Tax. Ch 7

Answer 1

TEMIZED DEDUCTIONS
* Below-the-Line Deductions
* Reported on Schedule A
* Include
* Medical Expenses
* Taxes
* Interest
* Charitable Contributions
* Casualty Losses
* Miscellaneous Itemized Deductions

Answer 2

MEDICAL EXPENSES
* Expenditures for:
* Diagnosis, cure, treatment, or prevention of disease affecting any
structure or function of the body

Answer 3

MEDICAL EXPENSES DEDUCTION
* Deductible in year paid
* Must exceed 7.5% of AGI to be deductible
* Example:
* Viola has AGI of $10,000 and medical expenses of $1,250
* Viola’s medical deduction = $500
[$1,250 - ($10,000 x 7.5%)] = $500

Answer 4

CAPITAL MEDICAL EXPENSES

• Includes:
• Wheelchairs
• Medical beds
• Seeing eye dogs
• Must be:
• Medical necessity
• Advised by a physician
• Used primarily by patient
• Reasonable
• Maintenance on capital expenditures also deductible as medical expense

Answer 5

CAPITAL IMPROVEMENT TO HOME

• Deductible to extent that the cost of improvement exceeds the increase in value to home
  – Exception: Removal of structural barriers to home of handicapped are deemed to add no value to home. Thus, full amount is a medical
  expense.
• Improvements for accessibility are always deductible
  – Handicapped entrance/exit ramps
  –Modifications to bathroom and kitchens

Answer 6

NURSING HOME & SPECIAL SCHOOL EXPENSES

• If the primary purpose is medical treatment, all costs (including meals and lodging) qualify as medical expenses
• If the primary purpose is personal, only specific medical costs qualify (no meals or lodging)

Answer 7

TRANSPORTATION AND LODGING

• Transportation to and from medical care is deductible
  –22¢ per mile for 2023
• Lodging while away from home for medical care
• Allowable amount is $50 per person per night
• If parent and/or aide needs to accompany patient, their expenses are also deductible

Answer 8

HEALTH INSURANCE PREMIUMS

• Premiums paid for medical care insurance are deductible medical
  expenses.
• For self-employed, 100% of insurance premiums are deductible above- the-line

Answer 9

REIMBURSED EXPENSES

• If reimbursed in same year as expense paid:
  – Reimbursement offsets deductible amount
• If reimbursed in the year after medical expenses were paid:
  –Reimbursement is income only to extent medical deduction was taken by taxpayer (tax benefit rule)

Answer 10

TAXES

• Deductions of up to $10,000 for the aggregate of:
  – State and local property taxes
  – State and local income taxes
  –or sales taxes in lieu of income taxes
• Non-deductible
  – Foreign property taxes
  – Prepayments of state or local income taxes

Answer 11

INTEREST

• General Rule: All interest paid or accrued within the taxable year on
  indebtedness is deductible.
• Many exceptions apply, making only the following types of interest
  deductible:
  – Qualified residence interest
  – Interest incurred in a trade or business
  – Interest incurred for production of income

Answer 12

“INTEREST” INCLUDES

• Prepayment penalties
• Points
• Late payment fees
• Mortgage insurance premiums (through December 31, 2021)

Answer 13

QUALIFIED RESIDENCE INTEREST (1 OF 3)

• Can deduct interest on:
• Principal residence
• One vacation home
  – Includes boat/vehicle with sleeping and eating accommodations
  –Vacation home treated as “qualified residence” if the home is not
  rented during the year or if the home does not meet the “rental use”
  exception of IRC Section 280A.

Answer 14

QUALIFIED RESIDENCE INTEREST (2 OF 3)

Acquisition Indebtedness
* Acquire, construct, or improve principal residence
* For acquisition indebtedness incurred on or before December 15, 2017,
interest is deductible on up to:
* $1 million maximum principal amount
* $500,000 for married filing separately

• During tax years 2018-2025, for acquisition indebtedness incurred after December 15, 2017, interest is deductible on up to:
  – $750,000 maximum principal amount
  – $375,000 for married filing separately

Answer 15

QUALIFIED RESIDENCE INTEREST (3 OF 3)

• Home Equity Indebtedness: Before 2018, and after 2025, interest is
  deductible on up to:
  –$100,000 maximum principal amount
  $50,000 for married filing separately
  –Cannot exceed FMV of home less acquisition indebtedness
• For tax years 2018-2025, no interest on home equity indebtedness may be deducted
  –This provision sunsets for tax years beginning after December 31, 2025.
  – Interest on home equity loan that qualifies as acquisition indebtedness is deductible.

Answer 16

PREPAID INTEREST (POINTS)

• Generally amortized over life of loan
• Exception: Points paid in the acquisition or improvement of principal residence
  – Entire amount is deductible in year paid.
• Only points paid on the first $1 million of acquisition indebtedness incurred on or before December 15, 2017, is deductible.
  –For tax years 2018-2025, only points paid on the first $750,000 of
  acquisition indebtedness incurred after December 15, 2017, is
  deductible.

Answer 17

INVESTMENT INTEREST

• Limited to Net Investment Income (NII)
• Unlimited carryforward is allowed
• Not subject to AGI phaseout for high income taxpayers

Answer 18

NET INVESTMENT INCOME

NII = Investment income - investment expenses other than interest

Investment income includes:
– Interest
– Nonqualified dividends
– Gains on property taxed at ordinary rates under depreciation recapture rules
–Capital gains and qualified dividends can be included if taxpayer elects to pay tax at ordinary rates

Investment expenses other than interest:
* Those that are directly connected with the production of investment
income

Answer 19

EXPENSE & INTEREST TO GENERATE TAX-EXEMPT INCOME

• Not deductible for regular tax purposes
  – If municipal bond interest is taxable when the AMT applies, the taxpayer may deduct interest expense incurred in purchasing the municipal bonds.
• Other expenses associated with the purchase of tax-exempt securities are not deductible

Answer 20

INTEREST EXPENSE AND PASSIVE ACTIVITIES

• If interest is incurred in acquiring a passive activity, the passive activity loss rules apply.
  –These are covered in detail later.

Answer 21

SUMMARY OF DEDUCTIBLE & NONDEDUCTIBLE INTEREST
EXPENSES AS ITEMIZED DEDUCTIONS

Answer 22

GENERAL REQUIREMENTS FOR INCOME TAX CHARITABLE DEDUCTION

• Made to qualified organizations
• Subject of the gift is property (not services)
• Deductible portion must exceed value received by donor
• Paid in cash or property before close of tax year

Answer 23

INCOME TAX DEDUCTION DEPENDS ON …

• Type of property given away
  – Identity of
  – The donee
• The contributor
• Amount of property given away
• Place where charity is organized

Answer 24

QUALIFIED CHARITY

• Must be operated exclusively for:
  – Religious, charitable, scientific, literary, or educational purposes, or
  – For the prevention of cruelty to animals or children
• No earnings may benefit a private party
• No substantial propaganda or lobbying
• For income tax purposes, must be a domestic charity

Answer 25

DONATIONS OF PARTIAL INTERESTS

• Right to use property is not deductible.
  – i.e., rent-free occupancy
• Gifts of less than entire interest are not deductible unless it is:
  –An undivided portion of donor’s entire interest
  –A remainder interest in personal residence or farm
  –A partial interest if transferred in trust (charitable remainder, trust
  charitable lead trust, pool income fund)
  *– A charitable gift annuity

Answer 26

GIFTS OF SERVICE

• Not deductible
  – Since the value of the gift was never brought into income, a deduction cannot result.
• Unreimbursed expenses and travel expenses are deductible.
• Mileage: 14¢ per mile

Answer 27

ITEMIZED DEDUCTION LIMITATIONS

Answer 28

CHARITABLE DEDUCTION LIMITATIONS

Interaction of Limitations

• When applying the yearly overall 50% limitation for contributions of
  property, allowable deductions first come from 50 percent gifts, then from 30 percent gifts, and finally from 20 percent gifts.

— If cash contributions are also made during the year, the overall 50
percent limit is first reduced by the amount of the cash contributions.

• Deductions disallowed because of AGI limitations may be carried over for five years (in FIFO order)

Answer 29

CHARITABLE DEDUCTION LIMITATIONS: EXAMPLE

• Taxpayer with $100,000 in AGI, contributed $40,000 cash and long-term stocks with a FMV of $35,000 and a basis of $8,000 to a university.
• Limits based on $100,000 AGI
  –60% limit (cash) = $60,000
  – 30% limit = $30,000
  – Overall: 50% limit for property = $50,000
• Taxpayer deduction
  –Amount of deduction = $50,000 (40,000 cash + 10,000 stock)
  – Contribution carryforward = $25,000 stock (as 30% asset)

Answer 30

GIFTS OF CASH

• Fully deductible subject to AGI limitations
• Excess contributions carry forward: 5 years
• Corporate deductions limited to 10% of taxable income
  – Can move charitable deductions above-the-line
• Contributions to institutions of higher education in return for a right to purchase tickets or seating at an athletic event:
  – No deduction is permitted

Answer 31

LONG-TERM CAPITAL GAIN PROPERTY

Intangible Personal Property and Real Property
– Subject to 30% limitation
– Can qualify for 50% limitation by reducing the value of the gift by 100% of the gain (i.e., limiting the value to the basis)

Tangible Personal Property
* Used by donee in tax-exempt purpose
– Entire fair market value at the date of the gift is deductible
– Subject to 30% AGI limitation

• Not used by donee in tax-exempt purpose
  –The fair market value of the gift must be reduced by 100 percent of
  the potential gain (i.e., value is limited to basis)
  –* Subject to the 50% limitation

Answer 32

ORDINARY INCOME PROPERTY

• Includes
  – Short-term capital gain assets
  –Works of art, books, letters, and musical compositions if given by the person who created or prepared them
  – Business person’s stock in trade and inventory
• Deduction limited to cost basis
  –These gifts should be avoided when the estate will not be subject to
  estate taxes

Answer 33

CHARITABLE DEDUCTIONS

Answer 34

CHARITABLE DEDUCTIONS BY CORPORATIONS

• C corporations can deduct up to 10% of their taxable income.
• S corporations pass through charitable gifts (Form K-1) to owners who deduct their portion on personal income tax return

Answer 35

CASUALTY LOSS DEDUCTION (1 OF 2)
* One of few tax deductions allowed for personal losses.
– For 2018-2025, loss deductible only if attributable to a declared federal disaster

• Applies in extreme cases where the taxpayer has suffered a large loss due to:
  –Fire
  – Storm
  – Shipwreck
  – Theft
  –Other sudden, unexpected events causing losses

Answer 36

CASUALTY LOSS DEDUCTION (2 OF 2)

Classification of Casualty Loss:
–Business Loss – Above-the-Line Deduction
– Personal Loss – Schedule A Itemized Deduction

Amount of loss and its deductibility depends on whether:
* Loss is from
—- Business or production of income property, or
—- Personal property
* Loss is partial or complete

Answer 37

PERSONAL CASUALTY AND THEFT LOSSES

• Deduction for personal losses is the lower of:
  – Decline in value of the asset less insurance proceeds received
  –Taxpayer’s adjusted basis in property, less insurance proceeds received
• Further Limitations
  –$100 is deducted from the loss caused by each occurrence
  – Only casualty losses in excess of 10% of AGI are deductible

Answer 38

PERSONAL CASUALTY AND THEFT GAINS

If casualty gains exceed casualty losses:

• Gain offsets any casualty losses suffered in the same year
• Excess gains are treated as the sale of a capital asset
  —Can be short-term or long-term, depending on holding period of the
  asset.
  —Deferral of gain provisions may apply and will be discussed in the
  non-taxable exchanges chapter.
• Personal casualty and theft gains and losses are not netted with the
  gains and losses on business and income-producing property

Answer 39

PERSONAL CASUALTY LOSS: EXAMPLE 1(1 OF 2)

• Dwight owned a home in New Orleans that was severely damaged by a hurricane.
• Dwight had purchased the home for $200,000, and the fair market value of the home prior to the hurricane was $400,000.
• His homeowner’s insurance policy had lapsed one month before the hurricane hit and Dwight had not obtained any other insurance.
• After the hurricane, the property had a fair market value of $90,000.
• The president declared the hurricane a disaster under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act

Answer 40

PERSONAL CASUALTY LOSS: EXAMPLE 1 (2 OF 2)

• Dwight’s casualty loss is valued at $200,000 which is his adjusted basis less insurance proceeds received (insurance proceeds in this case are zero).
• His economic loss (the fair market value before the event, $400,000 less the fair market value after the event, $90,000) is $310,000.
  –Since Dwight had never paid tax on the $200,000 gain in the
  property, however, he cannot take a tax deduction for the economic
  loss.
• If Dwight had the property fully insured, he would have received the full $310,000 (less his deductible) from the insurance company.

Answer 41

PERSONAL CASUALTY LOSS: EXAMPLE 2

• Continuing with the facts from the prior example, assume that Dwight’s AGI for the year is $100,000.

–Dwight’s casualty loss of $200,000 must be reduced by $100.
–The resulting loss is only deductible to the extent it exceeds 10% of AGI.
– The deductible portion of Dwight’s casualty loss is $189,900 ($200,000 - $100 - $10,000 [10% of AGI]).
– Had the loss not been caused by a presidentially declared disaster, it would not be deductible for tax years 2018-2025.

Answer 42

BUSINESS CASUALTY AND THEFT LOSSES

Above-the-Line Deduction

• Amount of deduction depends on whether the event caused
  • A complete casualty (FMV after the event = 0)
    Loss = Adj. basis in property less insurance proceeds
  • A partial casualty
    Loss is the lesser of
    Decline in value, or
    Adjusted basis in property, less insurance proceeds

Answer 43

BUSINES CASUALTY LOSS: EXAMPLE

• No insurance proceeds received.

Always limited to basis !

Answer 44

DEDUCTION CLUSTERING

• A tax planning strategy in which itemized deductions are clustered (or bunched) together in one year, making them higher than the standard deduction, while the standard deduction is taken the following year.
• Creates a higher amount of deductions overall
• A taxpayer can control the timing (within certain limitations) of:
  – Payment of state and local income or property taxes
  –Payment of mortgage interest
  – Medical expenses
  – Charitable donations

Answer 45

QUALIFIED BUSINESS INCOME (QBI) DEDUCTION: IRC SECTION 199A

• Below-the-line deduction
  – Available regardless of whether the taxpayer selects the standard
  deduction or itemized deductions
  – To create parity in tax treatment of pass-through entities versus C
  corporations
• Pass-through entities include:
  – Sole proprietorships
  – Partnerships
  – LLCs
  – S corporations

Answer 46

QUALIFIED BUSINESS INCOME

• QBI is the net amount of qualified items of income from eligible pass- through entities
• QBI does not include:
  – Capital gains and losses
  – Dividends
  –Interest not allocable to a trade or business
  –Commodities transactions
  – Reasonable compensation for S corporation owners
  – Guaranteed payments to partners for services rendered

Answer 47

THE QBI DEDUCTION

• In general, the QBI deduction is equal to the lesser of:

– 20% of Qualified Business Income, or
– 20% of the taxpayer’s adjusted taxable income

• Adjusted taxable income = taxable income from all sources, after taking above-the-line deductions (excluding the deductions related to the business for self-employment tax, self-insured health insurance premiums, and self- employed retirement plan contributions), and taking either the standard or itemized deductions, reduced by net capital gains.
  —Includes spouse’s income if MFJ

Answer 48

THE QBI DEDUCTION: EXAMPLE 1

• Jana’s share of qualified business income from a partnership is $90,000, and her total adjusted taxable income from all sources (after taking above- the-line deductions not related to the business, and either the standard or itemized deduction, but before taking the 20% deduction for QBI) is $70,000,

the deduction is the lesser of:

• 20% x $90,000, or
• 20% x 70,000
• Deduction limited to $14,000

Answer 49

THE QBI DEDUCTION: EXAMPLE 2
* Kaylan’s share of qualified business income from a partnership is $90,000, and her total adjusted taxable income from all sources (after taking above- the-line deductions not relating to the business and either the standard or itemized deduction, but before taking the 20% deduction for QBI) is

$110,000, the deduction is the lesser of:

• 20% x $90,000, or
• 20% x 110,000
• Deduction limited to $18,000

Answer 50

QBI DEDUCTION: SPECIFIED SERVICE TRADE OR BUSINESS (SSTB)

• The QBI deduction is limited for trades or business involving performance of services in the fields of:
  –3 TIERS OF IRC SECTION 199A (2024) Health
  – Law
  –Accounting
  – Actuarial services
  –Consulting
  – Performing arts
  – Athletics
  – Financial services
  – Investing
  – Investment management
  – Trading or dealing in securities
  –* Any trade or business where the principal asset of the business is the reputation or skill of one or more of its owners are SSTBs.

Answer 51

3 TIERS OF IRC SECTION 199A (2024)

Question 52

Trisha, age 66, has a severe asthmatic condition, and her physician recommended that she install a lap pool in her home so that she can swim regularly, which should help control her condition. Trisha has a friend who is a real estate agent, and strongly advised her not to install the pool, since pools depress the market value of homes in the area. If Trisha’s AGI for the year is $100,000 how much of the cost of the lap pool can Trisha actually deduct as a medical expense if it cost her $12,000 to install the pool and all of her other health insurance costs were covered by her health insurance policy?
The value of the house did not change due to the pool.

a. $0.
b. $4,500 as an itemized deduction.
c. $7,500 as an itemized deduction.
d. $12,000 as an adjustment to income.

Answer 52

The correct answer is b.

Capital improvements to a home can be deducted as medical expenses if they are medically necessary.

The only portion of the expense that can be deducted, however, is the difference between the cost of the improvement and the increase in the value of the home. In this case, installation of a pool did not result in a market value increase in Trisha’s home, so she is permitted to deduct the full cost of $12,000.

Out of the $12,000 cost, however, Trisha will only be able to deduct that portion of the cost that exceeds 7.5% of her AGI (in 2023).

Since her AGI is $100,000, she can deduct $4,500 (calculated by subtracting 7.5% of her AGI, $7,500 from the installation cost, $12,000).

Question 53

All of the following statements regarding the Section 199A qualified business income deduction are correct, EXCEPT:

a. The deduction is generally 20% of qualified business income.
b. The deduction is not available for service businesses such as health and accounting.
c. The deduction may be limited based on taxable income.
d. The deduction may be phased out for high income taxpayers.

Answer 53

The correct answer is b.

The Section 199A deduction is available for income from service businesses such as health and accounting if the taxpayer’s taxable income is below $182,100 ($364,200 MFJ) in 2023.

It is partially phased out for service businesses if taxable income is between $182,100 - $232,100 for single taxpayers
or between $364,200 - $464,200 for married taxpayers filing jointly.

The deduction is fully phased out for service businesses if the taxpayer’s taxable income is over the top threshold

Question 54

In June of this year, Wynonna purchased her first home. The price of the house was $260,000, and she financed the purchase with a 30-year, $200,000 mortgage. Since she plans on staying in the home for quite a while, and she expects interest rates to rise in the future, she paid $4,000 in points to receive a lower interest rate on the loan. As of the end of the year, Wynonna had paid $7,614 in interest on the loan by making her monthly installment payments. How much should she claim as mortgage interest on her itemized deductions this year?

a. $7,614.
b. $7,747.
c. $9,614.
d. $11,614

Answer 54

the correct answer is d.

In the year a home is acquired, the interest paid on a mortgage used to acquire the home, as well as the points paid to qualify for a lower interest rate on the loan are deductible as mortgage interest expense, subject to the overall limitations on acquisition indebtedness.

Since Wynonna acquired her home this
year, she can deduct the $4,000 she paid in points as well as the $7,614 paid in mortgage interest, for a total of $11,614.

Question 55

Jake’s AGI for 2023 is $100,000. He inherited a large amount of money from the estate of his grandfather, and is very charitably inclined. A recent earthquake devastated several cities on the West Coast, and Jake wanted to assist in getting the people affected back on their feet. He gave a $75,000 donation to the Red Cross, which is spearheading relief efforts in the region.

How much of the contribution can Jake deduct on his income tax return in 2023?

a. $20,000
. b. $30,000.
c. $60,000.
d. $75,000.

Answer 55

The correct answer is c.

Jake made a contribution of cash to a public charity. His contribution base is his AGI, or $100,000.

The maximum amount (the ceiling) that can be deducted in any one year for gifts of cash to a public charity (the Red Cross) is 60% of the taxpayer’s contribution base. Jake can deduct, therefore, $60,000 of the $75,000 gift.

The remaining $15,000 may be carried forward for up to five years and deducted against income from those years, subject to the ceiling limitations for charitable gifts

Question 56

Owen is a tax attorney who specializes in intergenerational wealth transfer planning. He is also very charitably inclined, and sits on several charitable boards. A local animal shelter and Friends of Animals group recently decided to work together on joint goals, and decided to form a new charitable organization, which meets the definition of a public charity. Owen created the organization and received exempt determination status from the IRS. He usually charges $5,000 to perform this service, plus the exempt determination letter fee charged by the IRS of $500, but he volunteered for this activity since his wife will be on the board. Owen was not reimbursed for the expenses he incurred. Assuming that his AGI and contribution base is $150,000, how much can Owen deduct for income tax purposes?

a. $0.
b. $500.
c. $2,750.
d. $5,500.

Answer 56

The correct answer is b.

In order to be deductible for federal income tax purposes, a taxpayer must make a gift of property, not services.

While Owen provided a valuable service to the charitable organization, he cannot deduct the value of his services as a charitable deduction since he never included the value of his services in income.

The actual expenses he incurred, however, are deductible. Since he paid $500 to obtain the exempt determination letter from the IRS, Owen is allowed to deduct $500 as a charitable deduction.

Question 57

Tammy has been an avid investor since her teenage years, when her uncle taught her the basics of investing. This year, Tammy incurred investment interest expense of $800.
Tammy had $200 of nonqualified dividend income and $100 of interest income this year since she has a growth focus in her portfolio.
Tammy also realized $600 of long-term capital gains for the current year. Applying the default rules for the deductibility of investment interest expenses, which of the following statements is correct?

Tammy can deduct the full $800 in investment interest expense this year.
Tammy’s investment income (for purposes of the investment interest expense deduction) for the year is $800.

Tammy will be able to carryover $500 of investment interest expense to deduct against future investment income in subsequent tax years.

Tammy can deduct the allowable portion of her investment expenses this year subject to the two percent floor that applies to miscellaneous itemized deductions

Answer 57

Tammy will be able to carryover $500 of investment interest expense to deduct against future investment income in subsequent tax years.
Rationale

Investment expenses are deductible to the extent of net investment income. Investment income includes interest and nonqualified dividends received on a portfolio, but does not include long-term capital gains or qualified dividends unless the taxpayer makes an affirmative election to include them in the definition of investment income (and, in the process, loses the special tax rate that applies to long-term capital gains).

Tammy’s investment interest expense was $800 and her investment income was $300, so she is able to claim $300 of the investment income expense this year. She can carry forward the remaining $500 of investment interest expense indefinitely, and claim it when she generates interest or nonqualified dividends in the future.

Question 58

In which of the following situations would educational expenses be deductible for income tax purposes in tax years after 2025?

A physician’s assistant who works the night shift is attending medical school during the day.

A paralegal attends law school at night, hoping to obtain a law degree.

A retired business executive begins a Ph.D. program in business to help relieve him of the boredom of retirement.

A financial planner takes classes necessary to sit for the CFP® Certification Examination.

Answer 58

A financial planner takes classes necessary to sit for the CFP® Certification Examination.

Rationale

In tax years after 2025, educational expenses are deductible if they are for the purpose of furthering and expanding the taxpayer’s knowledge in his/her chosen trade or profession.

Taking classes to enter a new trade or profession, such as medicine or law, will not qualify as an income tax deduction.

Furthermore, classes taken for personal enrichment, such as those referred to in option c, are not related to production of income or a trade or business, so they are not deductible.

Question 59

All of the following statements regarding the Section 199A qualified business income deduction are correct, except:

The deduction is generally 20% of qualified business income.

The deduction is not available for service businesses such as health and accounting.

The deduction may be limited based on taxable income.

The deduction may be phased out for high income taxpayers.

Answer 59

The deduction is not available for service businesses such as health and accounting.

Question 60

Sara is single and her share of qualified business income from a partnership is $80,000. Her total taxable income from all sources, before taking the 20% deduction for QBI, is $70,000.
What is the amount of the Section 199A qualified business income deduction that Sara can take this year?

$2,000.
$14,000.
$16,000.
$30,000.

Answer 60

$14,000.

Rationale

The deduction is the lesser of:
(1) 20% of QBI, or
(2) 20% of taxable income.

20% of QBI is $16,000.
20% of taxable income is $14,000.

Her deduction is $14,000.

Question 61

Which of the following miscellaneous itemized deductions is not subject to the 2 percent floor?

Gambling losses.
Investment expenses.
Hobby activity expenses.
Unreimbursed employee business expenses.

Answer 61

Gambling Loss

Question 62

Last year, Tim incurred the following tax expenses and related items:
Federal income tax paid with return $2,150
State income tax withheld this year $4,500
State income tax paid with return this year $600
Real estate taxes paid on residence $6,500
Sewer and water tax $600
Car tax (flat rate for all car owners) $300
State income tax refund from prior year $400

How much can Tim claim as a deductible tax expense for his itemized deductions this year?

Answer 62

$10,000.
Rationale

Federal income taxes are never deductible as an itemized deduction.

Generally, state and local income taxes are deductible as an itemized deduction. There are some limitations to this rule, however.

Use taxes, such as sewer and water tax, are not deductible.

Property taxes that are based on value (ad valorem taxes) are deductible, but flat rate property taxes, such as the car tax in this problem, are not deductible.

Consequently, Tim can deduct the $4,500 of state income taxes withheld this year,
the $600 of state income taxes paid with his return this year,
and the $6,500 of real estate taxes on his personal residence.

He may not deduct the car tax, sewer and water tax, or federal income tax. While his state income tax refund from a prior tax year is important in preparing his return, it is not factored into his itemized deductions – it is included in gross income pursuant to the tax benefit rule. The 2017 TCJA limited deductions for taxes paid to $10,000.

Question 63

Hardy, a vocalist, has frequently undergone cosmetic surgery. Hardy claims that the reason for his surgery is to maintain the air passages from his nose through his throat so he can have a consistent singing voice. Several other vocalists have claimed deductions for this type of surgery. This year, Hardy spent $25,000 on cosmetic surgery, and his AGI for the year was $200,000.

How much of the cosmetic surgery expenses will Hardy be able to deduct as an itemized deduction?

$0.
$10,000.
$15,000.
$25,000.

Answer 63

$0.

Rationale

While elective cosmetic surgery is generally not a deductible medical expense (it is specifically excluded from the type of medical expenses that can be claimed as an itemized deduction), when the expense is considered to be an ordinary and necessary business expense, it can be used to offset business income.

Since Hardy is undergoing surgery to ensure his continued ability to generate income, he can deduct the expenses on his Schedule C or business tax return, resulting in an above the line deduction that reduces his adjusted gross income.

He will not be permitted to deduct the expenses as a medical expense on his Schedule A (Itemized deductions).

Question 64

Nelson is in a high tax bracket and decided to add some public purpose municipal bonds to his portfolio. He did not want to liquidate any of his current positions to acquire the bonds, however, so he took out a margin loan to make the purchase. Nelson incurred $800 of margin interest on the loan used to purchase the bonds and received $600 of coupon payments from the bonds this year.

Assuming that Nelson had no other margin interest or other investment income this year, which of the following statements is correct?

Nelson cannot deduct any of the margin interest incurred this year.
Nelson can deduct $600 of the margin interest.
Nelson can deduct $800 of the margin interest.
If Nelson becomes an AMT taxpayer, he can deduct $600 of the margin interest

Answer 64

Nelson cannot deduct any of the margin interest incurred this year.

Rationale

Interest incurred to acquire tax-exempt investments may not be deducted as an investment interest expense.

Since Nelson used the margin proceeds to purchase public purpose municipal bonds, which will never be subject to income tax (in the regular or AMT tax systems), he may not deduct any portion of the $800 in margin interest paid to acquire the assets.

Question 65

Jackson, a U.S. Citizen, has always felt drawn to the town in Ireland that his family came from. The local church in that town is in dire need of repair, and Jackson would like to make a contribution to the restoration fund which is managed by the Archdiocese of Laois, Ireland. If Jackson makes a contribution, which of the following statements is correct?

If Jackson makes the contribution directly to the Archdiocese, he qualifies for an income tax deduction, since the money will be used for one of the classic charitable purposes – support of a religious organization.

Jackson’s deduction will be subject to the 60% limit if he makes the contribution to a church in Ireland.

If Jackson donates the funds to his parish in the United States, and the parish sends the fund to the church in Ireland, Jackson will qualify for an income tax charitable deduction.

If Jackson wants to get a charitable deduction for the gift, he must make the gift through his will when he dies, or no charitable deduction will be allowed.

Answer 65

If Jackson donates the funds to his parish in the United States, and the parish sends the fund to the church in Ireland, Jackson will qualify for an income tax charitable deduction.
Rationale

To be deductible for federal income tax purposes (unlike the rules that apply to the federal estate tax charitable deduction), a contribution must be made to a U.S. charity. Gifts to foreign charities are not deductible. One way to avoid this problem is to make a gift to a U.S.-based charity that will transfer the funds to the foreign charity, making option c the correct answer

Question 66

Barbara purchased a new car this year, and paid $3,600 in total sales taxes for the year. Barbara’s state income tax for the year was $2,000. The property taxes on Barbara’s home this year were $6,000, and she made approximately $12,000 in charitable deductions.

How much can Barbara deduct for taxes as an itemized deduction?

$3,600.
$6,000.
$8,000.
$9,600.

Answer 66

9,600.
Rationale

Taxpayers are permitted to claim the higher of state income taxes paid or sales taxes paid as an itemized deduction. Since Barbara paid $3,600 in sales taxes, but only $2,000 for income tax, she will claim sales taxes as an itemized deduction this year. This election does not impose limits on the deductibility of other taxes, so Barbara can still claim her property taxes of $6,000 as well as the $12,000 in charitable deductions.

Consequently, Barbara’s total itemized deductions for the year are $21,600 but her itemized deduction for taxes is $9,600, which is less than the $10,000 limit.

Question 67

Naomi, a small business owner who is worn out from years of work without a vacation, decides she needs a break and wants to go on a 3-month cruise around the world. The cost of the cruise is $45,000, and Naomi does not have the liquid funds to pay for the extravagant vacation. Naomi does not want to liquidate investments to cover the expenses, and does not want to incur high-interest credit card debt. Her only debt outstanding is the remaining balance on her mortgage of $60,000, so she decides to take out a home equity loan for $45,000 to pay for the trip.

Which of the following statements concerning this situation is correct?

Even though the proceeds will not be reinvested in her home, she can deduct the interest incurred on the home equity loan.

Taking the home equity loan out for this purpose would increase her acquisition indebtedness; therefore, some of her mortgage interest is deductible.

Naomi should consider having the business pay for the vacation, since the expense will be deductible as an above-the-line business expense.

The interest on the loan is not deductible because it is not acquisition indebtedness.

Answer 67

The interest on the loan is not deductible because it is not acquisition indebtedness.

Rationale

Taxpayers are permitted to deduct the interest on up to $750,000 of acquisition indebtedness as an itemized deduction.
To fund her trip, Naomi took out a home equity loan for $45,000.
The interest on this loan is not deductible since it is not acquisition indebtedness.

Question 68

Clint is an avid fan of his alma-mater’s football team. The team has had such a good record in the last six years that getting tickets to the games has proven difficult. Recently the school announced that those wishing to purchase football tickets could have their name placed on a waiting list once they made a $5,000 contribution to the University. Since Clint did not want to miss any of the games, he made the contribution, and also paid $1,000 for the season tickets.

How much can Clint deduct as a charitable contribution on his income tax return?

$0.
$4,000.
$5,000.
$6,000.

Answer 68

$0.
Rationale

When a contribution is made to a charity to

obtain an option

to purchase sporting tickets, there is no charitable deduction (TCJA 2017).

Question 69

risha, age 66, has a severe asthmatic condition, and her physician recommended that she install a lap pool in her home so that she can swim regularly, which should help control her condition. Trisha has a friend who is a real estate agent, and strongly advised her not to install the pool, since pools depress the market value of homes in the area. If Trisha’s AGI for the year is $100,000 how much of the cost of the lap pool can Trisha actually deduct as a medical expense if it cost her $12,000 to install the pool and all of her other health insurance costs were covered by her health insurance policy?
The value of the house did not change due to the pool.

$0.
$4,500 as an itemized deduction.
$7,500 as an itemized deduction.
$12,000 as an adjustment to income.

Answer 69

4,500 as an itemized deduction.
Rationale

Capital improvements to a home can be deducted as medical expenses if they are medically necessary.
The only portion of the expense that can be deducted, however, is the difference between the cost of the improvement and the increase in the value of the home. In this case, installation of a pool did not result in a market value increase in Trisha’s home, so she is permitted to deduct the full cost of $12,000.

Out of the $12,000 cost, however, Trisha will only be able to deduct that portion of the cost that exceeds 7.5% of her AGI (in 2023). Since her AGI is $100,000, she can deduct $4,500 (calculated by subtracting 7.5% of her AGI, $7,500 from the installation cost, $12,000).

Question 70

Rory and Joey Stapleton purchased their home in 2012 and took out a mortgage of $1,000,000. The current loan balance is $875,000 and the fair market value of the home is $1,400,000. The rate on their existing loan is 6% and the current rate for home loans is 4.5%. The Stapletons also have $7,000 of credit card debt at 14% interest. If the Stapletons refinance their mortgage, which of the following statements is(are) true regarding their ability to deduct interest on the refinanced loan?

1. The Stapletons can refinance the credit card debt into the refinanced mortgage and deduct the full amount of the interest.
2. The Stapletons can refinance the existing $875,000 mortgage and deduct the interest on the entire amount.
3. The Stapletons can take out a home equity loan for $7,000 to pay off their credit card debt and can fully deduct the interest.

1 only.
2 only.
2 and 3.
1, 2, and 3.

Answer 70

2 only.

Rationale

Statement 1 is false because if they refinance more than the existing loan balance, they are limited to deducting the interest on $750,000 of mortgage debt.

Statement 2 is a true statement because their original mortgage was taken out before December 15, 2017, allowing them to retain the right to deduct the interest on up to $1,000,000 of debt, so long as they do not refinance more than the existing acquisition loan balance.

Statement 3 is false because home equity debt is only deductible if used to improve the home (as part of acquisition debt).

Question 71

Alana, a college student, had her car recently broken into. The perpetrators caused $800 in damage to her car, and stole a camera with a fair market value of $700 that was originally purchased for $1,500. Alana’s AGI for the year is $8,000.

How much can Alana claim as a casualty loss deduction on her income tax return this year?

$0.
$600.
$700.
$1,400.

Answer 71

$0.
Rationale

Alana suffered a casualty loss. Casualty losses are only deductible if declared a national disaster by the President.

Question 72

Which of the following statements concerning the Section 199A qualified business income deduction is correct?

It results in a lower adjusted gross income.

It applies at the individual level, so one business owner may be able to take the deduction while another owner of the same business cannot.

It is available for distributions from C corporations.

It applies regardless of the taxpayer’s income.

Answer 72

It applies at the individual level, so one business owner may be able to take the deduction while another owner of the same business cannot.

Rationale

The Section 199A deduction is a below-the-line deduction, so it does not reduce AGI. The deduction applies to income from pass-through business entities, including sole proprietorships, but does not apply to income from C corporations. The deduction is phased out based on the taxpayer’s total taxable income (including the spouse’s income if MFJ). It applies at the individual level, so one business owner may be able to take the deduction while another owner of the same business may have a deduction that is partially or fully phased out.

Question 73

Brooke is the 100 percent owner, president, and CEO of FadCo, Inc. Her salary is approximately $1 million per year, and she has substantial income from investments and other business interests. FadCo’s taxable income each year is $10 million. Brooke would like to make a $1.8 million contribution to the local opera company to renovate the concert hall and stage, but does not feel that she can get significant tax benefits if she makes them herself. Instead, she has her company make the contribution on December 31, and she reduces her salary to $100,000 per year for the next two years so that the contribution does not deprive the company of cash flow needed for expansion. If FadCo makes the contribution in 2024,

which of the following statements concerning this situation is correct?

FadCo will be able to take a charitable deduction of $1.8 million on its tax return this year.

The reduction in salary will constitute a charitable gift that Brooke can deduct as an itemized deduction.

FadCo will qualify for a $1.8 million charitable deduction, some of which must be carried forward to future tax years.

Both Brooke and FadCo will qualify for a charitable deduction.

Answer 73

FadCo will qualify for a $1.8 million charitable deduction, some of which must be carried forward to future tax years.

Rationale

Corporations may make tax deductible gifts to charity, but may not deduct more than 10% of their taxable income. If FadCo donates the $1.8 million to the opera company, it will only be able to take a $1 million deduction in the current year. The excess $800,000 will be carried forward for up to 5 years. This works well for Brooke, since she can reduce her salary, thereby reducing her income subject to tax. In essence, by reducing her income to $100,000 Brooke has moved her charitable deduction above the line. She cannot take an itemized charitable deduction, since she did not make the contribution (the company did).

Question 74

June and Ernest Carter have asked their financial planner for advice on minimizing overall income taxation. The Carter’s AGI this year will be $120,000 and they expect it to remain the same next year. They expect to pay state and local income taxes of $5,900 and real property taxes of $2,500 both this year and next. They give $4,000 per year in offering to their church, and every three years they donate $11,000 to the children’s hospital that treated their 3-year-old daughter for cancer just prior to her death 11 years ago. The contribution to the children’s hospital will be made in February of next year. This year they will pay $8,000 in mortgage interest and will pay off the mortgage in December of the current year. Which of the following recommendations will result in the greatest tax savings for the Carters over the 2-year period?

Prepay next year’s real property taxes this year.

Defer the current year’s $4,000 church offering to next year.

Prepay next year’s real property taxes and Ernest’s January state estimated income tax in the current year.

Make the $11,000 contribution to the children’s hospital and donate $1,000 of next year’s offering to the church in December of the current year.

Answer 74

Make the $11,000 contribution to the children’s hospital and donate $1,000 of next year’s offering to the church in December of the current year.

Rationale

Total itemized deductions for the current year are $20,400 ($5,900 + $2,500 + $4,000 + $8,000) as stated. Since the standard deduction for 2024 is $29,200 (MFJ) (2023 is $27,700), the Carters will take the standard deduction.

If no changes are made, the total itemized deductions for next year will be $23,400 ($5,900 + $2,500 + $4,000 + $11,000) and they will also take the standard deduction next year.

If they were to make the $11,000 contribution to the children’s hospital and donate $1,000 of next year’s offering to the church in December of the current year, their total itemized deductions for the current year would be $32,400 and they would still take the standard deduction next year. This is an example of deduction clustering.

The other answer choices would also cluster some of the deductions, but option d results in the greatest amount of tax savings by preserving the standard deduction next year and increasing the itemized deductions in the current year when the mortgage interest is still available as an additional itemized deduction.
Confidence of your answer

This way one of the years gets the benefit of HIGHER deduction amount ABOVE the standard deduction.

Question 75

Which, if any, of the following expenses is a deductible miscellaneous itemized deduction in 2024?

A. Hobby expenses
B. Tax preparation fee
C. Gambling losses to the extent of winnings
D. Safe deposit box fee
E. All of the choices

Answer 75

Solution: The correct answer is C.

Miscellaneous itemized deductions subject to the 2% floor were suspended 2018 - 2025 based on TCJA 2017. All other miscellaneous itemized deductions not subject to the 2% floor are still deductible; for example: medical expense greater than 7.5% of AGI, gambling losses (to the extent of winnings), etc.

Question 76

Which of the following qualifies for the medical expense deduction?

A. Funeral expenses
B. Toiletries
C. Nonprescription drugs
D. Long-term care insurance premiums

Answer 76

he correct answer is D.

None of the listed expenses qualify for the medical expense deduction, except long-term care insurance premiums.

Question 77

Upon the recommendation of a physician, Thomas has a therapeutic pool installed in his personal residence. He suffers from severe muscular degeneration disease. If Thomas does not use the pool on a regular basis, his muscles will deteriorate to the point he will be unable to walk. In connection with this pool, Thomas incurs and pays the following amounts during the current year:

Therapeutic pool and cost of installation $12,000

Increase in utility bills due to the pool $400

Cost of certified appraisal $500

The pool has an estimated useful life of 5 years. The appraisal was to determine the value of Thomas‘ residence with and without the pool. The appraisal states that the pool increased the value of Thomas’ residence by $4,000. Disregarding percentage limitations, how much of the above expenditures qualify for the medical expense deduction in the current year?

A. $12,900
B. $12,400
C. $8,500
D. $8,400
E. None of the choices

Answer 77

The correct answer is D.

Only $8,000 of the cost of the pool qualifies since $4,000 of the $12,000 increased the value of Thomas’s residence.

The total medical expense is $8,400 ($8,000 + $400 additional operating costs).

Prior to TCJA 2017, the appraisal fee would have been deductible as a miscellaneous itemized deduction subject to the 2% of AGI floor, but not as a medical expense.

Post TCJA 2017, all itemized deductions subject to the 2% floor were repealed.

Question 78

Your friend Scotty informs you that he received a tax-free reimbursement in 2024 of some medical expenses he paid in 2023. Which of the following statements best explains why Scotty is not required to report the reimbursement in gross income?

A. Scotty itemized deductions in 2023.
B. Scotty did not itemize deductions in 2023.
C. Scotty itemized deductions in 2024.
D. Scotty did not itemize deductions in 2024.
E. Scotty itemized deductions in 2023 but not in 2024.

Answer 78

The correct answer is B.

If Scotty did not itemize in 2023, he can exclude the reimbursement from gross income in 2024.

If Scotty itemized deductions in 2023, he must report the reimbursement as gross income in 2024 to the extent he received a tax benefit from deducting medical expenses in 2023.

Whether he itemized in 2024 will have no impact on the treatment of the reimbursement.

Question 79

During the current year, Vijay, a self-employed individual, paid the following amounts:

Real estate tax on Kansas residence - $3,400
State income tax - $1,900
Real estate taxes on land in Costa Rica (held as an investment) - $1,100
Gift tax paid on gift to daughter - $1,500
State sales taxes - $1,950
State occupational license fee - $250
Property tax on value of his automobile (used 100% for business) - $450

What is the maximum amount Vijay can claim as taxes in itemizing deductions from AGI (assume the sales & use tax election is available)?

A. $5,350
B. $6,450
C. $6,900
D. $7,150
E. None of the choices

Answer 79

The correct answer is A.

The sales tax ($1,950) and the US real estate taxes ($3,400) are deductible as itemized deductions.

State sales taxes ($1,950) is deducted, so he will not deduct the lower state income tax ($1,900).

The state occupational license fee ($250) and the tax on his business use auto ($450) are deductible for AGI as business expenses.

The gift tax is not deductible. The total itemized deductions are $5,350 ($3,400 + $1,950).

Question 80

In the current year, Terry pays $10,000 to become a charter member of Mammoth University’s Athletic Council. The membership ensures that Terry will receive choice seating at all of Mammoth’s home basketball games. Also in the current year, Terry pays $1,200 (the regular retail price) for season tickets for himself and his wife. For these items, how much qualifies as a charitable contribution?

A. $0
B. $6,800
C. $8,000
D. $10,000
E. None of the choices

Answer 80

: The correct answer is A.

Under TCJA, this deduction is eliminated