Tax Quiz 3 Flashcards
Steve began his professional corporation single practitioner CPA firm 38 years ago. He worked profitably as a sole practitioner for the full 38 years until retiring December 31 of last year at his full retirement age. On January 1 of this year, he sold his practice for $400,000 to be received in 4 equal, annual payments of $100,000, beginning on the date of sale and continuing each January 1 for the next 3 years. Is Steve eligible for Social Security retirement benefits during this year and why?
A)
Yes, he is eligible because he retired at his full retirement age and is fully insured.
B)
No, even though he retired at his full retirement age, the proceeds from the sale of his practice will delay his receiving Social Security retirement benefits.
C)
Yes, he is entitled to benefits, but they will be reduced because of the payments from the sale of his practice.
D)
No, he is not considered retired for Social Security purposes until the installment payments are complete.
A
Cathy sold 100 shares of GlassCo stock for $5,200. She paid $4,000 for the stock 2 years ago. Commissions of $80 on the sale and $50 on the purchase were paid. What is the amount realized and the gain recognized, respectively, on this sale?
Amount realized Gain recognized A)
$1,200 $1,070 B)
$5,200 $1,200 C)
$5,070 $1,070 D)
$5,120 $1,070
D
The amount realized is the sales price less the commissions paid on the sale ($5,200 − $80 = $5,120). Her basis in the stock is the purchase price of the stock plus commissions paid at purchase ($4,000 + $50 = $4,050). Therefore, the amount realized is reduced by Cathy’s basis in arriving at the taxable gain of $1,070 ($5,120 − $4,050).
Bob and Heather form a partnership. Bob contributes $30,000 in cash and $20,000 in stock certificates. Heather contributes $10,000 in cash and a tract of commercial real estate worth $40,000. Heather's basis in the real estate is $15,000. Bob and Heather are equal partners. Immediately after forming the partnership, Heather sells her interest in the partnership for $50,000. How much of a gain must Heather recognize for tax purposes on the sale of her partnership interest? A) $75,000. B) $50,000. C) $25,000. D) $15,000.
C
Heather’s total basis in the partnership is equal to her basis in the property she contributed. Since she invested $10,000 in cash and real estate for which her basis was $15,000, her total basis in the partnership is $25,000. The sale of her partnership interest results in a gain of $25,000.
In Year 1, Woody loaned his friend, Wesley, $3,500 to help Wesley pay his creditors. Wesley was to repay the loan by the end of Year 2. Instead of paying his creditors, Wesley laid the entire loan down on one roll of the dice at the local casino and lost. In Year 3, after filing for bankruptcy, Wesley could repay Woody only $250. What is Woody’s realized loss in Year 3 as a taxpayer with a single filing status?
A)
$3,000 ordinary loss in Year 3.
B)
$3,500 short-term capital loss in Year 3.
C)
$3,000 short-term capital loss in Year 3 and $250 short-term capital loss in Year 4.
D)
$3,250 short-term capital loss in Year 3.
D
This loan is considered a nonbusiness bad debt. Nonbusiness bad debts are considered short-term capital losses in the year in which they become completely worthless. Woody will realize a short-term loss of $3,250 in Year 3 ($3,500 loan − $250 actually paid). Assuming Woody had no gains during the year, he will be able to recognize a $3,000 short-term capital loss in Year 3 and will carry over the remaining capital loss of $250 to the next year.
A client has an income tax liability of $20,000 before payments and credits. He made estimated payments of $6,000 and had $13,000 of taxes withheld from his paycheck. He also is eligible for a nonrefundable credit of $3,000 this year. Which of the following statements regarding this client’s income tax situation for the current year is CORRECT?
A)
The client will receive a refund of $2,000 after filing his federal income tax return.
B)
The client will owe $4,000 of additional tax when he files his federal income tax return.
C)
The client will owe $1,000 of additional tax when he files his federal income tax return.
D)
The client will file a federal income tax return, will owe no tax, and will not receive a refund.
A
The client will receive a refund this year of $2,000 because he is eligible for a nonrefundable credit. Nonrefundable credits are limited to a taxpayer’s tax liability.
Calculation:
Tax liability before credits and payments $20,000 Less nonrefundable tax credit (3,000) Total remaining tax liability $17,000 Less estimated payments (6,000) Less amount withheld (13,000)
Refund owed to taxpayer $2,000
Scott received an incentive stock option (ISO) from his employer. The option allows Scott to purchase 100 shares of company stock at $50 per share. Scott exercised the option 5 years later when the fair market value (FMV) of the stock was $125 per share. He held the stock for 3 more years and sold it on the secondary market for $175 per share. In the year of exercise, Scott had reportable amounts for regular tax purposes and for alternative minimum tax (AMT) purposes, respectively, of: A) $0 and $0. B) $0 and $7,500. C) $7,500 and $5,000. D) $12,500 and $5,000.
B
Rusty is the sole proprietor of a shoe factory. During the current year, he sold a packing machine for $2,000 that he had purchased several years ago for $10,000. The packing machine had an adjusted basis of $1,000 after depreciation. He also sold a delivery truck for $2,000 purchased several years ago which had a basis of $500 after depreciation and an original purchase price of $2,500. What is Rusty’s net gain or loss on the property and how will it be treated for tax purposes?
A)
$2,500 gain, treated as Section 1245 depreciation recapture (ordinary income).
B)
$1,000 gain, treated as a long-term capital gain.
C)
$2,500 gain, treated as a Section 1231 long-term capital gain.
D)
$1,000 gain, treated as ordinary income.
A
The properties in question qualify under Section 1231, which provides special treatment for certain properties used in a trade or business (i.e., machinery and vehicles) if they are held for longer than 1 year. The properties are also subject to Section 1245 depreciation recapture. The total gain is $1,000 on the sale of the machine and $1,500 on the sale of the vehicle. The entire $2,500 is treated as ordinary income for tax purposes because of Section 1245 depreciation recapture rules.
On February 2 of the current year, a taxpayer exchanged a bank building, having an adjusted tax basis of $600,000 and subject to a mortgage of $275,000 for another bank building with a fair market value of $800,000 and subject to a mortgage of $275,000. Transfers were made subject to outstanding mortgages. What amount of gain should the taxpayer recognize in the current year? A) $275,000. B) $75,000. C) $0. D) $200,000.
C
Jason, who is in the 35% marginal income tax bracket, wants to sell an office building which was fully depreciated at the date of sale (the basis in the land is $50,000). His brother, Sam, referred him to Sam’s own CFP® professional to make certain Jason knows the tax effects of the sale. Jason tells the CFP® professional his adjusted basis in the building is zero and of the $150,000 in depreciation taken, $50,000 was attributed to accelerated depreciation. Jason’s sale price was $500,000 and he is allowing the buyer to pay him using an installment sale. The buyer, Taylor, will make 20% down payment and finance the purchase with annual installments over the next 10 years, with the first payment due on March 1 of next year. Jason engages the CFP® professional to advise him on the transaction. What should the CFP® professional do next regarding the sale transaction, assuming Jason becomes a financial planning client?
A)
The CFP® professional should advise Jason on the tax ramifications based on Jason’s verbal recitation of the facts.
B)
Jason would have to also bring in Taylor to see the CFP® professional because he would have to help both sides in the transaction.
C)
Because Sam is the CFP® professional’s client, the CFP® professional cannot help Jason.
D)
The CFP® professional should ask for the documents supporting the numbers Jason has provided.
D
James has gross income of $40,000 this year. He pays $3,000 per year in property taxes on his home. He also pays property taxes of $12,000 on an apartment building that he owns. Assuming no other adjustments to gross income, how much is James’ adjusted gross income (AGI) for the year?
A) $37,000. B) $31,000. C) $28,000. D) $40,000.
C
Most individual tax payments are deductible only as itemized deductions from AGI. If the taxpayer does not have enough deductions to itemize, there is no tax benefit from the interest payment. There are two cases in which the taxpayer may deduct taxes from gross income in arriving at the adjusted gross income:
when the taxes are incurred in carrying on a trade or business.
when the taxes are incurred in connection with property held for the production of rents or royalties. Taxes paid on the apartment building can be deducted from James’s gross income to arrive at his AGI.
Therefore, James’ AGI is $28,000 ($40,000 − $12,000).
You are a CFP® professional and have a new client who has brought you financial information for the past 5 years. Upon review of the information you notice a discrepancy between the investment assets and the investment income reported. Your client informs you that the income from a rental property has been assigned to his adult daughter and is reported on her income tax return because she pays a lower tax rate while also providing the daughter the desired cash. The client prepares his own returns using income tax preparation software. What actions should you recommend to the client?
A)
Both the client and the daughter must file amended income tax returns and the client must report the rental income instead of his daughter.
B)
The assignment of income should be formalized by a written document prepared by an attorney.
C)
All the client needs to do is report the assigned income on a gift tax return because it is actually a gift from father to daughter and it will then be accounted for correctly.
D)
This is a routine assignment of income transaction and requires no further action on the taxpayer’s part..
A
William gave his son, Simon, a house on August 1 of this year. No gift tax was paid. The fair market value (FMV) of the house on January 1, August 1, and December 31 of the current year were as follows: $130,000, $140,000, and $150,000. William had purchased the property in 2001 for $60,000 and had used it as rental property the entire time he held it. He had taken cumulative straight-line depreciation of $10,000 through July 31 of the current year. What is Simon’s initial tax basis?
A)
Simon’s initial tax basis is zero because he did not pay for the house.
B)
Simon’s initial tax basis is the same as William’s cost, less depreciation, regardless of what Simon does with the property.
C)
Simon’s initial tax basis is the FMV on the date of the gift.
D)
Simon’s initial tax basis is the same as William’s cost.
B
Mike exchanged an old machine in a like-kind exchange: adjusted basis of old machine, $5,000; fair market value (FMV) of new machine, $10,000; FMV of boot received, $0; FMV of boot given, $6,000. What gain must be recognized by Mike, and what is his adjusted tax basis in the new asset, respectively?
Recognized gain Adjusted tax basis
A)
$0 $10,000
B)
$5,000 $11,000
C)
$0 $11,000
D)
$0 $5,000
C
when no boot is received your recognized gain will equal $0
To solve for adjusted tax basis:
original basis \+ boot given \+ gain recognized - boot received - loss recognized
Craig gives his son Scott stock with a basis of $80,000 and a fair market value of $70,000. No gift tax is paid. Scott subsequently sells the stock for $78,000. What is Scott's recognized gain or loss? A) $78,000 gain. B) No gain or loss. C) $8,000 gain. D) $2,000 loss.
B
Martin is in a year-end planning meeting with his clients, Sue and Robert. Robert mentions that since they last met, the couple has been providing support for Sue’s grandfather, David. Further questioning by Martin reveals that David disappeared late last year after his wife’s death and had been homeless when the couple located him and brought him home. David has had little known income this past year and has only been living with Sue and Robert for the last 7 months. They did not mention him at previous meetings because they were not certain he would stay. What steps should Martin take after receiving this information?
- Because David is only Sue’s grandfather and did not live with the couple the entire year, Martin should inform the couple David cannot be considered a dependent for income tax purposes.
- Martin should acquire information on the amounts Sue and Robert have paid out for David’s support.
- Martin should advise the couple that if the support tests are met, David may be considered a dependent this year.
- Martin needs to obtain actual information on any income David may have had during the year and used for his support.
2, 3, and 4
1 is incorrect because the grandfather does not have to live with them to be claimed as a dependent
Jenny incurred investment acquisition expenses of $10,000 this year. The investment income she received, as a result, was $40,000, of which $5,000 was tax-free interest income on bonds. How much of her investment expenses will be deductible for this year?
A) $8,750. B) $10,000. C) The amount cannot be determined from the information given. D) $7,500.
A
Business expenses generated by a source that creates tax-exempt income are not deductible. Because 12.5% ($5,000 ÷ $40,000) of her income was tax-exempt, the same proportion of her expenses is not tax deductible. In other words, because 87.5% of her income was taxable, 87.5% of her expenses were tax deductible ($8,750).
Margo files her tax return 39 days after the due date. Along with the return, she remits a check for $6,000 (the balance of the tax owed). Disregarding any interest element, her combined failure-to-file and failure-to-pay penalties are: A) $600. B) $440. C) $400. D) $660.
A
When reviewing the documents provided by your client, Randy, you, a CFP® professional, note that Randy implemented the plan to acquire new stores and expand his business, in accordance with his stated financial goals. Randy, a calendar-year, cash-basis taxpayer, owns and operates furniture rental outlets in Georgia. He wants to expand to other states. He spent $20,000 investigating furniture stores in Alabama and $12,000 investigating stores in Florida. He acquired the Alabama stores but not the stores in Florida. Randy is understandably concerned about the expenses he incurred investigating the stores in both states. He asks you to review his expenditures and tell him regarding the income tax implications. When reporting the above expenses on his income tax return you tell Randy he should: A) expense $32,000. B) expense $12,000 and capitalize $20,000. C) capitalize $32,000. D) capitalize $20,000 and not deduct $12,000.
A
Randy is already in the business; therefore, expenses are currently deductible and do not need to be capitalized. Deductible expenses include travel, engineering and architectural surveys, marketing reports, and legal and accounting services. (Domain 7: Monitoring the Recommendations)
Grace brought you a document she has executed stating that she is assigning the income from the ABC Mutual Fund shares that she owns to her son, Paul. Paul is facing some economic challenges and Grace believes the income from the mutual funds shares will help him. As Grace’s planner, what do you tell her about this income assignment?
A)
The assignment of income will be valid if the mutual fund manager also signs the document of assignment.
B)
Grace’s document assigning the mutual fund income to Paul makes the income taxable to Paul and not Grace.
C)
Grace can successfully assign the income to Paul because he is a family member. This option is unavailable to unrelated parties.
D)
Grace can assign the income to Paul but it is still taxable to Grace and not Paul because Grace still owns the mutual fund shares; she would be making a gift to Paul of the income.
D
Meredith is a physician in Louisiana. She has owned her office building for the past 15 years. The building currently has a FMV of $400,000. Meredith has an adjusted basis in the building of $100,000. She gives the other physician $200,000 in cash in addition to her building. She decides to move her medical practice to Texas and finds a physician there who wishes to move to Louisiana. They agree to trade ownership of their respective office buildings. The value of the office building in Texas is $600,000. How much gain must Meredith recognize for income tax purposes in the year the exchange takes place? A) $200,000. B) $400,000. C) $500,000. D) $0.
D
In a Section 1031 like-kind exchange, when the boot given up is cash and not other, not-like-kind property, there is no recognized gain on the transaction. When properties are traded and the newly acquired property is used for the same purpose as the old property, the Tax Code does not require the taxpayer to recognize any gain received in the exchange.
William is age 30, single and is covered by a qualified retirement plan. He provided the following information for his 2017 income tax return:
Salary $30,000
Contribution to a Roth individual retirement account $3,000
Total itemized deductions $6,500
Number of personal exemptions claimed 1
What is William’s taxable income for 2017?
A) $22,450. B) 19,950. C) $19,450. D) $15,450.
C
The following assets were used in John’s business:
Asset Holding Period Gain/Loss
Equipment 4 years $2,100
Truck 6 months ($1,200)
Common stock (capital assets) 3 years $2,000
The equipment had an adjusted basis of zero and was purchased for $8,000. The truck was purchased for $3,000 and sold for $1,800. The stock was purchased for $3,000 and sold for $5,000. In the current year (the year of the sale), John should report what amount of net capital gain and net ordinary income?
A)
$800 long-term capital gain and $900 ordinary gain.
B)
$2,000 long-term capital gain and $900 ordinary gain.
C)
$4,100 long-term capital gain and $1,200 ordinary loss.
D)
$2,100 long-term capital gain.
B
The equipment is fully depreciated, so the entire gain of $2,100 will be taxed as ordinary income because of Section 1245 depreciation recapture. The truck was held short term (not more than 1 year), and as a result, the entire $1,200 loss is treated as an ordinary, not capital, loss. The sale of the common stock is treated as a long-term capital gain.
Jack and Jill are in business together as partners. Their partnership agreement provides that Jack is to receive 60% of all profits and losses and Jill is to receive 40% of all profits and losses. If the partnership’s total charitable contributions for the year are $10,000, how much of the charitable contribution can Jill report as a deduction on her personal income tax return?
A) $5,000. B) $0. C) $6,000. D) $4,000.
D
Unless the partnership specifically describes how an item is to be distributed among the partners, it is presumed to be distributed in the same proportion as profits and losses. Because Jill is entitled to 40% of the profits and losses, she is also entitled to 40% of the charitable contributions, which equals $4,000.
Bob is a cash-basis, calendar year, sole proprietor. It is now December of the current year, and Bob has come to you for a strategy that would help reduce his income tax liability for the current year. You are a CFP® professional and have not seen Bob during the year. You are uncertain of his true tax position as this tax planning was not in the original letter of engagement. Which of the following actions should you perform in Bob’s best interest?
A)
You request a new letter of engagement and updated financial information for Bob personally as well as for the business before making recommendations.
B)
You decide to offer basic recommendations that will help no matter what his tax status is currently.
C)
You recommend Bob buy an interest in a RELP to shelter some of his income.
D)
Because this advice was not in the original scope of work, you cannot help Bob.
A
