balance due.
68
Joel paid $25,000 for a 30 percent interest in a general partnership. The partnership loss for the year is $180,000. How much can Joel deduct?
$0.
$25,000.
$54,000.
$60,000
Solution: The correct answer is B.
Joel's loss is limited to $25,000 due to the at-risk rules. He will also have a suspended loss of [($180,000 × 30%) - $25,000] = $29,000. The passive activity rules for income do not apply. Joel is a general partner which signifies he is a material participant.
69
Which is the best source for obtaining a plain language understanding about the current tax law? Commerce Clearing House Federal Tax Guide. Congressional Tax Committee Reports. Treasury Regulations. Tax Court Reports.
Solution: The correct answer is A. Option "A" is correct because Commerce Clearing House (CCH) provides plain language interpretation of tax law. Option "B" is incorrect as the Congressional Committee Reports (sometimes known as the Blue Book) provides congressional reasoning for enacting tax law. This language is often very technical and difficult to understand. Option "D" is incorrect because Tax Court Reports provide rulings of the U.S. Tax Court in the form of case law.
70
Julian purchased 100 shares of Home Depot, a domestic corporation, common stock on July 7th this year. The ex-dividend date for their quarterly dividend is July 12th. Julian sells the Home Depot stock on August 15th of this year. If Home Depot paid a dividend of $10 on Julian’s 100 shares, what are the tax consequences to Julian if Julian is in the 25% tax bracket?No tax liability since the qualified dividend rate is 0% for individuals in the 25% bracket.$1.50 of tax liability since the qualified dividend rate is 15% for individuals in the 25% bracket.$2.50 of tax liability since the ordinary dividend rate is the taxpayer’s marginal rate.Not enough information to answer the question.
Solution: The correct answer is C.Home Depot dividends will qualify for qualified dividend treatment if the individual meets the requisite holding period, which is more than 60 days in the 121 days surrounding the ex-dividend date. Since he only held the stock for 39 days, he does not meet the holding period. Therefore, the tax rate applied against the dividend is his ordinary income tax rate of 25%.
71
Michael purchased a mutual fund with a $25,000 five years ago. During the four years, $6,000 in dividends and capital gains were reinvested in the fund. Today, the fund is valued at $40,000. If Michael sells shares equal to $25,000, which statement(s) is/are correct?
The taxable gain can be based on an average cost per share.
The client can choose which shares to sell, thereby controlling the taxable gain.
To minimize the taxable gain today, the client would sell shares with the higher cost basis.
The client will NOT have a gain as long as he or she sells less than what he or she invested.
I, II and III only.
I and III only.
II and IV only.
IV only.
Solution: The correct answer is A.
Option I is correct because it is permissable to determine the per share of mutual funds using the average cost per share. Option II is correct because it is permissable to select specific identifiable shares of mutual funds to sell. Option III is correct because the higher cost basis will minimize the gain as long as the taxpayer uses the specific indentification method. Option IV is incorrect because the sales proceeds will be matched against the basis of the shares sold not the original plus adjusted investment.
72
In calculating a net operating loss for an individual, which of the following items would not be added back to negative taxable income?Net operating loss deductionLong-term capital losses in excess of short-term capital gains.Section 1202 exclusionsNone of the above would be added back.
Solution: The correct answer is D.In general, the following items are not allowed when figuring an NOL. · Any deduction for personal exemptions. · Capital losses in excess of capital gains. · The section 1202 exclusion… · Nonbusiness deductions in excess of nonbusiness income. · Net operating loss deduction. · The domestic production activities deduction.
73
One of the five tests which must be met to qualify as a dependent is:
The age of the dependent.
The dependent is either a member of the taxpayers household or meets the criteria for family relationship.
The taxpayer is a U.S. citizen.
All of the above.
Solution: The correct answer is B.
The five dependency tests are: 1) Gross Income Test, 2) Support Test, 3) Member of Household or Family Member Test, 4) Citizenship Test (U.S., Canada or Mexico), and 5) Joint Filing Test.
74
Under the Last In First Out (LIFO) inventory system:
The last goods purchased are the first goods sold.
LIFO means that the oldest goods will remain in inventory until sold.
The cost of goods is assigned the most current inventory costs.
LIFO insures that the newest goods are sold.
Solution: The correct answer is C.
The LIFO method is concerned with movement of costs through inventory, not goods. The cost of the last units purchased will be the first costs to be transferred to cost of goods sold when the goods are sold.
75
In which of the following situations, if any, may the individual NOT be deemed a dependent of the taxpayer:
A cousin who does not live with the taxpayer.
A former brother-in-law who does not live with the taxpayer. The taxpayer is divorced.
A nephew who does not live with the taxpayer.
A legally adopted child who does not live with taxpayer.
Solution: The correct answer is A.
All other parties either satisfy the relationship or member of the household test.
IRS Publication 501: Relatives who don't have to live with you. A person related to you in any of the following ways doesn't have to live with you all year as a member of your household to meet this test.
Your child, stepchild, foster child, or a descendant of any of them (for example, your grandchild). (A legally adopted child is considered your child.)
Your brother, sister, half brother, half sister, stepbrother, or stepsister.
Your father, mother, grandparent, or other direct ancestor, but not foster parent. Your stepfather or stepmother.
A son or daughter of your brother or sister. A son or daughter of your half brother or half sister.
A brother or sister of your father or mother.
Your son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
Any of these relationships that were established by marriage aren't ended by death or divorce.
76
When reviewing a client's income tax return from the prior year you notice that they had adjusted gross income of $175,000 and paid federal income tax of $31,500. Assuming that the client's income for this year will closely approximate that of last year, what is the minimum amount to pay in estimates to meet safe harbor?$28,350$31,500$34,650$37,800
Solution: The correct answer is A.Your primary choices are (A) = 90% of current year, (B) = 100% of prior year, and (C) = 110% of prior year. Since the client’s AGI from last year is greater than $150,000 the safe harbor is 90% of current year tax or 110% of prior year tax. Since the client’s income “closely approximates that of last year” we can utilize the 90% of current year amount. If the client’s income varies widely then we would use 110% of prior year.
77
For purposes of determining taxable income, which of the following is true?A taxpayer who finds a suitcase of money and spends the money is not required to recognize income.The taxpayer who collects income from a customer during the year, but the customer has sued for a refund, can defer recognition of the income until the suit has been resolved.Embezzlement proceeds are not included in the embezzler's gross income because the embezzler has an obligation to repay the owner.A person who rents out their personal residence 10 days during the year is not required to include any income received.
Solution: The correct answer is D.A person who rents their home for less than 15 days is not required to include the income as it is considered personal property, not rental or mixed use. However, no deductions related to the expense of renting out the home are allowed other than taxes and interest associated with the property that would normally be deductible as an itemized deduction.
78
A cash basis taxpayer includes income from a service business when:
The services are performed.
The client is invoiced for the services.
The client's check is deposited in the bank.
The client's check is received by the taxpayer.
Solution: The correct answer is D.
Cash basis is recognized as income when received.
79
Which of the following is not an exception to the passive activity rules for rental activities?
If the average period of customer use is seven days or less, the activity could be considered an active trade or business.
If the average period of customer use is 30 days or less but the taxpayer does not provide significant personal services in concert with the rental activity, the activity may be classified as an active trade or business.
The activity will be considered an active trade or business if the rental of property is incidental to the non-rental activity of the taxpayer.
A rental activity that the taxpayer customarily makes available during business hours for nonexclusive use by customers will be classified as the active conduct of a trade or business, provided the taxpayer materially participates.
Solution: The correct answer is B.
Option "B" is correct because the taxpayer must provide significant personal services in concert with the rental activity and must materially participate in the activity in order to classify the activity as an active trade or business.
80
Which of the following statements correctly describes the cash receipts and disbursements method of accounting?
Income is reported as it is earned and expenses are reported as they are incurred.
The cash receipts method is the most difficult accounting method to understand.
A taxpayer who uses the cash method for reporting most items may use a different method for reporting self-employment income.
Reporting of income and expenses is subject to the all events test.
Solution: The correct answer is C.
Options "A" and ""D" describe the accrual method of accounting, not the cash receipts and disbursements method of accounting. Option "B" is incorrect; the cash receipts method is generally the easiest method of accounting to understand and the simplest to use.
81
Alisha Syrmos, a CFP® Professional and fee-only financial planner, has assisted Bob Martin, a self-employed physician in tax and investment planning during the year. Identify the schedule(s) on which Alisha's fee may be deductible by Bob on his federal income tax return.Schedule A - itemized deductions.Schedule C - profit or loss from business.Schedule D - capital gains and losses.I only.II only.I and II only.I, II and III.
Solution: The correct answer is B.Tax planning fees may no longer be deducted against a taxpayer's itemized deduction, Schedule A. However, because the taxpayer is self-employed, the portion of services related to the business and not personal may be taken as a deductible expense on the taxpayer's Schedule C.
82
Dakota qualifies as a dependent of his parents. This year, he earned $500 from a part-time job and $1,500 in interest from a savings account. Dakota's taxable income for this year is:
$2,000
$1,100
$900
$600
Solution: The correct answer is C.
The calculation is as follows: $1,500 (interest) + $500 (wage) = $2,000 (gross income) - $1,100 (greater of standard deduction of $1,100 or $350 plus earned income) = $900 of taxable income, taxed at Dakota's tax rate.
83
Mr. Rangel files a fraudulent income tax return (again) and has a $10,000 income tax deficiency because of it. What is the amount of his penalty?
$10,000
$8,000
$7,500
$5,000
Solution: The correct answer is C.
The penalty for filing a fraudulent income tax return is 75% of the deficiency.
84
Billy, single (he divorced in 2010) and age 42, has the following items of income and expense for the current tax year.Wages: $60,000Interest: $1,200Inheritance: $50,000Alimony paid: $10,000Child support paid: $8,000Federal taxes paid: $5,000State taxes paid: $2,000Medical expenses: $7,500Tickets from his employer for one basketball game: $100What is his taxable income?$38,800$40,600$48,800$51,200
Solution: The correct answer is A.Wages $60,000Interest $1,200less Alimony AGI $51,200Std Deduction $12,400Taxable Income $38,800
85
Which of the following imposed the first constitutional federal income tax?Revenue Act of 1861.16th Amendment.Revenue Act of 1916.None of the above.
Solution: The correct answer is D.Answer "A" is incorrect because although the Revenue Act of 1861 did impose a federal income tax, it was later found to be unconstitutional because Congress did not have the power to levy an individual income tax at that time. Answer "B" is incorrect because the 16th Amendment gave Congress the power to impose an individual income tax, but did not itself impose that tax. Answer "C" is incorrect because the Revenue Act of 1916 raised the rates previously imposed under the Revenue Act of 1913. Therefore, answer "D" is correct because the Revenue Act of 1913 imposed the first constitutional income tax.
86
Vince, a single individual, is one of the founders and original shareholders of Security Consulting, Inc., a corporate security consulting firm. The company was initially capitalized with $200,000, and Vince was a 50 percent owner. The company was structured as a C corporation and filing requirements and permissible tax elections that could benefit the owners were made at the time the company was created. After several years of successful operations, Security Consulting lost market share to large national firms, and eventually closed down operations. Since it had no assets other than the goodwill of the business, there was nothing left to distribute to the shareholders. Assuming that there were no changes to Vince's ownership interest over the period of his ownership, and that Vince has no capital transactions in the current year, by how much can Vince reduce his adjusted gross income this year due to the company becoming worthless?
$3,000.
$50,000.
$53,000.
$100,000.
Solution: The correct answer is C.
Because it was capitalized with less than $1 million and Vince was an original shareholder, the stock is Section 1244 stock in Vince's hands. Vince can deduct up to $50,000 of losses as an ordinary loss in any one tax year and the remaining loss is treated as a capital loss. Therefore, Vince will be able to deduct $50,000 of his loss as a Section 1244 loss against ordinary income and will qualify for an additional $3,000 long-term capital loss deduction. The remaining capital loss of $47,000 will be carried forward to future tax years.
87
Which of the following is not an above-the-line deduction?
Medical expenses.
A contribution to an HSA.
A contribution to a traditional IRA.
Student loan interest.
Solution: The correct answer is A.
Medical expenses in excess of 7.5% (Taxpayer Relief Act 2019) of AGI are deductible below-the-line. All of the other options are above-the-line deductions.
88
Jacob is divorced and has full custody of his two children although they spend every other weekend with their mother. How many personal exemptions is Jacob permitted on his Form 1040?
0
1
2
3
Solution: The correct answer is A.
Per the TCJA, personal exemptions are suspended from 1/1/18 through 12/31/2025.
89
Standard Deduction for someone over 65
$1,650 for being 65 or over
90
The carrybacks and carryforwards associated with the general business credit must be used in a specific order. Which of the following correctly describes that order?
I. The business credit carryforwards to the current year
II. The amount of the current year business credit
III. The business credit carrybacks to the current year
III, II, I
II, III, I
I, III, II
I, II, III
Solution: The correct answer is D.
Answer "D" correctly describes the sequence in which the carrybacks and carryforwards associated with the general business credit must be used.
91
What is the major advantage of the cash method of accounting?
Income is counted at the time it is earned.
Income may be deferred.
Deductible expenses may be accelerated.
Deductible expenses may be used as carry-backs.
```
I and II only.
II and III only.
I and IV only.
III and IV only.
None of the above.
```
Solution: The correct answer is B.
Income may be deferred until cash is received and deductible expenses accelerated if paid.
92
Abby and Brock are divorced. They have one daughter, Caroline, who spends exactly six months of the year living with her mother and exactly six months of the year living with her father. Abby has an AGI of $200,000 and Brock has an AGI of $150,000. Caroline is a qualifying child of both Abby and Brock. Who can claim Caroline as a dependent?
Abby.
Brock.
Both Abby and Brock.
Neither Abby nor Brock.
Solution: The correct answer is A.
In this case, both parents are eligible to claim Caroline as a dependent because she is a qualifying child for both of them. However, an individual cannot be claimed as a dependent by more than one person. Because Caroline lives with each parent for the same amount of time, the parent with the higher AGI is allowed to claim the dependency exemption. In this case, Abby has a higher AGI than Brock, so she is allowed to claim a dependency exemption for Caroline.
93
The five dependency tests
1) Gross Income Test,
2) Support Test,
3) Member of Household or Family Member Test,
4) Citizenship Test (U.S., Canada or Mexico), and
5) Joint Filing Test.
94
Section 1245 recapture applies when:
A gain on sale of real property occurs due to the depreciated basis.
All or a portion of gain on tangible personal business property resulted from depreciation taken.
Tangible personal business property is sold regardless of whether there is a gain.
A gain on any class of property occurs due to cost reduction.
Solution: The correct answer is B.
Section 1245 recapture is treated as ordinary income for the gain realized resulting from depreciation taken that was greater than economic reality.
95
Gee and Bea Lee have a very diverse family. Which of the following children does not meet the relationship test for the purpose of Gee and Bea qualifying them as dependent for that child?
Dan, Bea's 8-year-old son from a prior marriage.
Fran, Gee's 10-year-old cousin.
Stan, a 5-year-old foster child placed with Gee and Bea by a state agency.
Xan, Bea's 12-year-old niece.
Solution: The correct answer is B.
Because Fran is from the same generation as Gee (even though she is presumably much younger than Gee), she does not meet the relationship test. A qualifying child must be from a lower generation than the taxpayer. All of the other options do meet the relationship test for being a qualifying child for the purpose of the dependency exemption.
96
Veronica has determined that she needs to make a 4th quarter federal estimated income tax payment. When is this payment due?January 15th of next year.December 31st of this year.December 15th of this year.September 15th of this year.
Solution: The correct answer is A.The 4th quarter federal income tax estimated payment is due by January 15th of the year following the year the payment is being made for.
97
Kathy operates a gym. Her customers pay $480 for 48 aerobic classes that can be taken any time in a 24-month period. If Kathy sells one of the agreements to a customer on June 30 of this year, and the customer takes six lessons during the year, how much of the income is Kathy required to recognize as income on this year's taxes?
$480 if she is a cash or accrual basis taxpayer.
$240 if she is an accrual basis taxpayer.
$60 if she is an accrual basis taxpayer.
$120 is she is a cash basis taxpayer.
Solution: The correct answer is C.
Accrual taxpayers who receive prepaid revenues do not recognize taxable income until the revenue is actually earned. Kathy has earned 6 out of 48 classes or 12.5% (6 / 48) of the revenue collected; 12.5% × $480 = $60.
98
The accrual method of accounting generally must be used to report income earned by:
A C corporation that made a S election.
A general partnership with a corporate partner.
A LLC that has business in most or all states.
None of the above.
Solution: The correct answer is B.
The key is the question of when the accrual system "Must" be applied. C Corporations must use the accrual method. Therefore, any entity where a C corporation is a partner or owner must use the accrual method. The correct answer is "B" - Partnerships with corporations as owners must use the accrual method. Option "D" is automatically eliminated because S corporations are not required to use the accrual method of accounting.
99
Eric's daughter Emilie is attending a local university. Listed below are the items that Eric has paid for this year related to Emilie's education. What are Eric's total qualified tuition and related expenses for the purpose of claiming the American Opportunity credit? $12,000 tuition paid directly to the university. $400 student activity fee which is required by the university for enrollment. $600 in textbooks purchased from an off-campus bookstore. $100 lab fee for a required science course.
$12,000.
$12,500.
$12,700.
$13,100.
Solution: The correct answer is D.
Item "I" is a qualified tuition and related expense. Item "II" is a qualified tuition and related expense because it is required by the university for enrollment. Item "III" is a qualified tuition and related expense because textbooks can be purchased directly from the school or another off campus source and still qualify as a qualified education expense. Item "IV" is a qualified tuition and related expense because the class is required as part of Emilie's degree program.
100
Refundable tax credits include the:
Foreign tax credit.
Tax credit for rehabilitation expenses.
Disabled access credit.
Earned income credit.
Solution: The correct answer is D.
Earned income tax credit is refundable. The remainder of the choices are not refundable credits.
101
Mel made the following contributions to charity during the past year:
Used clothing of the taxpayer and family - Basis = $900 and FMV = $300
Stock in GMC held as an investment for 13 months - Basis = $8,000 and FMV = $7,000
Stock in United Corp. held as an investment for 9 months - Basis = $9,000 and FMV = $10,000
Real estate held as an investment for six years - Basis = $10,000 and FMV = $25,000
The used clothing was donated to the Salvation Army; the other items of property were donated to a Methodist seminary. Disregarding any percentage limitations, Mel's charitable contribution deduction is:
$43,300
$42,900
$41,300
$26,300
Solution: The correct answer is C.
A donation of short-term capital assets is recognized as a charitable expense at the lower of the FMV or basis. Donations of appreciated long-term assets are recognized as a charitable expense at the fair market value unless basis is chosen. In this question, the United Corp stock is a short-term investment that was held for less than 12 months, therefore, it will be expended as a charitable contribution at the donor's basis of $9,000. The remainder of the donated assets are expensed for charitable purposes at their fair market value.
102
During the current year, Justin, a self-employed individual, paid the following amounts: Federal income tax = $5,000; State income tax = $3,000; Real estate taxes on land in a neighboring state (held as an investment) = $8,000; State sales taxes = $600; State occupational license fee = $400. What amount can Justin deduct as taxes by itemizing his deductions?
$3,600
$10,000
$11,000
$11,600
Solution: The correct answer is B.
State income or sales tax (whichever is higher) and real estate taxes are deductible as itemized deductions but for years after 12/31/17, they are capped at $10,000 (total). Federal income taxes paid are deductible from the tax liability, but are not an itemized deduction. Occupational license fees are deductible as a direct business cost in which they are deducted for AGI not as itemized deductions.
103
Veronica borrowed $300,000 to acquire a parcel of land to be held for investment purposes. During the year, she paid interest of $30,000 on the loan. She had AGI of $70,000 for the year. Other items related to Veronica's investments include the following:
Investment income = $15,200
Long-term gain on the sale of stock = $6,000
Investment counsel fees = $900
Veronica is unmarried and elected to itemize deductions. She had no miscellaneous deductions other than the investment counsel fees. Determine Veronica's maximum investment interest deduction.
$30,000
$21,200
$16,100
$15,200
Solution: The correct answer is B.
The taxpayer's investment interest deduction is limited to the investment income. The investment income is $15,200 plus she can add the capital gains of $6,000 and deduct $21,200. The excess investment interest ($30,000 - $21,200) can be carried over to next year.
104
Hal is an investment counselor who is employed by Richardson Investments. While he attended a conference on the impact of the new tax laws in investment choices, he incurred the following unreimbursed expenses: Airfare = $350; Lodging = $450; Meals = $330; Tuition and fees = $410. Without regard to his AGI, how much can Hal deduct on his return?
$0
$975
$1,150
$1,375
Solution: The correct answer is A.
Post 12/31/17, TCJA eliminated the deduction for unreimbursed employee business expenses.
105
Contributions to charity are limited to a certain percentage of income. How long is the carry-over period for individuals to use any excess current charitable deduction?
One year.
Five years.
Seven years.
Fifteen years.
Solution: The correct answer is B.
There is a five-year carry-over provision for charitable deductions. The total years are 6: The initial year plus five carry-over years.
106
Casualty losses are:
Reduced by $100 per event if the asset loss was held for personal use.
Generally, not deductible if they are personal.
Reimbursements are subject to inclusion in the taxpayers AGI.
Reimbursements reduce the loss amount.
I and II only.
II and IV only.
I, III and IV only.
I and IV only.
Solution: The correct answer is B.
Personal casualty losses are not deductible, unless the loss was as a result of a federally declared disaster. For business losses, reimbursements are not included in AGI but rather reduce the loss.
107
Which of the following statements concerning hobby activities is correct?
Any activity which does not generate a profit within three years must be treated for income tax purposes as a hobby activity.
The IRS must prove that the taxpayer does not have a profit motive to treat an activity as a hobby activity.
Expenses associated with the hobby activity can offset, without limitation, the income generated from the activity.
Hobby income is included in gross income above the line, while hobby expenses are not deductible.
Solution: The correct answer is D.
Income generated from a hobby activity is included in gross income, and expenses associated with the hobby are no longer deductible per TCJA for years after 12/31/17.
If the activity earns a profit in three out of five years, the IRS has the burden of proof of showing that there is no profit motive, but if there has not been a profit in three out of the last five years, the taxpayer has the burden of proof. There is no bright line test that requires an activity to be treated as a hobby activity based on the income trend of an activity.
108
What difference does it make if a taxpayer's expenses are classified as un-reimbursed employee expenses rather than expenses from self-employment?
Un-reimbursed employee expenses are subject to a hurdle of 2% of the taxpayer's AGI. They also require the taxpayer to itemize before the deduction can be taken.
Expenses from self-employment are deducted above the line and have no AGI floor.
Un-reimbursed employee expenses are not deductible.
Expenses from self-employment are subject to a floor of 2% of the taxpayer's AGI. They also require the taxpayer to itemize before the deduction can be taken.
I & IV only.
I only.
I and II only.
II and III only.
Solution: The correct answer is D.
Un-reimbursed employee expenses are not deductible after 1/1/18 per the TCJA. Expenses from self-employment are deducted above the line and have no AGI floor.
109
Mortimer is an avid collector of antiques associated with the funeral industry. The local hospital is running a campaign to redecorate and expand their lobby, and as a show of support, Mortimer donates a 19th century horse-drawn hearse in mint condition to the hospital. He purchased several of these hearses 30 years ago for $300 each, but the current estimated market value of the hearse today is in the range of $30,000. The hospital decides to sell the hearse and dedicate the proceeds to the renovation effort. Mortimer's AGI is $50,000. Which of the following statements concerning Mortimer's charitable deduction is correct?
Mortimer's deduction for the current tax year will be limited to $25,000.
Mortimer's deduction for the current tax year will be limited to $15,000.
At least $5,000 of the deductible amount will have to be carried over to future tax years.
Mortimer's income tax deduction is $300.
Solution: The correct answer is D.
When tangible personal property donated to a charity will not be used by the charity to carry out its tax-exempt purpose, the deduction available to the donor is limited to the donor's cost basis and will be subject to the 50 percent limitation. Redecorating the lobby is not part of the hospital's tax-exempt purpose. In this case, Mortimer's cost basis is $300 and since 50% of his AGI is $25,000, Mortimer may take his entire charitable deduction this year.
110
Howard is 53 years old and has decided to purchase Long-term Care Insurance. Which of the following most accurately describes the tax benefits of premiums paid on a long term care policy?
The policy must be guaranteed renewable or non-cancelable for the premiums to be deductible.
Since Howard is less than age 62, only 7.5% of premiums paid are deductible.
Premiums paid are deductible but limited based upon age.
The long term care insurance deduction is for AGI.
I and III only.
III only.
II and III only.
I, II, III and IV.
Solution: The correct answer is A.
The IRS provides guidelines for the amount of premiums that are deductible based upon the insured's age. The amount of premiums paid is included in the medical expense deduction for total expenditures exceeding 7.5% of AGI and is from AGI. The policy must be guaranteed renewable or non-cancelable to be qualified.
111
Bill and Nancy are married and together they have AGI of $80,000. They have no dependents and they file a joint income return. Each pays $1,200 for hospitalization insurance. During the year, they paid the following amounts for medical care: $7,200 in doctor and dentist bills and hospital expenses and $800 for prescribed medicine and drugs. In December, they received an insurance reimbursement of $1,500 for hospitalization. Determine the deduction allowable for medical expenses paid during the year.
$8,900
$2,400
$0
$2,900
Solution: The correct answer is D.
Bill and Nancy can claim a medical expense deduction for the current year of $2,900 determined as follows: Insurance Premiums $2,400; Doctor $7,200; Medicine $800; Total $10,400. Reimbursement $ 1,500, Total $8,900. 7.5% of AGI = $6,000. Deduction $2,900.
112
Lauren has purchased a home worth $1.5 million with an interest-only mortgage of $1.2 million on 12/20/17. She is currently only paying interest on the mortgage in the amount of $60,000 per year. What amount may she deduct as home mortgage interest on Schedule A of her individual income tax return?
$0
$37,500
$55,000
$60,000
Solution: The correct answer is B.
The calculation is calculated by dividing the qualified mortgage over the total mortgage times the interest paid.
(750,000/1,200,000) × 60,000 = 37,500
Per TCJA, home mortgages are limited to qualified residential interest and a maximum indebtedness of $750,000 if financed after 12/15/17. (For debt prior to 12/15/17, the $1 million limit applies.)
113
ma Clipper, a well-known artist, donated one of her original bronze creations to a local charity, which auctioned the piece for $3,000. Ima totaled her costs as follows:
Bronze = $425
Other materials = $150
Pro-rata overhead = $125
Furnace/casting fees = $200
Artistic contribution = $2,100
Assuming this is Ima's only charitable contribution and based on an annual income of $150,000, what is the maximum amount of charitable income tax deduction available to her?
$3,000
$2,100
$775
$900
Solution: The correct answer is C.
Only materials and expenses are deductible, not artistic contribution or time. No deduction is allowed for use of property; therefore, the pro-rata overhead would likely not be allowed.
114
Nina has been very ill this year and has a significant amount of medical expenses, as listed below. $1,200 in prescription drug costs. $2,000 in doctor's bills not reimbursed by Nina's insurance. $800 in travel expenses to see a specialist in another state. $2,000 in health insurance premiums. Nina's AGI is $20,000. What is the amount of her deduction for medical expenses?
$1,500
$2,000
$4,000
$4,500
Solution: The correct answer is D.
All of Nina's medical expenses are deductible medical expenses. Her total deductible medical expenses are $6,000. However, her actual deduction is limited to the amount of deductible medical expenses that exceed 7.5% of her AGI or $1,500. Therefore, her deduction for medical expenses is $4,500 ($6,000 - $1,500).
115
Which of the following is a deductible miscellaneous itemized deductions?
Union dues.
Appraisal fees for establishing a casualty loss.
Job hunting expenses.
Gambling losses to the extent of gambling gains.
Solution: The correct answer is D.
Gambling losses and all deductions incurred in carrying out wagering transactions are limited to gambling winnings for 2018 - 2025. TCJA of 20177 suspended itemized deductions that are subject to the 2% floor have been suspended after Dec 31, 2017 - before Jan 1 2026.
116
Valerie sued her former employer for a physical injury she sustained at work. Valerie was awarded $100,000 to compensate her for the injury and $25,000 in punitive damages. Valerie must include how much in her gross income:
$0
$25,000
$100,000
$125,000
Solution: The correct answer is B.
Compensation for damages for personal bodily injury are not included in taxable income. Punitive damages are included as taxable income.
117
Brody has set up a dividend reinvestment plan at Coca-Cola Enterprises, Inc. where all dividends are automatically reinvested into more Coca-Cola Enterprises stock. Brody never receives a check for the dividends. His initial stock ownership was 100 shares at a cost of $2,000. The total dividends for the year equaled $60. The administrative fee to convert into new shares was $5. How much, if any, of the dividends are included in Brody’s gross income?
None
$9
$55
$60
Solution: The correct answer is D.
All of the dividends are included in Brody’s gross income for the year. These dividends, while not received by Brody in the form of cash, could be taken as cash upon his election to end the dividend reinvestment plan. He has “constructively” received the dividends and decided to reinvest them in stock of Coca-Cola Enterprises, Inc. The administrative fee may be deducted but all the dividends must be reported as income.
118
Ashton, age 29, purchased stock in a real estate investment trust (REIT) with a dividend yield of 9%. He was concerned that the real estate market may have been hurt in the recent market turmoil. However, they kept paying the stated dividend but his 1099-DIV only lists 4% as ordinary dividends. How can this be possible?
The REIT was paying 5% in qualified dividends.
The REIT was making nondividend distributions.
The REIT was selling his shares.
The REIT already paid tax on the other 5% so Ashton does not have to.
Solution: The correct answer is B.
Nondividend distributions are a return of capital and are not included for gross income. (A) is incorrect because REITs cannot pay qualified dividends. (C) is incorrect because the REIT cannot sell an owner’s shares. (D) is incorrect because the REIT cannot pay the tax for the shareholder.
119
Dina loans $24,000 to her daughter Erin and does not charge any interest. Erin has investment income of $1,400 and investment expenses of $300. The applicable federal rate is 5%. How much interest must be imputed on the loan?
$1,000.
$1,100.
$1,200.
$1,400.
Solution: The correct answer is B.
Erin has net investment income of $1,100. Therefore, the amount of imputed interest is the lesser of net investment income or interest calculated using the AFR less interest calculated using the stated rate of the loan. Since the stated rate of interest on the loan is 0%, the amount of imputed interest is the lesser of $1,100 or $1,200 ($24,000 × 0.05). Therefore, $1,100 of interest must be imputed on the loan.
120
Matt owned stock in Whitline Corporation that he donated to a university (a qualified charitable organization) on May 1 of this year. What is the amount of Matt's charitable income tax deduction assuming that he had purchased the stock for $3,500 on March 3 of this same year, and the stock had a value of $4,600 when he made the donation? His AGI was $8,100.
$1,100
$3,500
$4,050
$4,600
Solution: The correct answer is B.
Taxpayers who donate short term gain property are required to use the lesser of fair market value or adjusted basis for the determination of the charitable income tax deduction. In this case, Matt only owned the stock for 2 months, therefore it will be short term. The basis ($3,500) in less than the FMV ($4,600).
121
James, a cash basis taxpayer received the following compensation and fringe benefits from his employer in the current year:
Salary = $60,000
Bonus for services = $8,000
Premium for disability income protection = $2,000
Premium for group hospitalization insurance = $2,500
The bonus is being paid in January of next year. The wage continuation insurance would pay James three-fourths of his regular salary if he became disabled. The insurance benefits are provided by the employer to all full-time employees. What is James' gross income in the current year?
$60,000
$62,000
$62,500
$68,000
Solution: The correct answer is A.
The premiums for disability insurance and group hospitalization insurance are not included in the taxpayers income. Because James is a cash basis taxpayer, income is recognized when received. So the salary is $60,000 in the current year and though he earned his bonus in the current year, he will not recognize it until next year when it is paid.
122
James received an academic scholarship to State University. He is a candidate for a degree. Under the scholarship agreement he received:
Tuition ($1,500)
Books ($400)
Room and board ($5,000)
What is James' gross income, if any, from the scholarship?
None
$5,000
$5,400
$6,900
Solution: The correct answer is B.
James' gross income is $5,000. Tuition and books are not included in income, but living expenses such as room and board are included in taxable income.
123
Ian, a single taxpayer, received $15,000 of Social Security retirement benefits in the current year. He also received $16,000 of interest income. How much of Ian's Social Security benefits must be included in his gross income?
$0.
$7,500.
$12,750.
$15,000.
Solution: The correct answer is A.
Since the total of Ian's MAGI ($16,000) and one-half of his Social Security benefits (0.50 × $15,000 = $7,500) is less than the base amount ($25,000), none of his Social Security benefits are included in gross income.
124
Fiona is a highly compensated employee of GreatWorks, Inc. Which of the following fringe benefits would be taxable to Fiona?
Health insurance provided by GreatWorks to all employees.
Group term life insurance in the amount of $40,000 paid for by GreatWorks.
Dependent care assistance for the highly compensated employees of GreatWorks.
On-premises athletic facilities that may only be used by the managers and vice-presidents of GreatWorks.
Solution: The correct answer is C.
Dependent care assistance can only be excluded from a highly compensated employee's gross income if it is provided on a nondiscriminatory basis. Answer "D" is not correct because access to athletic facilities can be provided on a discriminatory basis without causing inclusion in the employee's gross income.
125
Edward told his nephew that if the nephew would care for Edward in his old age, the nephew could have all of Edward's securities when he died. At the time of the promise, the securities had a fair market value of $50,000. The nephew took good care of Edward, whose will left the securities to the nephew. The fair market value of the securities at the time of Edward's death was $80,000. Edward could have gone to a nursing home and obtained the same services as provided by the nephew for $40,000. The nephew's gross income from the above is:
$0; this is an inheritance.
$40,000; this is earned income at the fair market value.
$50,000; this is earned income as of the time of the promise.
$80,000; this is earned income equal to the date of death value.
Solution: The correct answer is D.
Because the agreement was to compensate Edward's nephew for his services, even though the transfer occurred following death, it is not a gift or bequest. It is compensation for services performed. Compensation of property has a value equal to its fair market value on the date of transfer. The fact that Edward died and a step up in basis would ordinarily occur is immaterial.
126
Which of the following are requirements for satisfying the bona fide resident test necessary for excluding foreign earned income?
The taxpayer must establish permanent quarters in the foreign country for himself and his family.
The taxpayer may not return to the United States during the year.
The taxpayer must intend to work in the foreign country for an indefinite period of time.
I only.
I and II only.
II and III only.
I and III only.
Solution: The correct answer is D.
Occasional trips back to the United States for vacation or other purposes will not usually prevent a taxpayer from meeting the bona fide resident test.
127
Which of the following income(s) is/are NOT taxed under Social Security self-employment tax?
Income from personal property leased with real estate.
Income from debentures and investment notes.
Gain from the sale of property not held for sale in a trade or business.
Income of a person working as a private consultant who is over normal age retirement.
All of the above.
I and III only.
II and IV only.
I, II, and III only.
Solution: The correct answer is D.
Option "I" - Income from personal property leased with real estate is not subject to self-employment taxes. Option "II" - This implies there is debt involved. As such this income is not subject to self-employment taxes. Option "III" - This is not earned income and not subject to self-employment taxes. Option "IV" - Income from work as a private consultant is subject to self employment tax regardless of age.
128
Tom operates an illegal drug operation and incurred the following expenses: Salaries = $50,000; Illegal kickbacks = $20,000; Bribes to border guards = $25,000; Cost of goods sold = $150,000; Rent = $8,000; Interest = $10,000; Taxable income = $400,000. How much is his taxable income reduced by, based on the above expenses?
$-0-
$150,000
$218,000
$263,000
Solution: The correct answer is B.
Cost of goods sold is the only deduction allowed for illegal drug operation activities.
129
How much of the self-employment tax can be deducted from gross income?
None.
25%
40%
50%
Solution: The correct answer is D.
One half (50%) of self-employment tax is deductible from the taxpayer's gross income.
130
Which of the following is true of the substitute basis of a qualifying asset in a like-kind exchange?
The substitute basis is the asset's fair market value increased by the gain realized but not recognized.
The substitute basis is the asset’s basis reduced by the gain realized but not recognized.
The substitute basis is the asset’s basis increased by the gain realized but not recognized.
The substitute basis is the asset’s fair market value reduced by the gain realized but not recognized.
Solution: The correct answer is D.
Substitute basis is the fair market value of an asset, reduced by gain realized, but not recognized.
131
Peyton has a piece of equipment used in his business. He exchanges it for a like-kind asset owned by Eli. (Peyton and Eli are unrelated). The basis of Peyton's asset is $40,000 and he gives Eli $20,000 cash plus the asset in exchange for Eli's asset, which is worth $36,000. Eli's basis in his original asset is $10,000. What is Peyton's recognized gain or loss?
$0
$4,000 loss
$24,000 loss
$6,000 gain
Solution: The correct answer is C.
While losses are not recognized in like kind exchanges; this is not a like kind exchange. Only property is eligible to like kind treatment under the new law. As a result, Peyton has a realized/recognized loss as follows. Value received (new property) $36,000 - Basis $40,000 - cash $20,000 = $24,000 loss. His new basis is the value he "paid" $36,000.
132
Which of the following individuals can make a deductible contribution to a traditional IRA in the current year?
Jack, who is married, has an AGI of $180,000, and his spouse is an active participant in her employer's defined contribution plan, but he is not an active participant.
Kelly, who is single, has an AGI of $78,000, and is an active participant in her employer's defined benefit plan.
Leo, who is married, has an AGI of $128,000, and is an active participant in his employer's defined contribution plan.
Marni, who is single and has no earned income.
Solution: The correct answer is A.
Option "B" is incorrect because Kelly's AGI exceeds the phaseout range for single individuals who are active participants.
Option "C" is incorrect because Leo's AGI exceeds the phaseout range for married individuals who are active participants.
Option "D" is incorrect because Marni must have earned income in order to contribute to a traditional IRA.
Option "A" is correct because although Jack's spouse is an active participant, Jack is not. Therefore, Jack may make a deductible contribution to a traditional IRA as long as their joint AGI does not exceed $206,000 in 2020
133
Which of the following is not a requirement for a deductible business-related expense?
The expense must be ordinary.
The expense must be necessary.
The expense must be capitalized.
The expense must be reasonable.
Solution: The correct answer is C.
Deductible business expenses are usually not capital in nature. Capitalized expenses are recovered over the life of the asset through depreciation deductions, rather than through a deduction for a business expense.
134
Which of the following is a "trade or business" expense?
QNEC contribution to 401K plans to retain qualification.
Charitable contributions by a partnership.
Gifts to contract letting officals to get preferential treatment in contracts.
Prepaid parking fines paid at a discount to the city to avoid ticketing in high traffic areas.
Solution: The correct answer is A.
Charitable contributions by a partnership are personal expenses. Fines are not deductible. Gifts (bribes) are not deductible. QNEC, qualified non-elective contributions, to a 401K plan to maintain qualification is an ordinary/necessary business expense.
135
Which of the following must be capitalized by a business?
A major tune-up of a truck used in the business.
The replacement of a windshield of a business truck, which was broken in an accident.
The repair of a roof damaged by a hurricane.
The cost of a concrete pad upon which to place a machine.
Solution: The correct answer is D.
Costs to improve, better, or extend the life of an asset are capitalized. Tune-ups are a maintenance activity. Maintenance and repairs (roof and windshield) are period costs deductible in the period in which they were incurred.
136
Melissa is an employee and regional manager of "Burger Heaven," a national chain of fast-food outlets. On a particular day, she uses her personal car for the following trips: Melissa's home to post office to get Burger Heaven mail = 10 miles; Post office to her office = 30 miles; Office to Burger Heaven No. 1 = 20 miles; Burger Heaven No. 1 to Burger Heaven No. 2 = 25 miles; Burger Heaven No. 2 to home = 40 miles. Melissa's deductible mileage for the day is:
0 miles.
20 miles.
45 miles.
75 miles.
Solution: The correct answer is A.
The first trip out to the post office and the last trip home are considered non-deductible commuting miles. However as an employee, Melissa may not deduct unreimbursed employee expenses.
137
Which of the following statements regarding the deduction of costs associated with investigating the purchase of a new line of business is not correct?
If the new line of business is not purchased, no deduction is permissible.
If the new line of business is purchased and it is in the same line of business as the current trade or business operation, the cost of investigating the new business is fully deductible.
The ability to deduct the cost of investigating a new line of business is often overlooked by taxpayers.
If the new line of business is purchased and it is in a different line of business as the current trade or business operation, there is no way to recoup the costs of investigation.
Solution: The correct answer is D.
If the new line of business is purchased and it is in a different line of business as the current trade or business operation, the costs of investigation are recouped by capitalizing the expenses and amortizing it ratably over a 60-month period.
138
Albacore, Inc., an accrual method taxpayer, was incorporated on January 2 this year but did not begin business operations until July 1. Albacore adopted a calendar year tax year and incurred the following expenses during its first tax year:
Incorporation fees paid to State: $150
Expenses in connection with issuing and selling stock: $1,800
Legal fees incident to incorporation: $1,650
If Albacore, Inc. makes an appropriate and timely election, the maximum organizational expenditures that it can properly deduct for the current year would be:
None
$1,800
$3,450
$3,600
Solution: The correct answer is B.
Expenses incurred in connection with issuing and selling stock are not deductible. The rule is the lesser of expenditures or $5,000. Therefore, $1,650 + 150 = $1,800
139
John owns a rental home in Arizona. He decided that he would like to acquire a rental home in Washington. Ted who lives in Washington has a rental home. For health purposes, Ted must relocate to Arizona. John and Ted decide to exchange properties under section 1031 of the code. The other facts pertaining to the exchange are: Ted's Basis = $100,000 John's Basis = $75,000 Ted and John exchange the two properties, but Ted has to give John an additional $25,000 in cash. The fair market value of Ted's property is $100,000, and the fair market value of John's property is $125,000. What is John's recognized gain?
$0
$25,000
$50,000
$75,000
$25,000
140
Alice owns land "A" with an adjusted basis of $250,000, subject to a mortgage of $50,000. On July 1st, Alice exchanges land "A" and its mortgage for $300,000 in cash, a promissory note for $300,000, and property "B" that has a fair market value of $75,000 with Betty. What is the amount realized by Alice?
$675,000
$725,000
$925,000
$975,000
Solution: The correct answer is B.
The realized amount not only includes the monies and fair market value of property "B" received (and any indebtedness the buyer has to the seller), but also any liabilities for the seller is relieved. In this case, the seller received $675,000 in cash, property, and notes (buyers indebtedness to the seller) as well as relief from $50,000 in mortgage. The total amount realized is $725,000.
Summary:
When dealing with an exchange, there are two things to note: realized and recognized. Realized is a transaction happening. Recognized is when a realized transaction has not met an exception and must have tax calculated. A like kind exchange is an exception to realized transactions to not be recognized. This question asked the realized amount which is the value received plus debt relief totaling 725k. There is no recognized amount, which is what you were trying to calculate.
Alice is getting:
Relief from mortgage $ 50,000
+ Cash $300,000
+ note $300,000
+ property $ 75,000
= total received $725,000 this is her “amount realized”
141
Kevin owns a modified endowment contract. Kevin recently reassessed his insurance needs and decided that he would like to exchange his current modified endowment contract for a different insurance product. Which of the following transactions might result in gain realization and recognition?
If Kevin trades his modified endowment contract for a life insurance policy.
If Kevin trades his modified endowment contract for a different modified endowment contract.
If Kevin trades his modified endowment contract for an annuity.
None of the above transactions would result in the realization and recognition of gain.
Solution: The correct answer is A.
If Kevin trades his modified endowment contract for a life insurance policy, the transaction will not be eligible for the deferral of gain under Section 1035 of the Internal Revenue Code.
142
John owns a rental home in Arizona. He decided that he would like to acquire a rental home in Washington. Ted who lives in Washington has a rental home. For health purposes, Ted must relocate to Arizona. John and Ted decide to exchange properties under section 1031 of the code. The other facts pertaining to the exchange are: Ted's Basis = $100,000 John's Basis = $75,000 Ted and John exchange the two properties, but Ted has to give John an additional $25,000 in cash. The fair market value of Ted's property is $100,000, and the fair market value of John's property is $125,000. What is John's basis in the property received in the exchange?
$75,000
$50,000
$25,000
$100,000
Solution: The correct answer is A.
Since John received boot and "traded down" his recognized gain equals the lesser of the realized gain or boot received, which is $25,000. John's basis will be his original basis ($75,000) less the boot received ($25,000) plus the gain recognized ($25,000) or $75,000. Ted's basis will increase by $25,000 because he is paying $25,000 in boot.
143
Your client Bebe Rebozo is contemplating the exchange of two parcels of investment land for two similar parcels in two separate transactions. Given the following details of the proposed transaction, compute the amount of recognized gain and loss (if any) on both parcels if your client completes the exchanges: Parcel A: Ten acres of land acquired 15 years ago with a current basis of $50,000. In exchange your client will receive eight acres of land (FMV = $80,000) and $20,000 in cash. Parcel B: Twenty acres of land acquired two years ago with a current basis of $100,000. In exchange, your client will receive twelve acres of land (FMV = $75,000) and $10,000 in cash.
Parcel A Recognized Gain = $20,000; Parcel B Recognized Loss = $0
Parcel A Recognized Gain = $20,000; Parcel B Recognized Loss = $10,000
Parcel A Recognized Gain = $50,000; Parcel B Recognized Loss = $10,000
Parcel A Recognized Gain = $20,000; Parcel B Recognized Loss = $15,000
Solution: The correct answer is A.
This question pertains to like kind exchanges where boot is involved. The rule is that any realized gain will be recognized to the extent of the lesser of realized gain or boot received. In this case, there was a realized gain of $50,000 ($50,000 basis for $100,000 market value). The boot of $20,000 is recognized as gain since it is the lesser of boot or realized gain. Parcel B will have no gain in that there is no realized gain between the basis of the property given up and the fair market value of the property received. There is a realization but it is not recognized. Losses in like kind exchanges are not recognized.
144
Alice owns land "A" with an adjusted basis of $250,000, subject to a mortgage of $50,000. On July 1st, Alice exchanges land "A" and its mortgage for $300,000 in cash, a promissory note for $300,000, and property "B" that has a fair market value of $75,000 with Betty. What is the amount realized by Alice?
$675,000
$725,000
$925,000
$975,000
Solution: The correct answer is B.
The realized amount not only includes the monies and fair market value of property "B" received (and any indebtedness the buyer has to the seller), but also any liabilities for the seller is relieved. In this case, the seller received $675,000 in cash, property, and notes (buyers indebtedness to the seller) as well as relief from $50,000 in mortgage. The total amount realized is $725,000.
145
Peyton has a warehouse used in his business. He exchanges it for a storage building owned by Eli. (Peyton and Eli are unrelated). The basis of Peyton's asset is $40,000 and he gives Eli $20,000 cash plus the asset in exchange for Eli's asset, which is worth $36,000. Eli's basis in his original asset is $10,000. What is Eli's gain or loss?
$20,000 gain recognized.
$26,000 gain realized and recognized.
$0 gain recognized.
$0 loss recognized.
Solution: The correct answer is A.
Eli must recognize gain to the extent of the boot paid to him ($20,000) limited by his potential gain. Note: only real property is eligible for like kind treatment.
146
Frank is considering selling a parcel of raw land located in South Dakota that he owns. If Frank sells the land, he would like to invest the proceeds in another piece of real property and would like to qualify for like-kind exchange treatment. Which of the following assets would not qualify as like-kind property for the sale of raw land?
Raw land located in Florida.
Raw land located in Canada.
New land located in South Dakota.
An industrial warehouse located in California.
Solution: The correct answer is B.
U.S. real estate and foreign real estate are not like-kind assets for income tax purposes. Therefore, if Frank exchanges his raw land in South Dakota for raw land in Canada, he will not qualify for like-kind exchange treatment.
147
Ron sells two personal use assets during the taxable year. A gain of $3,000 is realized on the sale of one asset and a loss of $9,000 is realized on the sale of another asset. What is his gain or loss for the year?
($3,000) loss
$3,000 gain
($6,000) loss of which only $3,000 is deductible this year.
($9,000) loss of which only $3,000 is deductible, the $6,000 is carried over indefinately.
Solution: The correct answer is B.
The loss on sale of a personal asset (one not used in business) is not deductible. The sale of a personal asset at a gain is included in income. Therefore, the $9,000 loss does not offset the $3,000 gain.
148
How would the realization requirement influence an investor's decision to purchase stocks expected to appreciate in value but not paying dividends versus stocks paying dividends but not expected to appreciate in value?
Dividends are recognized income in the year they are received.
Appreciation in value is taxed in the year in which it occurs.
Stock dividends are not recognized until the stock is sold.
Realization is an economic concept and recognition is a tax concept.
I and IV only.
II and III only.
I, III, and IV only.
I, II, and III only.
Solution: The correct answer is C.
Dividends paid in cash are recognized as income in the year the dividends were paid. A dividend paid in shares of stock is not taxed upon receipt and will appreciate in value until the stock is sold. A cash based taxpayer recognizes income when received either actually or constructively. Realization is an economic concept, recognition is a tax concept.
149
Brenda purchased 50 shares of Walsh Co. stock three years ago for $1,000. Brenda recently gifted the stock to her brother, Brandon. On the date of the gift, the stock had a fair market value of $750. Six months after receiving the stock from Brenda, Brandon decides to sell the stock. Which of the following statements is correct?
If Brandon sells the stock for $700, he will have a long-term capital loss.
If Brandon sells the stock for $1,100, he will have a short-term capital gain.
If Brandon sells the stock for $675, he will have a short-term capital loss.
If Brandon sells the stock for $800, he will have a long-term capital gain.
Solution: The correct answer is C.
If Brandon sells the stock for $700 he will have a short-term capital loss of $50 (basis is $750).
If Brandon sells the stock for $1,100 he will have a long-term capital gain of $100 (basis is $1,000).
If Brandon sells the stock for $675 he will have a short-term capital loss of $75 (basis is $750).
If Brandon sells the stock for $800 he will have no gain or loss.
150
Your client is contemplating the sale of some of her holdings in her employer's stock. The stock was acquired in four separate purchases as follows:
Stock #1 - purchased 200 shares for $2,000 ($10 per share) on June 1, 2006.
Stock #2 - purchased 200 shares for $3,600 ($18 per share) on June 1, 2007.
Stock #3 - purchased 200 shares for $2,400 ($12 per share) on June 1, 2008.
Stock #4 - purchased 200 shares for $4,000 ($20 per share) on June 1, 2009.
She wants to know the least amount of gain she would be required to report if she sold 500 shares for $12,500. Compute this gain, assuming she has previously sold no shares.
$500
$3,700
$4,300
$5,000
Solution: The correct answer is B.
The 500 shares would be sold as follows: 200 shares from Stock #4; 200 shares from Stock #2; and 100 shares from Stock #3. These would total $4,000 + $3,600 + $1,200 = $8,800 basis. This subtracted from $12,500 - $8,800 = $3,700.
151
On December 31 of last year, Uli purchased 100 shares of Runway, Inc. (a publicly held company) for $5,000. On March 1 of this year, Runway, Inc. declared that it was bankrupt, that it will wrap up operations, and that all of its assets will be used to satisfy secured creditor claims so there will be no residual equity left for the stockholders. Which of the following statements describes the tax treatment of this transaction?
Uli may deduct the $5,000 as an ordinary loss.
Uli may deduct the $5,000 investment as a short-term capital loss.
Uli may deduct the $5,000 investment as a long-term capital loss.
No loss deduction is permitted.
Solution: The correct answer is B.
Since the company became worthless during the year, a constructive sale of the stock occurs on December 31 of this year. Therefore, Uli has a short-term holding period because she is deemed to have held the stock for exactly one year (long-term holding period requires at least one year and one day). Therefore, Uli will be able to deduct the full $5,000 investment as a short-term capital loss in the year the company becomes worthless.
152
Reagan purchased stock in XYZ Corporation three years ago for $110,000. Today it is worth $100,000. Reagan exchanges (sells) the stock to a local charity for $10,000. What is Reagan’s capital loss on the transaction?
$0
$10,000
$100,000
$3,000
Solution: The correct answer is A.
For tax purposes, bargain sale transactions cannot generate capital losses.
Answer B, C, & D are incorrect because this is a bargain sale, and no amount of loss is permitted.
153
Ellen lost a $40,000 deposit in Tan financial institution when Tan became insolvent. If Ellen has a salary of $50,000, short-term capital gains of $38,000, and no other deductions, determine the maximum deduction Ellen may take with respect to the loss in computing this year's taxable income.
$31,000
$34,900
$38,000
$40,000
Solution: The correct answer is D.
Ellen would treat the loss as a short-term capital loss rather than as a personal casualty loss. She could use $38,000 of the Short Term Capital Loss (STCL) to offset the $38,000 capital gains. The remaining $2,000 of the STCL can then be deducted against ordinary income since it is within the $3,000 statutory limit.
154
The constructive receipt doctrine:
Applies to a secular trust used for deferred compensation.
Does NOT apply to cash basis taxpayers.
Is used to distinguish unearned income from earned income.
Means that a taxpayer cannot plan transactions to defer the recognition of income.
Solution: The correct answer is A.
The cash method of accounting recognizes income when received. Receipt may be either actual or constructive. Constructive receipt is when the taxpayer has the right to the money although they are not in possession thereof. A secular trust constructively belongs to the beneficiary therefore constructive receipt applies.
155
Cindy owned her home six months prior to moving into it. She had lived in her home for 18 months when her employer required that she move to another state to manage its sales office. Her realized gain from the sale of her home is $149,000. Does Cindy have to report income, and if so, how much?
Cindy does not have to report income because she has owned and used her home for 18 months and her gain is less than the pro rata exemption.
Cindy reports a gain of $149,000 because she did not meet the owned and used rule.
Cindy may exclude up to 75% of her actual gain under the allowable exclusion because the move was job related.
Cindy may exclude up to 75% of the allowable exclusion but must purchase a replacement home within two years at a cost equal to or exceeding the selling price.
Solution: The correct answer is A.
Section 121 requires that to qualify for the exemption she must have 1) owned and 2) used as principal residence for two years out of the past 5 years. An exception to the rules exists where a taxpayer moved because of employment transfer. In this case, Cindy owned and lived in the home for 18 of the 24 months. Cindy is entitled to 75% of the allowable $250,000 gain exemption or $187,500.
156
Craig and Mallory got married and bought a house 15 months ago. Mallory's job recently transferred her to an office in a different state, so Craig and Mallory sold their house. What is the maximum amount of gain from the sale of the personal residence that Craig and Mallory can exclude from income taxation?
$0.
$250,000.
$312,500.
$500,000.
Solution: The correct answer is C.
Although they did not live in their house for a full two years, Craig and Mallory are eligible for a prorated exclusion because of Mallory's change in employment. Therefore, they are eligible for a maximum exclusion of [(15 / 24) × $500,000]=$312,500.
157
Last year, Paris bought a home in Los Angeles. Paris is now considering selling her home and buying a new home, but she is not sure whether she can qualify for a prorated exclusion of the gain on the sale of her Los Angeles home under Section 121 of the IRC. Under which of the following circumstances would Paris not qualify for a prorated exclusion?
Paris has decided to sell her house because she has accepted a new job in New York City. Her last job was in Los Angeles.
Paris has decided to sell her house because her personal physician recommended that she move to the desert in Arizona because the smog in Los Angeles was causing her asthma to get worse.
Paris has decided to sell her house because her dog Tinkerbell has arthritis and can't walk down the stairs in Paris' home.
Paris has decided to sell her house because she is bothered by excessive noise from a nearby airport.
Solution: The correct answer is C.
The health of a pet is not considered a change in health that justifies a partial exclusion under Section 121. All of the other options are reasons that would justify a partial exclusion under Section 121.
158
Britney owned an office building in Los Angeles that she rented out to several production companies. The building was destroyed by a fire and was a complete loss. Britney received a settlement from her insurance company and would like to reinvest in a new property. Britney wants to make sure that she is eligible for nontaxable exchange treatment. Which of the following is not correct regarding the requirements for nontaxable exchange treatment on Britney's transaction?
Because Britney rented out the building instead of using the property directly, the replacement property must meet the functional use test.
Britney must invest the proceeds in a replacement property that has a similar use to the property that was destroyed in the fire.
Britney must reinvest the insurance proceeds within two years from the end of the year in which she received the insurance proceeds.
Since Britney received cash as a result of the involuntary conversion, nonrecognition treatment is not mandatory even if she meets all of the requirements.
Solution: The correct answer is A.
The replacement property must meet the taxpayer use test, not the functional use test, since Britney did not use the property directly. The taxpayer use test requires replacement property to be used by the taxpayer in an activity which is treated the same for tax purposes in order to qualify for nontaxable exchange treatment. All of the other statements regarding the nontaxable exchange treatment of Britney's transaction are correct.
159
Capital recoveries include:
The initial outlay for capital improvements.
Repair and maintenance expenditures.
Salvage value.
Amortization of bond premium.
Solution: The correct answer is D.
Capital recovery is the expensing of certain acquisition costs. Bonds purchased at a premium are amortized over their life to expense the premium paid. The theory is that when they mature, their basis will be equal to their face value and not the face plus premium. Bond expenditures are, therefore, a recovery of capital.
160
Which of the following properties has a 7-year MACRS depreciation life?
Computers
Residential real property
Office furniture
Autos
Solution: The correct answer is C.
Remember “CAT-CORN” Computers, Autos, and Trucks are 5 year. Office furniture is 7 year. Residential real property (rental houses) is 27.5 year and Nonresidential real property (commercial buildings) is 39 year.
161
Diane purchased a hotel on November 15, five and 1/4 years ago for $5,000,000. Determine the cost recovery deduction for one month.
$10,683
$15,152
$21,368
$128,200
Solution: The correct answer is A.
To depreciate real property, the mid-month convention is used. In addition, a hotel is not considered residential real property and is therefore depreciated using straight line depreciation over 39 years
1 ÷ 39 = .02564
$5,000,000 × 2.564% = $128,200 of annual depreciation expense
$128,200 ÷ 12 = $10,683 for one month's depreciation in the current year
162
Depreciation Schedules for different types of assets
Computers, Autos, and Trucks are 5 year.
Office furniture is 7 year.
Residential real property (rental houses) is 27.5 year
Nonresidential real property (commercial buildings) is 39 year.
163
What characteristics of an automobile lease might cause the lease to be treated as a purchase for tax purposes?
Intent of the parties to the transaction.
Whether any equity results from the arrangement.
Whether any interest is paid.
Whether the fair market value of the car is less than the "lease payment" or option when the option to buy is exercised.
I and IV only.
I, III and IV only.
I and III only.
Any of the above
Solution: The correct answer is D.
Any sign of ownership, including that of an installment sale will cause a leased vehicle to be treated for tax purposes as a purchased vehicle. Rather than deducting the lease payments, the taxpayer will be required to elect either standard mileage or to take depreciation plus actual expenses.
164
What classifications of property are subject to cost recovery?
```
Personalty.
Personal use property.
Natural resources.
Intangible property.
Real estate including land.
```
II and IV only.
I, III and IV only.
V only.
All of the above.
Solution: The correct answer is B.
Personal use property is not subject to cost recovery since it is not used for income generating business purposes. Natural resources are subject to depletion and intangibles are subject to amortization. Personalty assets are used in business and are subject to depreciation. Real estate, as in permanent structures on land, are subject to cost recovery, but the land is not.
165
For tax purposes, a deduction is allowed for the consumption of the cost of an intangible asset through:
Depletion.
Depreciation/Cost Recovery.
Goodwill.
None of the above.
Solution: The correct answer is D.
Cost recovery of an intangible asset is allowed through amortization. Cost recovery and depreciation (one in the same) are applied to tangible assets. The costs of natural resources are recovered through depletion.
166
Which of the following statements regarding depreciation is/are correct?
Real estate used for residential rental purposes is depreciated on a straight-line basis over 27 1/2 years.
Real estate used for commercial purposes is depreciated on a straight-line basis over 39 years.
Both the land and the value of the improvements on the land can be depreciated.
A mid-year convention is used in the depreciation of real property.
I and II only.
I, II and III only.
I, II, and IV only.
I, II, III, and IV.
Solution: The correct answer is A.
Statement "III" is incorrect because only the value of the improvements on the land can be depreciated. The value of the land itself cannot be depreciated. Statement "IV" is incorrect because a mid-month, not a mid-year convention is used in the depreciation of real property.
167
Explain the reason for the inclusion amount with respect to leased passenger automobiles.
The inclusion amount estimates the difference between business and personal use.
The inclusion amount is the result of the formula that determines whether it is best to lease or to buy an automobile.
The inclusion amount is designed to help to level out the lease expense vs. the depreciation expense.
The inclusion amount is the commuting miles that are included as part of the standard deduction on a leased auto, which cannot be deducted on an owned auto.
Solution: The correct answer is C.
The inclusion amount is designed to help to smooth the lease expense vs. the depreciation expense. The lease is front loaded.
168
Martha gives her niece a machine to use in her business with a fair market value of $4,200 and a basis of $4,400. What is the niece's basis for depreciation (cost recovery)?
$0; Gift property is not depreciable.
$4,200
$4,300
$4,400
Solution: The correct answer is B.
Your basis for depreciation is the lower of FMV or adjusted basis for depreciation.
169
Sara and Bill have rental property that was rented this year to a family whose primary bread winner lost his job. As a result they had uncollected rent for 2 months before they began the eviction process and 1 additional month before the family was finally evicted. If the rent was $800 per month, how much of a deduction may Sara and Bill claim on their income tax return for the uncollected rent?
None, uncollected rent is not deductible.
$800 of uncollected rent for the month it took to evict the renters.
$1,600 of uncollected rent before action was taken to evict the renters.
$2,400 of uncollected rent for the entire delinquency.
Solution: The correct answer is A.
They cannot deduct from ordinary income an amount that was never included in taxable income. Therefore, Sara and Bill will not receive any deduction for the uncollected rents.
170
Mackenzie has two apartment units that are occupied by tenants all year long. In December, the tenants in unit 2 paid him in advance for the next January’s rent. The regular rent is $1,000 per month for each of the units. How much rental income must Mackenzie include in taxable income this year?
$12,000
$24,000
$25,000
It depends on which accounting method he uses.
Solution: The correct answer is C.
According to Publication 17, “Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.”
171
Your client is the sole shareholder of a closely-held corporation. In the current year, the IRS has deemed the operation to be a Personal Holding Company (PHC) because of involvement in a number of investments other than the stated business purpose. It has cited the business as having undistributed holding company income. What are the possible implications of this decision for your client?
A penalty of 35% can be imposed on the value of the assets of the PHC because of potential fraud.
A penalty tax of 20% can be imposed on the undistributed PHC income.
A penalty tax of 35% can be imposed on the undistributed PHC income.
Because the corporation is a PHC, there is no penalty tax, but the PHC will be required to pay tax at the 20% corporate level.
Solution: The correct answer is B.
If the business is deemed to be a PHC by the IRS, then a penalty tax of 20% can be imposed on the undistributed personal holding company income.
172
Giselle became an AMT taxpayer last year. She had to add several items to her regular taxable income in arriving at alternative minimum taxable income. Which of the following items will result in an AMT credit that can be used to offset future regular tax liability?
$5,000 in property taxes paid on her principal residence if paid in advance.
A $75,000 difference between the fair market value of stock and the strike price in the incentive stock option used to purchase the stock.
$4,000 in interest on private activity municipal bonds.
$4,000 in additional medical expenses.
Solution: The correct answer is B.
The inclusion of the difference between the fair market value and exercise price of the stock options will result in a credit that Giselle can use against future regular income tax liability. The other items are adjustments made to her itemized deductions, which result in permanent differences in tax liability as a result of the imposition of the AMT.
173
Sabina Herz, a school teacher who is in a low marginal income tax bracket and is interested in investing in an educational business with some of her colleagues. Sabina says that she wants to keep the money in the business and doesn't want to pay taxes on income she never sees. Furthermore, Sabina wants to be assured the business would NOT be disrupted if one of her partners lost interest or encountered personal financial problems. What legal form of business makes the most sense, given Sabina's desires?
A Limited Partnership.
A General Partnership.
A C Corporation.
A Professional Corporation.
Solution: The correct answer is C.
Options "A" and "B" are incorrect in that they would dissolve in the event of a 50% turnover in ownership in a 12-month period. Option "C" is correct because a C corporation generally retains income that is not passed to its owners through dividends. Option "D" is incorrect because it is structured as a C corporation for professional services. Not an educational business.
174
David is a wealthy attorney in the highest marginal income tax bracket. He is interested in purchasing a franchise in a fast-growing food chain with some of his associates. After reviewing the proposal, you have determined that apart from a substantial up-front investment, the business will NOT need to retain income and any income generated in subsequent years will be paid out to the investors.
David wants to be assured the business would NOT be disrupted if one of his associates lost interest or encountered personal financial reversals. What form of business structure would make the most sense?
A Limited Partnership.
A General Partnership.
A C Corporation.
A S Corporation.
Solution: The correct answer is D.
Options "A" and "B" are incorrect in that they would dissolve in the event of a 50% turnover in ownership in a 12-month period. Option "C" is incorrect because a C corporation generally retains income. Option "D" is correct as an S corporation holds no retained earnings since all profits or losses are passed through to its owners.
175
All of the following statements concerning the AMT as it applies to individual taxpayers are correct EXCEPT:
Some itemized deductions taken for regular tax purposes must be added back to regular income to determine income under AMT.
Taxpayers are permitted to take the standard deduction for both regular and AMT tax purposes.
All adjustments made to itemized deductions when calculating AMT result in a permanent increase in tax.
Charitable deductions are claimed in the same manner for regular tax and for AMT tax purposes.
Solution: The correct answer is B.
Taxpayers who do not itemize deductions take the standard deduction for regular tax purposes, but this is added back to alternative minimum taxable income for AMT purposes. All of the other statements are correct.
176
Which of the following are preference items or adjustments for purposes of the individual alternative minimum tax?
Qualified private-activity municipal bond interest.
The excess of percentage depletion over the property's adjusted basis.
Investment interest in excess of net investment income.
Qualified housing interest.
I only.
II and IV only.
I and II only.
II and III only.
Solution: The correct answer is C.
By definition, investment interest expense in excess of net investment income and qualified housing interest are not preference items or adjustments for purposes of the alternative minimum tax.
177
Which of the following statements concerning the Alternative Minimum Tax (AMT) system is correct?
Deferral items for AMT purposes result in a permanent increase in tax.
Exclusion items for AMT purposes may be reversed in future tax years.
There is an unlimited carryforward for AMT credit generated in a year the taxpayer becomes an AMT taxpayer.
The AMT credit can be carried back for up to two years, provided that use of the credit does not force the taxpayer to become an AMT taxpayer in those years.
Solution: The correct answer is C.
The AMT credit that is generated from deferral items in the AMT calculation may be carried forward indefinitely. The AMT credit may not be carried back. Deferral items may be reversed in future years through the use of the AMT credit, while exclusion items result in a permanent increase in tax.
178
What effect does claiming the Section 179 deduction have on an asset's adjusted taxable basis?
Immediate expense of the total cost and a resulting basis of zero not subject to recapture.
Immediate expense of the total cost and a resulting basis of zero subject to recapture.
Partial expense with a reduced basis and not subject to recapture.
Any amount of expense not to exceed the total cost, subject to income and Section 179 expense limits, reduces the adjusted taxable basis.
Solution: The correct answer is D.
Claiming Section 179 expense immediately reduces the basis of the property by whatever the amount claimed (not to exceed original cost). The amount of deduction is limited in total and further subject to income limitation before the deduction is taken.
179
When do the recapture rules for Section 179 apply:
When the asset is sold before it would have been fully depreciated.
When the business use drops below 50%.
When the Section 179 deduction taken in one year exceeds the allowable maximum.
When there is sufficient income in one tax year to support the deduction taken.
When the deduction causes the tax liability to become negative.
III and IV only.
I and II only.
V only.
All of the above.
Solution: The correct answer is B.
Section 179 recapture rules apply when the business use of an asset drops below 50% for a given year or when the asset is disposed of before it would have been fully depreciated.
180
Chelsea had to put more money into her rental property this year. She had the exterior of the rental home painted and the roof replaced at a cost of $12,500 and $18,000, respectively. How much is depreciable?
$0
$12,500
$18,000
$30,50
Solution: The correct answer is C.
Painting, inside or out, is considered a repair, which is immediately expensed. The roof replacement is an improvement that substantially prolongs the asset’s life, which is capitalized and depreciated over the useful life.
181
Kal has taxable income this year of $6 million. He purchased $2,594,000 worth of depreciable property this year and is trying to calculate his §179 deduction. What is the correct amount?
$466,000
$530,000
$1,036,000
$1,040,000
Solution: The correct answer is C.
Since he placed into service more assets than allowed under the limitation you must calculate the phase-out.
2,594,000 placed into service less 2,590,000 placed into service limit = 4,000
$1,040,000 - $4,000 = $1,036,000.
Since this is below the net income of the business there are no further limitations.
182
Mrs. Eagleton is in the 35% tax bracket and her child just started delivering papers on the weekend. His total earnings from the paper route are $2,200 for the taxable year. What is the amount of tax owed on the son's income?
None
$110.00
$385.00
$735.00
Solution: The correct answer is A.
The $2,200 is earned income. Earned income is not subject to kiddie-tax. His standard deduction is the greater of $1,100 or his earned income plus $350, not to exceed $12,400 in 2020. Therefore his standard deduction is $2,550, which eliminates his income so he owes no tax.
183
Steven and Julie's children have the following for this year: - Brian, age 12, earns $2,500 in salary mowing lawns. - Courtney, age 19, earns $2,300 in dividends and capital gains. - Derek, age 16, earns $2,300 in dividends and interest. - Danny, age 10, earns $900 in dividends and interest. Whose income is subject to the tax at their parent's tax rate?
Brian.
Courtney and Derek.
Derek.
Brian, Courtney and Derek.
Solution: The correct answer is C.
In 2020, a person under the age of 19 or under the age of 24 and a full-time student at the end of the tax year, would pay tax at their parent's tax rate if they had more than $2,200 in unearned income. Thus, $100 of Derek's income is taxed at his parent's tax rate. Danny avoids this as $900 is under the standard deduction. Brian's income is earned and the kiddie tax applies only to unearned income and Courtney is 19. If the question stated that Courtney was a full-time college student then "B" would be the correct answer but you can't assume those facts.
184
Junior is 8 years old and has an UGMA account that has been funded with various bonds by Senior. Junior's interest income is $5,000 for the current tax year. How much of the interest will be subject to the parent's tax rate?
$1,100
$2,200
$2,800
$3,900
Solution: The correct answer is C.
For dependent children, unearned income over $2,200 is subject to tax at the parent's tax rates.
5,000-2,200 = 2,800 (SECURE Act 2019)
185
Which of the following are below the line deductions?
```
Medical expenses.
Alimony paid.
Moving expenses.
Penalties for early withdrawal of savings.
Tax preparation fees.
```
I, and V only.
III, IV and V only.
II and IV only.
I only
Solution: The correct answer is D.
Below the line deductions include all itemized deductions. Alimony and penalties for early withdrawal are above the line deductions found in the Adjustment section of the 1040.
186
Two years ago, Green Corporation, a cash basis taxpayer, sold services to Albert for $25,000. During the prior year, Green collected $10,000 from Albert. In the current year, Green collected $5,000 from Albert in final settlement of the debt. The proper treatment for the bad debt deduction is:
$0 for the prior year and $0 for the current year.
$0 for the prior year and $10,000 for the current year.
$15,000 for the prior year and $0 for the current year.
$15,000 for the prior year and $5,000 income for the current year.
Solution: The correct answer is A.
A cash basis taxpayer does not recognize income not received. Since the bad debt was never recognized as income, it cannot be recognized as a loss or a bad debt expense.
187
Edgar pays alimony under a divorce decree dated 6/1/17 to his former spouse, Frances, in the following amounts: $150,000 in year 1; $40,000 in year 2; and $20,000 in year 3. How much, if any, recaptured alimony must be added to Edgar's gross income in year 3?
$0.
$32,500.
$112,500.
$150,000.
Solution: The correct answer is C.
The alimony recapture in year 3 can be calculated by using the formula: R3 = P1 + P2 - 2P3 - $37,500 R3 is the recapture in year 3. P1 is the payment in year 1, P2 is the payment in year 2, and P3 is the payment in year 3. The amount of alimony recapture in year 3 is $112,500 [$150,000 + $40,000 - (2 × $20,000) - $37,500].
188
Saul was divorced in 1996 and is now single, age 63. He has gross income of $50,000. His bona fide deductible expenses are as follows:
Alimony = $8,000;
Charitable contributions = $2,000;
Contribution to an IRA = $2,000;
Net expenses paid on rental property = $5,000;
Interest and taxes on personal residence = $7,000;
State income tax = $1,200.
What is Saul's AGI?
$28,000
$33,000
$35,000
$40,000
Solution: The correct answer is C.
Saul's AGI is calculated as follows:
Gross income of $50,000
minus deductions for AGI of $15,000 (Alimony* of $8,000, IRA of $2,000, and expenses on rental of $5,000)
= $35,000.
The others are deductions from AGI or below-the-line deductions.
*Alimony due to a divorce finalized by 12/31/18 will remain under the old rules, deductible to payor and included in income for the recipient. Divorces finalized after 12/31/18 will follow the new rules; not deductible and not includable in income.
189
Heather had the following transactions for the 2020 tax year, following her 2018 divorce:
Alimony received = $2,400;
Salary earned = $38,000;
Cash dividends received on stock investments = $1,000;
Child support payments received = $12,000;
Heather's AGI for this tax year is:
$39,000
$41,400
$51,000
$53,400
Solution: The correct answer is B.
Child support payments are neither deductible from nor includible in income. Note: alimony received from a contract dated prior to 12/31/18 remains includible income.
190
Under the terms of a divorce agreement dated 1/3/18, Larry is required to pay his wife Joyce $2,100 per month in alimony for a minimum period of 10 years and $300 per month in child support. For a twelve-month period, Larry can deduct from gross income (and Joyce must include in gross income):
$0
$25,200
$3,600
$28,800
Solution: The correct answer is A.
The $300 per month for child support is not deductible by Larry. Child support payments are not deductible to the payor nor includable to the payee. Larry's $300 per month in child support will remain part of his gross income. The $2,100 is not alimony since it could extend beyond her death as the required payment is for a minimum of 10 years.
191
Paul (age 35) and his wife Stacey (age 33) are married with three young children. They both work outside the home. Paul is a corporate executive with Wellstar and Stacey is an executive assistant with a small local company. Paul fully participates in his company’s qualified retirement plan by contributing $17,500 of his salary, which is matched 100% up to 3% of compensation. Stacey’s employer does not offer a retirement plan. In addition, during the year they had the following items of income and expense:
Paul’s gross salary: $150,000
Stacey’s gross salary: $32,000
Stacey’s cash gift to her mother: $5,000
Interest from a joint savings account: $100
Federal income taxes withheld from paychecks: $30,000
State income taxes withheld from paychecks: $12,000
Charitable contributions made: $3,400
Rent paid for apartment: $24,000
Contribution to Paul’s traditional IRA: $5,500
Contribution to Stacey’s traditional IRA: $5,500
What is Paul and Stacey’s adjusted gross income?
$159,100
$164,600
$176,600
$182,000
Solution: The correct answer is A.
150,000 Paul's gross salary
+32,000 Stacey's gross salary
182,000
+ 100 Interest
182,100
-17,500 His 401K
164,600
-5,500 Her IRAs
159,100 AGI
192
Isaac is a middle school teacher with gross income this year of $35,000. Based on the following, what is Isaac’s adjusted gross income?
$4,000 qualified education interest expense
$2,000 alimony received under a pre-2018 agreement
$1,000 contribution to a traditional IRA
$30,000
$31,500
$32,000
$33,500
Solution: The correct answer is B.
Isaac’s adjusted gross income is his total gross income of $35,000 - $2,500 in qualified education interest expense (the deductible amount is limited to $2,500) - $1,000 contribution to a traditional IRA = $31,500. The alimony is RECEIVED, which is included in determining his gross income of $35,000. If it was paid then there would be a deduction but that’s not the case.
NOTE: the question gave you his GROSS income, not his salary.
193
Janice, who is single, had gross income of $38,000, and incurred the following expenses:
Charitable contributions = $2,500
Taxes and interest on home = $9,000
Legal fees incurred in a tax dispute = $1,000
Medical expenses = $4,000
Penalty on early withdrawal of savings = $200
Her AGI is:
$38,000
$21,300
$29,000
$37,800
Solution: The correct answer is D.
All but penalty for early withdrawal of savings are itemized deductions. The question asks to determine the AGI. Therefore, the AGI is $38,000 less $200 in penalties which equals $37,800.
194
Leon, age 32, is an active participant in his employer's defined benefit plan, but he would also like to make a deductible contribution to a traditional IRA this year. Leon is married, files a joint return with his wife, and has an AGI of $111,000 in the current year. What is the maximum deductible contribution that they each can make to a traditional IRA, assuming his wife is also an active participant?
$0.
$2,100.
$3,900.
$6,000.
Solution: The correct answer is C.
The phase-out range for taxpayers who are active participants and use the married filing jointly filing status is $104,000 - $124,000 for 2020. Since Leon's AGI is within this range, he may not make a full $6,000 deductible contribution to a traditional IRA, but may make a reduced deductible contribution, as calculated by the following formula: Reduction = Contribution Limit × AGI-Lower Limit ÷ $20,000 Therefore, Leon's deductible contribution is reduced by $2,100 which is calculated as follows: [$6,000 × (111 - 104) / 20)]. Therefore, the maximum deductible contribution that each can make to a traditional IRA is (6,000 - 2,100) = $3,900.
195
Greg just received his student loan statement that indicates that he has paid $3,000 of interest on his student loan during this tax year. How much of the interest may he deduct?
None of the interest is deductible since it is consumer debt.
$3,000 as an itemized deduction.
$2,500 as an itemized deduction.
$2,500 as an adjustment to income.
Solution: The correct answer is D.
Student loan interest is an "above-the-line" deduction. The amount that can be taken is limited to $2,500 of interest paid.
196
Above the line deductions.
Educator expenses for classroom supplies, up to $250
Business expenses for government officials who work on a fee basis, performing artists, and members of the military reserve forces (reservists) who travelled more than 100 miles to perform reserve services
Health savings account (HSA) contributions you made with post-tax money
Moving expenses for active-duty members of the U.S. Armed Forces
The employer portion of the self-employment tax
Retirement account contributions for self-employed individuals and small business owners
The cost of health insurance premiums for self-employed workers, including dental and long-term care insurance
Early withdrawal penalties of savings accounts, like a certificate of deposit (CD)
Alimony payments for agreements that took effect before 2019 (the deduction for alimony payments was ended in 2018)
Contributions to a traditional IRA, as long as it’s money you already paid income tax on (learn more about how to contribute to traditional IRA)
The student loan interest deduction is for up to $2,500 of interest you paid on student loans
Tuition and fees for you, your spouse, or a dependent
197
Below the line deductions
The standard deduction
The medical expense deductions, for expenses worth more than 7.5% of your AGI
The SALT deduction for state and local taxes you have already paid
Other income taxes you’ve already paid, such as to a foreign government
The mortgage interest deduction
Interest for a loan on an investment property
The deduction for charitable contributions
Casualty and theft losses from a federally declared disaster
198
Which of the following individuals can make a deductible contribution to a traditional IRA in the current year?
Jack, who is married, has an AGI of $180,000, and his spouse is an active participant in her employer's defined contribution plan, but he is not an active participant.
Kelly, who is single, has an AGI of $78,000, and is an active participant in her employer's defined benefit plan.
Leo, who is married, has an AGI of $128,000, and is an active participant in his employer's defined contribution plan.
Marni, who is single and has no earned income.
Solution: The correct answer is A.
Option "B" is incorrect because Kelly's AGI exceeds the phaseout range for single individuals who are active participants.
Option "C" is incorrect because Leo's AGI exceeds the phaseout range for married individuals who are active participants.
Option "D" is incorrect because Marni must have earned income in order to contribute to a traditional IRA.
Option "A" is correct because although Jack's spouse is an active participant, Jack is not. Therefore, Jack may make a deductible contribution to a traditional IRA as long as their joint AGI does not exceed $206,000 in 2020.
199
Alimony Recapture Formula
(P1 + P2 - (2P3)) - 37,500
200
Which of the following is incorrect?
All business deductions are classified as deductions FOR AGI.
Some personal deductions are classified as deductions FROM AGI.
Some business and some personal deductions are classified as deductions FOR AGI.
Some business and some personal deductions are classified as deductions FROM AGI.
Solution: The correct answer is D.
Deductions occur above the line (for) AGI and below the line (from) AGI. All business deductions are for AGI (above the line).
All business expenses (taken by their owners, i.e. sole proprietor or partner) are taken above the line or FOR AGI.
A "business deduction" is tied to the business or owners. These are reported on the sole proprietor's schedule C, or a partner's K-1 (which flows onto the Schedule E of Form 1040), for example. Business deductions are all above the line (FOR AGI).
"Personal deductions" are not tied to a business. For example, mortgage interest is a personal deduction below the line (FROM AGI). An HSA contribution is a personal deduction above the line (FOR AGI).
"Job-related employee expenses" used to be deductible as a miscellaneous itemized deductions subject to the 2% floor, a below the line deduction (FROM AGI). Those are no longer available for tax years 2018-2025.
201
Which of the following entities would be required to adopt a calendar year for federal income tax purposes?
A. Estate.
B. Irrevocable life insurance trust.
C. Partnership.
D. S Corporation.
Solution: The correct answer is B.
A trust must adopt a calendar year for federal income tax purposes.
A is incorrect. The executor of an estate can elect a fiscal year end for the estate.
C is incorrect. A partnership must adopt the tax year end of its partners. If the partners have a fiscal year, the partnership can have a fiscal year. For example, if a partnership has two corporations as its partners, and the corporations have June 30 year ends, the partnership would have a June 30 year end.
D is incorrect. An S corporation can have a fiscal year end for tax purposes.
202
Which of the following would be required to make federal estimated tax payments, assuming each had earnings in excess of $200,000?
I. Estate.
II. Partnership.
III. C corporation.
IV. Sole proprietor.
A. I and II.
B. III and IV.
C. I, III, and IV.
D. II and III.
Solution: The correct answer is C.
Partnerships are flow-through entities that never pay income tax. Therefore, partnerships would never be required to pay estimated taxes.
203
Five years ago, Jordan was granted a nonqualified stock option giving him the right to purchase 1,000 shares of employer stock at $8 per share. He exercised the option three years ago, when the value of the stock was $10 per share. He sold the shares today at a price of $15 per share. Which of the following statements is correct regarding this series of events?
A. Jordan reported $8,000 of ordinary income upon exercise.
B. Jordan will have a capital gain of $7,000 as a result of selling the stock today.
C. Jordan reported an alternative minimum tax adjustment of $2,000 when he exercised the options.
D. Jordan’s employer received an income tax deduction of $2,000 when Jordan exercised the option.
Solution: The correct answer is D.
When Jordan exercised the option, the bargain element was $2,000 [($10 Fair Market Value less $8 cost) x 1,000 shares]. The $2,000 will be reported as ordinary income by Jordan, and his employer will receive a $2,000 deduction.
A is incorrect. Jordan was only required to report $2,000 of income.
B is incorrect. Jordan’s basis in the stock is $10,000 ($10 Fair Market Value x 1,000 shares). Therefore, his capital gain would be $5,000 ($15,000 sales price less $10,000 basis).
C is incorrect. Alternative minimum tax does not apply to nonqualified stock options.
204
Charlie purchased a 25% interest in a general partnership for $40,000. He is a material participant in the partnership’s activities. In the current year, the partnership borrowed $20,000 from a local bank. The loan is considered a recourse loan. Assuming the partnership incurred a total loss for the current year of $200,000, how much of the loss will Charlie be permitted to deduct on his federal income tax return?
A. $0.
B. $40,000.
C. $45,000.
D. $50,000.
Solution: The correct answer is C.
Charlie’s share of the loss is $50,000 ($200,000 total loss x 25% ownership interest). However, his deductible loss is limited to the amount Charlie has “at risk.” Charlie’s “at risk” amount is equal to the amount he contributed to the partnership, plus his share of recourse loans incurred by the partnership.
Charlie’s share of recourse loans is $5,000 ($20,000 total loan x 25%). Therefore, the total amount at risk for Charlie is $45,000 ($40,000 contributed + $5,000 recourse loan).
205
John took out a loan of $40,000 from his home equity line of credit account, and used the proceeds to pay for his daughter’s wedding. Which of the following statements is correct regarding the regular income tax and alternative minimum tax (AMT) consequences of the interest expense paid by John on the HELOC this year?
A. The interest expense is deductible for regular tax purposes and deductible for AMT purposes.
B. The interest expense is not deductible for regular tax purposes but is deductible for AMT purposes.
C. The interest expense is deductible for regular tax purposes but not deductible for AMT purposes.
D. The interest expense is not deductible for regular tax purposes and not deductible for AMT purposes.
Solution: The correct answer is D.
Interest from a home equity loan or HELOC is not deductible for regular tax purposes, unless the proceeds are used to purchase or improve a residence.
206
Chris is a CPA and recently donated a rare coin valued at $10,000 to his church. He acquired the coin at a flea market several years ago for $20. In addition, he performed six hours of bookkeeping work for the church at no charge. He normally bills $150 per hour. Ignoring AGI limits, what is the amount that Chris may deduct as a charitable contribution?
A. $0.
B. $20.
C. $920.
D. $10,000
Solution: The correct answer is B.
The value of services donated to charity is nondeductible. He will only be entitled to a $20 deduction for the coin, because the deduction is limited to basis for a use-unrelated asset.
207
Which would require income recognition by a taxpayer in Year 1?
A. John, a cash basis taxpayer, owns apartment building and charges $800 per month rent. Susan, his tenant, offers $600 but John doesn’t accept it. Susan then pays John $800 in Year 2.
B. Chris, a cash basis physician, performs medical services for a patient who is in a Medicaid program. The state doesn’t set the value of the services until Year 2.
C. Terri, an accrual basis taxpayer, performs services in Year 1, but doesn’t collect cash until Year 2 because the client didn’t have money to pay.
D. Ron, a cash basis taxpayer, receives restricted stock worth $5,000 in Year 1. The restriction lapses if Ron continues to work for his employer until Year 3.
Solution: The correct answer is C.
A is incorrect. A taxpayer will not have constructive receipt if the taxpayer refuses to accept less money than what is owed to him or her.
B is incorrect. A taxpayer is not required to report income until the income is known.
D is incorrect. Restricted stock is not taxed until the employee no longer has a substantial risk of forfeiture.
208
If a 42-year old individual wants to begin taking substantially equal periodic payments from their IRA to avoid an underpayment penalty, the payments must continue for:
A. 5 years.
B. 13 years.
C. 18 years.
D. 29 years.
Solution: The correct answer is C.
To avoid an underpayment penalty, substantially equal periodic payments must continue for the greater of: 1) 5 years, or 2) until the individual attains age 59 ½. Therefore, a 42-year old would need to continue payments for 18 years.
209
On the evening of its silent auction, Vokel Museum has a roomful of tables with various auction items. The items are numbered and the bid list is placed beside each item. A card beside each item on the tables states the estimated fair market value of the item as determined by the auction committee, generally based on representations made by the item donor. Rebecca was the successful bidder on a football autographed by a famous quarterback. The contributor of the item was a local sports memorabilia dealer who was an expert in valuing items of this nature. He represented to the Museum that the item had a fair market value of $500. Rebecca bid and paid $800 for the football. A similar football without the autograph can be purchased at the local sporting goods store for $100. Assuming she itemizes her deductions, and ignoring any adjusted gross income limits, Rebecca will be entitled to a charitable contribution deduction in the amount of:
A. $100.
B. $300.
C. $500.
D. $800.
Solution: The correct answer is B.
Rebecca is entitled to a charitable contribution deduction in the amount of $300 because she paid more for the item than the value she received in return. The excess payment is a gift and a deduction is allowed but only to the extent of that excess.
210
Georgia recently rolled over her traditional IRA from one institution to another. When preparing Georgia’s tax return for the year, which combination of IRS forms would be used by her CPA to obtain necessary information relating to the rollover?
A. Form 8606 and Form 1040.
B. Form 8606 and Form 5498.
C. Form 1099-R and Form 5498.
D. Form 1099-R and Form 1040.
Solution: The correct answer is C.
Form 1099-R is used to report the amount of the rollover. Form 5498 reflects contributions to the IRA.
211
Jordan was granted a nonqualified stock option by his employer six years ago, giving him the right to purchase 1,000 shares of employer stock at $7 per share. He exercised the option two years ago, when the value of the stock was $12 per share. He sold the shares today at a price of $32 per share. Assuming an ordinary tax rate of 24%, what is the tax due on the sale?
A. $3,000.
B. $3,750.
C. $4,800.
D. $6,000.
Solution: The correct answer is A.
Jordan’s basis in his employer stock is $12 per share (the fair market value at the date of exercise).
He sold the stock for $32 per share, resulting in a gain of $20,000 [(32-12) x 1,000 shares]. The gain will be taxed as a long-term capital gain (holding period begins at the date of exercise). Therefore, the rate applied to the gain will be 15%, resulting in a tax of $3,000 (20,000 gain x 15%).
212
Which of the following can own stock in an S corporation?
A. Non-resident alien.
B. Publicly-traded corporation.
C. Partnership
D. Grantor retained annuity trust.
Solution: The correct answer is D.
A grantor trust can own stock in an S Corporation.
213
Which of the following is the best reason to select a C corporation over an S corporation?
A. Losses are expected during the first few years of the business’s operations.
B. The organization has significant earnings in excess of business needs.
C. The owners of the business need income from the business for personal purposes.
D. Various fringe benefits will be offered by the company to owner-employees.
Solution: The correct answer is D.
While restrictions apply to various fringe benefits offered to more-than-2% shareholders of S corporations, a C corporation can offer fringe benefits without restriction.
