Tax Quiz 4 Flashcards
Cynthia and Ted are married and file a joint return for 2017. They report $50,000 of adjusted gross income ($15,000 salary earned by Ted and $35,000 salary earned by Cynthia). They currently claim two exemptions for their dependent children. During 2017, they paid the following amounts to others to care for their 5-year-old son, Alex, and 7-year-old daughter, Tedra, while they worked:
Day care center $3,000
Housekeeping services provided by Ted’s mother while she is babysitting $1,000
Ted’s mother for babysitting $4,000
Cynthia and Ted may claim a credit for child and dependent care expenses of:
A) $1,200. B) $1,600. C) $8,000. D) $6,000.
A
The Child and Dependent Care Credit can be worth from 20% to 35% of some or all of the dependent care expenses you paid. The percentage you use depends on your income. If your income is below $15,000, you will qualify for the full 35%. The percentage falls by 1% for every additional $2,000 of income until it reaches 20% (for an income of $43,000 or more).
The 20%-35% is taken from up to $3,000 of expenses paid for one Qualifying Person, or from up to $6,000 of expenses paid for two or more Qualifying Persons. Therefore, the maximum Child and Dependent Care Credit is worth $2,100 (based on 2 or more dependents and $6,000 or more of qualifying expenses).
In the current year, Heather purchased $500,000 of common stock in ADM Corporation. To purchase the stock, she borrowed the $500,000 from her bank. During this year, she received $25,000 in dividend payments from the stock and paid $35,000 in interest on the loan. How much of an investment interest deduction will Heather be allowed to take on her tax return for this year?
A) $10,000. B) $25,000. C) $35,000. D) $0.
B
The maximum deduction allowed for interest related to an investment debt is the taxpayer’s net investment income. Because Heather received dividend income of $25,000, that is her net investment income; therefore, she can only deduct $25,000 of the interest payment this year. She can carry the excess deduction of $10,000 over to a future year.
Philip, a professor, earned a salary of $140,000 from a university in the current year. He received $35,000 in dividends and interest during the year. In addition, he incurred a loss of $25,000 from an investment in a passive activity. His at-risk amount in the activity at the beginning of the current year was $15,000. What is Philip's adjusted gross income (AGI) for the current year? A) $160,000. B) $115,000. C) $175,000. D) $150,000.
C
Philip’s AGI, after considering the passive investment, is $175,000 ($140,000 active income + $35,000 portfolio income). He cannot offset the passive loss against active or portfolio income. The loss may be deducted only against passive income, which he does not have in the current year.
In November of the current year, Sara opened a bakery. For legal purposes, the bakery is owned and operated through the use of an LLC (calendar year) created by Sara and her husband. The LLC is taxed as a partnership for federal income tax purposes. In the current year, Sara incurred legal fees of $10,000 to set up the LLC, and to provide the appropriate legal documents for the operation of the bakery. She also purchased $125,000 of equipment used in the bakery. Because the bakery was only open for 2 months during the current year, Sara will report a loss from operations. However, she expects the bakery to be profitable in 3 years. Sara’s LLC has 14 full time employees including herself and 2 part-time employees that are provided with a group health insurance plan. Which of the following statements is (are) CORRECT?
- Sara’s company will be required to provide continuation of coverage under COBRA.
- If instead Sara chooses to depreciate the equipment using MACRS, the half-year convention will apply to all of the personal property.
- If Sara establishes a profit-sharing plan for the business, she can exclude part-time employees from the plan as long as the employees work less than 1,000 hours during the year.
- If Sara implements an entity buy-sell agreement, the LLC would own the policy on Sara’s life, and would be allowed a deduction for premiums paid, as long as Sara is an employee for the business.
3 only
The business would not be required to provide continuation coverage under COBRA because it has less than 20 employees. Sara placed her equipment in service during the last quarter of the year so the mid-quarter convention will apply. Part-time employees working less than 1,000 hours can be excluded from qualified plan participation. The LLC would own the policy, but the premiums will not be deductible.
You are a CFP® professional and are meeting with your client Brenda to monitor her ongoing financial status. Brenda owns a vacation home in New Mexico. She rented the property to others for the entire year, except for 10 days during the summer when she and her family used it for their vacation. The gross rental income that Brenda received is $65,000. Her rental expenses total $5,000. Brenda would like you to explain how this will change her income tax situation, in particular, how much of the rental expenses are deductible. After reviewing the documents she sent to you prior to the meeting, you have an answer for Brenda. How much of a deduction for rental expenses can Brenda take on her tax return? A) $4,863. B) $4,721. C) $3,411. D) $5,000.
A
Brenda can deduct the cost of renting the home if she occupies it for the greater of no more than 14 days per year or for 10% of the number of days the property is rented. Because Brenda occupied the house for only 10 days during the year, this test is satisfied. Even though this rental use exception is allowed, the deductible expenses related to the rental of the house are limited. Specifically, she can only deduct a portion of the actual rental expenses, which equals the number of days during the year that the house is rented to others, divided by the total number of days that the house is used by either tenants or Brenda. Given 365 days per year, Brenda’s tenants occupy the house all but 10 days, for a total of 355 days. She is allowed to deduct 97.26% (355 days ÷ 365 days) of the $5,000 rental expenses, which equals $4,863. (Domain 7 Monitoring the Recommendations)
Kate was recently diagnosed with a terminal illness and was certified by her doctor on June 1 of the current year as terminally ill and expected to die within 24 months. On July 1 of the current year, Kate sold her life insurance policy with a face value of $500,000 to a viatical settlement provider for $340,000. Assuming she had paid $50,000 in premiums, how much of the $340,000 proceeds must Kate include in her gross income for the current year?
A) $0. B) $290,000. C) $50,000. D) $340,000.
A
If the insured is terminally ill (expected to die within 24 months), proceeds received from a viatical settlement by the insured are not taxable.
Tom was involved in an automobile accident that damaged his 1963 mint condition Chevy Corvette. Tom recently purchased the car for $36,000. Damages are estimated to be $20,000. Because Tom only intended to use the vehicle for special occasions, he did not fully insure it. The insurance company paid $5,000 towards the damages. Tom’s adjusted gross income is $62,000. What amount can Tom deduct for the loss on his federal income tax return?
A) $8,700. B) $0. C) $8,800. D) $15,000.
A
Individual casualty losses on property not used for business are deductible only to the extent that the casualty loss exceeds $100 and 10% of the taxpayer’s adjusted gross income. The casualty loss deduction is the lesser of the asset’s basis or decrease in FMV. In this situation, the decrease in value is less than the basis of the asset. The calculation is: (Loss − insurance reimbursement − $100 in 2017 − 10% of AGI) or ($20,000 − $5,000 − $100 − $6,200) = $8,700
Brenda, age 32, an employee of ABC Co., had an adjusted gross income of $100,000 this tax year. She incurred a variety of qualified medical expenses during the year totaling $20,000. In addition, her health insurance premiums were $2,000 for the year paid through a Section 125 plan through her employer. Brenda’s health insurer reimbursed her for $18,000 of her medical bills. How much of a deduction for medical expenses would Brenda be allowed in this tax year?
A) $500. B) $0. C) $2,000. D) $10,000.
B
Medical expenses are deductible only to the extent they exceed 10% of AGI, which in this case equals $10,000. The total deductible medical expenses for the year are $20,000 less any insurance recovery. Because the insurance premiums she paid were from pre-tax dollars, they are not deductible (you cannot deduct from income items which were paid for using pre-tax dollars). Brenda’s total qualified medical expenses for the year are $2,000 ($20,000 − $18,000 reimbursement from the health insurer). The deductible amount is $0, because Brenda’s qualified medical expenses for the year do not exceed 10% of her AGI ($10,000).
ABC, Inc., is an S corporation. Bill and Diane are married and the sole owners of ABC. They are 2 of the 20 employees of the firm. ABC provides each of its employees $50,000 of group term life insurance coverage. The premiums on what total amount of insurance coverage are taxable to Bill and Diane? A) $0. B) $100,000. C) $75,000. D) $50,000.
B
Fringe benefits are not deductible by an S corporation and the benefits are not tax free for the greater than 2% shareholders. Rather, the cost of coverage for both policies is taxable to Bill and Diane.
Joseph, age 54 and single, earns a salary of $180,000 working for a manufacturing company. He is an avid saver, and over the years has amassed an investment portfolio of $2 million. He expects the portfolio to appreciate in value at an average rate of 8% per year. Last year he received $40,000 in dividends and interest from the portfolio. After speaking with a financial planner, Joseph decided to invest $30,000 in the current year to purchase a 15% interest in a passive activity. Operations of the activity resulted in a loss of $300,000, of which Joseph’s share was $45,000. How is Joseph’s loss for the current year treated for income tax purposes?
A)
$30,000 is suspended under the at-risk rules, and $15,000 is suspended under the passive loss rules limits.
B)
$15,000 is suspended under the at-risk rules, and $30,000 is suspended under the passive loss rules limits.
C)
$45,000 is suspended under the passive loss rules limits.
D)
$45,000 is suspended under the at-risk rules.
B
The at-risk rules must be applied before the passive loss rules limits. Under the at-risk rules, a taxpayer may only deduct losses to the extent of his amount at risk. Passive losses may only be deducted against passive income. Joseph has invested $30,000 in the passive activity. Therefore, his at-risk amount is $30,000. His share of the loss from the activity is $45,000, so he will be allowed to deduct only $30,000, his amount at-risk. Also, $15,000 of the loss ($45,000 less $30,000 deductible under the at-risk rules) has been suspended (disallowed) because of the at-risk rules and must be carried forward. Even though Joseph has a $30,000 loss after applying the at-risk rules, he will not be allowed a deduction for the $30,000 loss because he has no passive income. Therefore, $30,000 ($30,000 loss deductible under the at-risk rules less $0 loss deductible under the passive loss rules limits) of the loss has been suspended (disallowed) under the passive loss rules limits and must be carried forward.
Ron has 3 separate passive activities and has an at-risk amount in excess of $100,000 for each. During the year, the activities produced the following income (losses):
First activity ($40,000) Second activity ($20,000) Third activity $15,000 Net passive loss ($45,000) Ron's suspended losses are as follows:
A)
$22,500 to activity 1; $22,500 to activity 2.
B)
$0 to activity 1; $0 to activity 2.
C)
$40,000 to activity 1; $20,000 to activity 2.
D)
$30,000 to activity 1; $15,000 to activity 2.
D
($40,000 ÷ $60,000) × $45,000 = $30,000 to activity 1.
($20,000 ÷ $60,000) × $45,000 = $15,000 to activity 2.
Losses are allocated on their percentage of the total loss.
A calendar-year taxpayer made the following charitable contributions in the current year:
Basis Fair Market Value Cash to church $5,000 $5,000 Unimproved land to the city of Kenner, Louisiana
$40,000 $70,000 The land had been held as an investment and was acquired 5 years ago. Shortly after receipt, the city of Kenner sold the land for $90,000. If the taxpayer's adjusted gross income (AGI) for the current year is $120,000, the taxpayer's allowable charitable contribution deduction is:
D
The charitable contribution deduction for long-term capital gain property is limited to 30% of AGI or, here, $36,000 ($120,000 × 0.30). Calculation: $5,000 (cash) + $36,000 (30% × $120,000) = $41,000. The carryover to the next 5 years is $34,000 [$70,000 (FMV of the land) − $36,000 (deduction allowed for the current year)]. If the reduced deduction election is made, the deduction becomes $45,000 [$5,000 (cash) + $40,000 (basis of land)] but does not carry over.
Max is the sole shareholder in the ABC Corporation. This year, ABC has accumulated earnings and profits of $40,000. Max's basis for the stock he owns in the company is $7,000. ABC makes a distribution of $60,000 to Max. How much of this distribution is taxable to Max as a capital gain? A) $13,000. B) $20,000. C) $7,000. D) $0.
A
Earnings and profits of the corporation are considered to be the first source of the distribution and are considered dividends. The first $40,000 is treated as a dividend. From the remaining $20,000, Max deducts his tax-free return of basis of $7,000. The net amount remaining of $13,000 will be treated as a capital gain.
Thomas previously named his wife, Kim, the beneficiary of a $120,000 (face amount) insurance policy on his life. The policy provided that upon his death, the proceeds would be paid to Kim with interest over her remaining life expectancy (which was calculated at 20 years). Thomas has now died, and Kim has begun receiving a regular annual payment of $15,000 from the insurance company. How much of each payment must Kim include in her gross income each year? A) $9,000. B) $0. C) $6,000. D) $15,000.
A
Expected proceeds over life = $15,000 × 20 years = $300,000
Inclusion ratio = (proceeds − basis) ÷ expected proceeds
= ($300,000 − 120,000) ÷ 300,000
= 60%
Annual payment of: $15,000 × 60% for inclusion = $9,000
Barry files jointly with his spouse as MFJ for federal income tax purposes and has the following gains and losses this year:
Short-term gain (STG) = $5,000.
Short-term loss (STL) = $12,000.
Long-term gain (LTG) = $10,000.
Long-term loss (LTL) = $17,000.
What is the amount and character of the gain or loss that Barry will realize and recognize this year? (Realize; recognize) A) $14,000 loss; $0. B) $14,000 loss; $3,000 LTL. C) $14,000 loss; $14,000 LTL. D) $14,000 loss; $3,000 STL.
D
Barry will realize a $7,000 long-term loss and a $7,000 short-term loss, but he will get to recognize only $3,000 of the short-term loss this year. He will carry forward a $4,000 short-term capital loss and a $7,000 long-term capital loss.
