Reading...
Play button
Play button
Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
96 Cards in this Set
- Front
- Back
|
Susan Everhardt is a single taxpayer with one child. Susan worked in maintenance during the year and reports adjusted gross income of $14,000. She had to pay exactly $1,000 this year to have her child taken care of so that she could be employed. What is the amount of child care credit that she is allowed as a reduction to her income taxes for the period?
|
For one child, a taxpayer can utilize up to $3,000 of child care payments as long as they were needed for employment.For two or more children, the taxpayers can utilize up to $6,000 of their payments as long as they were needed for employment. Although the taxpayers here paid $7,000, the credit is only based on $6,000. The amount of the credit depends on the taxpayers adjusted gross income. At very low levels, $15,000 or less, the credit is 35 percent. That rate is reduced gradually to 20 percent at over $44,000 in adjusted gross income. The Bowlings have adjusted gross income above $44,000 and must use 20 percent. The credit that they can take to reduce their income tax is $1,200 ($6,000 times 20 percent).
|
|
|
The Hope Scholarship credit is nonrefundable. That term means that the credit cannot be larger than the amount of income tax. If a taxpayer has income taxes of $200 but a Hope Scholarship credit of $290, the extra $90 does not generate a refund to the taxpayer. Which of the following income tax credits is refundable? It can generate a refund even if no tax payments have been made by the taxpayer.
A Lifetime learning credit B Credit for adoption expenses C Earned income credit D Child and dependent care credit |
Under normal circumstances, income tax credits are nonrefundable. The taxpayer can use them to reduce income taxes to zero but cannot use them to create credits. One major exception to that rule does exist: the earned income credit. This credit is designed to provide benefit to low-income workers who have wages or salaries (and, in most cases, a qualifying child). Because the purpose is to benefit workers with low income, the earned income credit was designed to be refundable; the benefit is available regardless of the amount of income tax that is owed.
|
|
|
Jason and Elena Kordosky have two children, both of whom are dependents for tax purposes. Their son Robert is a freshman at State University and their daughter Amanda is a senior at Tech College. The Kordoskys paid $9,000 in tuition and related educational costs for each of their children. Which credits can they take?
|
The Kordoskys can take Hope Scholarship credit for Robert and the lifetime learning credit for Amanda.
This money was paid for the education costs of the taxpayers or their dependents so the Kordoskys are eligible for these education credits. However, both credits cannot be taken for any one student. In addition, the Hope Scholarship credit is only available for the first two years of post-secondary education. Consequently, the money spent for Amanda cannot be used for that credit. Only the lifetime learning credit is available for her costs. Robert is in his first year at college. Therefore, in connection with his costs, they may take either the Hope Scholarship credit or the lifetime learning credit. |
|
|
Ms. Polly Atkini collects $1,000 in dividends from a company located in Italy. A foreign tax of $93 was withheld on this income by the local authorities. Ms. Atkini is attempting to determine the impact of this foreign tax when she is filing her United States income tax return for this year. Which of the following is correct?
A The foreign tax cannot be taken as either an itemized deduction or as a tax credit. B The foreign tax must be taken as an itemized deduction. C The foreign tax must be taken as a tax credit. D The foreign tax can be taken as a tax credit or as an itemized deduction. |
The payment of a foreign income tax is one of the few items in federal income tax rules that an item can be used at either of two places. Normally, the benefit is larger if a credit is taken but the taxpayer is also allowed the option of using the amount as an itemized deduction.
|
|
|
Jim and Wanda had been married for several years but separated on January 1, Year One. Jim gave Wanda $10,000 to live on at that time. They were granted a legal decree of separation on March 1, Year One and were divorced on December 1, Year One. According to the separation decree, Jim was to pay Wanda $3,000 per month with 1/3 of that amount designated to support their daughter Stephanie. According to the divorce agreement, Jim was to pay Wanda $5,000 per month with half of that to support Stephanie. The payments for Stephanie will cease when she turns 21 and the payments to Wanda will cease at her death or remarriage. All payments were made in a timely fashion. At the time of the divorce, Jim gave Wanda cash of $90,000 and an automobile valued at $20,000 as a final property settlement. What is the tax effect to Jim of these payments?
|
Alimony is taxable income for the recipient but it is also a deduction to arrive at adjusted gross income for the party making the payment. To qualify as alimony, cash must be paid to a spouse (or for the benefit of the spouse) after a legal decree of separate maintenance or after the couple is divorced. The $10,000 payment made here before the decree is not considered alimony and is not deductible. The child support is also not alimony and not deductible. Any money paid as a property settlement is not viewed as alimony. Here, the deductible alimony for Jim is 9 payments (March 1 to December 1) where $2,000 (or 2/3) is alimony and one payment (December) where $2,500 (or 1/2) is alimony. That is a total of $20,500 (nine times $2,000 plus $2,500).
|
|
|
Harland Parker deposits $10,000 in a savings account. He is supposed to leave the money there for one year and will receive $11,000. He is forced to take the money out of the account early. The interest on the day of withdrawal was computed as $710. However, he was charged a penalty of $200 because of the early withdrawal and only received $10,510. What should be reported?
|
He should report interest revenue of $710 and a deduction for adjusted gross income of $200.
|
|
|
Mary Sue Weatherburn filed her tax return for Year One and took the standardized deduction. Within the required monetary limits, which of the following cannot be used to reduce her taxable income?
A Qualified expenses paid as an educator B Costs paid for child care so that taxpayer could be employed. C Interest incurred on a student loan D Qualified moving costs from Texas to Idaho that related to her job |
Taxpayers are allowed to take a number of costs as deductions in arriving at adjusted gross income. These deductions are allowed regardless of whether the taxpayer uses the standard deduction or takes itemized deductions. They include (within various monetary limits) qualified educator expenses, interest on student loans, qualified moving expenses that are job related, alimony paid, contributions to traditional IRA plans, and any penalty paid on the early withdrawal of money from a savings account. Money paid for child care so that the taxpayer can be employed is a tax credit that reduces the taxpayers income tax rather than a deduction in arriving at adjusted gross income.
|
|
|
What are the two categories of capital assets for individual taxpayers?
|
Personal and investment
Capital assets for individual taxpayers are personal property such as household furniture and tools and investment property (such as real estate and securities such as stocks and bonds). |
|
|
Which of the following statements is true with respect to capital assets for individual taxpayers?
A Gains and losses for both investment and personal property are reported on schedule D of the form 1040. B The taxpayer must report gains and losses on investment property, but only reports gains on personal property. C Losses on personal property are deductible only to the extent of gains on personal property D Losses on investment property are deductible only to the extent of gains on investment property |
The correct answer was B.
Taxpayers must report gains and losses on investment property (such as their investment stocks and bonds) but only gains on personal property are reported. For example, if a taxpayer sells personal furniture at a gain, that capital gain must be reported. However, if the same personal property is sold at a loss, no deduction is allowed. |
|
|
Bob Gibson purchased 2,000 shares of IBC Corporation three years ago for $32 per share. The shares are currently at $11 per share on the stock market. Bob sells all of these stock on February 1 and then repurchases the same number of shares on February 22 for $11.50. What is the amount of gain/loss to be reported on Bobs tax return for this year?
|
The correct answer was A.
Taxpayers cannot sell capital assets to create losses to offset capital gains if they, in essence, replace the capital asset. This is referred to as a wash sale and occurs when, substantially identical securities are bought within 30 days either before or after the date of the sale or disposal. Here, the taxpayer bought the same shares within 30 days of the sale. This is a wash sale and the taxpayer cannot deduct the loss. The taxpayer does not have a loss because the taxpayer still holds the same shares. Gains on stocks sold under the same scenario are fully taxable. |
|
|
Maggie Miranda had the following transactions during last year: $36,000 short-term capital loss, $15,000 long-term capital loss, $25,000 short-term capital gain and $ 22,000 long-term capital gain. What is the impact on taxable income for this year?
|
A net capital loss of up to $3,000 is deductible against ordinary income each year. Because it is an individual taxpayer, the remaining $1,000 loss is carried forward indefinitely to impact future capital gain and loss computations.
There is a net $11,000 short term capital loss ($36,000 minus $25,000) and a net $7,000 long term capital gain ($22,000 minus $15,000). The $11,000 loss and the $7,000 gain net to a $4,000 loss which is short-term because $11,000 is larger than $7,000. |
|
|
Tom Metty sold property to his son in a transaction that was viewed as a related party transactions for income tax purposes. Which is true regarding related party transactions?
|
Because of the potential for abuse that would be available on transactions between related parties, gains are taxed but losses are not deductible. Thus, if Tom has a gain on the transaction with his son, it must be repeated. However, if a loss occurs as a result of this transaction, no deduction is allowed.
|
|
|
Three years ago, Abbey Hoffman loaned $19,000 to her brother-in-law Tom Osborne. Tom signed a note and promised to make monthly payments including interest at a 6 percent annual rate. Tom never paid her any of this money and she had recognized no revenue from this loan. During the current year, Tom admitted to Abbey that he is never going to repay her. What is the tax effect for Abbey?
|
Non-business bad debts are written-off in the year the loan is deemed worthless and is categorized as short-term irrespective of the time period involved. The foregone interest is not deductible. Therefore, she will report a $19,000 short-term capital loss in the current year.
|
|
|
JayJ Conover incurred a non-business bad debt of $9,700 in the current tax year. The loan had been outstanding for 13 months but was now viewed as completely worthless. Which of the following statements are true in connection with the individual's income tax return/
A All $9,700 is a short-term capital loss. B All $9,700 is a long-term capital loss. C It is a short-term capital loss of $3,000 and a long-term capital loss of the remaining $6,700. D It is a long term capital loss of $3,000 and a short term capital loss of $6,700. |
Non-business bad debts are deductible as short term capital losses on Schedule D of the form 1040 in the year the debt becomes worthless. Such losses are treated as short-term capitales loss no matter how long the debt was outstanding.
|
|
|
Ramona gave Abigail three acres land which she had purchased eight years ago for $23,000. The fair value of the land on the date of the gift was $42,000. Shortly thereafter, Abigail sells the land for $39,000. What is the tax basis of the land to determine the gain or loss on this sale?
|
The basis of a gift received is the basis in the hands of the gift giver. In this case, that is the original cost of $23,000. There is a significant exception although it does not apply here. When a gift received is sold for less than the basis in the hands of the previous owner, the seller will use the lower of that basis or the fair value at the date of the gift as the basis. That limits the amount of loss that can be deducted by the seller. If the sales price is more than the fair value at the date of the gift but less the original owner's basis, no gain or loss at all is reported.
|
|
|
Susan McKenzie inherited 500 shares of a stock with a market value of $40 per share from her aunt. The aunts basis in the stock was $22 per share. What amount of income should McKenzie report on her income statement as a result of this conveyance?
|
The value of assets received through inheritance is not reportable on an income tax return as income for the simple reason that inheriting assets is not earning income. The property will have a tax basis equal to the fair value of the assets on the date of death. However, the executor of the estate may choose an alternate valuation date which is 6 months from the date of death (or the date of conveyance, if earlier).
|
|
|
Simon Garfinkel is a single taxpayer who incurred a $19,000 short-term capital loss during the most recent tax year. In addition, he had a $2,000 long-term capital gain. What is the impact on his taxable income for this year?
|
The short-term capital loss and the long-term capital gain must be netted to arrive at a single $17,000 loss. Because the short-term number is larger in an absolute sense, this amount is viewed as a net short-term loss. Individual taxpayer can deduct capital losses but only up to $3,000 per year. Any remaining loss can be carried over indefinitely.
|
|
|
Mr. Jones had a net short-term capital gain in Year One of $18,000. By coincidence, Ms. Smith had a net long-term capital gain of $18,000 in that same year. Without consideration for these capital gains, both taxpayers had taxable income amounts of $100,000. They are both single taxpayers. Which of the following statements is true?
A In connection with the capital gains, the two taxpayers will pay the same amounts. B In connection with the capital gains, Mr. Jones will pay more taxes than Ms. Smith. C In connection with the capital gains, Ms. Smith will pay more taxes than Mr. Jones. D From the information provided, it is impossible to tell which party will pay the most income taxes. |
The correct answer was B.
Net short-term capital gains are taxed at ordinary income rates. Net long-term capital gains are taxed at lower rates. The specific rate depends on the income level of the taxpayer. Net long-term capital gains receive this tax advantage to encourage investors to buy capital assets and hold them for longer than one year. |
|
|
J. R. Jackson received cash dividends of $3,000 this year. The tax information provided by the company indicated that these were qualified dividends. Which of the following statements is true?
A The dividends are tax-free because they are viewed as a return of capital to the owner. B These dividends are taxed at the lower rate that is applicable for net long-term capital gains. C These dividends must have been received by a foreign corporation. D Unless the stock was held for more than a year, these dividends would be taxed at the rate applicable to short-term capital gains. |
The correct answer was B.
Qualified dividends are those dividends collected from a US domestic corporation or a qualified foreign corporation. To encourage investments in these companies, the dividends are taxed at the same reduced rate that applies to long-term capital gains. |
|
|
Mr. Albertson operates a business as a sole proprietorship. In Year One, he trades one of his depreciable assets with a tax basis of $32,000 and a fair value of $37,000 to another company for an asset that qualifies as being like-kind. This new asset has a fair value of $39,000. To even out the trade, Mr. Albertson also had to pay cash of $2,000. What is his tax basis for the new asset and what gain must he report on the exchange?
|
Because this trade was of like-kind property and no boot (cash) was received, no taxable gain or loss is recognized. Because no gain or loss is recognized, the taxpayer retains the tax basis given up. Mr. Albertson exchanged property with a tax-basis of $32,000 and cash with a tax-basis of $2,000. The tax-basis of the new property is that same total tax basis or $34,000.
|
|
|
Nancy Stuart operates a business as a sole proprietorship. In Year One, she trades one of her depreciable assets with a tax basis of $25,000 and a fair value of $34,000 to another company for an asset that does not qualify as being like-kind. This new asset has a fair value of $36,000. To even out the trade, Stuart also had to pay cash of $2,000. What is her tax basis for the new asset and what gain must she report on the exchange for tax purposes?
|
Because the trade was not of like-kind property, the basis of the property given up is removed ($25,000 plus $2,000 or $27,000 in total) and the asset received is recorded at its fair value ($36,000). The difference in the new tax basis ($36,000) and the tax basis given up ($27,000) is recorded as a gain on the exchange.
|
|
|
Jan Livingston passed away on February 1, Year One. In her will, she left securities and her investments that had cost her $11,000 to her nephew Ron. The fair value of these securities at the date of death was $15,000. However, the securities were only worth $14,000 when conveyed to Ron on June 9, Year One. The executor to the estate chose the alternative valuation date. The value of the securities on August 1, Year One, was $13,000. Ron held the securities until March 3, Year Two, and sold them for $17,000. What gain should Ron report in Year Two as a result of this sale?
|
The basis of inherited property is normally its fair value at the date of the previous owners death. However, the executor to the estate has the right to choose an alternative date for valuation purposes. That is the date of conveyance or six months after death, whichever comes first. Because Ron received these securities prior to the six-month date, the value of $14,000 when received is used. For income tax purposes, the gain is $3,000 ($17,000 sales price less $14,000 tax basis).
|
|
|
Abigal Van Jones owned a large building with a tax basis of $700,000 but had an estimated fair value of $820,000. The property was condemned by the state government so that the building could be torn down to make way for a new highway. She was paid the fair value for the property. In a short period of time, she used $800,000 of this money to buy property that qualified as replacement property. The other $20,000 was invested in State of Idaho bonds. What gain, if any, should she recognize on this condemnation of this building?
|
When property is condemned, destroyed, or stolen, it is viewed as an involuntary conversion. If the owner receives an amount below the tax basis, a loss must be recognized for the difference. However, in this case, the owner received $120,000 more than the tax basis. Because the sale was not intended but was created by an involuntary conversion, the gain that is reported for tax purposes is this $120,000 gain or the amount of the proceeds left over after similar replacement property is acquired. Although $820,000 was received, only $800,000 was used for the replacement property. The $20,000 that is left is less than the $120,000 gain and must be reported for tax purposes.
|
|
|
Horace Turner owned a building with an income tax basis of $400,000 but with an estimated fair value of $510,000. The property was condemned by the local government so that the property could be used for a landfill. To avoid litigation, the government paid him $530,000. He used $360,000 of this money to buy property that qualified as replacement property. What gain, if any, should she recognize on this condemnation of this building?
|
When property is condemned, destroyed, or stolen, it is viewed as an involuntary conversion. If the owner receives an amount below the tax basis, a loss must be recognized for the difference. In this case, the owner collected $130,000 in excess of the tax basis. Because the sale was not intended but was created by an involuntary conversion, the gain that is reported for tax purposes is this $130,000 gain or the amount of the proceeds remaining after similar property is acquired as a replacement. Although $530,000 was received, only $360,000 was used for the replacement property. The $170,000 in cash that is left is more than the $130,000 gain. As the lower figure, the $130,000 is Turners taxable gain.
|
|
|
Alison Long owns securities with a tax basis of $3,000. She gives them to Ned Simmons when they are worth only $2,100. Simmons held these securities until they were worth $3,400 and sold them. What amount of gain does he have to report on this sale?
|
When property that has been received as a gift is sold above the previous owners tax basis, the difference is the gain on the sale. Simmons sold the property for $3,400 which is $400 more than the basis to Long of $3,000. That difference is the gain that Simmons must report.
|
|
|
Candy Valentine owns securities with a tax basis of $5,000. She gives them to Bill Wallace when they are worth $6,100. He holds them but they begin to fall in value. He finally sells them for $5,200. What is the impact on taxable income that he must report on this sale?
|
When property that has been received as a gift is sold above the previous owners tax basis, the difference is the gain on the sale. Wallace sold the property for $5,200 which is $200 more than the basis to Valentine of $5,000. That $200 difference is the gain that Wallace must report.
|
|
|
Thomas Hightower owns securities with a tax basis of $6,000. He gives them to Selma Alexander when they are worth $6,400. She holds them but they begin to fall in value and are finally sold for $5,200. What is the impact on taxable income that she must report on this sale?
|
When property that has been received as a gift is sold below the previous owners tax basis, a loss must be computed by comparing the amount received with the lower of the previous owners basis or the fair value at the date of gift. In this problem, the previous basis was $6,000 and the fair value at the time of the conveyance was $6,400. Consequently, the $5,200 is compared to the $6,000 (because it is lower than $6,400) and a loss of $800 is recognized for income tax purposes.
|
|
|
Billy Bob Lowdermilk owns securities with a tax basis of $8,000. He gives them to Jamie Orwell when they are worth $7,100. She holds them and they begin to climb slowly in value. She eventually sells them for $7,800. What is the impact on taxable income that she must report on this sale?
|
Zero
|
|
|
Carmen DiAnno is filing her income tax return for Year One. She has a number of different revenues and wants to determine their impact on the amount of tax she will have to pay. Which of the following income items is taxed at the ordinary income tax rate?
A Interest is received from bonds issued by the City of Atlanta, Georgia. B Qualified dividends are received from a large computer software company based in California. C She has a long-term capital gain of $11,000 and a short-term capital loss of $10,000. D She has a short-term capital gain of $7,000 and a long-term capital loss of $3,000. |
The correct answer was D.
Capital gains rates are lower than ordinary income rates and they are applied to net long-term capital gains (where the long-term gains are larger than any net short-term capital loss) as well as to qualified dividend revenue. The interest from the bonds issued by the City of Atlanta is tax free. Municipal and state bond interest is tax free to stimulate investor interest. The net short-term capital gain ($7,000 gain less $3,000 loss) is taxed at ordinary income rates. The government wants to encourage investors to hold bonds longer than one year. Thus, a net long-term capital gain is taxed at a lower rate but a net short-term gain is not. |
|
|
In Year One, James Hayes owned a valuable pocket watch. It had a tax basis of $12,000 but a fair value of $23,000. The pocket watch was stolen and never recovered. The insurance company settled his claim with the payment of $20,000. He immediately took this money and another $1,000 of his own money and bought a replacement pocket watch for $21,000. In Year Two, he sold this second pocket watch for $24,000 in cash. What is the impact of these transactions from an income tax perspective?
|
The original asset was converted into cash but that event was not based on the intent of the taxpayer. Thus, the Year One transactions fall under the heading of an involuntary conversion. If a loss had occurred, it would have been reported as a casualty loss reported within the itemized deductions. However, a gain took place since the taxpayer received more than the tax basis for the original pocket watch. By buying a replacement and using all of the received funds, that gain is deferred (because it resulted from an involuntary conversion). In Year Two, the second watch is sold and the gains must be recognized. The taxpayer had paid a total of $13,000 ($12,000 for the first watch and an additional $1,000 for the second) and received $24,000. The $11,000 difference is a gain to be recognized in Year Two when the watch is sold to the outside party.
|
|
|
Mr. and Mrs. Pigg live in a brick house for 24 months. Then, for the next 24 months, they live in a traditional wood house. Then, for the next 12 months, they live in a contemporary house made of stone. At that time, they sell the brick house with a tax basis of $300,000 and receive $420,000. After another 12 months, they sell the traditional wood house. It had a tax basis of $400,000 and is sold for $490,000. What of the following statements is true? A The gain on both the brick house and the traditional wood house are taxable because they were not serving as their principal residence at the time of sale.
B The gain on one of the two houses can be tax free but not the gain on both. C The gain on both of these houses is tax free because the total is less than $500,000. D The gain on the traditional wood house can be tax free but the gain on the brick house cannot be tax free. |
They can exclude one gain but not both.
A gain on a house can be tax free up to $500,000 on a joint return and $250,000 on a single return but certain rules must be met. First, the house must have served as the principal residence for the taxpayers in at least two of the previous five years. Both the brick house and the traditional wood house meet this requirement. Second, this exclusion can only be taken once every two years. Since the brick house and the traditional wooden house were sold 12 months apart, it is not possible to exclude both gains. |
|
|
Estelle Adams bought some securities on January 6, Year One for $140,000. Unfortunately, she then died on October 19, Year One when these investments were worth $175,000. Her final will left these securities to her nephew John. The securities were valued at $158,000 on April 19, Year Two but had risen to a value of $164,000 on May 23, Year Two when physically conveyed to him. The executor of Estelle Adams’s estate opted to use the alternative valuation date. John held these securities until December of Year Two and sold them for $160,000. What is his tax effect for that year?
|
When property is received by inheritance, the tax basis is usually the fair value at death. An exception does exist; the executor of the estate can choose an alternative date for valuation purposes. That is six months after death unless the property is conveyed to the beneficiary prior to that date. In this problem, the alternative was picked but the property was not given to John until later. Thus, the tax basis is the value of these securities on April 19, Year Two, six months after death. That gives John a tax basis of $158,000. The investments are then sold for $160,000 so that a gain of $2,000 must be recognized.
|
|
|
Jane Rembrandt is an accountant. She accepted shares of a client's common stock in lieu of payment for services rendered. The stock had a fair value of $8,000. The value of services rendered was $9,000. After receipt, the stock appreciated and Jane sold the stock for $8,600. All of these transactions occurred in the same year. What is the type and amount of income reported by Jane?
|
The fair value of the stock received for the work done is ordinary income for the taxpayer. Even though the value of the services was $9,000, she accepted something worth $8,000 so that is the amount of ordinary income as well as the tax basis for the stock. When the stock is then sold for $8,600, Jane will have a $600 capital gain.
|
|
|
Julia sold her stock in ABC Company to her sister Hannah for $30,000. Julia's tax basis in this investment was $33,000. Sixteen months later, Hannah sold the stock to an unrelated third party for $32,000 in cash. What is the income tax effect of Hannah's sale?
|
The first transaction results in a disallowed loss of $3,000 ($30,000 less $33,000) because the investment was sold to a related party. The second transaction was to an unrelated party and results in a gain of $2,000 ($32,000 less $30,000). The disallowed loss of $3,000 can then be used to reduce this gain for tax purposes to zero. However, a disallowed loss of this type cannot be used to create a taxable loss. Therefore, although the loss of $3,000 is greater than the eventual gain of $2,000, it can only reduce the gain to zero. That is its limit.
|
|
|
Silas Wykowski receives 20 shares of stock from a friend as a gift. These shares had originally cost the friend $400 but were only worth $300 when the conveyance to Silas was made. The stock was held for some time and then sold for $280. What is the income tax effect recognized by Silas Wykowski?
|
There is no income tax effect when a gift is made. A gift tax might have to be paid if the amount is large but this is a small gift. If the value then goes down, the owner can recognize a loss when sold. That loss is the difference in what was received and the lower of the tax basis to the previous owner (usually original cost) and the fair value at the date of the gift. Here, that fair value when conveyed ($300) is less. So, the tax loss is this $300 less the $280 sales price or $20.
|
|
|
The Oregon Company has a large donut maker used in its business which has a tax basis of $14,000 but a fair value of $11,000. It is exchanged for a new donut maker worth $10,000. Oregon also collected $1,000 in cash to even up the trade. What is the tax basis to Oregon of the new donut maker after the trade?
|
In a like-kind exchange, the taxable gain is the lower of the gain on the trade or the cash (boot) received. Here, the gain is actually a loss of $3,000 so no gain is recognized. The loss is the tax basis given up ($14,000) less the fair value received ($11,000 or $10,000 plus $1,000). So, if Oregon is given up a tax basis of $14,000 and no gain is recognized, the items received must have a tax basis of that same $14,000. The cash has to have a tax basis of $1,000. That leaves $13,000 as the remaining tax basis for the new donut-maker.
|
|
|
Walters owns land with a tax basis of $125,000 but a value of $160,000. This land is traded for like-kind land with a value of $150,000. To even up the trade, cash of $10,000 is also conveyed to Walters. What taxable gain should Walters report on the exchange in filing his federal income taxes?
|
Normally, the exchange of like-kind property is tax free. However, Walters also received boot (the $10,000 in cash) that was not like-kind. The receipt of boot changes the rule. Then, the taxable gain is the lower of the boot ($10,000) or the exchange gain. The exchange gain is the difference in the fair value received ($150,000 plus $10,000 or $160,000) and its tax basis ($125,000). The exchange gain is $35,000 ($160,000 less $125,000). That is more than the cash collected so the lower number (the $10,000 in cash) is the taxable gain.
|
|
|
Mr. and Mrs. Archibald Taylor are filing their income tax return for the current year. They have short-term capital losses of $10,000 and long-term capital losses of $20,000. What is the income tax effect?
|
For individual taxpayers filing a joint return, $3,000 in capital losses can be deducted each year. Short-term losses are deducted first. The remaining amounts can be carried forward indefinitely. In the carryover process, short-term losses remain short-term and long-term losses remain long-term. Corporate rules are quite different for capital gains and losses.
|
|
|
Walker Ambrose owns three acres of land in Tennessee with a cost of $70,000 and a fair value of $110,000. The state of Tennessee condemns the land and takes ownership so that a road can be built through the property. The state pays Ambrose $114,000 for the land it took. Ambrose takes this money and buys similar land four miles away for $111,000. What is the tax effect of these events?
|
This is an involuntary conversion since the property was sold without the owner’s consent. More money was received then the tax basis of this property so there was a gain of $44,000 ($114,000 less $70,000). Part of the money was then used to buy similar replacement property. In an involuntary conversion, the taxable gain is the lower of the actual gain on the transaction ($44,000) or the money left over after the replacement ($3,000 or $114,000 less $111,000). Thus, if all of the money is used in buying a replacement, there is no taxable gain. Here, $3,000 was left and that was less than the $44,000 gain.
|
|
|
Alex opened a repair garage to fix cars owned by his neighbors. He rented space and purchased equipment and tools. Although he did generate revenues, Alex experienced a loss during each of the first two years of operations. His expenses have exceeded his revenue and he has been using his personal credit cards to pay his bills. Which of the following statements is true?
A Alex must make a profit in each of the next three years or will be presumed to be engaged in a hobby rather than a business so that the losses cannot be deducted. B Alex is not subject to hobby loss rules if his business is incorporated as an S corporation C Because no profits have been made, Alex cannot immediately utilize the losses but must carry them forward indefinitely to reduce future profits from the same venture. D Even if this business is judged to be a hobby, losses are still deductible because the garage does generate revenues. |
The correct answer was A.
Hobby loss rules apply to individuals, S corporations, partnerships, estates, and trusts that are attributable to an activity not engaged in for profit. Taxpayers are presumed to be engaged in a hobby if the operation fails to earn a profit in any three of the most recent five years including the tax year in question. Losses from a business can be used to reduce other income but expenses related to a hobby are deductible only to the extent of revenues earned. |
|
|
Ann received the following cash payments during the year: Partnership income: $15,000, Interest on certificate of deposit: $800, Alimony: $12,000, Child support: $8,000, Life insurance collected when her mother died: $50,000. Ann will receive the alimony payments until she remarries. What is the amount that would be included in taxable income?
|
Ann received the following cash payments during the year: Partnership income: $15,000, Interest on certificate of deposit: $800, Alimony: $12,000, Child support: $8,000, Life insurance collected when her mother died: $50,000. Ann will receive the alimony payments until she remarries. What is the amount that would be included in taxable income?
|
|
|
Mary received the following amounts during the year: Wages: $40,000, Child care reimbursement from her employer: $10,000, Group-term life insurance premium on coverage equal to her salary ($40,000): $ 2,100, Unemployment compensation: $ 7,200. Mary receives the child care reimbursement and group life insurance as part of her employers cafeteria plan. What amount is included in Marys gross income?
|
Wages are includible in gross income. Cafeteria plans provide options from which employees choose their coverage. Benefits received under a cafeteria plan are not taxable unless received in cash. Therefore, child care reimbursements are included because Mary received the cash but not group-term life insurance premiums for coverage up to $50,000 of benefit. The cost of group-term life insurance above $50,000 is taxable. Unemployment compensation benefits are included as taxable income.
|
|
|
What is the total amount of the following that are included in gross income: employer-provided health insurance premiums of $6,000 and debts forgiven of $21,000?
|
Employer-provided health insurance is not included in income. That is viewed by the government as a taxfree fringe benefit. However, debt forgiven by an employer is viewed as the same as a cash payment to the employee and is taxable income. Other items included in income are breach of contract damages, compensation for services, jury duty fees and unemployment compensation.. Other items that would be excluded include gifts and inheritance and workers compensation. None of these final three are viewed as compensation for work done.
|
|
|
What amount from the following items are not included in gross income in determining an individual's taxable income: Unemployment compensation of $8,800 and Workers compensation benefits.of $24,000?
|
According to current tax laws, unemployment compensation benefits are included in taxable income but workers compensation benefits are not. Other items that would be included in taxable income are breach of contract damages, compensation for services, debts forgiven and jury duty fees. Employer-provided health insurance, gifts, and inheritances are all examples of other items that are excluded from net income because they are clearly not earned income.
|
|
|
Martha had 1,000 shares of common stock in XYZ Corporation for which she paid $37 per share. The company distributed a 5% common stock dividend to all holders of common stock. The fair market value of the stock on date of distribution was $63. With respect to this dividend, how much must be included in Marthas gross income?
|
Common stock dividends on common stock are not taxable. The cost of the original shares must be spread over the new shares because that is the taxpayer's actual cost. The gain or loss on the stock will be included on the tax return when the stock is eventually sold. There is an exception, though. Stock dividends are taxable if the taxpayer has the right to choose cash instead of the stock.
|
|
|
Maggie had 1,000 shares of common stock in XYZ Corporation for which she paid $25 per share. The company distributed one share of preferred stock for each 20 shares of common stock held by an owner. The fair market value of the preferred stock was $75. With respect to this dividend, how much should be included in her gross income?
|
Stock dividends are not taxable as long as the new shares are the same type as the previous shares. However, preferred stock dividends issued on common stock are taxable because the stocks are different. The taxable amount is the fair market value per share times the number of shares issued. In this case, there are 50 additional shares of stock being issued to the taxpayer and the market value is $75. Therefore, $3,750 is the amount included in income and also becomes the cost basis for the preferred shares.
|
|
|
Andy s employer provides life insurance equal to each employees annual salary under a qualified plan. Andy makes $60,000 per year. How much of the premium paid by the employer is taxable to Andy?
|
If the employer offers life insurance as part of a qualified plan, the premium on the first $50,000 of coverage is not includable in the employees gross income. That amount is viewed as a nontaxable fringe benefit. However, the employer must include in the employee's wages the amount of premium attributable to the life insurance coverage in excess of $50,000. Here, that is the cost of the last $10,000 ($60,000 salary minus $50,000 limit).
|
|
|
Group term life insurance is provided to all the employees of the ABC Corporation. The CEO of the company has a policy with a benefit of $95,000. The annual premium on this policy is $8.50 per thousand. What is the taxable income for the CEO?
|
Employer provided group-term life insurance with benefits up to $50,000 is a tax-free benefit. When the benefit exceeds this amount, the premium on the amount of the policy over the limit is taxable to the recipient. Here, the excess benefit is $45,000 so the taxable amount is $382.50. That is 45 thousands times $8.50 per thousand.
|
|
|
Jacks employer offers benefits to its employees using a cafeteria plan. Employees are able to choose between cash and nontaxable benefits. Jack chooses to receive only the health insurance, the value of which is $350 per month and opts to receive cash instead of the life insurance. The cash value of the life insurance is $1,100 per year. How much must Jack include in gross income?
|
Normally, employees who have the option of receiving benefits or cash are deemed to have constructive receipt of the money and must include the amount of cash or benefit no matter which option is chosen. An exception to this rule is provided under the rules for cafeteria plans. Employees are only required to include the cash received in lieu of benefits that are offered under these plans. Employees are not required to include the value of benefits received as part of a cafeteria plan. Thus, the value of the health insurance is not viewed as taxable.
|
|
|
Bart McHenry likes to gamble and has won money during several period of the year but lost money during other periods. What are the tax consequences of these gains and losses?
|
Winnings from gambling activities are reported within the income of the taxpayer. Losses are shown as miscellaneous itemized deductions. However, the losses deducted cannot exceed the amount of gambling winnings being reported.
|
|
|
Which of the following can never qualify as tax exempt income for an individual who is filing a federal income tax return?
A Interest on United States treasury bonds B Interest on United States Series EE bonds C Interest on state bonds D Interest on bonds issued by a town to finance its school system. |
Interest revenue on United States treasury bonds is taxable on a federal income tax tax return. Interest revenue on US Series EE bonds is tax exempt but only when it meets specific rules: the bonds must have been purchased by the taxpayer who was over 24 years old and the proceeds must be used to pay college costs for taxpayer, spouse or a dependent. Interest revenue on state and municipal bonds are always tax free on a federal return.
|
|
|
Ben is a limited partner in three different partnerships. Two of the partnerships lost money and one was profitable: Partnership A: loss of $2,000, Partnership B: profit of $3,300, Partnership C: loss of $4,100. What is the amount of deductible loss on Bens individual tax return as a passive loss?
|
Passive activity losses are not deductible on an income tax return.
They are carried over and used to offset passive income in the future until used up. A passive activity is a business in which the taxpayer serves as an owner but does not materially participate in the operation. Rental activities and limited partnerships are also included in this category, regardless of the owner's participation. |
|
|
Dr. Al-Matine practices medicine in the City of Walzone. This year she performed medical services on a local carpenter and charged him the normal fee of $3,000. He could not pay the entire amount so they agreed that he would pay her cash of $200 and also build her a new bookcase. The bookcase cost the carpenter $700 but had a fair value of $1,100. When Dr. Al-Matine files her income taxes for the year, what amount should be included for the work done on the carpenter?
|
Under normal situations, revenue reported for tax purposes is equal to the value of the items actually received. Here, the doctor received cash of $200 and a book case valued at $1,100 for a total earned income of $1,300.
|
|
|
Horace Fife is a 20 percent partner of a local convenience store although he does not actively participate in its operations. This year he was allocated a loss from this business of $24,000. He also owns shares of several publicly held companies and received dividends this year of $17,000. Fife owns two rental houses. During the year, their revenues totaled to $40,000 and operating expenses were $30,000. Finally, Fife held a share of a limited partnership and reported income this year of $4,000 as a result of that ownership. What is the increase in Fife's adjusted gross income as a result of all these investments?
|
All of these income items except for the $17,000 in dividends are passive activities. Passive activity gains and losses are netted together. A net gain is taxable. A net passive loss cannot be deducted but can be carried over into future years. Here, there is a passive activity loss of $10,000: $24,000 loss on the business where Fife is not an active participant, $10,000 income from rental property, and $4,000 income from limited partnership. That loss is not deducted but is carried forward.
|
|
|
Wyman Jones is employed during the day and had a salary this year of $49,000. During the evening, he runs a small business that he operates as a sole proprietorship. He made profits during his first three years of operation but had a net loss this year of $4,000. He also received $2,000 in unemployment compensation when he was out of work early in the year. He also received interest revenue of $5,000 from US bonds. What is his total income to be reported for income tax purposes?
|
The salary, the unemployment compensation, and the US bond interest are all taxable and should be included. The loss can be deducted as long as it does not exceed the amount that Jones has personally at risk in this business. Because the business has been profitable for three years, it is likely that he has a sufficient at-risk balance to absorb the loss. Thus, total income is $49,000 less $4,000 plus $2,000 plus $5,000 or $52,000.
|
|
|
Stephanie Plum buys a tract of land with a small house on it. The house sits vacant for several months but finally, on December 1, Year One, she rents the property to Mr. Lance for one year. The rental charge is $1,000 per month and he pays for the entire year in advance on that date. At the end of December, Ms. Plum is beginning to prepare her income tax return for Year One. How much of this rental income should she include in her Year One return?
|
The normal rule is that if a taxpayer receives an asset as revenue, it is immediately taxable unless it is likely that it will have to be returned. She received $12,000 in Year One and that amount is taxable at that time.Mr. Lucky wins $2,000 from gambling in Year One. Unfortunately, he also loses $2,700 in other gambling activities. Mr. Lucky is single and has no dependents. He plans to take the standard deduction. What is the impact of his gambling activities on his taxable income for Year One?
|
|
|
Mr. Lucky wins $2,000 from gambling in Year One. Unfortunately, he also loses $2,700 in other gambling activities. Mr. Lucky is single and has no dependents. He plans to take the standard deduction. What is the impact of his gambling activities on his taxable income for Year One?
|
The winnings from gambling activities are reported as taxable income. Loses are shown separately as miscellaneous itemized deductions. However, Mr. Lucky is taking the standard deduction rather than itemizing his deductions. Therefore, the losses have no impact. Only the winnings appear on the tax return for this year.
|
|
|
Sal Graziano began to buy US Series EE bonds when he got a new job at the age of 29. A number of years later, he cashed in bonds that had cost him $11,000 and received $17,000. He used this money to pay the tuition for his daughter when she started college as a freshman. His daughter was still his dependent for tax purposes. Without including these bonds, his taxable income was $64,000. What amount of income did Graziano have to report on his federal income tax return in connection with the redemption of these bonds?
|
When several requirements are met, interest earned on Series EE bonds is tax free. Graziano has met these requirements. He was over 24 when the bonds were acquired. When converted into cash, the money was used to pay the college costs for himself, his spouse, or a dependent. Finally, his taxable income was not extremely high. This law was created primarily to encourage parents to save money to pay for the cost of college for their children.
|
|
|
Mark Johnson had earned income this year of $68,000. In addition, he also received $4,000 in social security benefits. What is his total taxable income for the period?
|
At low income levels, social security benefits payments are tax free. However, when the taxpayer has a reasonably high income level (such as Johnson has in this case), social security is 85 percent taxable. Thus, Johnson has to pay tax on 85 percent of $4,000 or $3,400. There is a relatively small transitional level of income where 50 percent of social security is taxable.
|
|
|
Sonya Wilson returns to college to earn a Ph. D. which will enable her to do research in chemistry. The tuition for the first year is $19,000 but she receives a scholarship of $12,000 to offset part of that cost. In return, she must teach two introductory classes in chemistry to freshmen students. What is the impact on her taxable income as a result of this scholarship?
|
Scholarships that cover part or all of college tuition (and course related costs) are tax free. However, scholarships become taxable income if the recipient is not seeking a degree. The scholarships are also taxable if the person is required to perform work in exchange. Her Ms. Wilson is required to teach which is certainly work. Therefore, for tax purposes, the $12,000 is not viewed as a scholarship but as payment for work done and is, thus, taxable income.
|
|
|
Patrice Giambanco entered and won the combination for Citizen of the Year in her hometown based on a number of good deeds that she had done. She was awarded a prize of $1,000 in cash. In addition, without any action on her part, she was named one of the top poets in the country and won another $3,000 in cash. What amount of this money will increase her taxable income?
|
Prizes and awards are viewed as taxable income. This handling is not impacted by the efforts of the recipient to win. Thus, Ms. Giambanco must report both of these awards within her taxable income.
|
|
|
James and Joyce had been married for 12 years but separated on January 1, Year One when Joyce moved into an apartment. James gave Joyce $5,000 to live on at that time. They were granted a legal decree of separation on February 1, Year One and were divorced on December 1, Year One. According to the separation decree, James was to pay Joyce $3,000 per month with 1/3 of that amount designated to support their son Stephen. According to the divorce agreement, James was to pay Joyce $5,000 per month with half of that to support Stephen. The payments for Stephen will cease when he turns 21 and the payments to Joyce will cease at her death or remarriage. All payments were made in a timely fashion. At the time of the divorce, James gave Joyce cash of $110,000 as a final property settlement. What amount of these payments must be reported by Joyce in her taxable income?
|
Cash paid to a spouse (or for the benefit of the spouse) after a legal decree of separate maintenance or a divorce agreement is taxable alimony. The $5,000 payment made here before the decree is not considered alimony and is not taxable. The child support is also not alimony and is not taxable. Any money received as a property settlement is not taxable. Here, the taxable alimony is 10 payments (February 1 to December 1) where $2,000 (or 2/3) is alimony and one payment (December) where $2,500 (or 1/2) is alimony. That is a total of $22,500 (ten times $2,000 plus $2,500).
|
|
|
Ralph Sinclair owns several small houses that he rents. He files Schedule E of Form 1040 to report his revenues and expenses. In Year One, he generates revenues of $33,000 but has the following costs: depreciation of $6,000, interest on debt to buy property of $3,000, charitable contribution to school in neighborhood of $2,000, insurance of $5,000, and repair and maintenance of $1,000. What is his taxable income reported for the rental property?
|
All ordinary and necessary expenses to maintain and rent these houses can be taken as a deductible expense. This includes costs such as depreciation, interest, insurance, repair, and maintenance. Charitable contributions are not necessary for the operation of rental homes. However, that $2,000 donation can be included as an itemized deduction on Schedule A of Form 1040. On Schedule E, the revenue of $33,000 less ordinary and necessary expenses of $15,000 ($6,000 + $3,000 + $5,000 + $1,000) leaves income of $18,000.
|
|
|
Bob and Allie Katzenbach are both over 70 years old. They do not work but do earn interest on several certificates of deposit. In the current year, they earned interest of $19,500. They also collected $7,000 in social security benefits during the year. What is their taxable income before any deductions?
|
The taxpayers have taxable income that is relatively low. Thus, the social security benefits are not included. If their income was higher, 50 percent would have been taxable or, at higher levels of income, 85 percent is taxed.
|
|
|
In his spare time, Robert Granger operates a lawn care service. He owns several lawn mowers and purchased a small shed in which to keep them and his supplies. During Year One, he generated revenues of $11,000. He also spent $220 on a business license and $600 for gasoline, motor oil, and spark plugs. He had taken out a loan to allow him to buy his mowers. He paid $3,000 on the loan this year which included interest of $500. He paid for advertising in a local newspaper at a cost of $900 and he made a contribution of $300 to the local church. He also made an estimated tax payment on his federal taxes of $1,000. Depreciation on his lawn mowers and the shed were $1,200. Granger is currently filing his Form 1040 for the year. He is computing his net income on his sole proprietorship on Schedule C. What is the income from this business?
|
Expenses incurred in a business can be deducted if they are ordinary and necessary for that type of operation. For Grangers business, the following expenses meet both criteria: the business license ($220), gasoline and other supplies ($600), interest on the loan ($500), advertising ($900), and depreciation ($1,200). Federal income taxes are not deductible on a federal return. The contribution is not an ordinary and necessary business expense. Thus, it is not deductible on Schedule C but can be included as an itemized deduction by Granger.
|
|
|
Abigail Van Buren is completing her tax return for the current year. She has received income from several different sources: interest on US treasury bonds, $3,000; interest on state of Montana bonds, $4,000; cash gift from former boyfriend, $14,000; fee for serving on jury duty, $2,000; prize for being named citizen of the year in her town, $5,000; alimony payment from ex-spouse, $8,000; child support payment from ex-spouse, $9,000. What is the total amount that she should report on her federal individual tax return as income?
|
Federal income tax laws are specific in most cases as to what income is taxable and what is not. For the CPA Exam, there is usually a need to remember the proper tax handling for a list of relatively common items. The following items should be included in the taxpayer’s income: interest on US treasury bonds ($3,000), fee for serving on jury duty ($2,000), prizes ($5,000), and alimony as long as it qualifies as alimony and not as a gift or child support ($8,000). The total of taxable income is $18,000. The other items are not taxable for federal income tax purposes: state and municipal bond interest ($4,000), cash gifts although a gift tax payment might be required ($14,000), and child support ($9,000).
|
|
|
Dave and Dyan are married and had interest income on a bank savings account of $4,000, interest on federal treasury bonds of $3,400, interest on their state income tax refund of $400, and interest of $1,500 on New York City bonds. What is the amount includible in the couple's taxable income?
|
The interest from the savings account, federal bonds, and federal income tax return are all taxable. Municipal bond interest is not taxable.
|
|
|
Which of the following is not taxable as dividend income?
A Cash dividend on life insurance policy B Cash dividend on stock in ABC Corporation C Dividend on mutual fund which was reinvested in more stock and not sent to the taxpayer D Dividend taken in new shares of stock where owner had chose of taking cash |
Cash dividends from corporations and mutual funds are taxable even if they are reinvested. Dividends in a company's own stock are usually taxfree unless the owner also had the option of taking cash instead. Dividends on a life insurance policy are not taxable; they are treated as a reduction in the expense of the policy.
|
|
|
Which of the following is not a condition that must be met for the accumulated interest received on United States Series EE Savings bonds to be viewed as tax exempt?
A Bonds must have been issued after December 31, 1989. B The purchaser must be the sole owner (or a joint owner with spouse). C Proceeds must be used to pay the tuition and fees incurred by the taxpayer, spouse, or dependent to attend college, university, or vocational school. D Bonds must list the name of the eventual recipient of the proceeds. |
The correct answer was D.
According to federal income tax laws, in order to qualify for tax exemption of accumulated interest on EE bonds, the bonds must be issued after December 31, 1989, be purchased by the sole (or joint owner) and the buyer must be at least 24 years old when bonds are purchased. The proceeds of the bonds must be used to pay the higher education tuition and fees for taxpayer, spouse or dependent. The bond will indicate the name of the owner but not the eventual recipient of the proceeds. |
|
|
Winston Albertson is an attorney who performs legal services for H & A Partnership during the current year. Near the end of the year, Albertson presents an invoice to H & A for $60,000 but offers to accept an immediate cash payment of $52,000. He is offered $2,000 in cash and an 8 percent interest in the partnership which has a value of $44,000 as payment in full. He accepts the offer. What is the impact on his taxable income for that year?
|
For tax purposes, when work is done and an asset is received as payment other than cash, the assumption is that the fair value of this asset has been earned. Here, the fair value of the interest in the partnership is $44,000 and that should be recognized as taxable income by the taxpayer. The taxpayer also receives $2,000 in cash so the total amount earned is $46,000.
|
|
|
Joannie McKenzie is a single taxpayer. She incurs the following medical expenses for the current year: Medical insurance premiums: $2,000, Doctors' appointments: $800, Eyeglasses: $900, Handicapped ramp installation which does not increase the value of her home: $2,810, Home health nurse: $16,000, Dentist: $580, Nonprescription medicine for heartburn and migraines: $120, Liposuction: $21,000, Cost of mileage for medical appointments: $54. The taxpayer is single and has an adjusted gross income of: $82,000. What is the amount of her medical deduction on Schedule A of form 1040?
|
Surgery that is only cosmetic in nature (liposuction) and nonprescription medicine (such as for heartburn and migraines) are not deductible for income tax purposes. Mileage for health care is deductible at the medical mileage rate in effect at the time. The medical ramp is deductible if medically necessary. All the rest of the items listed are deductible. The actual deduction is the amount that exceeds 7.5% of adjusted gross income. The total of these deductible expenses is $23,144 and 7.5% of AGI is $6,150. Therefore, the deductible amount for medical expenses on Schedule A of the Form 1040 is $16,994.
|
|
|
Which of the following does not qualify as a miscellaneous itemized deduction on the Schedule A of Form 1040 if the total exceeds 2 percent of adjusted gross income?
A Cost of business suits required to meet dress code at work. B Tax preparation fees C Job-hunting expenses D Fees incurred for tax litigation |
The cost of a business suit is not deductible even if it is required to comply with a dress code because such clothing can be worn outside the workplace. Tax preparation fees and job hunting expense as well as fees incurred for tax litigation are all 2 percent miscellaneous itemized deductions. If the total exceeds 2 percent of adjusted gross income, that excess is included as an itemized deduction.
|
|
|
Which of the following can be taken as an itemized deduction in the tax year that it is paid?
A Points paid to refinance an existing mortgage B Points paid on a home equity loan used to add a swimming pool C Points paid on a home equity loan used to purchase a boat D Prepaid mortgage interest |
To be deductible, points must be paid to secure a home equity or home acquisition loan . If the points are on the original mortgage or the purpose of the loan is to make improvements to the property, the points can be deducted in the year paid. Otherwise, the points must be amortized and deducted over the life of the loan. Thus, points paid simply to refinance an existing mortgage must be amortized over the life of the loan. Points paid on a home equity loan used to improve the property (such as by adding a swimming pool) are deductible when paid. Points paid on home equity loan where the proceeds are not used for home improvements must be amortized over the life of the loan. Prepayments of mortgage interest are required to be matched with the tax years to which the interest applies.
|
|
|
Billy and Maria Willingham live in South Dakota with their daughter Jaime (who provides over half of her own support). The Willinghams also have twin sons (Mark and Zachary) who live in South Dakota. Mark and Zach have an income this year of approximately $10,000 each but the Willinghams continue to provide over half of their support. Mark is their dependent because he is a full-time student. Zach is not a dependent because he is not a full-time student. During the year, the Willinghams paid the following medical expenses for their children: Jaime $1,000, Mark $2,000, and Zachary $4,000. What amount of these costs can they include when determining their itemized deductions?
|
To determine itemized deductions, a taxpayer includes medical and dental costs incurred for the taxpayer and spouse as well as any dependents (such as Mark). In addition, medical and dental expenses paid for a person who would have been a dependent except for the income test can also be listed. Thus, the amount paid for Zachary is also added. The cost of the medical care for Jaime is not included because she is not a dependent because the Willinghams do not meet the support test. The amount of medical and dental expenses (before subtracting 7 1/2 percent of adjusted gross income) is $6,000 ($2,000 plus $4,000).
|
|
|
Ben and Amanda Jonsen live in a state that assesses a tax on income. For Year One, they paid $7,000 in connection with the state income tax. However, this state also has a general sales tax. The Jonsens are trying to determine how these two taxes affect their income taxes for the year.
|
The Jonsens can include either the state income tax or the state general sales tax as an itemized deduction but not both.
|
|
|
Arthur Heyman borrows $320,000 on a loan that carries a 10 percent annual interest rate. He invests that money in stocks and bonds. During the current year, he generates net investment income of $29,000. In addition, he earns another $7,000 in interest from state of New Hampshire bonds. What amount can Heyman include as interest expense in determining his itemized deductions for the current year?
|
Interest expense is a deductible expense when money is borrowed to make investments. The amount of the deduction is limited to the net investment income. Income that is tax-free is not included in that maximum limitation. Where the income is tax free, related expenses are not usually deductible. The total interest expense incurred is $32,000 (10 percent of $320,000). However, because net investment income is $29,000, the amount of that interest expense to be included as an itemized deduction is only $29,000.
|
|
|
On November 1, Year One, Dr. I. M. Rich donates 1,000 shares of Company X to a qualified charity. The stock had been bought on March 1, Year One for only $11 per share. Mr. Rich is now attempting to figure out the tax consequences of this gift
|
Because these shares were not held by the taxpayer for more than one year, any gain or loss on a sale would have been short-term for tax purposes. The government wants to encourage investors to hold securities for one year or more so the tax advantages associated with capital assets are only for those designated as long-term. If a long-term capital asset is donated to a qualified charity, the itemized deduction is based on the fair value of the item. However, if there has been appreciation of value, no gain has to be reported for tax purposes. The deduction is larger without the need for reporting any gain. This tax advantage is not available for these short-term capital assets. The deduction is the lesser of the cost or fair value of the gift.
|
|
|
On November 1, Year One, Dr. I. M. Rich donates 1,000 shares of Company X to a qualified charity. The stock had been bought on March 1, Year One for only $11 per share. Mr. Rich is now attempting to figure out the tax consequences of this gift.
|
Because these shares were not held by the taxpayer for more than one year, any gain or loss on a sale would have been short-term for tax purposes. The government wants to encourage investors to hold securities for one year or more so the tax advantages associated with capital assets are only for those designated as long-term. If a long-term capital asset is donated to a qualified charity, the itemized deduction is based on the fair value of the item. However, if there has been appreciation of value, no gain has to be reported for tax purposes. The deduction is larger without the need for reporting any gain. This tax advantage is not available for these short-term capital assets. The deduction is the lesser of the cost or fair value of the gift.
|
|
|
Benjamin Lee owns a large truck that he drives for his own personal use. The truck has a tax basis of $59,000 but a fair value of $64,000. As a result of a sudden hail storm, the truck is severely damaged so that its value drops to $37,000. His insurance company only pays him $16,000 because of several deductible clauses in the contract. Mr. Lee uses that money to repair the truck but it only has a value of $57,000 thereafter. If Mr. Lee has adjusted gross income of $50,000, what amount of this casualty loss can be included on his income tax return as an itemized deduction? Assume that he had no other casualties during the year.
|
A casualty loss is one caused by theft, vandalism, fire, storm, or similar causes, and boat, car, and other accidents. It also includes loss caused by the insolvency or bankruptcy of a financial institution. The loss is the lower of the tax basis of the property ($59,000) or the drop in value ($27,000 or $64,000 dropping to $37,000). Thus, the casualty loss is $27,000. That amount is then reduced by any insurance payment to arrive at the actual loss incurred ($11,000 or $27,000 less $16,000). Each casualty loss must then be reduced by $100 and all of the casualty losses combined must be further reduced by 10 percent of adjusted gross income. The deduction here is $11,000 less $100 and also less $5,000 (10 percent of $50,000) or $5,900.
|
|
|
Jennifer Lyndon owns a large truck that she drives for her own personal use. The truck has a tax basis of $39,000 but a fair value of $45,000. As a result of a sudden hail storm, the truck is severely damaged so that its value drops to $2,000. Her insurance company only pays $26,000 because of several deductible clauses in the contract. She spends this money and another $3,000 of her own money to repair the truck but it only has a value of $35,000 thereafter. If Ms. Lyndon has adjusted gross income of $60,000, what amount of this casualty loss can be included on her income tax return as an itemized deduction? Assume she had no other casualties during this tax year.
|
A casualty loss is one that is caused by theft, vandalism, fire, storm, or similar causes, and boat, car, and other accidents. It also includes a loss caused by the insolvency or bankruptcy of a financial institution. The loss is the lower of the tax basis of the property ($39,000) or the drop in value ($43,000 or $45,000 dropping to $2,000). Thus, the casualty loss for tax purposes is $39,000. That amount is then reduced by any insurance payment to arrive at the actual loss incurred ($13,000 or $39,000 less $26,000). Each casualty loss must then be reduced by $100 and all of the casualty losses combined must be further reduced by 10 percent of adjusted gross income. The deduction here is $13,000 less $100 and also less $6,000 (10 percent of $60,000) or $6,900.
|
|
|
Roberto Manzela made the following contributions to a qualified charity: Land with a tax basis of $4,000 and a fair value of $16,000 and shares of stock with a tax basis of $6,000 and fair value of $9,000. Both assets had been held for several years. The taxpayer's adjusted gross income is $60,000. What is the limit on the amount that can be claimed as an itemized deduction?
|
Individual taxpayers can deduct the fair value of contributions made to qualified charities. For long-term capital gain property, the amount of the deduction is limited to 30 percent of adjusted gross income. Here, that would be 30 percent of $60,000 or $18,000. The limitation is 50 percent of adjusted gross income if the amount of the gain is not included. Here, though, using this exception would lead to a smaller deduction.
|
|
|
Simon Verzales made several contributions to a qualified charity. Land (which had been held for four years) with a tax basis of $4,000 and a fair value of $9,000 was donated to a church. Cash of $6,000 was given to a university. Household goods with a cost of $900 and fair value of $250 were given to a hospital. The taxpayer's adjusted gross income is $50,000. What amount can Simon include within itemized deductions as charitable contribution for the year?
|
Simon Verzales can deduct all of the $6,000 cash and the $250 fair value for the household goods. Long-term capital gain property is deductible at fair value if this amount does not exceed 30 percent of adjusted gross income (or $15,000). Thus, the entire $9,000 value of the land can be included as an itemized deduciton for a total of $15,250 ($6,000 plus $250 plus $9,000).
|
|
|
Anna and Jim have been separated for two years as of December 31, Year One. They have never obtained a separate maintenance agreement or filed for divorce. They have two children who live full time with Anna and qualify as dependents. What filing status must Anna use?
|
For individual income tax purposes, filing status is determined by examining the taxpayer's marital status as of December 31 of the tax year. Taxpayers who are married as of the end of the year and do not have a separate maintence agreement must file either a joint return or each must file as married but filing separately. Anna may not file head of household, even though she maintains a home for dependent children, because she is not legally separated.
|
|
|
Which of the following statements is true with respect to filing status in connection with an individual tax return?
A Taxpayers who meet the requirements for qualifying widow(er) status may choose to file as head of household. B Taxpayers who file as head of household get the same standard deduction as single filers but are taxed at a lower rate. C Taxpayers who file joint returns are taxed at the same rate as individuals who file as head of household, but the standard deduction is higher D Single taxpayers pay a higher tax rate than individuals who file as head of household or joint filers. They also have the lowest standard deduction of the three. |
Taxpayers who meet the requirements for qualifying widow(er) may not file as head of household. Head of household is taxed at lower tax rate than single filers but at a higher rate than joint filers. Head of household also gets a higher standard deduction than single filers but lower than joint filers. Single taxpayers pay the highest tax rate of the three and have the lowest standard deduction.
|
|
|
David and Dyan were married on December 31, Year One. Throughout Year One, they each had their own personal residences and qualified dependents. They combined the two families and moved into a new residence after the marriage. What is the correct filing status for Year One?
|
Filing status is determined as of December 31 of the tax year in question. Daivd and Dyan are married as of the end of Year One. Therefore, their choices are married filing jointly or married filing separate. They may not file as head of household. Head of household is for single filers who maintain a home for an unmarried child or dependent relative. These taxpayers are married.
|
|
|
JayZ and Vonda have been married for a number of years and file a joint tax return. They provide over half of the support for several children who are single. Their daughter Jane is 17 and made $9,000 during the current tax year but is not in school. Their son Theodore is 20 and made $9,000 and is not in school. Their daughter Nanci is 23 and made $9,000 and is in school full-time. Their son Franklin is 25 and made $9,000 and is in school full-time. How many of these four children can they claim as dependents for income tax purposes?
|
Normally, as long as a couple provides over half of the support for their children and the children do not file a joint return, they can claim the children as dependents. However, dependents cannot make too much income (this limit changes each year but it in the $3,400 to $4,000 range currently). The income requirement does not apply to children if they are under 19 or if they are under 24 and in school full-time for at least five months of the year. The first child is under 19 so the income is not an issue. The second child is not under 19 and not in school so the income prohibits them from taking him as a dependent. The third child is under 24 and in school full-time so the income is not a problem. The fourth child is 24 or older and the level of income keeps them from taking him as a dependent. Only the first and third children qualify.
|
|
|
Abbey and Ben have several people who lived with them during the latest tax year. Which of the following individuals qualifies as their dependent?
A The 19 year old daughter of a friend who lives with the taxpayers while attending college from September through May. She lives free of charge and pays no expenses. B The taxpayers 24 year old son who only lives with the taxpayers during the summer months and holidays. The rest of the year he is a college student and makes $12,000 per year in salary. C The taxpayers 20 year old married daughter whos husband is away on military duty. The daughter will file a joint return with her husband D The taxpayers 12 year old daughter who attends boarding school during the year. |
The daughter of the friend is not a dependent because she is not a blood relative and she did not live with the taxpayer for the entire year. The 24 year old son made too much money even if it he is a student because he is 24 or older. The daughter is married and will file a joint return with her husband. This precludes her from being a dependent on her parent's tax return. The younger daughter is a blood relative who is considered to have lived with her parents for the entire year even though she attends boarding school.
|
|
|
Suzie Benson is 20 and a full-time college student throughout the year. She is single and her parents provide over half of her support. She did make $8,000 this year in a summer job. Which of the following statements is true?
A Because of her level of income, she cannot be taken by her parents as a dependent. B She must file an income tax return but is not entitled to any personal exemption amount. C As long as she is a full-time student, her age is not relevant to whether her parents can take her as a dependent. D If she qualifies as a dependent for her parents, she does not need to file a tax return herself. |
Ms. Benson has earned income over a minimum amount and must file an income tax return. However, because she is under 24 and a full-time student for at least five months of the year, her income is not important. She can be taken as a dependent by her parents who provided a majority of her support. Because she is being taken as a dependent by another party, when she files her own return, she does not get any reduction in connection with a personal exemption amount.
|
|
|
In Year One, Sarah Scott earned income of $60,000 and paid income taxes in a timely fashion of $19,000. In Year Two, Scott had earned income of $68,000 and her total income tax was $23,000. She had made timely quarterly payments during the year that amounted to $20,000. In connection to the possibility that she is subject to a penalty for underpaying her income taxes in Year Two, which of the following statements is true?
A She has no penalty because she paid more than her tax for the previous year. B She has a penalty because she paid only 87 percent of her current income tax. C She has no penalty because she paid 87 percent of her current income tax. D She has a penalty because she owes over $2,500 at the end of the year. |
Unless a taxpayer has a high level of income, the penalty can be avoided by paying an amount equal to or greater than 100 percent of the tax in the previous year or 90 percent of the taxes due for the current year. Although Scott did not pay 90 percent of the current tax of $23,000, she did pay more than her tax for the previous year. If either limit is met, there is no penalty for underpayment during the year.
|
|
|
William Hitchcock is 76 years old but still files an income tax return because he works part-time at the local library. Which of the following is true?
A Because of his age, he receives an additional amount if he claims itemized deductions. B Because of his age, he receives an additional amount of personal exemptions. C Because of his age, the first $6,200 of his salary is nontaxable. D Because of his age, he receives an additional amount for his standard deduction. |
The tax laws provide a few tax benefits for the elderly. One of those is an increased level for the standard deduction. If Hitchcock does not itemize his deductions, he will take the standard deduction and he will be somewhat higher because of his age.
|
|
|
Isaac is 44 years old and lives alone. In the current year, he provided 90 percent of all support for his father Abraham who is a widower and lives in a retirement condominium owned by Isaac. Abraham made $9,300 doing odd jobs in the area. All of this money was put into a savings account. When Isaac files his income tax return, what is his filing status and how many exemptions is he entitled to take?
|
Single and one exemption
The father does not qualify as a dependent for Isaac because he has too much earned income this year. Because he is not a dependent, Isaac does not qualify as a head of household. Only an unmarried child living with the taxpayer can lead to head of household status without the child having to be a dependent. |
|
|
Mr. and Mrs. Alexander Torington have completed their income tax return for the current year. They are now determining whether they owe any additional tax based on the alternative minimum tax. They are trying to figure out what amounts should be added to their taxable income for alternative minimum tax computation purposes. Which of the following statements is not true?
A All interest expense that was deducted based on payments on home equity loans must be added to taxable income. B The entire amount of their personal exemptions deducted for tax purposes must be added back to taxable income. C All medical expenses deducted based on payments for the year must be added to taxable income. D The entire standard deduction (assuming that the taxpayers did not itemize their deductions) must be added back to taxable income. |
For the alternative minimum computation made by an individual taxpayer, certain tax advantages are added back to net income. These amounts include interest expense on home equity loans, personal exemptions, and the standard deduction. However, for medical expenses, the deduction is reduced but not eliminated entirely. Therefore, the amount added back is not necessarily the entire amount of the original deduction.
|
|
|
Mr. and Mrs. Ed Cobalt have one child, a daughter (Patti, age 22). She and her husband Paul (age 23) live with the Cobalts while they are in graduate school and are supported by them. Together, Patti and Paul had adjusted gross income of $7,000 from providing tutoring services and file a joint return. Mrs. Cobalts mother (Maggie) also lives with them and is supported by them. She is 74 and has $8,000 in interest revenue on bonds issued by a prominent business. Maggie has retained her Greek citizenship. The Cobalts file as a married couple filing a joint return. How many exemptions are they entitled to claim?
|
TWO
Mr. and Mrs. Cobalt get two exemptions because they file a joint tax return. The daughter and her husband do not qualify as dependents because they also filed a joint return. Even if they meet the requirements for dependency, filing the joint return eliminates that possibility. They are not entitled to take Maggie either because her income is too high. If the income is above the amount of a personal exemption (roughly $3,400 to $4,000 depending on inflation), the person cannot be taken unless exceptions are met (for children of a certain age that depends on whether they are in school). |
|
|
You own a CPA firm in a small town in Missouri. A couple come to you to prepare their tax return. They plan to claim a $10,000 payment for fixing up their house as a medical expense. You have explained that you do not feel that this claim will be allowed but they believe it is appropriate and want it to be included. Which of the following statements is true?A The return cannot be filed until you have determined whether the claim will be allowed or not.
B If you believe that there is at least a 33 percent chance that the deduction will be allowed if examined, then you should complete the return and include the expense. C The return belongs to these taxpayers and you should complete it as instructed. D If there is not at least a 51 percent chance of this deduction being allowed, you should refuse to take the engagement. |
When doing a tax return for a client, the CPA is not required to do any investigation and can rely on the information provided unless it appears to be incomplete, inconsistent, or inaccurate. If a question arises, the CPA can complete the return and take any position as long as it has a realistic possibility of being sustained. That has been defined as a one-third likelihood of success.
|
|
|
Alan Huffman is a CPA who does a lot of individual tax returns. A new client came to his office on March 4, Year Three asking Huffman to do the Year Two tax return. Huffman gathers the necessary information and several days later begins to work on the tax return. At that time, Huffman discovers that the client had taken a very large charitable contribution on his Year One but the gift was not deductible because the charity did not qualify. What is the appropriate action for Huffman to take?
A Tell the client that he will not take the job until there is documentation that this mistake has been corrected. B Because of the size of the error, he must contact the Internal Revenue Service to explain the situation. C Notify the new client that the deduction was not appropriate and that an amended return for Year One needs to be filed. D Because of his professional status, he must file an amended return to correct the Year One figures. |
The CPA has been hired to complete the Year Two tax return. The Year One tax return is the property of the client. The problem may well have been an innocent mistake. Huffman should advise the client that the deduction was not appropriate and an amended return needs to be filed as quickly as possible. If the client does not file the amended return to correct the problem, Huffman should consider resigning from the Year Two engagement. The CPA should not be associated with a party who files erroneous tax returns and refuses to correct them.
|
|
|
Mary, a single individual, has provided more than half of the support for the following three people. Her mother who lives in a nursing home and who earned $10,000 in social security and $2,000 in interest income. Her son who is 19 and a full-time student who received $20,000 in scholarship income. Her friend who has lived with her all year because is in the process of getting a divorce. The friend has no income and is not filing a joint return with her estranged husband. How many dependents can Mary include on her personal income tax return?
|
Three
The mother is a dependent because she earned such a low amount of income that was subject to taxation. The son is a dependent because he is under 24 and a full-time student so that the amount of income is not a factor. The friend is a dependent because she lives with Mary and does not file a joint return. There are five basic rules for being a dependent and these individuals meet the specific rules that appear to be in question for each of them. |
