Chapter I7 

1) For individuals, all deductible expenses must be classified as deductions for AGI or deductions from AGI.

Answer:  TRUE

Page Ref.:  I:7-2

Objective:  1

2) In 2013, medical expenses are deductible as a from AGI deduction to the extent that they exceed 7.5 percent of the taxpayer’s AGI.

Answer:  FALSE

Explanation:  Starting in 2013, the floor for medical expenses has increased to 10% of AGI (unless the taxpayer is 65 or older.

Page Ref.:  I:7-2

Objective:  1

3) Medical expenses paid on behalf of an individual who could be the taxpayer’s dependent except for the gross income or joint return tests are deductible as itemized deductions.

Answer:  TRUE

Page Ref.:  I:7-2

Objective:  1

4) Medical expenses incurred on behalf of children of divorced parents are deductible by the parent who pays the expenses but only if that parent also is entitled to the dependency exemption.

Answer:  FALSE

Explanation:  As long as one divorced parent qualifies to claim the dependency exemption under Sec. 152(e), the parent who pays medical expenses on behalf of the children may deduct the expenses.

Page Ref.:  I:7-2

Objective:  1

5) The definition of medical care includes preventative measures such as routine physical examinations.

Answer:  TRUE

Page Ref.:  I:7-3

Objective:  1

6) Due to stress on the job, taxpayer Charlie began to experience chest pains. In order to relax and relieve the pains, he and his spouse went on an ocean cruise. The cost of the cruise to alleviate this medical condition is tax deductible.

Answer:  FALSE

Page Ref.:  I:7-3; Example I:7-2

Objective:  1

7) Expenditures for a weight reduction program are deductible if recommended by a physician to treat a specific medical condition such as hypertension caused by excess weight.

Answer:  TRUE

Page Ref.:  I:7-3; Example I:7-3

Objective:  1

8) In order for a taxpayer to deduct a medical expense, the amount must be paid to a certified medical doctor (M.D.).

Answer:  FALSE

Explanation:  Taxpayers may deduct payments to a wide range of medical, dental, and other diagnostic and healing services.

Page Ref.:  I:7-3 and I:7-4

Objective:  1

9) Jeffrey, a T.V. news anchor, is concerned about the wrinkles around his eyes. Because it is job-related, the cost of a face lift to eliminate these wrinkles is a deductible medical expense.

Answer:  FALSE

Explanation:  Cosmetic surgery is not deductible unless such surgery is necessary to correct a deformity arising from a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease.

Page Ref.:  I:7-4

Objective:  1

10) Expenditures for long-term care insurance premiums qualify as a medical expense deduction subject to an annual limit based upon the age of an individual.

Answer:  TRUE

Page Ref.:  I:7-5

Objective:  1

11) Capital expenditures for medical care which permanently improve or better the taxpayer’s property are deductible to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.

Answer:  TRUE

Page Ref.:  I:7-5

Objective:  1

12) Expenditures incurred in removing structural barriers in the home of a physically handicapped individual are deductible only to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.

Answer:  FALSE

Explanation:  Such expenses are fully deductible subject to the 10% (7.5% for those 65 and older) limitation on all medical expenses.

Page Ref.:  I:7-5

Objective:  1

13) If the principal reason for a taxpayer’s presence in an institution is the need and availability of medical care, the entire cost of lodging and meals is considered qualified medical expenditures.

Answer:  TRUE

Page Ref.:  I:7-6

Objective:  1

14) A medical expense is generally deductible only in the year in which the expense is actually paid.

Answer:  TRUE

Page Ref.:  I:7-6

Objective:  1

15) If a prepayment is a requirement for the receipt of the medical care, the payment is deductible in the year paid rather than the year in which the care is rendered.

Answer:  TRUE

Page Ref.:  I:7-7

Objective:  1

16) If a medical expense reimbursement is received in a year after a deduction has been taken on a previous year’s return, the previous year’s return must be amended to eliminate the reimbursed expense.

Answer:  FALSE

Explanation:  The reimbursement should be included in gross income in the year received to the extent the taxpayer received a tax benefit in the year of payment.

Page Ref.:  I:7-7

Objective:  1

17) Assessments or fees imposed for specific privileges or services are not deductible as taxes.

Answer:  TRUE

Page Ref.:  I:7-9

Objective:  2

18) Foreign real property taxes and foreign income taxes are not deductible as itemized deductions.

Answer:  FALSE

Explanation:  Both are deductible as itemized deductions.

Page Ref.:  I:7-9

Objective:  2

19) A personal property tax based on the weight of the property is deductible.

Answer:  FALSE

Explanation:  In order to be deductible, a personal property tax must be ad valorem (based on value).

Page Ref.:  I:7-10

Objective:  2

20) Assessments made against real estate for the purpose of funding local improvements are not deductible in the year paid but rather should be added to the cost basis of the property.

Answer:  TRUE

Page Ref.:  I:7-11

Objective:  2

21) Self-employed individuals may deduct the full self-employment taxes paid as a for AGI deduction.

Answer:  FALSE

Explanation:  One-half of the self-employment tax is a deduction for AGI. 

Page Ref.:  I:7-12

Objective:  2

22) Finance charges on personal credit cards are considered interest and are, therefore, deductible.

Answer:  FALSE

Explanation:  The charge is a nondeductible personal expense.

Page Ref.:  I:7-12

Objective:  3

23) In general, the deductibility of interest depends on the purpose for which the indebtedness is incurred.

Answer:  TRUE

Page Ref.:  I:7-13

Objective:  3

24) Interest expense incurred in the taxpayer’s trade or business is deductible as a for AGI deduction without limitation if the taxpayer materially participates in the business.

Answer:  TRUE

Page Ref.:  I:7-14

Objective:  3

25) Investment interest expense which is disallowed because it exceeds the taxpayer’s net investment income may be carried over and treated as incurred in subsequent years.

Answer:  TRUE

Page Ref.:  I:7-14

Objective:  3

26) Investment interest includes interest expense incurred to purchase tax-exempt securities.

Answer:  FALSE

Page Ref.:  I:7-15

Objective:  3

27) Taxpayers may elect to include net capital gain as part of investment income.

Answer:  TRUE

Page Ref.:  I:7-15

Objective:  3

28) Taxpayers may not deduct interest expense on personal debt including credit card debt, car loans, and other consumer debt.

Answer:  TRUE

Page Ref.:  I:7-16

Objective:  3

29) Qualified residence interest consists of both acquisition indebtedness and home equity interest.

Answer:  TRUE

Page Ref.:  I:7-16

Objective:  3

30) Acquisition indebtedness for a personal residence includes debt incurred to substantially improve the residence.

Answer:  TRUE

Page Ref.:  I:7-16

Objective:  3

31) A taxpayer is allowed to deduct interest expense incurred on home equity indebtedness limited to the lesser of $100,000 or the home equity (FMV of the residence less the acquisition indebtedness).

Answer:  TRUE

Page Ref.:  I:7-17

Objective:  3

32) While points paid to purchase a residence are deductible as interest in the period paid, points associated with the refinancing of a residence must be amortized and deducted over the life of the loan.

Answer:  TRUE

Page Ref.:  I:7-17 and I:7-18

Objective:  3

33) Christopher, a cash basis taxpayer, borrows $1,000 from ABC Bank by issuing a 3-month note on December 1, 2013. Christopher receives $940 but must repay $1,000 on the due date. The amount of interest expense deductible in 2013 is $20.

Answer:  FALSE

Explanation:  He is cash basis and does not pay the interest until the following year.

Page Ref.:  I:7-20; Example I:7-22

Objective:  3

34) Charitable contributions made to individuals are deductible if the individuals can show extreme financial need.

Answer:  FALSE

Explanation:  Charitable contributions made directly to individuals are generally not deductible.

Page Ref.:  I:7-22

Objective:  4

35) For charitable contribution purposes, capital gain property includes property which, if sold, would produce a long-term capital gain.

Answer:  TRUE

Page Ref.:  I:7-23

Objective:  4

36) A charitable contribution deduction is allowed for the FMV of services rendered to a qualified charitable organization.

Answer:  FALSE

Explanation:  The taxpayer may deduct only the unreimbursed expenses incurred incident to rendering the services.

Page Ref.:  I:7-24

Objective:  4

37) A charitable contribution in excess of the deduction limit for one taxable year can be carried forward five years.

Answer:  TRUE

Page Ref.:  I:7-25

Objective:  4

38) If a taxpayer makes a charitable contribution to a university and in return receives the right to purchase tickets to athletic events, the taxpayer may deduct only 80% of the payment.

Answer:  TRUE

Page Ref.:  I:7-25

Objective:  4

39) Corporate charitable deductions are limited to 10% of the corporation’s taxable income for the year.

Answer:  TRUE

Page Ref.:  I:7-26

Objective:  4

40) Legal fees for drafting a will are generally deductible.

Answer:  FALSE

Explanation:  To be deductible, such fees must deal with tax-related items.

Page Ref.:  I:7-29

Objective:  6

41) Van pays the following medical expenses this year:

•    $1,500 for doctor bills for Van’s son who is claimed as a dependent by Van’s former spouse.

•    $300 for Van’s eyeglasses.

•    $900 for Van’s dental work.

•    $3,800 for Van’s face lift. Van, a newscaster, is worried about the wrinkles around his eyes.

How much can Van include on his return as qualified medical expenses before limitation?

A) $1,200

B) $2,400

C) $2,700

D) $6,500

Answer:  C

Explanation:  C) ($1,500 + $300 + $900) = $2,700

Page Ref.:  I:7-2 through I:7-4

Objective:  1

42) All of the following are deductible as medical expenses except

A) vitamins and health foods that improve a taxpayer’s general health.

B) payments for a vision exam and contact lenses.

C) payments to a hospital for laboratory fees and X-rays for diagnosis of a medical problem.

D) cosmetic surgery necessary to correct a deformity arising from a congenital abnormality.

Answer:  A

Explanation:  A) Nonprescription drugs, except for insulin, are not deductible as medical expenses.

Page Ref.:  I:7-3 and I:7-4

Objective:  1

43) All of the following payments for medical items are deductible with the exception of the payment for

A) insulin.

B) general appointment for teeth cleaning.

C) acupuncture for specific medical purposes.

D) nonprescription medicine for treatment of a specific medical condition.

Answer:  D

Explanation:  D) Only prescription drugs and insulin are deductible.

Page Ref.:  I:7-3 and I:7-4

Objective:  1

44) In 2013 Sela traveled from her home in Flagstaff to San Francisco to seek medical care. Because she was unable to travel alone, her mother accompanied her. Total expenses included:

Hotel room en route ($150 × 2 rooms × 3 nights)$900
Mileage, 1,000 miles 
Doctors bills in San Francisco1,600

The total medical expenses deductible before the 10% limitation are

A) $1,600.

B) $2,140.

C) $2,500.

D) $2,730.

Answer:  B

Explanation:  B) $300 [($50 maximum × 2) for 3 nights ] + $240 mileage (1,000 × 24 cents per mile) + $1,600 doctors = $2,140.

Page Ref.:  I:7-4

Objective:  1

45) Leo spent $6,600 to construct an entrance ramp and to widen doorways in his personal residence to make the home accessible for his wife, who is disabled and confined to a wheelchair. The $6,600 expenditure increased the value of the residence by $2,000. How much of the $6,600 is a deductible medical expense (before considering limits based on AGI)?

A) $0

B) $2,000

C) $4,600

D) $6,600

Answer:  D

Explanation:  D) Expenditures to remove structural barriers in the home of a physically handicapped individual such as costs of constructing entrance ramps, widening doorways and halls, etc. are deductible in full.

Page Ref.:  I:7-5

Objective:  1

46) Linda had a swimming pool constructed at her house. Her physician advised and prescribed to her that the pool would slow the effects of her degenerative disease. The pool was not suitable for recreational use. Prior to the construction of the pool, the fair market value of her house was $172,000. After the construction of the pool, the appraised fair market value of the house was $181,000. The cost of the pool was $13,000. What is the amount of Linda’s qualified medical expense (before considering limits based on AGI)?

A) $0

B) $4,000

C) $9,000

D) $13,000

Answer:  B

Explanation:  B) The deduction is limited to the portion of the cost which exceeds the increase in the house’s FMV or $13,000 – ($181,000 – $172,000) = $4,000.

Page Ref.:  I:7-5; Example I:7-4

Objective:  1

47) Alan, who is a security officer, is shot while on the job. As a result, Alan suffers from a chronic leg injury and must use a wheelchair and undergo therapy to regain and retain strength. Alan’s physician recommends that he install a whirlpool bath in his home for therapy. During the year, Alan makes the following expenditures:

Wheelchair$ 1,200
Whirlpool bath2,000
Maintenance of the whirlpool250
Increased utility bills associated with whirlpool450
Entrance ramp, various home modifications7,200

A professional appraiser tells Alan that the whirlpool has increased the value of his home by $1,000. Alan’s deductible medical expenses (before considering limitations based on AGI) will be

A) $6,000.

B) $10,100.

C) $7,000.

D) $7,700.

Answer:  B

Explanation:  B)

Wheelchair$ 1,200
Whirlpool bath – increase in home value1,000
Maintenance of the whirlpool250
Increased utility bills associated with whirlpool450
Entrance ramp, various home modifications7,200
Total qualifying expenses$10,100

Page Ref.:  I:7-6; Example I:7-4

Objective:  1

48) Mitzi’s medical expenses include the following:

Medical premiums$10,850
Doctors fees2,000
Hospital fees3,350
Prescription drugs600
Eyeglasses350
General purpose vitamins100

Mitzi’s AGI for the year is $33,000. She is single and age 49.  None of the medical costs are reimbursed by insurance. After considering the AGI floor, Mitzi’s medical expense deduction is

A) $12,9000.

B) $13,850.

C) $14,675.

D) $16,325.

Answer:  B

Explanation:  B) [$10,850 + $2,000 + $3,350 + $600 + $350] = $17,150 total expenses – ($33,000 × 0.10) = $13,850.  The general purpose vitamins do not qualify.

Page Ref.:  I:7-2 through I:7-7; Example I:7-6

Objective:  1

49) Caleb’s medical expenses before reimbursement for the year include the following:

Medical premiums$11,000
Doctors, hospitals3,500
Prescriptions600

Caleb’s AGI for the year is $50,000. He is single and age 58.  Caleb also receives a reimbursement for medical expenses of $1,000. Caleb’s deductible medical expenses that will be added to the other itemized deduction will be

A) $10,350.

B) $9,100.

C) $14,500.

D) $15,100.

Answer:  B

Explanation:  B) ($11,000 + $3,500 + $600 – $1,000) – 5,000 ($50,000 × 0.10) = $9,100

Page Ref.:  I:7-7

Objective:  1

50) A review of the 2013 tax file of Gregory, a single taxpayer who is age 40, provides the following information regarding Gregory’s 2013 tax status:

Adjusted gross income$40,000
Medical expenses (before percentage limit)5,000
Itemized deductions other than medical5,400
2013 potential standard deduction6,100

In 2014, Gregory receives a reimbursement for last year’s medical expenses of $1,200. As a result, Gregory must

A) include $300 in gross income for 2014.

B) include $1,200 in gross income for 2014.

C) reduce 2014’s medical expenses by $1,200.

D) amend the 2013 return.

Answer:  A

Explanation:  A) Include in 2014’s income the lesser of the reimbursement or to the extent the tax benefit received in 2013.

Medical Expenses$5,000 
Limit (10% × $40,000)($4,000) 
  $1,000
Other itemized $5,400
Total 2013 Itemized Deduction Allowed $6,400
2013 Standard Deduction ( 6,100)
Tax Benefit included on the 2014 return $    300

Page Ref.:  I:7-7; Example I:7-7

Objective:  1

51) Mr. and Mrs. Thibodeaux, who are filing a joint return, have adjusted gross income of $75,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Thibodeaux’s mother, Mrs. Watson (age 63). Mrs. Watson provided over one-half of her own support.

Prescription drugs for Mr. Thibodeaux$3,600
General vitamins for Mrs. Thibodeaux$   100
Doctor bill for Mr. Thibodeaux$1,800
Doctor bill for Mrs. Thibodeaux$4,000
Hospital bill for Mrs. Watson$2,200

Mr. and Mrs. Thibodeaux received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?

A) $1,900

B) $2,000

C) $4,100

D) $9,400

Answer:  A

Explanation:  A)

Prescription drugs for Mr. Thibodeaux$3,600
Doctor bill for Mrs. Thibodeaux4,000
Doctor bill for Mr. Thibodeaux  1,800
Total expenses$9,400
Minus: 10% of AGI ($75,000 × 0.10( 7,500)
Deduction$ 1,900

No deduction is allowed for the mother’s expenses because she provided more than half of her own support.  Mrs. Thibodeaux’ vitamins are not a prescription drug and do not qualify.

Page Ref.:  I:7-2 through I:7-7

Objective:  1

52) Mr. and Mrs. Gere, who are filing a joint return, have adjusted gross income of $50,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Gere’s mother, Mrs. Williams. The Gere’s could claim Mrs. Williams as their dependent, but she has too much gross income.

Insulin for Mr. Gere$1,000
Health insurance premiums for Mrs. Gere$3,100
Hospital bill for Mrs. Williams$5,200
Doctor bill for Mrs. Gere$4,000

Mr. and Mrs. Gere received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?

A) $5,200

B) $8,300

C) $4,300

D) $13,300

Answer:  B

Explanation:  B)

Insulin for Mr. Gere$1,000
Health insurance premiums for Mrs. Gere3,100
Hospital bill for Mrs. Williams5,200
Doctor bill for Mrs. Gere4,000
Total expenses$13,300
Minus: 10% of AGI ($50,000 × 0.10)( 5,000)
Deduction$8,300

Page Ref.:  I:7-2 through I:7-7; Example I:7-6

Objective:  1

53) The following taxes are deductible as itemized deductions with the exception of

A) state income taxes.

B) federal income taxes.

C) foreign real property taxes.

D) local personal property taxes.

Answer:  B

Explanation:  B) Federal income taxes are not deductible.

Page Ref.:  I:7-9

Objective:  2

54) Matt paid the following taxes:

Real estate taxes on rental property he owns$4,000
Real estate taxes on his own residence3,600
Federal income taxes8,000
State income taxes3,400
Local city income taxes500
State sales taxes700

What amount can Matt deduct as an itemized deduction on his tax return?

A) $7,500

B) $11,500

C) $15,500

D) $19,500

Answer:  A

Explanation:  A)

Real estate taxes on his own residence$3,600
State income taxes3,400
Local city income taxes     500
Total itemized deduction$7,500

Page Ref.:  I:7-9, I:7-10 and I:7-12

Objective:  2

55) In 2013, Carlos filed his 2012 state income tax return and paid taxes of $800. Also in 2013, Carlos’s employer withheld state income tax of $750 from Carlos’s salary. In 2014, Carlos filed his 2013 state income tax return and paid an additional $600 of state income tax due for 2013. How much state income tax can Carlos deduct on his 2013 federal income tax return for state income tax?

A) $1,350

B) $1,400

C) $1,550

D) $2,150

Answer:  C

Explanation:  C)

State income tax withheld in 2013$ 750
2012 state income tax paid in 2013     800
Total Deduction$1,550

Page Ref.:  I:7-10; Example I:7-8

Objective:  2

56) Doug pays a county personal property tax on his automobile of $1,500. The $1,500 includes $800 based on the weight of the car and $700 based on the value of the car. How much of the tax can Doug deduct on his tax return?

A) $0

B) $700

C) $800

D) $1,500

Answer:  B

Explanation:  B) Personal property taxes are deductible to the extent that they are ad valorem or based on value.

Page Ref.:  I:7-10; Example I:7-9

Objective:  2

57) During the year Jason and Kristi, cash basis taxpayers, paid the following taxes:

State gift tax$1,000
Property tax on home in the United States4,100
State income tax (withholdings)3,000
Estimated federal income tax4,500
Estimated state income tax (paid by check)800
Special assessment by city for sidewalks and street lighting      on their street2,000

What amount can Kristi and Jason claim as an itemized deduction for taxes on their federal income tax return in the current year?

A) $7,900

B) $8,900

C) $10,900

D) $15,400

Answer:  A

Explanation:  A) $4,100 + 3,000 + 800 = 7,900

Page Ref.:  I:7-9 through I:7-12

Objective:  2

58) In February of the current year (assume a non-leap year), Ken and Kelsey received their property tax statement for last calendar-year taxes of $1,600, which they paid to the taxing authority on March 1 of the current year. They had purchased their home on May 1 last year. What amount of property tax on this statement may they claim as an itemized deduction this year?

A) $0

B) $1,069

C) $1,074

D) $1,600

Answer:  C

Explanation:  C) (245/365 × $1,600 = $1,074)

Page Ref.:  I:7-11; Example I:7-10

Objective:  2

59) On September 1, of the current year, James, a cash-basis taxpayer, sells his farm to Bill, also a cash-basis taxpayer, for $100,000. James’ basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable in November of the current year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Bill pays all of the real estate taxes in the current year. The effects of this sales structure will be:

A)

Taxes allocated to JamesTaxes allocated to BillEffect on James’ Gain
$0$3,650no effect on gain

B)

Taxes allocated to JamesTaxes allocated to BillEffect on James’ Gain
$3,650$0decrease gain by $1,220

C)

Taxes allocated to JamesTaxes allocated to BillEffect on James’ Gain
$2,430$1,220increase gain by $2,430

D)

Taxes allocated to JamesTaxes allocated to BillEffect on James’ Gain
$1,220$2,430increase gain by $1,220

Answer:  C

Explanation:  C) Taxes allocated to Bill:

(122/365 days) × $3,650 = $1,220.

Taxes allocated to James = $3,650 – $1,220 = $2,430.

Increase James’ gain by $2,430.

Page Ref.:  I:7-11; Example I:7-10

Objective:  2

60) On September 1, of the current year, Samuel, a cash-basis taxpayer, sells his farm to Edward, also a cash-basis taxpayer for $100,000. Samuel’s basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable on April 1 of the following year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Samuel pays all of the real estate taxes prior to the sale. The effects of this sales structure will be: 

A)

Taxes allocated to SamuelTaxes allocated to EdwardEffect on Samuel’s Gain
$1,220$2,430increase gain by $1,220

B)

Taxes allocated to SamuelTaxes allocated to EdwardEffect on Samuel’s Gain
$2,430$1,220increase gain by $2,430

C)

Taxes allocated to SamuelTaxes allocated to EdwardEffect on Samuel’s Gain
$2,430$1,220decrease gain by $1,220

D)

Taxes allocated to SamuelTaxes allocated to EdwardEffect on Samuel’s Gain
$1,220$2,430decrease gain by $1,220

Answer:  C

Explanation:  C) Taxes allocated to Edward:

(122/365 days) × $3,650 = $1,220 rounded.

Decrease Samuel’s gain by $1,220.

Taxes allocated to Samuel = $3,650 – $1,220 = $2,430.

Page Ref.:  I:7-11; Example I:7-10

Objective:  2

61) Peter is assessed $630 for street improvements in front of his house. Which of the following statements is correct?

A) Peter must deduct the assessment as a tax.

B) Peter must reduce the property basis by $630.

C) Peter must increase the property basis by $630.

D) Peter can elect to deduct the $630 currently or increase the basis in the property.

Answer:  C

Explanation:  C) Tax law requires capitalization of assessments as part of the property’s adjusted basis.

Page Ref.:  I:7-11

Objective:  2

62) Which of the following is deductible as interest expense?

A) personal credit card interest

B) interest to purchase tax-exempt bonds

C) bank service charges on personal account

D) interest on home equity loan

Answer:  D

Explanation:  D) Interest on home equity loans is deductible.

Page Ref.:  I:7-12, I:7-15 through I:7-17

Objective:  3

63) Riva borrows $10,000 that she intends to use for purchasing supplies for her business.  She temporarily deposits the funds in her personal checking account.  Prior to the deposit, the checking account held $40,000 of personal funds.  Riva books a vacation for $6,000 and writes a check to the travel agency from her personal account.  Later in the month, the business supplies bill arrives and Riva writes a check for $10,000 from the personal account.  With respect to the interest expense on the $10,000 loan,  

A) it will all be treated trade or business expense.

B) 60 percent will be treated as personal interest expense and 40 percent as trade or business expense.

C) it will all be treated as personal expense.

D) 20 percent will be treated trade or business expense.

Answer:  B

Explanation:  B) If borrowed and personal funds are mingled in the same account, expenditures from that account are treated as coming first from borrowed funds.  Therefore, the $6,000 vacation payment is considered as coming from borrowed funds, and only $4,000 of the business supply bill is treated as coming from borrowed funds.  Accordingly, the interest expense will be allocated 60% to personal use and 40% to business use.

Page Ref.:  I:7-13 and I:7-14; Example I:7-13

Objective:  3

64) When both borrowed and owned funds are mingled in the same account, for purposes of categorizing interest expense, a repayment of the debt is allocated first to

A) personal expenditures.

B) trade or business expenditures.

C) investment expenditures.

D) passive activity expenditures in real estate.

Answer:  A

Explanation:  A) When the taxpayer repays the debt, the tax law requires that the allocation of the repayment to the expenditures made with the borrowed funds occur in the following order: (1) personal expenditures, (2) investment expenditures and passive activity expenditures other than rental real estate, (3) passive activity expenditures in rental real estate, and (4) trade or business expenditures.

Page Ref.:  I:7-13 and I:7-14

Objective:  3

65) All of the following statements are true except

A) investment interest expense is deductible to the extent of a taxpayer’s net investment income.

B) short-term capital gains meet the definition of net investment income.

C) investment interest expense includes interest expense to purchase or carry tax-exempt securities.

D) net investment income is the taxpayer’s investment income in excess of investment expenses.

Answer:  C

Explanation:  C) Investment interest does not include interest expense incurred to purchase or carry tax-exempt securities.

Page Ref.:  I:7-14 through I:7-16

Objective:  3

66) In the current year, Julia earns $9,000 in net investment income and incurs $14,000 of investment interest expense. What is the maximum amount of investment interest expense she is allowed to deduct this year?

A) $0

B) $3,000 deductible this year; $11,000 carried forward to next year

C) $9,000 deductible this year; $5,000 carried forward to next year

D) $14,000 deductible this year; nothing to be carried forward to next year

Answer:  C

Explanation:  C) Investment interest expense is deductible to the extent of net investment income. The remainder is carried over to the next tax year.

Page Ref.:  I:7-14; Example I:7-14

Objective:  3

67) Ted pays $2,100 interest on his automobile loan, $120 interest on a loan to purchase a computer for personal use, $630 interest on credit cards, and $1,100 investment interest expense. Ted has net investment income of $850. Ted’s deductible interest is

A) $850.

B) $1,100.

C) $2,950.

D) $3,200.

Answer:  A

Explanation:  A) Only the investment interest expense, to the extent of net investment income of $850 is deductible.

Page Ref.:  I:7-14 through I:7-16

Objective:  3

68) Dana paid $13,000 of investment interest expense in a year in which she earned $4,500 in dividends, $5,400 in interest income, and had a short-term capital gain of $1,000 and a long-term capital gain of $2,200. The capital gains resulted from the sale of stock held as an investment. She has no other investment-related expenses.  What is her maximum deduction for investment interest expense if Dana makes the proper elections to raise her ceiling as high as possible?

A) $5,400

B) $9,900

C) $13,100

D) $13,000

Answer:  D

Explanation:  D) If she makes the appropriate election on her return to include the dividends and long-term capital gain in her ceiling, she can deduct the investment interest expense to the extent of net investment income including the dividends and long-term capital gain. $4,500 + $5,400 + 1,000 + $2,200 = $13,100 limited to $13,000 of investment interest expense.

Page Ref.:  I:7-15; Example I:7-15

Objective:  3

69) Teri pays the following interest expenses during the year:

Home mortgage interest on personal residence$8,500
Credit card interest on personal purchases550
Interest on loans used to purchase investments (Net investment income is $2,000)2,400
Interest on loans used for a business conducted as a sole proprietorship3,800
Interest on a credit card used exclusively in the business470

What is the amount of interest expense that can be deducted as an itemized deduction?

A) $10,500

B) $10,900

C) $14,300

D) $14,700

Answer:  A

Explanation:  A)

Home mortgage interest$ 8,500
Investment interest limited to net investment income    2,000
Total as itemized deduction$ 10,500

Personal interest is not deductible. Interest for the business is deducted as a for AGI deduction on the Schedule C.

Page Ref.:  I:7-14 through I:7-16

Objective:  3

70) On July 31 of the current year, Marjorie borrows $120,000 to purchase a new fishing boat. The loan is secured by her personal residence. On the date of the loan, the outstanding balance on the original debt incurred to purchase the residence is $300,000 and the FMV of the home is $450,000. What is the total amount of debt on which Marjorie can deduct interest in the current year?

A) $300,000

B) $400,000

C) $420,000

D) $450,000

Answer:  B

Explanation:  B) Interest on $300,000 of acquisition indebtedness and $100,000 of home equity indebtedness. The home equity indebtedness is the lesser of home equity of $150,000 or $100,000.

Page Ref.:  I:7-17; Example I:7-18

Objective:  3

71) Wayne and Maria purchase a home on April 1 of the current year.  In order to obtain a thirty-year mortgage, they are required to pay $7,200 in points at closing. Charging points is a customary business practice in the area.  In addition, they pay $4,400 of interest during the year.  What is their current year deduction related to their home?

A) $4,400

B) $4,580

C) $7,200

D) $11,600

Answer:  D

Explanation:  D) Points on the purchase of a home are deductible in the year paid.

Page Ref.:  I:7-18; Example I:7-19

Objective:  3

72) Claudia refinances her home mortgage on June 1 of the current year.  She obtains a 30 year mortgage at 5%.  As part of the refinancing, she pays points of $3,600 (a customary practice in her location). What amount, if any, of the points are deductible?

A) $0

B) $70

C) $120

D) $3,600

Answer:  B

Explanation:  B) $3,600/(30 × 12) = $10 monthly amortization.  $10 × 7 months = $70

Page Ref.:  I:7-18

Objective:  3

73) Leslie, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses.  She has not received any type of educational assistance or scholarships. The amount of interest paid during the year amounted to $3,800. What is the amount and classification of her student loan interest education deduction if her modified AGI is $40,000?

A) $2,500 for AGI

B) $2,500 from AGI

C) $3,800 for AGI

D) $3,800 from AGI

Answer:  A

Explanation:  A) The limit for the student loan interest deduction is $2,500, and it is a deduction for AGI.

Page Ref.:  I:7-19

Objective:  3

74) Marcia, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses.  She has not received any type of educational assistance or scholarships.  The amount of interest paid during the year amounted to $3,000. What is the amount and classification of her student loan interest deduction if her AGI is $63,000?

A) $500 for AGI

B) $2,000 for AGI

C) $2,500 for AGI

D) $3,000 for AGI

Answer:  B

Explanation:  B) The limit for student loan interest deduction is $2,500, and it is a deduction for AGI. The limit is phased-out ratably between $60,000 and $75,000 of AGI for a single person. [($63,000 – $60,000)/($75,000 – $60,000)] = 20% phase-out. $2,500 limit × (100% – 20%)= $2,000 maximum due to excess AGI.

Page Ref.:  I:7-19; Example I:7-21

Objective:  3

75) Don’s records contain the following information:

1.     Donated stock having a fair market value of $3,600 to a qualified charitable organization. He acquired the stock five months previously at a cost of $2,400.

2.     Paid $700 to a church school as a requirement for the enrollment of his daughter.

3.     Paid $200 for annual homeowner’s association dues.

4.     Drove 400 miles in his personal auto at 14 cents per mile. The travel was directly related to volunteer services he performed for his church (actual costs were not available).

What is Don’s charitable contribution deduction?

A) $2,456

B) $3,156

C) $3,356

D) $3,656

Answer:  A

Explanation:  A) [$2,400 + (400 × $.14/Mile)] = $2,456.  School tuition and homeowner association dues do not qualify, and the stock was held short-term so it is deducted at basis.

Page Ref.:  I:7-22 through I:7-25

Objective:  4

76) Erin’s records reflect the following information:

1.  Paid $200 dues to a fraternal organization (such as the Elks Club)

2.  Donated stock having a fair market value of $3,500 to a qualified charitable organization. She purchased the stock 2 years earlier for $3,000.

3.  Paid $1,600 cash to qualified public charitable organizations

Erin’s adjusted gross income for this year was $50,000. What is the amount of her charitable contribution deduction for the year?

A) $4,600

B) $4,800

C) $5,100

D) $5,300

Answer:  C

Explanation:  C)

Cash$1,600
FMV Stock (held long-term)3,500
Total Charitable Contributions$5,100

Page Ref.:  I:7-22 through I:7-25

Objective:  4

77) Sacha purchased land in 2010 for $35,000 that she held as a capital asset. This year, she contributed the land to the Boy Scouts of America (a charitable organization) for use as a site for a summer camp. The market value of the land at the date of contribution is $40,000. Sacha’s adjusted gross income is $90,000. Assuming no special elections, Sacha’s maximum deductible contribution this year is

A) $13,000.

B) $27,000.

C) $35,000.

D) $40,000.

Answer:  B

Explanation:  B) The potential deduction is the $40,000 FMV.  Ceiling on current year contribution:

$90,000   AGI

×      .30    Limit on capital gain property

$ 27,000 Maximum current year deduction

$ 13,000 Carryover

Page Ref.:  I:7-23 and I:7-25; Examples I:7-24 and I:7-30

Objective:  4

78) Clayton contributes land to the American Red Cross for use as a future site for a new building. His AGI is $50,000. Clayton paid $20,000 for the land eight months ago but its market value at the date of contribution is $25,000. With no special elections, Clayton’s deductible contribution this year is

A) $7,000.

B) $18,000.

C) $20,000.

D) $25,000.

Answer:  C

Explanation:  C) Since the property was held by Clayton for less than one year, the contribution amount is the adjusted basis of $20,000.  The $20,000 does not exceed the 50% of AGI ceiling.

Page Ref.:  I:7-24 and I:7-25; Example I:7-26

Objective:  4

79) Carl purchased a machine for use in his trade or business two years ago for $30,000. During the current year, Carl donates the machine to the local community college. At the time of the contribution, the machine’s adjusted basis is $10,000 and its FMV is $15,000. Carl’s AGI for the year is $48,000. What is the amount of his charitable contribution deduction?

A) $10,000

B) $14,000

C) $15,000

D) $25,000

Answer:  A

Explanation:  A) Because the machine is ordinary income property (if sold the machine would have resulted in section 1245 ordinary income), the amount of the contribution is adjusted basis of $10,000.

Page Ref.:  I:7-24; Example I:7-27

Objective:  4

80) During the current year, Jane spends approximately 90 hours of her time in developing computer software for a church. As a programmer and data analyst, Jane normally bills her clients at $130 per hour for her time. Jane also drives her car a total of 800 miles in performing her voluntary work. Jane’s deductible contribution is

A) $0.

B) $112.

C) $11,700.

D) $11,812.

Answer:  B

Explanation:  B) (800 miles × $.14/mile) = $112.  The value of service provided is not deductible.

Page Ref.:  I:7-25; Example I:7-29

Objective:  4

81) Carol contributes a painting to a local museum for display. Her AGI is $60,000. Carol paid $22,000 for the painting in 2006, but its market value at the date of the contribution is $25,000. With no special elections, Carol’s deductible contribution this year is

A) $ 7,000.

B) $18,000.

C) $22,000.

D) $25,000.

Answer:  B

Explanation:  B) The potential deduction is $25,000, the FMV as of the contribution, but it is limited by the percentage of AGI ceiling.

$60,000   AGI

×     .30     Limitation on capital gain property to public charities

$18,000   Charitable Contribution allowed for this year

$ 7,000    Carryover

Page Ref.:  I:7-25; Example I:7-30

Objective:  4

82) Hugh contributes a painting to a local museum for display. His AGI is $35,000. Hugh paid $16,000 for the painting in 2000, but its market value at the date of the contribution is $22,000. If Hugh makes the election to maximize the current year deduction, his deductible contribution for this year will be

A) $10,500.

B) $16,000.

C) $17,500.

D) $22,000.

Answer:  B

Explanation:  B) To avoid the 30% of AGI ceiling ($10,500), he can elect to use the adjusted basis rather than FMV and instead apply the 50% of AGI ceiling.

Page Ref.:  I:7-25; Example I:7-30

Objective:  4

83) Patrick’s records for the current year contain the following information. He donated stock having a fair market value of $5,000 to a qualified charitable organization. Patrick acquired the stock two years ago at a cost of $3,000. He paid $1,000 for membership in an athletic scholarship program maintained by the university. The only benefit of the membership is that Patrick is entitled to purchase a season ticket to the university’s home football games. He also donated $7,500 cash to a qualified charitable organization. Patrick’s adjusted gross income for the year is $100,000. What is the amount of his charitable contribution deduction?

A) $11,300

B) $11,500

C) $13,300

D) $13,500

Answer:  C

Explanation:  C)

FMV Stock$5,000
Athletic Program ($1,000 × 0.80)800
Cash    7,500
Total$13,300

Page Ref.:  I:7-25

Objective:  4

84) Grace has AGI of $60,000 in 2012 and 2013. She makes cash contributions to public charities of $34,000 in 2012 and $31,000 in 2013. Grace’s charitable contribution carryover to 2014 is

A) $0.

B) $1,000.

C) $4,000.

D) $5,000.

Answer:  D

Explanation:  D) $60,000 AGI × 50% = $30,000 limit each year. Thus, from last year to this year, $4,000 was carried over. This year the total contributions were $31,000 + $4,000 carryover = $35,000. $30,000 is deductible with $5,000 carried over to next year.

Page Ref.:  I:7-25 and I:7-26; Example I:7-32

Objective:  4

85) Daniel had adjusted gross income of $60,000, which consisted of $55,000 in wages and $5,000 in dividend income from taxable domestic corporations. His expenses include:

Investment counseling fee$800
Attorney fee for preparing a will200
Union dues350
Tax return preparation fee450

What is the net amount deductible by Daniel for the above items?

A) $400

B) $600

C) $1,000

D) $1,600

Answer:  A

Explanation:  A)

Investment counseling fee$ 800
Will preparation—personal expense-0-
Union dues350
Tax return preparation fee      450
Total1,600
Minus: 2% of AGI (60,000 × 2%)( 1,200)
Net Deduction$  400

Page Ref.:  I:7-28 and I:7-29

Objective:  6

86) Wang, a licensed architect employed by Skye Architects, incurred the following unreimbursed expenses this year:

Subscription to architectural journals                                                               $800

Dues to Professional Architecture Society                                                          400

Tax return preparation                                                                                             600

Investment advice                                                                                                      500

Wang’s AGI is $75,000. What is his net deduction for miscellaneous itemized deductions?

A) $0

B) $1,900

C) $800

D) $1,500

Answer:  C

Explanation:  C) ($800 + 400 + 600 + 500) – (.02 × 75,000) = $800

Page Ref.:  I:7-28

Objective:  6

87) Tasneem, a single taxpayer has paid the following amounts this year:

State income taxes                                                                                             $10,000

Property taxes on home                                                                                        4,000

Mortgage interest on home                                                                                12,000

Charitable contributions                                                                                    14,000

Tasneem’s AGI is $360,000. What is her net itemized deduction allowed?

A) $40,000

B) $38,200

C) $36,700

D) None of the above.

Answer:  C

Explanation:  C) $40,000 gross itemized deductions before phaseout – [($360,000 – $250,000) × .03] = $36,700 itemized deductions allowed.

Page Ref.:  I:7-29

Objective:  6

88) Which of the following is not required substantiation for a noncash charitable contribution?

A) name and address of charitable organization

B) method used to determine the donated property’s fair market value

C) date and location of property donated

D) use of donation by charitable organization

Answer:  D

Explanation:  D) Use of donation by charity is not required in the substantiation.

Page Ref.:  I:7-33

Objective:  8

89) During the current year, Deborah Baronne, a single individual, paid the following amounts:

Federal income tax                                                            $10,000

State income tax                                                                    $4,000

Real estate taxes on land in France                                 $1,500

Real estate taxes on land in U.S.                                      $1,700

State sales taxes                                                                    $2,000

State occupational license fee                                           $   600

How much can Deborah deduct in taxes as itemized deductions?

Answer:  $4,000 + 1,500 + 1,700 = $7,200.

Page Ref.:  I:7-9 through I:7-12

Objective:  2

90) Phoebe’s AGI for the current year is $120,000. Included in this AGI is $100,000 salary and $20,000 of interest income. In earning the investment income, Phoebe paid investment interest expense of $30,000. She also incurred the following expenditures subject to the 2% of AGI limitation:

Investment expenses:

        Subscriptions to investment journals                                                   $   500

        Investment counseling                                                                                1,500

        Safe-deposit box rental for stock certificates                                            100

Noninvestment expenses:

        Unreimbursed employee business expenses                                     $1,800

Tax return preparation fees (non-business-related)                                      500

What is Phoebe’s investment interest expense deduction for the year?

Answer: 

Investment expenses:

        Subscriptions to investment journals                                                     $ 500

        Investment counseling                                                                                1,500

        Safe-deposit box rental                                                                                   100

                Total                                                                                                        $2,100

Disallowed by the 2% limitation:

        .02 × $120,000                                                                           $2,400

        Unreimbursed employee expenses                                   (1,800)

        Tax return preparation fees                                                  (   500)

Investment expenses

(remainder of 2% limit allocated to investment exp)                              (    100)

Deductible investment expenses                                                                 $  2,000

Net investment income ($20,000 – 2,000)                                                  $18,000

$18,000 is currently deductible; $12,000 is carried over and deducted in a subsequent year.

Page Ref.:  I:7-15 and I:7-16; Example I:7-16

Objective:  3

91) On December 1, 2012, Delilah borrows $2,000 from her credit union to use in her business. Under the terms of the contract, Delilah actually receives $1,940 but is required to repay $2,000 in three months.

a.     What amount may Delilah deduct as interest expense in 2012 and in 2013 if she is a cash basis taxpayer?

b.     What amount may Delilah deduct as interest expense in 2012 and in 2013 if she is an accrual basis taxpayer?

Answer: 
a.     A cash basis taxpayer may deduct the full amount, $60, when the loan is repaid in 2013 but cannot deduct any in 2012.

b.     An accrual basis taxpayer may deduct 1/3 × $60 or $20 in 2012 and $40 in 2013.

Page Ref.:  I:7-20; Example I:7-22

Objective:  3

92) During 2013 Richard and Denisa, who are married and have two dependent children, have the following income and losses:

Total salaries                                                                                  $150,000

Bank account interest                                                                       25,000

Short-term capital gains                                                                    4,000

Short-term capital losses                                                                 ( 1,500)

They also incurred the following expenses:

Qualified medical expenses                                                          $ 8,000

State income taxes paid                                                                   12,000

Property taxes on home                                                                     2,300

Qualified residence interest                                                              9,000

Investment interest expense                                                             7,500

Cash charitable contributions                                                       15,000

Tax return preparation fees                                                              3,600

Unreimbursed employee business expenses                              4,000

Compute Richard and Denisa’s taxable income for the year. (Show all calculations in good form.)

Answer: 

Salaries                                                                                                $150,000

Interest income                                                                                       25,000

Net STCG                                                                                                   2,500

        AGI                                                                                                $177,500

Itemized deductions                                                                          (49,850)

Exemptions ($3,900 × 4)                                                                 (  15,600)

Taxable income                                                                              $   112,050

Itemized deductions:

Medical expenses [$8,000 – ($177,500 × 10%)] =                                                        $ 0

State income taxes                                                                                                        12,000

Property taxes                                                                                                                  2,300

Interest on residence                                                                                                      9,000

Investment interest deduction – limited to net investment income

        ($27,500 interest income. No need to make elections)                                 7,500

Contributions – limited to 50% × AGI of $177,500                                              15,000

Misc. 2% deductions:

        Unreimbursed employee business expenses                  $ 4,000

        Tax return preparation fee                                                       3,600

                Subtotal                                                                                  7,600

        Less: 2% × $177,500 AGI =                                                (    3,550)

                Allowable 2% deductions                                                                            4,050

Itemized deductions                                                                                                 $49,850

Page Ref.:  This is a comprehensive problem. See text and examples throughout chapter.

Objective:  7

93) Hope is a marketing manager at a local company.  Information about her 2013 income and expenses is as follows:

Income received 
Salary$150,000
Taxes withheld from salary: Federal income tax                $30,000 State income tax                         8,000 Social Security tax                      9,300 Medicare tax                               2,175     
Interest income from bank6,000
Dividend income from U.S. stocks4,000
Short-term capital gain2,000
Long-term capital gain3,000
State income tax refund from last year500
Expenses paid: 
Unreimbursed dental and eyecare costs$1,800
Property taxes on her home3,900
Fees paid to town for garbage pick-up400
Stock donated to American Red Cross; FMV $5,000; purchased three years ago for $3,100 
Dues paid to American Marketing Association600
Subscription to professional marketing journals300
Fee for preparation of 2012 tax return and IRS audit assistance2,000
Investment advisor fee1,000
Home mortgage interest10,000
Interest on borrowing to purchase investment assets11,000
Interest on car loan1,100

Compute Hope’s taxable income for the year in good form.  Show all supporting computations.  Hope is single, and she elects to itemize her deductions each year. Assume she does not make any elections regarding the investment interest expense.  Also assume that her tax profile was similar in the preceding year.

Answer: 

Salary $150,000
Interest income 6,000
Dividends 4,000
STCG 2,000
LTCG 3,000
State tax refund (tax benefit rule) 500
AGI $165,500
Itemized Deductions:  
Medical-  
Eyecare and dental costs$1,800 
– 10% AGI-16,550$    -0-
Taxes-  
State income tax withheld$8,000 
Property tax3,900 
Garbage fee and Social Security/Medicare tax-0-11,900
Charitable contribution 5,000
Miscellaneous-  
Unreimbursed employee business 600 + 300900 
Tax advisor fees2,000 
Investment advisor fee1,000 
– 2% AGI-3,310590
Interest-  
Home mortgage interest$10,000 
Investment interest (see below)7,410 
Car loan interest-0-17,410
Total itemized deductions $34,900
Personal exemption    3,900
Taxable income $126,700
   
Investment interest expense calculation:  
Interest income6,000 
STCG2,000$8,000
Deducted investment expense-  
Investment advisor fee$1,000 
2% floor offset-                                                 3,310  
Employee business expense                             -900  
Tax advisor fee                                                -2,000-410-590
Net investment income ceiling $7,410
Allowable deduction–lesser of  
$11,000 Interest paid or $7,410 ceiling $7,410
$3,590 is carried forward  

Page Ref.:  This is a comprehensive problem. See text and examples throughout chapter.

Objective:  7

94) Explain under what circumstances meals and lodging en route to a medical facility may be deductible.

Answer:  Certain courts have held that the cost of meals is deductible while enroute if the trip to the medical facility is long enough to warrant a meal. The lodging is only deductible if the following three criteria are met: (1) the travel to the medical facility was primarily for and essential to the medical care, (2) there was no significant personal pleasure or recreation in the travel, and (3) the individual receives treatment in a licensed hospital or its equivalent.

Page Ref.:  I:7-4

Objective:  1

95) Explain when the cost of living in an institution other than a hospital may be deductible.

Answer:  If an individual is living in an institution other than a hospital, such as a nursing home, the deductibility of the related costs depends on the individual facts and circumstances. If the principal reason the taxpayer is in the institution is the need for and availability of medical care furnished by the institution, all costs of meals, lodging, and other services necessary for furnishing the medical care are qualified medical expenditures and may be deductible. However, if the individual is in the institution primarily for considerations other than the furnishing of medical care, only costs directly associated with the furnishing of medical care are deductible. The costs of meals, lodging, and other services are not qualified medical expenditures.

Page Ref.:  I:7-6

Objective:  1

96) Discuss the timing of the allowable medical expense deduction.

Answer:  Generally, a deduction for medical expenses is allowed only in the year in which the expenses are actually paid, regardless of the taxpayer’s method of accounting or when the event that caused the expenditure occurs. For example, if medical care is received during the year but remains unpaid as of the end of the year, the deduction for that care is deferred until the year in which payment occurs. If medical care is prepaid, no deduction is allowed until the year the care is actually rendered unless there is a legal obligation to pay or unless the prepayment is a prerequisite to receipt of the medical care. If the obligation is charged on a credit card, payment is deemed to have been made on the date of the charge, not on the later date when the credit card balance is paid.

Page Ref.:  I:7-6 and I:7-7

Objective:  1

97) Patrick and Belinda have a twelve year old son, Aidan, who is autistic.  Patrick and Belinda pay tuition of $20,000 annually for Aidan to attend a school for autistic children.  What tax issues should be considered?  What additional information would you need?

Answer:  Will the tuition qualify as a deductible medical expense?

Other information needed is:

Does the school provide any medical services?

Does Aidan go to the school only during the day, or is it a boarding school?

Do Patrick and Belinda receive any reimbursement for the tuition paid to the school?

What is their AGI?

Page Ref.:  I:7-4

Objective:  1

98) Discuss what circumstances must be met for personal property taxes to be deductible.

Answer:  Two basic tests must be met in order for a personal property tax to be deductible. The first is that the tax must be an ad valorem tax on personal property. This means a tax is imposed based on the value of the property. The second requirement is that the tax must be imposed on an annual basis, even if the tax is not paid annually.

Page Ref.:  I:7-10

Objective:  2

99) Explain why interest expense on investments is limited to net investment income.

Answer:  With no limitation, high-income taxpayers could realize significant tax savings by borrowing large amounts of money for investments that appreciate in value but that produce no current income. This would allow the taxpayer to have a large interest expense deduction in the current year to offset current high ordinary income and enjoy tax savings at ordinary tax rates while deferring the tax on the capital gain on the investments until they are sold and then paying taxes at the preferential capital gain rate.

Page Ref.:  I:7-14

Objective:  3

100) When are points paid on a loan deductible as interest expense?

Answer:  Points paid for the purchase, construction, or substantial improvement of a taxpayer’s principal residence are deductible if the loan is secured by the residence and the payment of points is an established business practice in that particular area. Points paid on a loan to purchase property other than a principal residence or to refinance a mortgage on a principal residence must be capitalized and amortized over the life of the loan.

Page Ref.:  I:7-17 and I:7-18; Example I:7-19

Objective:  3

101) Sharif is planning to buy a new car for personal use and will need to take out a loan.  His sources of the financing include (1) a loan from the car dealership charging 6% interest, (2) a loan from his brokerage firm secured against his stock portfolio charging 6.2% and (3) a home equity bank loan secured against his home charging 7%.  Sharif has AGI of $150,000 and does itemize his deductions.  He is in the 28% tax bracket.  Discuss how income taxes can influence his decision regarding the source of financing.

Answer:  Interest on the car dealership loan will be considered personal interest expense and will not be deductible at all so the after-tax cost of borrowing will be 6%.   The loan from the brokerage firm will also be considered an personal loan so the interest will not be deductible.  Therefore the after-tax cost will be 6.2%.  Securing the loan against the stock portfolio does not turn the interest expense into investment interest expense.  Assuming Sharif has net equity in his home at least equal to the loan principle needed for the car purchase (and that the loan does not exceed $100,000), interest on the home equity loan will be treated as qualified residential interest and therefore deductible.  The after-tax cost of borrowing will be 5.04% [.07 × (1 – .28)].  The home equity loan will provide the lowest cost means of financing the car purchase.

Page Ref.:  I:7-19

Objective:  3

102) May an individual deduct a charitable contribution for services rendered to a charitable organization?

Answer:  No deduction is allowed for the value of the services provided. The unreimbursed expenses incurred in performing the services are deductible. For example, actual out-of pocket transportation expenses (or 14 cents a mile), the cost of lodging and 50% of the cost of meals while away from home, and the cost of a uniform without general utility that is required to be worn in performing the donated services are deductible. No deduction is allowed for traveling expense while away from home unless there is no significant element of personal pleasure, recreation, or vacation in such travel.

Page Ref.:  I:7-24 and I:7-25

Objective:  4

103) What is the result if a taxpayer makes a contribution to a college or university and in return receives the right to purchase tickets to athletic events?

Answer:  The taxpayer may only deduct 80% of the payment to the college or university as a charitable contribution.

Page Ref.:  I:7-25

Objective:  4

104) What is the treatment of charitable contributions in excess of the applicable limits for the current year?

Answer:  The charitable contribution in excess of the limits is carried forward to the subsequent five tax years. These carryovers are subject to the same limitations that apply in the subsequent years. That is, a contribution carryover subject to the 30% limit remains subject to the 30% limit in the carryover years. Carryovers may only be deducted to the extent that the limit in the subsequent year exceeds the contributions made during that year.

Page Ref.:  I:7-26

Objective:  4

105) Explain how tax planning may allow a deduction of qualified medical expenses.

Answer:  Medical expenses may be pushed into one year so that the total exceeds 10% of the taxpayer’s AGI (7.5% for those 65 and older). New eyeglasses, contact lenses, or other non-time sensitive dental treatments are examples.

If medical treatment has already been received, the medical expenses may be pushed into one year by borrowing cash to pay the expenses or by using a credit card. 

Page Ref.:  I:7-30

Objective:  7

106) Explain what types of tax planning are available for taxpayers making charitable contributions.

Answer: 
1.     A taxpayer who plans to sell substantially appreciated long term capital asset and contribute the cash proceeds to charity should instead donate the property directly to charity. A direct donation will give the taxpayer a deduction equal to FMV of the property and will avoid a gain on the property’s disposition.  On the other hand, if a taxpayer is planning to contribute a capital asset that has declined in the value, the taxpayer should sell the property, recognize the loss and contribute the cash.

2.     Taxpayers who don’t have any other large itemized deductions may want to bunch their charitable contributions into one year and then take the standard deduction in a year when they don’t make substantial charitable contributions.

3.     A contribution of long-term capital gain property to a public charity is subject to a 30% of AGI limit. An election can be made to have the property subject to a 50% of AGI limit. This election reduces the amount of contribution of the property’s FMV by the gain that would have been realized had the property been sold. Thus, this election should only be made in special circumstances.  (e.g. the 30% limit applies and there is little difference between the property’s FMV and its basis).

Page Ref.:  I:7-31 and I:7-32

Objective:  7

107) Jill is considering making a donation to her church. She wants to give $50,000 for the new church building. She has some stock with a FMV of $50,000 and an adjusted basis of $10,000 that she has held for 3 years. She is planning to sell the stock and donate the $50,000 proceeds to the church. What should she consider before taking that action?

Answer:  If Jill sells the stock, she will realize a long-term capital gain of $40,000 on which she will pay 15% tax ($6,000) if she has no losses against which to offset the gain. Her after-tax proceeds will be $44,000 and she will need an additional $6,000 to donate $50,000 to the church. However, when a taxpayer donates long-term capital gain property, the amount of the contribution is the FMV of the property. Thus, Jill gets a tax deduction of $50,000 (subject to the charitable contribution limits).

Page Ref.:  I:7-31 to I:7-32; Example I:7-36

Objective:  7

Chapter I8 

1) In order to be recognized and deducted on a tax return, a loss must first be realized.

Answer:  TRUE

Page Ref.:  I:8-2

Objective:  1

2) The amount of loss realized on the sale of property is computed by subtracting adjusted basis from amount realized.

Answer:  TRUE

Page Ref.:  I:8-2

Objective:  1

3) A loss incurred on the sale or exchange of property is deductible only if the property is used in a trade or business or held for investment.

Answer:  TRUE

Explanation:  Losses on personal assets cannot be recognized.

Page Ref.:  I:8-3

Objective:  1

4) The sale of inventory at a loss results in an ordinary loss.

Answer:  TRUE

Explanation:  Losses on assets used in a trade or business are generally ordinary.

Page Ref.:  I:8-3

Objective:  1

5) Losses incurred in the sale or exchange of personal-use property are deductible as capital losses.

Answer:  FALSE

Explanation:  With limited exceptions, losses on personal assets cannot be recognized.

Page Ref.:  I:8-3

Objective:  1

6) A loss on business or investment property which is abandoned is deductible as an ordinary loss to the extent of the property’s adjusted basis on the date of abandonment.

Answer:  TRUE

Explanation:  If a taxpayer abandons an asset which has basis remaining, the taxpayer realizes a loss.  The loss can be recognized assuming it is not personal use property.

Page Ref.:  I:8-3

Objective:  1

7) The total worthlessness of a security results in an ordinary loss.

Answer:  FALSE

Explanation:  Losses are worthless securities are treated as capital losses.

Page Ref.:  I:8-4

Objective:  1

8) A capital loss may arise from the sale or exchange of a capital asset.

Answer:  TRUE

Page Ref.:  I:8-5

Objective:  2

9) The destruction of a capital asset by a casualty gives rise to a capital rather than ordinary loss.

Answer:  FALSE

Explanation:  A casualty is not a sale or exchange so the loss is treated as ordinary.

Page Ref.:  I:8-5

Objective:  2

10) One of the requirements which must be met for stock to be considered Section 1244 stock is that the stock must be owned by an individual or a partnership.

Answer:  TRUE

Page Ref.:  I:8-5

Objective:  2

11) One of the requirements which must be met for stock to be considered Section 1244 stock is that the corporation cannot have more than $10 million of total paid in capital as of the stock issuance.

Answer:  FALSE

Explanation:  The paid in capital limitation is $1 million.

Page Ref.:  I:8-6

Objective:  2

12) When applying the limitations of the passive activity rules, a taxpayer’s AGI is classified into active income, portfolio income and passive income.  For this purpose, portfolio income includes dividends, interest, annuities, and royalties.

Answer:  TRUE

Page Ref.:  I:8-7

Objective:  3

13) Losses from passive activities that cannot be deducted currently are carried over for up to 5 subsequent years.

Answer:  FALSE

Explanation:  Losses may be carried over indefinitely.

Page Ref.:  I:8-8

Objective:  3

14) Individual taxpayers can offset portfolio income with passive losses.

Answer:  FALSE

Explanation:  Under the general provisions, passive losses can only offset passive income.

Page Ref.:  I:8-8

Objective:  3

15) If a taxpayer disposes of an interest in a passive activity, unused carryover losses are available to the purchaser of the interest.

Answer:  FALSE

Explanation:  The taxpayer will recognize his unused carryover passive losses when his passive activity is disposed of in a taxable manner.

Page Ref.:  I:8-8

Objective:  3

16) A taxpayer may deduct suspended losses of a passive activity when the taxpayer completely terminates his or her ownership of the activity.

Answer:  TRUE

Page Ref.:  I:8-8

Objective:  3

17) Once an activity has been classified as passive, it is considered passive with regard to that taxpayer until it is sold.

Answer:  FALSE

Explanation:  The taxpayer can become a material participant in an activity at a later time.  Status is determined each year.

Page Ref.:  I:8-9

Objective:  3

18) A passive activity includes any rental activity or any trade or business in which the taxpayer does not materially participate.

Answer:  TRUE

Page Ref.:  I:8-10

Objective:  3

19) Two separate business operations conducted at the same location may be treated as separate activities under the passive activity rules.

Answer:  TRUE

Page Ref.:  I:8-10 and I:8-11

Objective:  3

20) Partnerships and S corporations must identify their business and rental activities by applying the passive activity rules at the partnership or S corporation level and then must report the results of their operations by activity to the partners or shareholders.

Answer:  TRUE

Explanation:  Each partner or shareholder then takes the results from these activities and, using the same rules, combines them where appropriate with operations conducted either directly or through other pass-through entities.

Page Ref.:  I:8-11

Objective:  3

21) Material participation by a taxpayer in a passive activity is satisfied if the individual participates in the activity for more than 500 hours during the year.

Answer:  TRUE

Page Ref.:  I:8-11

Objective:  3

22) For purposes of the application of the passive loss limitations, a closely-held C corporation is a C corporation where more than 50 percent of the stock is owned by five or fewer individuals at any time during the last half of the taxable year.

Answer:  TRUE

Page Ref.:  I:8-12

Objective:  3

23) A closely-held C Corporation’s passive losses may offset its active income.

Answer:  TRUE

Page Ref.:  I:8-13

Objective:  3

24) Individuals who actively participate in the management of rental real property may deduct up to $25,000 in losses, subject to AGI limitations.

Answer:  TRUE

Explanation:  A rental real estate activity which does not meet the real property trade or businessstandard may still allow recognition of losses up to $25,000 if the owner meets certain criteria.

Page Ref.:  I:8-15

Objective:  3

25) For purposes of applying the passive loss limitations for rental real estate, active participation requires a greater time commitment by the taxpayer than does material participation.

Answer:  FALSE

Explanation:  Regular, continuous and material involvement is not required for active status so it is a lighter standard of involvement.

Page Ref.:  I:8-15

Objective:  3

26) Taxpayers are allowed to recognize net passive losses from all actives up to a ceiling of $25,000.

Answer:  FALSE

Explanation:  The $25,000 loss allowance ceiling only applies to rental real properties in which the taxpayer is an “active” participant.  The $25,000 ceiling applies to the total of qualifying losses.

Page Ref.:  I:8-15

Objective:  3

27) A taxpayer may deduct a loss resulting from the theft of business and investment property but not a theft of personal-use property.

Answer:  FALSE

Explanation:  A limited deduction is allowed for the loss on personal-use property due to casualty or theft.

Page Ref.:  I:8-20

Objective:  4

28) When business property involved in a casualty is totally destroyed, the amount of the loss is limited to the lesser of the taxpayer’s adjusted basis in the property or the reduction in FMV.

Answer:  FALSE

Explanation:  The amount of the loss is the taxpayer’s adjusted basis in the property.

Page Ref.:  I:8-19

Objective:  4

29) In the case of casualty losses of personal-use property, the losses sustained in each separate casualty are reduced by both $100 and 10 percent of the taxpayer’s AGI for the year.

Answer:  FALSE

Explanation:  It is the total casualty loss that is reduced by 10 percent of the taxpayer’s AGI.

Page Ref.:  I:8-20

Objective:  4

30) A theft loss is deducted in the year in which the theft is discovered.

Answer:  TRUE

Page Ref.:  I:8-22

Objective:  4

31) When personal-use property is covered by insurance, no deduction is available for a casualty loss of the property unless the taxpayer timely files an insurance claim for the loss.

Answer:  TRUE

Page Ref.:  I:8-22

Objective:  4

32) When the taxpayer anticipates a full recovery on a casualty loss of personal-use property but receives less than full recovery in a subsequent year, the unrecovered portion may be deducted.

Answer:  TRUE

Page Ref.:  I:8-22

Objective:  4

33) If a taxpayer suffers a loss attributable to a disaster in an area subsequently declared a disaster area, the casualty loss may be deducted in the year preceding the year in which the loss actually occurs.

Answer:  TRUE

Page Ref.:  I:8-23

Objective:  4

34) For a bad debt to be deductible, the taxpayer must have a basis in the debt.

Answer:  TRUE

Page Ref.:  I:8-24

Objective:  5

35) A bona fide debtor-creditor relationship can never exist in the case of related parties.

Answer:  FALSE

Explanation:  A bona fide debtor-creditor relationship can exist between related parties, but it can be harder to substantiate.

Page Ref.:  I:8-24

Objective:  5

36) A taxpayer guarantees another person’s obligation and is forced to pay the debt under the terms of the guarantee.  The original debtor does not repay the taxpayer.  The taxpayer/guarantor may deduct the loss.

Answer:  TRUE

Page Ref.:  I:8-25

Objective:  5

37) Lisa loans her friend, Grace, $10,000 to finance a new business. If Grace defaults on the loan, Lisa may take a deduction for a business bad debt in the year of total worthlessness.

Answer:  FALSE

Explanation:  In order to be classified as a business bad debt, the debt must be related to the taxpayer’s trade or business. See “Typical Misconception.”

Page Ref.:  I:8-26

Objective:  5

38) A business bad debt gives rise to an ordinary deduction while a nonbusiness bad debt is treated as a short-term capital loss.

Answer:  TRUE

Page Ref.:  I:8-26

Objective:  5

39) No deduction is allowed for a partially worthless nonbusiness debt.

Answer:  TRUE

Explanation:  A taxpayer cannot deduct a loss for a nonbusiness debt that is still partially recoverable during the year.

Page Ref.:  I:8-27

Objective:  5

40) A net operating loss (NOL) occurs when taxable income for any year is negative because itemized deductions and total exemptions exceed business income.

Answer:  FALSE

Explanation:  A net operating loss generally involves only business income and expenses.

Page Ref.:  I:8-29

Objective:  6

41) A net operating loss can be carried back three years or carried forward five years.

Answer:  FALSE

Explanation:  The relevant period is two year carry back and 20 year carry forward.

Page Ref.:  I:8-32

Objective:  6

42) All of the following losses are deductible except

A) decline in value of securities.

B) total worthlessness of securities.

C) sale or exchange of business property.

D) destruction of personal use property by fire, storm, or casualty.

Answer:  A

Explanation:  A) Securities must be sold or determined to be worthless in order for the loss to be realized and then recognized.

Page Ref.:  I:8-2; Example I:8-1

Objective:  1

43) The amount realized by Matt on the sale of property to Caitlin includes all of the following with the exception of

A) cash received by Matt.

B) mortgage on the property that is assumed by Caitlin.

C) mortgage on the property paid off by Matt prior to the sale.

D) the FMV of any other property received by Matt in the transaction.

Answer:  C

Explanation:  C) Cash received, the mortgage assumed by the buyer, and the FMV of property received in the transaction are all part of amount realized.

Page Ref.:  I:8-2

Objective:  1

44) In 2000, Michael purchased land for $100,000. Over the years, economic conditions deteriorated, and the value of the land declined to $60,000. Michael sells the property in this year, when it is subject to a $30,000 nonrecourse mortgage. The buyer pays Michael $34,000 cash and takes the property subject to the mortgage. Michael incurs $5,000 in real estate commissions. Michael’s gain or loss on the sale is

A) $4,000 gain.

B) $1,000 loss.

C) $36,000 loss.

D) $41,000 loss.

Answer:  D

Explanation:  D) ($30,000 + $34,000 – $5,000) – $100,000 = $41,000 loss

Page Ref.:  I:8-2; Example I:8-2

Objective:  1

45) Jamie sells investment real estate for $80,000, resulting in a $15,000 loss. Jamie’s loss is

A) an ordinary loss.

B) a capital loss.

C) a Sec. 1231 loss.

D) a Sec. 1244 loss.

Answer:  B

Explanation:  B) Real estate held for investment is considered a capital asset, therefore the loss on the sale or exchange is a capital loss.

Page Ref.:  I:8-5; Example I:8-4

Objective:  2

46) Juan has a casualty loss of $32,500 on investment property after receiving an insurance settlement. This is Juan’s only casualty transaction this year. Juan’s loss is

A) an ordinary loss.

B) a capital loss.

C) a Sec. 1231 loss.

D) a Sec. 1244 loss.

Answer:  A

Explanation:  A) Although property held as an investment is a capital asset, the $32,500 loss is ordinary since a casualty is not a sale or exchange.

Page Ref.:  I:8-5; Example I:8-4

Objective:  2

47) All of the following are true of losses from the sale or worthlessness of small business corporation (Section 1244) stock with the exception of

A) the stock must be owned by an individual or a partnership.

B) the stock must have been issued by a domestic corporation.

C) the stock must have been issued for cash or property other than stock or securities.

D) a single taxpayer may deduct, as ordinary losses, up to a maximum of $100,000 per tax year with the remainder treated as capital losses.

Answer:  D

Explanation:  D) Single taxpayers may deduct up to $50,000 per tax year.

Page Ref.:  I:8-5

Objective:  2

48) Stacy, who is married and sole shareholder of ABC Corporation, sold all of her stock in the corporation for $100,000. Stacy had organized the corporation in 2009 by contributing $225,000 and receiving all of the capital stock of the corporation. ABC Corporation is a domestic corporation engaged in the manufacturing of ski boots. The stock in ABC Corporation qualified as Sec. 1244 stock. The sale results in a(n)

A) ordinary loss of $125,000.

B) long-term capital loss of $125,000.

C) long-term capital loss of $100,000 and ordinary loss of $25,000.

D) ordinary loss of $100,000 and long-term capital loss of $25,000.

Answer:  D

Explanation:  D) The loss realized is $100,000 – $225,000 = ($125,000). Since the stock is Section 1244 stock and Stacy is an original owner, the first $100,000 (for married individuals) of the loss is treated as ordinary. The remainder of $25,000 ($125,000 – $100,000) is treated as long-term capital gain since Stacy held the stock longer than 12 months.

Page Ref.:  I:8-5

Objective:  2

49) Amy, a single individual and sole shareholder of Brown Corporation, sold all of the Brown stock for $30,000. The stock basis was $150,000. Amy had owned the stock for 3 years. Brown Corporation meets the Section 1244 requirements. Amy has

A) a $50,000 ordinary loss and $70,000 LTCL.

B) a $50,000 STCL and a $70,000 LTCL.

C) a $100,000 ordinary loss and a $20,000 LTCL.

D) a $100,000 LTCL and a $20,000 ordinary loss.

Answer:  A

Explanation:  A) The loss realized is $30,000 – $150,000 = ($120,000). Since the stock is Section 1244 stock and Amy is an original owner, the first $50,000 (for single individuals) of the loss is treated as ordinary. The remainder of $70,000 ($120,000 – $50,000) is treated as long-term capital gain since Amy held the stock longer than 12 months.

Page Ref.:  I:8-5

Objective:  2

50) Sarah had a $30,000 loss on Section 1244 stock, a $15,000 loss on sale of a personal use automobile and a $8,000 loss on stock that is not classified as Section 1244. Without regard to net capital loss limitations, Sarah should recognize

A) a ordinary loss of $38,000.

B) a capital loss of $53,000.

C) an ordinary loss of $30,000 and a capital loss of $8,000.

D) an ordinary loss of $30,000 and a capital loss of $23,000.

Answer:  C

Explanation:  C) $30,000 Section 1244 ordinary loss + $8,000 capital loss. The loss on the sale of personal use assets, the automobile, is not deductible.

Page Ref.:  I:8-3 and I:8-5

Objective:  2

51) During the year, Mark reports $90,000 of active business income from his law practice. He also owns two passive activities. From Activity A, he earns $20,000 of income, and from Activity B, he incurs a $30,000 loss. As a result, Mark

A) reports AGI of $80,000.

B) reports AGI of $90,000 with a $10,000 passive loss carryover.

C) reports AGI of $90,000 with a $30,000 passive loss carryover.

D) reports AGI of $110,000 with a $30,000 passive loss carryover.

Answer:  B

Explanation:  B) Mark offsets $20,000 of B’s loss against A’s income and carries forward the $10,000 loss. His AGI is $90,000 from the active business income.

Page Ref.:  I:8-8; Example I:8-5

Objective:  3

52) Joy reports the following income and loss:

Salary$ 120,000
Income from activity A60,000
Loss from activity B( 35,000)
Loss from activity C( 55,000)

Activities A, B, and C are all passive activities.

Based on this information, Joy has

A) adjusted gross income of $90,000.

B) salary of $120,000 and deductible net losses of $30,000.

C) salary of $120,000 and net passive losses of $30,000 that will be carried over.

D) salary of $120,000, passive income of $60,000, and passive loss carryovers of $90,000.

Answer:  C

Explanation:  C) The losses from passive activities B and C may offset and eliminate the income from passive activity A resulting in a net passive loss of $30,000 ($60,000 income less $90,000 loss). The passive loss of $30,000 may not offset the salary and must be carried over to the next tax year.

Page Ref.:  I:8-8; Example I:8-6

Objective:  3

53) Jeff owned one passive activity.  Jeff sold the activity and realized a $2,000 gain on the sale.  Prior to the sale, he realized a current year loss from the activity of $6,000.  In addition, he has suspended losses from prior years of $7,000.  What is the net impact on Jeff’s AGI this year due to the passive activity?

A) increase of $2,000

B) no net change

C) decrease of $4,000

D) decrease of $11,000

Answer:  D

Explanation:  D) Due to the sale, the current year loss and the suspended loss will be recognized.  $2,000 gain – $6,000 current loss – $7,000 suspended loss = $11,000 loss.

Page Ref.:  I:8-8 and I:8-9; Example I:8-7

Objective:  3

54) Nancy reports the following income and loss in the current year.

Salary$ 60,000
Income from activity A18,000 
Loss from activity B(  9,000)
Loss from activity C( 13,000)

All three activities are passive activities with respect to Nancy. Nancy also has $21,000 of suspended losses attributable to activity C carried over from prior years. During the year, Nancy sells activity C and realizes a $15,000 taxable gain. What is Nancy’s AGI as a result of these transactions?

A) $50,000

B) $55,000

C) $64,000

D) $71,000

Answer:  A

Explanation:  A)

Loss from C for the year ($  13,000)
Gain on sale of C 15,000
Suspended loss from C (  21,000)
Total loss from C ($19,000)
Income from A$ 18,000 
Loss from B(  9,000)     9,000
Nancy’s deduction against salary income ($  10,000)
AGI = Salary – passive deduction $50,000

Page Ref.:  I:8-8; Example I:8-7

Objective:  3

55) Lewis died during the current year. Lewis owned passive activity property with a FMV of $61,000 and a basis of $48,000. Suspended losses of $15,000 were attributable to the property. How much of the suspended loss is deductible on Lewis’s final income tax return?

A) $0

B) $2,000

C) $13,000

D) $15,000

Answer:  B

Explanation:  B) ($61,000 – $48,000) is increase in basis; $13,000 of suspended losses is lost. $15,000 – $13,000 = $2,000.

Page Ref.:  I:8-9; Example I:8-9

Objective:  3

56) Mara owns an activity with suspended passive losses from prior years of $13,000.  In the current year, Mara becomes a material participant in the activity.  This year the activity generates $6,000 of income.  The net effect of this activity on Mara’s current year AGI is a(n)

A) increase of $6,000.

B) decrease of $13,000.

C) -0-.

D) decrease of $7,000.

Answer:  C

Explanation:  C) The suspended passive loss will be allowed to offset this year’s non-passive income from the activity, but the excess suspended passive loss of $7,000 will carryforward.

Page Ref.:  I:8-9; Example I:8-9

Objective:  3

57) Charlie owns activity B which was considered a passive activity and generated a $17,000 suspended loss.  Charlie increases his involvement with activity B so that this year activity B is not considered passive for Charlie. During this year, activity B produces a $9,000 loss. In addition, Charlie acquires an investment in activity X, a passive activity, this year. Charlie’s share of activity X’s income is $13,000. Charlie’s salary this year is $70,000. As a result, this year Charlie must

A) offset B’s loss carryover against X’s current income and carry over $9,000 loss from activity B to next year.

B) offset B’s carryover loss and current loss against X’s income first and then offset any remaining loss against salary.

C) offset B’s $9,000 loss against X’s $13,000 income and offset B’s loss carryover against the remaining $4,000 of X’s income.

D) offset B’s current $9,000 loss against his salary and offset B’s loss carryover against X’s income and carry over $4,000 of loss to next year.

Answer:  D

Explanation:  D) Charlie may deduct Activity B’s current $9,000 loss since it is not a passive activity.  He may also offset passive activity X’s income of $13,000 with the $17,000 carryover from Activity B resulting in a $4,000 carryover.

Page Ref.:  I:8-9; Example I:8-9

Objective:  3

58) Jorge owns activity X which produced a $20,000 passive loss last year. Jorge’s only income last year was wages of $30,000. Jorge is a material participant in activity X this year when it produces a $14,000 loss. This year, Jorge’s wages are $40,000. This year, Jorge also has passive activity income from activity Y of $16,000. What is the total passive activity loss carryover to next year?

A) $-0-

B) $3,000

C) $4,000

D) $18,000

Answer:  C

Explanation:  C) $20,000 carryover from prior year – $16,000 current passive income offset = $4,000 carryover to next year. This year’s $14,000 active business loss from Activity X may offset Jorge’s wages.

Page Ref.:  I:8-9; Example I:8-9

Objective:  3

59) Which of the following is not generally classified as a passive activity?

A) an activity in which the taxpayer does not materially participate

B) a limited partnership interest

C) rental real estate

D) a business in which the taxpayer owns an interest and works 1,000 hours a year

Answer:  D

Explanation:  D) An individual participating in a business for more than 500 hours per year is generally classified as a material participant.

Page Ref.:  I:8-10 and I:8-11

Objective:  3

60) An individual is considered to materially participate in an activity if any of the following tests are met with the exception of

A) the individual participates in the activity for more than 500 hours during the year.

B) the individual participates in the activity for 75 hours during the year, and that participation is more than any other individual’s participation for the year.

C) the individual has materially participated in the activity in any five years during the immediate preceding 10 taxable years.

D) the individual’s participation in the activity for the year constitutes substantially all of the participation in the activity by all individuals.

Answer:  B

Explanation:  B) The individual participates in the activity for more than 100 hours (not 75) during the year, and that participation is more than any other individual’s participation for the year.

Page Ref.:  I:8-11

Objective:  3

61) Tom and Shawn own all of the outstanding stock of Brady Corporation (a retail store operated as a C corporation). This year, Brady generates taxable income of $20,000 from active business operations, and also reports investment interest of $22,000 and losses of $28,000 from a passive activity. As a result, Brady Corporation reports

A) net income of $42,000.

B) interest income of $22,000 and a passive loss carryover of $8,000.

C) business income of $20,000 and a passive loss carryover of $6,000.

D) business income of $20,000, interest income of $22,000, and a passive loss carryover of $28,000.

Answer:  B

Explanation:  B) Because Brady is a closely-held C corporation, the $20,000 of active business income may be offset by $20,000 of the passive loss. The remaining $8,000 loss may be carried over. The investment interest of $22,000 is currently taxable.

Page Ref.:  I:8-13; Example I:8-13

Objective:  3

62) Justin has AGI of $110,000 before considering his $30,000 loss from rental property, which he actively manages. How much of the rental loss can Justin deduct this year?

A) $10,000

B) $20,000

C) $25,000

D) $30,000

Answer:  B

Explanation:  B) Justin must reduce the $25,000 rental loss allowance by 50% of his AGI over $100,000, resulting in a deductible loss of $20,000 [$25,000 – .5($110,000 – $100,000)].

Page Ref.:  I:8-14 and I:8-15; Example I:8-16

Objective:  3

63) Joseph has AGI of $170,000 before considering the $20,000 rental loss for property which he actively manages. How much of the rental loss can he deduct?

A) $0

B) $10,000

C) $20,000

D) $25,000

Answer:  A

Explanation:  A) His AGI exceeds $150,000, so no portion of the rental loss is deductible.

Page Ref.:  I:8-15

Objective:  3

64) Shaunda has AGI of $90,000 and owns rental property generating a $27,000 loss. She actively manages the property. Her deductible loss is

A) $0.

B) $13,500.

C) $25,000.

D) $27,000.

Answer:  C

Explanation:  C) Since her AGI is less than $100,000, she is allowed a $25,000 rental loss. She has a $2,000 suspended loss.

Page Ref.:  I:8-15

Objective:  3

65) Brandon, a single taxpayer, had a loss of $48,000 from a rental real estate activity in which he actively participated. He also had $27,000 of income from another rental real estate activity in which he actively participated. He acquired both investments in 2013. If Brandon has no other passive income or losses and has adjusted gross income of $84,000 before considering passive activities, how much loss from rental activities can he use to offset his nonpassive income?

A) $21,000

B) $24,000

C) $25,000

D) $45,000

Answer:  A

Explanation:  A) $27,000 of the loss offsets $27,000 income from the other passive activity, leaving a net.$21,000 loss. The $21,000 net rental loss may offset nonpassive income using the special allowance of up to $25,000.

Page Ref.:  I:8-15

Objective:  3

66) Which of the following is most likely not considered a casualty?

A) fire loss

B) water damage caused by a busted water heater

C) death of a pine tree due to a two-day infestation of pine beetles

D) water damage to the walls and ceiling of a taxpayer’s personal residence as the result of gradual deterioration of the roof

Answer:  D

Explanation:  D) Water damage due to the gradual deterioration of a roof is not a casualty.  It is not sudden or unexpected.

Page Ref.:  I:8-18

Objective:  4

67) Nicole has a weekend home on Pecan Island that she purchased in 2005 for $250,000. Recently, the home was appraised at $260,000. After the appraisal, a hurricane hit Pecan Island, severely damaging Nicole’s home. An appraisal placed the value of the home at $140,000 after the hurricane. Because of its prohibitive cost, Nicole had no hurricane insurance. Before any reductions or limitations, Nicole’s casualty loss amount is

A) $0.

B) $10,000.

C) $120,000.

D) $140,000.

Answer:  C

Explanation:  C) Lesser of:

Basis$250,000

or Reduction in FMV:

   FMV Before casualty$260,000
   Minus:  FMV After casualty( 140,000)
Reduction in FMV$120,000

Page Ref.:  I:8-19; Example I:8-21

Objective:  4

68) A fire totally destroyed office equipment and furniture which Monica uses in her business. The equipment had an adjusted basis of $15,000 and a FMV of $10,000 before the fire. The furniture’s adjusted basis was $5,000 and its FMV was $2,000 before the fire. Monica’s AGI for the year is $60,000. Monica does not have insurance on the destroyed assets. How much is Monica’s deductible casualty loss?

A) $5,900

B) $12,000

C) $13,900

D) $20,000

Answer:  D

Explanation:  D) For business property totally destroyed, the amount of the loss is the property’s adjusted basis. There is no reduction for the $100 floor and 10% of AGI for business property. The loss equals the $20,000 adjusted bases of the property destroyed ($15,000 + $5,000).

Page Ref.:  I:8-19 and I:8-20; Example I:8-22

Objective:  4

69) Lena owns a restaurant which was damaged by a tornado. The following assets were partially destroyed:

 Basis  Reduction in FMVInsurance Payment
Building$150,000$200,000$100,000
Equipment$30,000$20,000$10,000

Lena has AGI of $50,000. What is the amount of Lena’s deductible casualty loss?

A) $54,900

B) $60,000

C) $70,000

D) $180,000

Answer:  B

Explanation:  B) (150,000 – 100,000) + (20,000 – 10,000) = $60,000. The amount of the loss is the lower of the property’s adjusted basis or the decline in FMV, reduced by the insurance proceeds.  Since the property was used in Lena’s business, there is no 10% of AGI and $100 floor.

Page Ref.:  I:8-19 and I:8-20

Objective:  4

70) Leonard owns a hotel which was damaged by a hurricane. The hotel had an adjusted basis of $1,000,000 before the hurricane. A recent appraisal determined that the hotel’s FMV was $1,500,000 before the hurricane and $700,000 afterwards. Leonard received insurance proceeds of $500,000. His AGI is $60,000. What is the amount of his deductible casualty loss?

A) $293,900

B) $300,000

C) $793,900

D) $800,000

Answer:  B

Explanation:  B) For business property partially destroyed, the amount of the loss is the lower of the decline in FMV or adjusted basis. The decline in FMV is $800,000. Leonard received insurance proceeds of $500,000, resulting in a deductible casualty loss of $300,000.

Page Ref.:  I:8-19 and I:8-20

Objective:  4

71) Jarrett owns a mountain chalet that he purchased in 2008 for $175,000. This year, the home appraised at $300,000. Shortly after the appraisal, a blizzard hit the area in spring of the current year, destroying trees and severely damaging several homes, including Jarrett’s chalet. Its value was reduced to $135,000. Jarrett does not have insurance. Jarrett’s AGI is $200,000. Jarrett’s deductible loss after limitations is

A) $135,000.

B) $144,900.

C) $164,900.

D) $165,000.

Answer:  B

Explanation:  B) Lesser of:

Basis$ 175,000

or Reduction in FMV:

   FMV Before casualty$300,000
   Minus:  FMV After casualty(  135,000)
Reduction in value$ 165,000
Loss$ 165,000
Minus:  $100 floor(      100)
 $ 164,900
Minus:  10% of AGI(    20,000)
Deductible loss$  144,900

Page Ref.:  I:8-20; Example I:8-23 and I:8-24

Objective:  4

72) Hope sustained a $3,600 casualty loss due to a severe storm. She also incurred a $800 loss from a theft in the same year. Both the casualty and theft involved personal-use property. Hope’s AGI for the year is $25,000 and she does not have insurance coverage. Hope’s deductible casualty loss is

A) $1,700.

B) $1,800.

C) $4,200.

D) $4,300.

Answer:  A

Explanation:  A)

StormTheftTotal
Loss before limits$3,600$ 800$4,400
Minus: $100 floor(   100)(  100)(   200)
$3,500$  700$4,200
Minus: 10% of AGI( 2,500)
Deductible loss$ 1,700

Page Ref.:  I:8-20; Example I:8-24

Objective:  4

73) In the current year, Marcus reports the following casualty gains and losses on personal-use property. Assets X and Y are destroyed in the first casualty while Z is destroyed in a second casualty.

AssetReduction  in FMVAdjusted BasisInsuranceHolding  Period
X$8,000$2,000$7,0002 years
Y3,0005,0002,00010 months
Z2,5001,3001,0008 months

As a result of these losses and insurance recoveries, Marcus must report

A) a net gain of $3,700.

B) a long-term gain of $4,900 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $200 on asset Z.

C) a long-term capital gain of $5,000 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $200 on asset Z.

D) a long-term capital gain of $5,000 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $300 on asset Z.

Answer:  C

Explanation:  C)

Gain on X: $7,000 – $2,000 $5,000
Minus: Loss on Y: $2,000 – $3,000 – 100    (   900)
Net gain on first casualty $4,100
Loss on Z: $1,000 – $1,300300 
Minus: $100 floor( 100)(   200)
Net casualty gain $3,900

If the netting process results in a net gain, each item is treated as a separate capital gain and loss. Thus, there is a $5,000 LTCG on Asset X; the $1,000 STCL on Asset Y is reduced by the $100 floor; the $300 STCL on Asset Z is reduced by the $100 floor.

Page Ref.:  I:8-21; Example I:8-25

Objective:  4

74) Wesley completely demolished his personal automobile in a car accident. Damage to the auto was estimated at $35,000. Wesley had purchased the car a few years ago for $60,000. He received an insurance reimbursement of $28,000. His adjusted gross income this year was $55,000 and he incurred no other losses during the year. What amount can he deduct as a casualty loss on his income tax return after limitations?

A) $1,400

B) $1,500

C) $6,900

D) $7,000

Answer:  A

Explanation:  A) ($35,000 – $28,000 – $100 – $5,500) = $1,400

Page Ref.:  I:8-22

Objective:  4

75) A flood damaged an auto owned by Mr. and Mrs. South on June 15 of this year. The car was only used for personal purposes.

Fair market value before the flood$18,500
Fair market value after the flood2,000
Cost basis20,000
Insurance proceeds13,000
Adjusted gross income for this year25,000
Business use of auto-0-

Based on these facts, what is the amount of the South’s casualty loss deduction after limitations for this year?

A) $900

B) $1,000

C) $4,400

D) $4,500

Answer:  A

Explanation:  A)

Fair market value before the flood$18,500
Fair market value after the flood( 2,000)
Decline in FMV$16,500
Cost basis 20,000
Lesser of basis or decline in FMV$16,500
Minus:  Insurance proceeds( 13,000)
Net loss$3,500
Minus: $100 Floor(    100)
10% of AGI( 2,500)
Deductible Loss$     900

Page Ref.:  I:8-20; Example I:8-24

Objective:  4

76) In February 2013, Amelia’s home, which originally cost $150,000, is damaged by a windstorm. Amelia had refinanced the home shortly before the storm, and it was appraised at $200,000. After the storm, the home appraised at $120,000. Amelia has received no insurance reimbursement by December 31, but expects to recover 90 percent of the loss. In the subsequent year, the insurance company pays Amelia $50,000. Amelia’s AGI is $85,000 in 2013, and her 2014 AGI is $80,000. Amelia suffers no other casualty losses in either year. Amelia may deduct

A) $7,900 in 2013.

B) $22,000 in 2014.

C) $13,900 in 2014.

D) $14,000 in 2014.

Answer:  D

Explanation:  D) Loss deducted 2013:

Decrease in FMV (200,000 -120,000)$80,000
Minus: Anticipated recovery( 72,000)
Loss before floors$  8,000
Minus: Floor(      100)
Tentative loss$  7,900
Minus: 10% of AGI(   8,500)
Deductible loss       -0-
Loss in 2014, additional loss due to     smaller recovery ($72,000 – 50,000)$22,000
10% of AGI( 8,000)
Deductible in subsequent year$14,000

Page Ref.:  I:8-22 and I:8-23; Example I:8-29

Objective:  4

77) This summer, Rick’s home (which has a basis of $80,000) is damaged by a tornado. An appraisal by a realtor placed the FMV of the home at $120,000 before the tornado and at $85,000 after the tornado. Rick estimates that the insurance company will reimburse him for 60% of the loss.  Next year, the insurance company pays Rick $20,000. Rick’s current year’s AGI is $50,000 and his next year’s AGI is $55,000. Rick suffers no other casualty losses in either year. After limitations, Rick may deduct a casualty loss this year of

A) $ 8,900.

B) $ 9,900.

C) $15,000.

D) $35,000.

Answer:  A

Explanation:  A) Where partial recovery is expected in a subsequent year, the loss may be deducted in the year of the casualty for the estimated unrecovered amount. Lesser of adjusted basis or loss in value [($120,000 – $85,000) – $21,000 anticipated insurance recovery – $100 floor – $5,000 AGI =$8,900].  Anticipated recovery is 60% × $35,000 = $21,000.

Page Ref.:  I:8-22 and I:8-23; Example I:8-29

Objective:  4

78) Juanita, who is single, is in an automobile accident in 2013 and her car sustains $6,200 in damages. Because both drivers received tickets in the accident, Juanita does not expect to recover any of the loss from her insurance company. Juanita’s 2013 AGI is $31,000, and she deducts a $3,000 loss on her 2013 tax return. Her other itemized deductions in 2013 exceed $12,000. In 2014, Juanita’s insurance company reimburses her $2,800. Juanita’s 2014 AGI is $28,000. As a result, Juanita must

A) amend 2013 to show a $200 loss.

B) do nothing and simply keep the $2,800.

C) do nothing to the 2013 return but report $2,800 of income on her 2014 return.

D) amend the 2013 return to show $0 loss and file her 2014 return to show a $200 loss.

Answer:  C

Explanation:  C)

Loss deducted in 2013:$6,200
Minus: Floor(  100)
 $6,100
Minus: 10% of AGI(3,100)
Loss deducted in 2013$3,000
Tax benefit received$3,000
Reimbursement received in 2014$2,800
Report lesser amount in 2014 income$2,800

Page Ref.:  I:8-23; Example I:8-30

Objective:  4

79) Constance, who is single, is in an automobile accident in 2013, and her car sustains $6,200 in damages. Because both drivers received tickets in the accident, Constance does not expect to recover any of the loss from her insurance company. Constance’s 2013 AGI is $31,000. Her casualty loss is $3,000; she has other itemized deductions of $1,200. In 2014, Constance’s insurance company reimburses her $2,800. Constance’s 2014 AGI is $28,000. As a result, Constance must

A) amend the 2013 return to show the $200 loss.

B) do nothing and simply keep the $2,800.

C) amend the 2013 return to show $0 loss and file her 2014 return to show $200 loss.

D) do nothing to the 2013 return but report $2,800 of income on her 2014 return.

Answer:  B

Explanation:  B)

Loss deducted in 2013:$6,200
Minus: Floor(  100)
 $6,100
Minus: 10% of AGI(3,100)
Loss$3,000
Tax benefit received (not enough to itemize)$   -0-
Reimbursement in 2014$2,800
Report lesser amount in year received$   -0-

Page Ref.:  I:8-23; Example I:8-30

Objective:  4

80) Last year, Abby loaned Pat $10,000 as a gesture of their friendship. Although Pat had signed a note payable that contained interest payments and a maturity date, the loan had not been repaid this year when Pat died insolvent. For this year, assuming that the loan was bona fide, Abby should account for nonpayment of the loan as a(n)

A) itemized deduction.

B) ordinary loss.

C) long-term capital loss.

D) short-term capital loss.

Answer:  D

Explanation:  D) Because the debt is not related to Abby’s trade or business, it is a nonbusiness bad debt. All nonbusiness bad debts are deductible as short-term capital losses.

Page Ref.:  I:8-26

Objective:  5

81) In October 2013, Jonathon Remodeling Co., an accrual-method taxpayer, remodels and renovates an office building for Dale and bills him $30,000. Dale signs a note for the debt. Dale keeps delaying payment and files bankruptcy in 2014. Creditors are informed that no assets are available for payment.  Jonathon Remodeling Co. will report

A) $0 income in both years.

B) $30,000 income in 2013 and a bad debt deduction of $30,000 in 2014.

C) $30,000 income in 2013 and a STCL of $30,000 in 2014 limited to $3,000 after netting.

D) $30,000 income in 2013 and then must amend last year’s return to show $0 income when advised of the bankruptcy.

Answer:  B

Explanation:  B) Since Jonathon Remodeling Co. is an accrual-basis taxpayer, the $30,000 is recognized in income when billed in 2013. The debt is a business bad debt since it is related to a trade or business. The nonpayment in 2014 results in a business bad debt which is an ordinary loss deductible in 2014.

Page Ref.:  I:8-26

Objective:  5

82) Martha, an accrual-method taxpayer, has an accounting practice. In 2012, she performs tax analyses for Arnold and sends him an invoice for $10,000. In 2013, Martha sells her practice and all accounts to David. Arnold’s debt becomes worthless that year. The result is

A) Martha deducts a nonbusiness bad debt in 2013.

B) Martha deducts a business bad debt in 2013

C) David deducts a business bad debt in 2013.

D) David deducts a nonbusiness bad debt in 2013.

Answer:  C

Explanation:  C) Since David acquired the account upon acquiring the business, he is entitled to a business bad debt deduction because the debt was incurred in the trade or business in which David is currently engaged.

Page Ref.:  I:8-27; Example I:8-34

Objective:  5

83) Vera has a key supplier for her business who was facing cash flow problems which would impair Vera’s ability to get shipments of key components for her production.  Vera made a $10,000 loan to the supplier.  Unfortunately the supplier filed for bankruptcy and has gone out of business without repaying Vera.  Vera will be able to recognize a loss of

A) $10,000.

B) $3,000.

C) $7,000.

D) -0-

Answer:  A

Explanation:  A) The motivation for the loan is to assist the functioning of Vera’s business so it will be considered a business bad debt.  An ordinary loss of the full amount will be allowed.

Page Ref.:  I:8-27; Example I:8-35

Objective:  5

84) In 2012 Grace loaned her friend Paula $12,000 to invest in various stocks. Paula signed a note to repay the principal with interest. Unfortunately the market for that industry sector plunged, and Paula incurred large losses. In 2013 Paula declared personal bankruptcy and Grace was unable to collect any of her loan. Grace had no other gains or losses last year or this year. The result is

A) Grace deducts a business bad debt of $12,000 in 2013.

B) Grace deducts a $12,000 nonbusiness bad debt as a short-term capital loss in 2013.

C) Grace deducts a $3,000 nonbusiness bad debt as a short-term capital loss in 2013 and carries $9,000 over to subsequent years.

D) Grace deducts a business bad debt of $3,000 in 2013 and carries $9,000 over to subsequent years.

Answer:  C

Explanation:  C) The debt is a nonbusiness bad debt since it is not related to Grace’s trade or business. Therefore, the $12,000 loss is treated as a short-term capital loss, $3,000 of which is deductible this year and $9,000 of which may be carried over to next year.

Page Ref.:  I:8-27; Example I:8-36

Objective:  5

85) Which of the following expenses or losses could create a net operating loss for an individual taxpayer?

A) large losses on sales of investment assets

B) an operating loss from a sole proprietorship

C) large charitable contributions

D) all of the above

Answer:  B

Explanation:  B) Generally only business losses will allow the creation of an NOL.

Page Ref.:  I:8-29

Objective:  6

86) An individual taxpayer has negative taxable income for the year.  In calculating the net operating loss created, which of the following expenses or losses will be added back to the negative taxable income?

A) capital losses

B) personal and dependency exemptions

C) nonbusiness deductions in excess of nonbusiness income

D) all of the above

Answer:  D

Explanation:  D) The NOL is due to business losses so all of the above will be added back in the computation of the NOL.

Page Ref.:  I:8-30 and I:8-31

Objective:  6

87) A taxpayer incurs a net operating loss in the current year.  With respect to the application of the NOL,

A) the taxpayer will carry back the NOL three years first, then carry forward any balance for five years.

B) the taxpayer must carry forward the loss and has up to 20 years to use it.

C) the taxpayer can carry forward the loss indefinitely until there is sufficient taxable income to use it up.

D) the taxpayer will first carry back the NOL for two years, then carryforward the balance for a period of 20 years, or the taxpayer can elect to only carry forward the loss for the 20-year allowable period.

Answer:  D

Explanation:  D) The normal application period for utilizing the NOL is carry back two years and then carry forward for up to 20 years, but the taxpayer does have the option to forego the carryback period.

Page Ref.:  I:8-32 and I:8-33

Objective:  6

88) Kendal reports the following income and loss:

Salary                                                           $120,000

Income from activity A                               36,000

Loss from activity B                                  ( 30,000)

Loss from activity C                                 ( 60,000)

Activities A, B, and C are all passive activities, but none are rental properties.  What is the amount of the suspended loss attributable to each activity?

Answer:  Kendal has a net passive loss for the year of $54,000 ($90,000 losses – 36,000 income) which must be carried over to subsequent years. The carryover is allocated as follows:

Activity B:      $54,000     ×                = $18,000

Activity C:      $54,000     ×                = $36,000

Page Ref.:  I:8-8; Example I:8-6

Objective:  3

89) During the year, Patricia realized $10,000 of taxable income from activity A, $4,000 loss from activity B, and $6,000 of taxable income from activity C. All three activities are passive activities with regard to Patricia. In addition, $32,000 of passive losses from activity C is carried over from prior years. During the current year, Patricia sells activity C for an $18,000 taxable gain. Patricia’s salary for the year is $100,000. What is the amount of Patricia’s deduction against salary income?

Answer: 

Income for the year from C                                             $6,000

Gain from the sale of C                                                    18,000

Suspended losses from C                                             (32,000)

Total loss from C                                                                                                                ($8,000)

Income for the year from A                                           $10,000

Loss for the year from B                                                (   4,000)                                       6,000

Patricia’s deduction against salary income                                                              ($2,000)

Page Ref.:  I:8-8 and I:8-9; Example I:8-7

Objective:  3

90) Hersh realized the following income and loss this year:

Net taxable income from chocolate shop                                 $50,000

Interest income                                                                                   10,000

Loss from passive activity (not a rental property)                 (58,000)

a.   Assume Hersh is an individual taxpayer and the chocolate shop is his sole proprietorship.  Determine Hersh’s AGI and any carryovers.

b.   Assume the taxpayer is Hersh Inc.,  a C corporation, owned 100% by the Hersh family.  Determine Hersh Inc.’s taxable income and any carryovers.

Answer: 

 a. Individualb. C corporation
Active trade or business income$50,000$50,000
Portfolio (interest) income10,00010,000
Allowed passive loss         0(50,000)
AGI/Taxable income$60,000$10,000
Passive loss carryover$58,000$8,000

Hersh Inc. is a closely held C corporation and can recognize passive losses up to the level of its active trade and business income, but it cannot offset portfolio income.

Page Ref.:  I:8-12 and I:8-13; Example I:8-13

Objective:  3

91) Adam owns interests in partnerships A and B, both of which are Publicly Traded Partnerships. During the current year, Adam’s share of the income from A is $12,000. Adam’s share of B’s loss is $3,500. B also generates portfolio income of which Adam’s share is $2,000. What are the tax consequences of these income and loss items?

Answer:  The $12,000 income from A and the $2,000 from B are portfolio income. Thus, Adam reports $14,000 of portfolio income. He also has a suspended loss of $3,500 from partnership B.

Page Ref.:  I:8-13 and I:8-14; Example I:8-14

Objective:  3

92) Parveen is married and files a joint return. He reports the following items of income and loss for the year:

Salary                                                                                                                $ 135,000

Activity A (passive)                                                                                            13,000

Activity B (nonbusiness rental real estate)                                              ( 45,000)

If Parveen actively participates in the management of Activity B, what is his AGI for the year and what is the passive loss carryover to next year?

Answer: 

Salary                                                                                               $135,000

Passive Activity A Income                               $13,000

Less: Portion of Activity B Loss                     ( 13,000)                      -0-

Less: Special Allowance

Maximum rental real estate loss

Allowed for Activity B                                       $25,000

Reduced by Phase-out:

    ($135,000 – 100,000) × .50                             (17,500)            (  7,500)

AGI                                                                        $127,500

The carryover is $45,000 – 13,000 – 7,500 = $24,500.

Page Ref.:  I:8-14 and I:8-15; Example I:8-16

Objective:  3

93) Aretha has AGI of less than $100,000 and a 25% marginal tax rate. During the year, she reports a $36,000 loss from Activity A and a $24,000 loss from Activity B. Additionally, Activity A generates $8,000 of tax credits. Both activities A and B are passive real estate rental activities in which Anita actively participates and owns over 10% of each activity.

a.    How much loss can be recognized from each activity?

b.    What is the amount of Aretha’s suspended loss from each activity?

c.     How much of the tax credits can be applied this year?

Answer: 
a.    There are losses from each activity, totalling $60,000.  Because AGI is less than $100,000, the special rental loss provision will allow the deduction of losses up to $25,000.  The $25,000 deduction is first allocated to the losses. Because the sum of the losses ($60,000) exceeds the limit, the deductible loss must be allocated ratably between the activities as follows:

Activity A:                    $25,000         ×         $36,000            =      $15,000

                                                                            $60,000

Activity B:                    $25,000         ×         $24,000            =      $10,000

                                                                            $60,000

b.    Activity A has a suspended loss of $21,000 (36,000 – $15,000), and Activity B has a suspended loss of $14,000 ($24,000 – $10,000).

c.     Because the activities are utilizing the full $25,000 loss ceiling, the credits cannot be applied this year.  Activity A has $8,000 of suspended tax credits.

Page Ref.:  I:8-14 through I:8-16; Example I:8-18

Objective:  3

94) Wes owned a business which was destroyed by fire in May 2013. Details of his losses follow:

                              Adj.                       FMV                       FMV                     Insurance

Asset                  Basis                     Before                     After               Reimbursement

    A                    $1,000                   $2,000                          $ 0                      $2,000

    B                     15,000                   10,000                     3,000                        2,000

    C                       2,400                      5,000                     2,500                        1,000

His AGI without consideration of the casualty is $45,000.

What is Wes’s net casualty loss deduction for 2013?

Answer: 

Asset A: $1,000 basis – $2,000 insurance =                                 $ 1,000 gain

Asset B: $7,000 loss in value – $2,000 insurance =                   (  5,000) loss

Asset C: $2,400 basis – $1,000 insurance =                                 (  1,400) loss

For AGI deduction                                                                             ($5,400) loss

Page Ref.:  I:8-19 and I:8-20

Objective:  4

95) Determine the net deductible casualty loss on the Schedule A for Alan Michael when his adjusted gross income was $40,000 in 2013 and the following occurred:

                              Adj.                       FMV                       FMV                      Insurance

Asset                  Basis                    Before                     After                Reimbursement

    A                    $1,200                    $2,000                      $ 500                        $ 100

    B                    14,000                    12,000                      5,000                        1,100

    C                          600                      3,000                      2,775                           125

A and B were destroyed in the same casualty in March. C was destroyed in a separate casualty in July.

All casualty losses were nonbusiness personal use property losses and none occurred in a federally declared disaster area.

What is the amount of the net deductible casualty loss?

Answer: 

March casualty:     A: Loss is lesser of basis or loss in value      $1,200

                                    Less: Insurance reimbursement                      (   100)               $1,100

                                    B: Loss is lesser of basis or loss in value       $7,000

                                    Less: Insurance reimbursement                     ( 1,100)               $5,900

                                    Loss before $100 floor                                                                    $7,000

                                    Less: $100 floor                                                                                      100

                                    Casualty loss from March casualty                                           $6,900

July casualty:          C: Loss is lesser of basis or loss in value         $ 225

                                    Less: Insurance reimbursement                      (   125)                 $ 100

                                    Less: $100 floor                                                                                (   100)

                                    Casualty loss from July casualty                                                  $      0

Total loss before 10% AGI                                                                                                 $6,900

10% AGI                                                                                                                                   4,000

Net deductible casualty loss                                                                                            $2,900

Page Ref.:  I:8-21; Example I:8-25

Objective:  4

96) Frank loaned Emma $5,000 in 2011 with the agreement that the loan would be repaid in three years. In 2012, Emma filed for bankruptcy and based on available information from the bankruptcy court, it was estimated that Frank could expect to receive $.65 on the dollar. In 2013, final settlement was made and Frank received $600.

a.    Assuming the loan is a business bad debt, what is the amount of and the nature of Frank’s deduction in 2012?

b.    Assuming the loan is a business bad debt, what is the amount of and the nature of Frank’s deduction in 2013?

c.     Assuming instead that the loan is a nonbusiness bad debt, what is the amount of and the nature of Frank’s deduction in 2012? 2013?

Answer: 
a.    2012 deduction–$1,750 ordinary loss ((1.00 – .65 = .35 expected loss rate) × $5,000 loan))

b.    2013 loss–$2,650 ordinary loss ($5,000 loan – $1,750 prior year deduction – $600 recovery)

c.     In 2012, the loss is partially worthless, so no deduction is allowed until settlement has occurred. In 2013, the $4,400 short-term capital loss ($5,000 loan – $600 recovery) will be netted against other capital gains and losses. If there are no other capital gains and losses, the loss is limited to the $3,000 current deduction.

Page Ref.:  I:8-26 through I:8-28

Objective:  5

97) Becky, a single individual, reports the following taxable items in 2013:

Gross income from business                                                                                         $ 93,000

Minus: Business expenses                                                                                           ( 105,000)

                                                                                                                                             ($ 12,000)

Interest income                                                                                                                        1,500

AGI                                                                                                                                    ($  10,500)

Itemized deductions:

Interest expense                                                                            $ 3,100

State Income Taxes                                                                         1,900

Casualty                                                                                             3,000

Total itemized deductions                                                                                             (   8,000)

Minus: Personal exemption                                                                                           (   3,900)

Taxable income                                                                                                                ($22,400)

What is Barbara’s NOL for the year?

Answer: 

Taxable income                                                                                                              ($22,400)

Plus: Nonbusiness deductions:

Itemized deductions                                                                   $ 8,000

Minus: Casualty loss                                                                (  3,000)

                                                                                                          $ 5,000

Minus: Nonbusiness income:

      Interest income                                                                        (1,500)

Plus: Excess of nonbusiness deductions

      over nonbusiness income                                                                                             3,500

Plus: Personal exemption                                                                                                  3,900

Net operating loss                                                                                                         ($15,000)

Page Ref.:  I:8-31; Example I:8-41

Objective:  6

98) Harley, a single individual, provided you with the following information for this year:

Income:

Salary from part-time employment$ 16,000
Interest income from savings1,000
Net long-term capital gain from investment property3,000

Deductions:

Net business loss (sales of $100,000 less expenses of $130,000)($30,000)
Personal exemption(   3,900)
Standard deduction(   6,100)
Net-operating loss carryover from last year(   3,000)

What is the amount of Harley’s net operating loss for this year?

Answer: 

Salary from part-time employment $ 16,000
Interest income from savings 1,000
Net long-term capital gain from inv. property    3,000
Subtotal 20,000
Net business loss(30,000) 
Personal exemption(  3,900) 
Standard deduction(  6,100) 
Net-operating loss carryover from last year(  3,000)( 43,000)
Taxable Income  (23,000)
NOL Deduction + 3,000
Excess of non-business deductions    over non-business income ($6,100-4,000)  2,100
Exemption 3,900
Net Operating Loss ($14,000)

Page Ref.:  I:8-30 through I:8-33; Example I:8-42

Objective:  6

99) Businesses can recognize a loss on abandoned property. What types of factors would indicate that property had been abandoned?

Answer: 
1.     Worthlessness of the property

2.     The property is not worth placing into a serviceable condition

3.     If it is depreciable property, taxpayer must physically abandon property.

Page Ref.:  I:8-3

Objective:  1

100) What must an individual taxpayer prove to receive a worthless security deduction?

Answer: 
1.     Security is completely worthless

2.     Security became worthless during the current tax year

Page Ref.:  I:8-3 and I:8-4

Objective:  1

101) Erin, a single taxpayer, has 1,000 shares of 1244 stock she purchased directly from AAA Corporation for $120,000 five years ago. The stock has a FMV of $30,000, and Erin is thinking of selling the stock. She has no other capital gains or losses for the year. Discuss the tax consequences and planning opportunities relating to selling the stock.

Answer:  A single taxpayer may deduct up to $50,000 as an ordinary loss when Section 1244 stock is sold at a loss. To maximize the benefit, Erin should consider selling part of the stock this year (enough to generate a $50,000 loss) and selling the remainder next year. By splitting the sale, she will be able to convert all of the $90,000 loss to an ordinary loss and maximize the tax benefits. Ordinary loss treatment is preferable to capital loss treatment since Erin has no other capital gains and losses and the net capital loss deduction is limited to $3,000 per year. Non-tax considerations include Erin’s need for the sale proceeds currently as well as the time value of money and the risk of further losses on the stock.

Page Ref.:  I:8-5

Objective:  2

102) Why was Section 1244 enacted by Congress? Specifically, consider and discuss some of the individual qualifying requirements of Sec. 1244.

Answer:  Sec. 1244 was enacted in order to encourage investment in small business enterprises. By allowing an ordinary (instead of a capital) deduction a tax break is given to individuals and partnerships when they sell stock in small new enterprises that suffer reductions in stock equity.  In order for stock to qualify under Sec. 1244:

-The stock must be owned by an individual or partnership.

-The stock must have been originally issued by the corporation to the shareholder.

-The corporation must be a domestic corporation.

-The stock must have been issued for cash or property other than stock or securities.

-The stock must not have been issued in exchange for services.

-More than 50% of the gross receipts must be from sources other than passive income during the five preceding years.

-Paid in capital did not excess $1 million at the time of stock issuance.

Page Ref.:  I:8-5 and I:8-6

Objective:  2

103) Why did Congress enact restrictions and limitations on losses from passive activities?

Answer:  If there were no restrictions or limitations on passive losses many taxpayers would engage in passive activities for a tax shelter. These tax shelters would create deductions and credits from passive activities to offset and sometimes eliminate income from active business activities, which is what Congress is trying to prevent.

Page Ref.:  I:8-7

Objective:  3

104) What is required for an individual to be considered as actively participating in a real estate activity for purposes of utilizing the $25,000 ceiling on rental real estate losses?

Answer:  The taxpayer must participate in making management decisions or arrange for others to provide services in a significant and bona fide sense. Some of these management decisions include approving new tenants, deciding on rental terms, and approving expenditures.  This is a lower level of participation than material participation.

Page Ref.:  I:8-15

Objective:  3

105) What is or are the standards that must be present to warrant a casualty loss deduction?

Answer: 
1.     The loss must arise in an identifiable event

2.     The event is sudden or unexpected or unusual

Page Ref.:  I:8-17 and I:8-18

Objective:  4

106) A taxpayer suffers a casualty loss on personal-use property for which he has insurance coverage. However, to avoid a premium adjustment, the taxpayer fails to make a timely claim. In this situation is the full deduction for the casualty, after the normal floors, available to the taxpayer? Why or why not?

Answer:  No deduction is allowed. Sec. 165(h)(4)(E) states that a timely insurance claim is required for a casualty loss on personal-use property to be deductible.

Page Ref.:  I:8-21

Objective:  4

107) If a loan has been made to a related party, what are some considerations for determining whether the loan is a bona fide debt or is, in fact, merely a gift?

Answer:  Consider whether there is a written instrument to indicate evidence of an obligation to repay. Is there a definite schedule of repayment? Consider whether a reasonable rate of interest has been imposed. Also, determine whether an unrelated party would make a similar loan.

Page Ref.:  I:8-24 and I:8-25

Objective:  5

108) Distinguish between the accrual-method taxpayer and the cash-method taxpayer with regard to basis in a receivable.

Answer:  An accrual-method taxpayer reports income in the year services are performed or property is provided. Thus the accrual-method taxpayer has a basis in a receivable equal to the amount included in gross income.

A cash-method taxpayer reports income only in the year in which payment is received. Thus, if a receivable is an open account item, a cash-method taxpayer reports no income until the receivable is collected. Because no income is reported until the receivable is collected, there is no basis in the receivable.

Page Ref.:  I:8-26

Objective:  5

109) What are some factors which indicate that a debt may be worthless?

Answer: 
1.     Bankruptcy of the debtor.

2.     Death or disappearance of the debtor.

3.     Repeated unsuccessful attempts at collection.

Page Ref.:  I:8-26

Objective:  5

110) If an NOL is incurred, when would a taxpayer elect to forgo the carryback period and only carry the loss deduction forward?

Answer:  The taxpayer should elect to forgo carryback if the marginal tax rate in future years is expected to be higher than the marginal tax rate in carryback years.

General business and other tax credits may be reduced by an NOL carryback because these credits must be recomputed based upon the adjusted tax liability after the NOL carryback.

Page Ref.:  I:8-34

Objective:  7

111) How is a claim for refund of taxes filed by an individual who carries an NOL deduction back to a prior year?

Answer:  A claim for refund of taxes is filed by either filing an amended return on Form 1040X or filing for a quick refund on Form 1045. If Form 1045 is used, the IRS must act on the application for refund within 90 days from the later of (1) the date of the application or (2) the last day of the month in which the return of the loss year must be filed. Form 1045 must be filed within a year after the end of the year in which the NOL arose.

Page Ref.:  I:8-35

Objective:  8

Chapter I9 

1) Deferred compensation refers to methods of compensating employees based upon their current service where the benefits are deferred until future periods.

Answer:  TRUE

Page Ref.:  I:9-2

Objective:  1

2) If an individual is self-employed, business-related expenses are deductions forAGI.

Answer:  TRUE

Page Ref.:  I:9-2

Objective:  1

3) Unreimbursed employee business expenses are deductions from AGI.

Answer:  TRUE

Page Ref.:  I:9-2

Objective:  1

4) An employer-employee relationship exists where the employer has the right to control and direct the individual providing services with regard to the end result and the means by which the result is accomplished.

Answer:  TRUE

Page Ref.:  I:9-2 and I:9-3

Objective:  1

5) A nondeductible floor of 2% of AGI is imposed on unreimbursed employee business expenses, investment expenses, and many other miscellaneous itemized deductions such as tax preparation fees.

Answer:  TRUE

Page Ref.:  I:9-4

Objective:  1

6) Gambling losses are miscellaneous itemized deductions subject to the 2% of AGI floor.

Answer:  FALSE

Explanation:  Gambling losses are miscellaneous itemized deductions but are not subject to the 2% floor.

Page Ref.:  I:9-4

Objective:  1

7) Personal travel expenses are deductible as miscellaneous itemized deductions subject to the 2% of AGI floor.

Answer:  FALSE

Explanation:  Personal travel expenses are not deductible.

Page Ref.:  I:9-5

Objective:  2

8) The deduction for unreimbursed transportation expenses for employees is subject to the 2% of AGI floor.

Answer:  TRUE

Page Ref.:  I:9-5

Objective:  2

9) If an individual is not “away from home,” expenses related to local transportation are never deductible.

Answer:  FALSE

Explanation:  Such expenses may be classified as deductible transportation expenses.

Page Ref.:  I:9-5

Objective:  2

10) Jason, who lives in New Jersey, owns several apartment buildings in Baltimore. His travel expenses to Baltimore to inspect his property are tax deductible.

Answer:  TRUE

Explanation:  See Table I:9-1.

Page Ref.:  I:9-5

Objective:  2

11) According to the IRS, a person’s tax home is the location of the family residence regardless of the location of the taxpayer’s principal place of employment.

Answer:  FALSE

Explanation:  According to the IRS, a taxpayer’s home is his principal place of employment.

Page Ref.:  I:9-6

Objective:  2

12) In determining whether travel expenses are deductible, a general rule is that if a person is reassigned for an indefinite period, the individual’s tax home shifts to the new location and travel expenses are not deductible.

Answer:  TRUE

Page Ref.:  I:9-6

Objective:  2

13) Travel expenses related to temporary work assignments of one year or less are deductible.

Answer:  TRUE

Page Ref.:  I:9-6

Objective:  2

14) If the purpose of a trip is primarily personal and only secondarily related to business, the transportation costs to and from the destination are deductible.

Answer:  FALSE

Page Ref.:  I:9-7

Objective:  2

15) Incremental expenses of an additional night’s lodging and additional day’s meals that are incurred to obtain “excursion” air fare rates with respect to employees whose business travel extends over Saturday night are not deductible business expenses.

Answer:  FALSE

Page Ref.:  I:9-8

Objective:  2

16) Travel expenses for a taxpayer’s spouse are deductible if the spouse is an employee, the travel is for a bona fide purpose, and the expenses are otherwise deductible.

Answer:  TRUE

Page Ref.:  I:9-8

Objective:  2

17) Travel expenses related to foreign conventions are disallowed unless the meeting is directly related to the taxpayer’s business or is employment related and it is reasonable for the meeting to be held outside of North America.

Answer:  TRUE

Page Ref.:  I:9-8

Objective:  2

18) Commuting to and from a job location is a deductible expense.

Answer:  FALSE

Page Ref.:  I:9-9 and I:9-10

Objective:  3

19) Transportation expenses incurred to travel from one job to another are deductible if a taxpayer has more than one job.

Answer:  TRUE

Page Ref.:  I:9-10

Objective:  3

20) Taxpayers may use the standard mileage rate method when five vehicles are used simultaneously for business.

Answer:  FALSE

Explanation:  When multiple vehicles are used simultaneously for business, the standard mileage method is only allowed when four or fewer vehicles are in service.

Page Ref.:  I:9-11

Objective:  3

21) If the standard mileage rate is used in the first year, the actual expense method may not be used in future years.

Answer:  FALSE

Explanation:  A taxpayer can switch to the actual cost method, but basis adjustments are required.

Page Ref.:  I:9-11

Objective:  3

22) A taxpayer goes out of town to a business convention.  The 50% reduction applies to the cost of food, entertainment and transportation expenses.

Answer:  FALSE

Explanation:  The 50% reduction does not apply to transportation expenses.

Page Ref.:  I:9-13

Objective:  4

23) Self-employed individuals receive a for AGI deduction for 50% of entertainment expenses paid or incurred in the trade or business.

Answer:  TRUE

Page Ref.:  I:9-13

Objective:  4

24) If an employee incurs business-related entertainment expenses that are fully reimbursed, it is the employer who is subject to the 50% limitation.

Answer:  TRUE

Page Ref.:  I:9-13

Objective:  4

25) If a meeting takes place at a sporting event or night club, the entertainment can not be “directly related” and, thus, can not be deductible.

Answer:  FALSE

Explanation:  To be deductible, entertainment must be either “directly related” expenses or “associated with” expenses.

Page Ref.:  I:9-13

Objective:  4

26) “Associated with” entertainment expenditures generally must occur on the same day that business is discussed.

Answer:  TRUE

Explanation:  The entertainment must directly precede or follow a bona fide business discussion, i.e., entertainment and business discussion generally must occur on the same day.

Page Ref.:  I:9-14

Objective:  4

27) Dues paid to social or athletic clubs are deductible if they meet a primary-use test, requiring that more than 50% of the use of the facility be for business purposes.

Answer:  FALSE

Explanation:  Club dues are not deductible.

Page Ref.:  I:9-15

Objective:  4

28) Generally, 50% of the cost of business gifts is deductible up to $25 per donee per year.

Answer:  FALSE

Explanation:  There is no 50% reduction for the deduction of business gifts.

Page Ref.:  I:9-16

Objective:  4

29) Incidental costs such as gift wrapping, mailing, and delivery of gifts are included in the $25 per donee limitation.

Answer:  FALSE

Page Ref.:  I:9-16; Example I:9-33

Objective:  4

30) A gift from an employee to his or her superior does not qualify as a business gift.

Answer:  TRUE

Page Ref.:  I:9-16

Objective:  4

31) An accountant takes her client to a hockey game following a business meeting.  Because it is a playoff game, and the tickets were purchased that day, a premium was paid.  The deduction for the tickets is limited to 50% of the face value.

Answer:  TRUE

Page Ref.:  I:9-16

Objective:  4

32) If an employee incurs travel expenditures and is fully reimbursed by the employer, neither the reimbursement nor the deduction is reported on the employee’s tax return if reporting is pursuant to an accountable plan.

Answer:  TRUE

Page Ref.:  I:9-17; Example I:9-35

Objective:  5

33) Kim currently lives in Buffalo and works in Rochester, a 60-mile commute each way.  Kim accepts a new job in a town outside of Rochester, and the new commute is 75-miles each way.  Kim decides the commute for the new job is too long, and she moves to Rochester.  Kim is eligible to deduct her moving expenses.

Answer:  FALSE

Explanation:   The new commute must be at least 50 miles further than the old commute (110 miles in this case).

Page Ref.:  I:9-19 and I:9-20; Example I:9-42

Objective:  6

34) Deductible moving expenses include the cost of moving household goods and personal effects as well as temporary living expenses.

Answer:  FALSE

Explanation:  Temporary living expenses are not deductible as a moving expense.

Page Ref.:  I:9-20 and I:9-21

Objective:  6

35) When a public school system requires advanced education for a teacher to continue employment, the teacher’s expenses are a deductible education expense.

Answer:  TRUE

Page Ref.:  I:9-23 and I:9-24; Example I:9-48

Objective:  7

36) Educational expenses incurred by a CPA for courses necessary to meet continuing education requirements are fully deductible.

Answer:  TRUE

Page Ref.:  I:9-23

Objective:  7

37) Educational expenses incurred by a bookkeeper for courses necessary to sit for the CPA exam are fully deductible.

Answer:  FALSE

Explanation:  Expenses are not deductible if the education is required to meet minimum educational requirements for a new trade or business (or employment activity).

Page Ref.:  I:9-23; Example I:9-49

Objective:  7

38) In-home office expenses are deductible if the office is used exclusively on a regular basis as the principal place of business for any trade or business of the taxpayer.

Answer:  TRUE

Page Ref.:  I:9-24 and I:9-25

Objective:  8

39) In addition to the general requirements for in-home office expenses, employees must also prove that the exclusive use of the office is for the convenience of the employer.

Answer:  TRUE

Page Ref.:  I:9-25

Objective:  8

40) In-home office expenses for an office used by the taxpayer for administrative or management activities of the taxpayer’s trade or business are never deductible.

Answer:  FALSE

Explanation:  Such expenses are deductible if there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business.

Page Ref.:  I:9-25

Objective:  8

41) In-home office expenses which are not deductible in the year in which the costs were incurred due to limitations may be carried forward to subsequent years.

Answer:  TRUE

Page Ref.:  I:9-26

Objective:  8

42) An employer receives an immediate tax deduction for pension and profit-sharing contributions made on behalf of employees.

Answer:  TRUE

Page Ref.:  I:9-27

Objective:  9

43) In a defined contribution pension plan, fixed amounts are contributed based upon a specific formula and retirement benefits are based on the value of a participant’s account at the time of retirement.

Answer:  TRUE

Page Ref.:  I:9-28

Objective:  9

44) A qualified pension plan requires that employer-provided benefits must be 100 percent vested after five years of service.

Answer:  TRUE

Page Ref.:  I:9-30

Objective:  9

45) Under a qualified pension plan, the employer’s deduction is usually deferred until the employee recognizes income.

Answer:  FALSE

Explanation:  A qualified plan will allow the employer an immediate deduction.

Page Ref.:  I:9-30

Objective:  9

46) Nonqualified deferred compensation plans can discriminate in favor of highly compensated executives.

Answer:  TRUE

Page Ref.:  I:9-32

Objective:  9

47) Corporations issuing incentive stock options receive a tax deduction for compensation expense.

Answer:  FALSE

Explanation:  The employer foregoes the compensation expense deduction when it issues incentive stock options.

Page Ref.:  I:9-34 and I:9-35

Objective:  9

48) Employees receiving nonqualified stock options recognize ordinary income at the grant date or exercise date if there is a readily ascertainable fair market value.

Answer:  TRUE

Page Ref.:  I:9-36

Objective:  9

49) A sole proprietor establishes a Keogh plan.  The highest effective percentage of earned income she can contribute is 25 percent.

Answer:  FALSE

Explanation:  Due to the effect of reducing the earned income base by one-half of self-employment tax and the contribution itself, the permissible 25% contribution is reduced to an effective 20% contribution rate.

Page Ref.:  I:9-37

Objective:  9

50) The maximum tax deductible contribution to a traditional IRA in 2013 is $5,500 ($6,500 for a taxpayer age 50 or over).

Answer:  TRUE

Page Ref.:  I:9-38 and I:9-39

Objective:  9

51) The maximum tax deductible contribution to a Roth IRA in 2013 is $5,500 ($6,500 for a taxpayer age 50 or over).

Answer:  FALSE

Explanation:  Contributions to Roth IRAs are not tax deductible.

Page Ref.:  I:9-40

Objective:  9

52) A contributor may make a deductible contribution to a Coverdell Education Savings Account for a qualified designated beneficiary of up to $2,000.

Answer:  FALSE

Explanation:  Contributions to CESAs are not tax deductible.

Page Ref.:  I:9-42

Objective:  9

53) All taxpayers are allowed to contribute funds to Health Savings Accounts to supplement their health insurance.

Answer:  FALSE

Explanation:  Only taxpayers covered by high-deductible health plans can contribute funds to an HSA.

Page Ref.:  I:9-43

Objective:  9

54) In which of the following situations is the individual is an independent contractor rather than an employee?

A) a nurse who is directly supervised by doctors in an office

B) a computer programmer who is instructed as to what projects to undertake, programming language and format, and hours of work

C) a nurse who travels to several different patients. She sets her own hours and is responsible for the delivery of nursing care and end result

D) a teacher whose hours, classroom responsibilities, content and methods of instruction are established by the school

Answer:  C

Explanation:  C) This nurse is not under supervision of an employer.  The nurse sets her own hours and the delivery of care and the end result.

Page Ref.:  I:9-2 and I:9-3; Examples I:9-1 and I:9-2

Objective:  1

55) Which of the following statements regarding independent contractors and employees is true (ignore temporary provisions)?

A) Independent contractors pay Social Security and Medicare tax of 15.3%.

B) Employees must pay unemployment taxes.

C) Independent contractors and employees pay the same Social Security and Medicare tax rates.

D) Independent contractors deduct their business expenses “from AGI.”

Answer:  A

Explanation:  A) Independent contractors are responsible for their own Social Security taxes and Medicare taxes which are paid as a “self employment” tax in addition to income taxes.

Page Ref.:  I:9-3

Objective:  1

56) West’s adjusted gross income was $90,000. During the current year he incurred and paid the following:

Publications (unreimbursed and related to employment)$2,000
Tax return preparation fee1,000
Dues to professional organizations1,500
Fees for will preparation (no tax advice)800
Life insurance premiums1,400

Assuming he can itemize deductions, how much should West claim as miscellaneous itemized deductions (after limitations have been applied)?

A) $2,700

B) $4,500

C) $3,500

D) $5,300

Answer:  A

Explanation:  A) The first three items are deductible—$2,000 + $1,000 + $1,500 = $4,500. The floor is $1,800 (.02 × $90,000), leaving a deduction of $2,700.

Page Ref.:  I:9-4; Example I:9-3

Objective:  1

57) Allison, who is single, incurred $4,000 for unreimbursed employee expenses, $10,000 for mortgage interest and real estate taxes on her home, and $500 for investment counseling fees. Allison’s AGI is $80,000. Allison’s allowable deductions from AGI are (after limitations have been applied)

A) $10,500.

B) $12,900.

C) $14,000.

D) $14,500.

Answer:  B

Explanation:  B) Only the mortgage interest and taxes are allowable deductions not subject to the 2% floor. Unreimbursed employee expenses and investment fees are miscellaneous itemized deductions subject to the 2% nondeductible floor. $10,000 + [(4,000 + $500) – $1,600] = $12,900.

Page Ref.:  I:9-4; Example I:9-4

Objective:  1

58) All of the following are allowed a “For AGI” deduction except:

A) Cora owns her own CPA firm and travels from Lafayette, LA. to Washington, D.C. to attend a tax conference.

B) Jennifer, who lives in Houston, is the owner or several apartment buildings in Salt Lake City and travels there to inspect and manage her investments.

C) Alan is self-employed and is away from home overnight on job-related business.

D) Alison is an employee who is required to travel to company facilities throughout the U.S. in the conduct of her management responsibilities. She is not reimbursed by her employer.

Answer:  D

Explanation:  D) Unreimbursed employee business expenses (Alison in “d”) are from AGI deductions, specifically, miscellaneous itemized deductions subject to the 2% floor.

Page Ref.:  I:9-5; Table I:9-1

Objective:  2

59) Ron is a university professor who accepts a visiting position at another university for six months and

obtains a leave of absence from his current employer. Ron rents an apartment near the university and purchases his food.  These living expenses incurred by Ron while visiting the university will be

A) deductible for AGI.

B) deductible from AGI, without application of a floor.

C) deductible from AGI, subject to the 2% of AGI floor.

D) nondeductible.

Answer:  C

Explanation:  C) Ron has accepted a temporary assignment of one year or less so the living expenses are deductible.  He is an employee so the deductible expenses will be subject to the 2% of AGI floor.

Page Ref.:  I:9-6 and I:9-7

Objective:  2

60) Gwen traveled to New York City on a business trip for her employer. Gwen spent 4 days in business meetings and conferences and then spent 2 days sightseeing in the area. Gwen’s plane fare for the trip was $250. Meals cost $160 per day. Hotels and other incidental expenses amounted to $250 per day.  Gwen was not reimbursed by her employer for any expenses. Her AGI for the year is $50,000 and she itemizes but has no other miscellaneous itemized deductions. Gwen may deduct (after limitations)

A) $570.

B) $890.

C) $1,890.

D) $1,570.

Answer:  A

Explanation:  A)

Plane fare $ 250
Meals ($160 × 4)$640 
Minus: 50% of meals cost(320)320
Hotels ($250 × 4)     1,000
Subtotal $1,570
Minus: 2% of $50,000 AGI ( 1,000)
Deductible expenses $     570 

Page Ref.:  I:9-8; Example I:9-10

Objective:  2

61) Norman traveled to San Francisco for four days on vacation, and while there spent another two days conducting business for his employer. Norman’s plane fare for the trip was $500; meals cost $150 per day; hotels cost $300 per day; and a rental car cost $150 per day that was used for all six days. Norman was not reimbursed by his employer for any expenses. Norman’s AGI for the year is $40,000 and he did not have any other miscellaneous itemized deductions. Norman may deduct (after limitations)

A) $250.

B) $800.

C) $1,050.

D) $1,200.

Answer:  A

Explanation:  A)

Meals ($150 × 2)$ 300  
Minus: 50% of meals( 150)$150
Hotels ($300 × 2) 600
Rental car ($150 × 2)    300
Total expenses $1,050
Minus: 2% of $40,000 ( 800)
Deductible expenses $ 250 

Because the taxpayer spent more than half the days on vacation, the plane fare is not allowed at all.

Page Ref.:  I:9-8; Examples I:9-10 and I:9-11

Objective:  2

62) Gayle, a doctor with significant investments in the stock market, traveled on a cruise ship to Bermuda.  Investment specialists provided daily seminars which Gayle attended.  The cost of the cruise for four days is $2,500. Gayle can deduct (before application of any floors)

A) $0.

B) $1,250.

C) $2,000.

D) $2,500.

Answer:  A

Explanation:  A) None of the travel expenses are deductible because the expenses are related to income-producing activities under Section 212 and are not related to Gayle’s trade or business.

Page Ref.:  I:9-8 and I:9-9; Example I:9-15

Objective:  2

63) Chelsea, who is self-employed, drove her automobile a total of 20,000 business miles in 2013. This represents about 75% of the auto’s use.  She has receipts as follows:

Parking (business only)$500
Tolls (business only)200
Repairs$1,000

Chelsea has an AGI for the year of $50,000. Chelsea uses the standard mileage rate method.  After application of any relevant floors or other limitations, she can deduct

A) $11,000.

B) $12,000.

C) $11,825.

D) $13,000.

Answer:  B

Explanation:  B) (20,000 miles × .565) + $500 parking + $200 tolls = $12,000. The cost of repairs would not be added to the standard mileage method.  Chelsea is self-employed so the 2% of AGI floor does not apply.

Page Ref.:  I:9-11

Objective:  3

64) Brittany, who is an employee, drove her automobile a total of 20,000 business miles in 2013. This represents about 75% of the auto’s use.  She has receipts as follows:

Parking (business only)$500
Tolls (business only)200
Repairs$1,000

Brittany’s AGI for the year of $50,000, and her employer does not provide any reimbursement. She uses the standard mileage rate method.  After application of any relevant floors or other limitations, Brittany can deduct

A) $11,000.

B) $12,000.

C) $11,825.

D) $13,000.

Answer:  A

Explanation:  A) (20,000 miles × .565) + $500 parking + $200 tolls – $1,000 (2% of AGI) = $11,000.  The cost of repairs would not be added to the standard mileage method. 

Page Ref.:  I:9-11

Objective:  3

65) Rajiv, a self-employed consultant, drove his auto 20,000 miles this year, 15,000 to meetings with clients and 5,000 for commuting and personal use.  The cost of operating the auto for the year was as follows:

Gasoline and repairs$7,000
Insurance1,000
Depreciation4,000

Rajiv’s AGI is $100,000 before considering the auto costs.  Rajiv has used the actual cost method in the past.  What is Rajiv’s deduction for the use of the auto after application of all relevant limitations?

A) $8,325

B) $9,000

C) $6,325

D) $7,000

Answer:  B

Explanation:  B) ($7,000 + $1,000 + $4,000) × 15,000/20,000.  Rajiv is self-employed so the 2% of AGI floor does not apply.

Page Ref.:  I:9-11

Objective:  3

66) Jordan, an employee, drove his auto 20,000 miles this year, 15,000 to meetings with clients and 5,000 for commuting and personal use.  The cost of operating the auto for the year was as follows:

Gasoline and repairs$7,000
Insurance1,000
Depreciation4,000

Jordan submitted appropriate reports to his employer, and the employer paid a reimbursement of $ .50 per mile.  Jordan has used the actual cost method in the past.  Jordan’s AGI is $50,000.  What is Jordan’s deduction for the use of the auto after application of all relevant limitations?

A) $1,500

B) $500

C) $1,000

D) $8,000

Answer:  B

Explanation:  B) ($7,000 + $1,000 + $4,000) × 15,000/20,000 = $9,000.  $9,000 – (15,000 × .50) – (2% × $50,000) = $500.  Jordan is an employee so qualifying expenses after reduction for reimbursement are limited by the 2% of AGI floor.

Page Ref.:  I:9-11 and I:9-12; Example I:9-24

Objective:  3

67) Sarah incurred employee business expenses of $5,000 consisting of $3,000 business meals and $2,000 customer entertainment. She provided an adequate accounting to her employer’s accountable plan and received reimbursement for one-half of the total expenses. How much of the meals and entertainment will be deductible by Sarah without consideration of the 2% of AGI limit?

A) $0

B) $1,250

C) $2,500

D) $5,000

Answer:  B

Explanation:  B) $3,000 + $2,000 = $5,000 total expenses × .50 reimbursed = $2,500 unreimbursed × .50 = $1,250.

Page Ref.:  I:9-13

Objective:  4

68) Austin incurs $3,600 for business meals while traveling for his employer, Tex, Inc. Austin is reimbursed in full by Tex pursuant to an accountable plan. What amounts can Austin and Tex deduct?

A)

AustinTex
$0$1,800

B)

AustinTex
$0$3,600

C)

AustinTex
$1,800$1,800

D)

AustinTex
$3,600$0

Answer:  A

Explanation:  A) The taxpayer who ultimately pays the expenses is subject to the 50% cutoff. $3,600 × .50 = $1,800.

Page Ref.:  I:9-13; Example I:9-26

Objective:  4

69) Joe is a self-employed tax attorney who frequently entertains his clients at his country club. Joe’s club expenses include the following:

Annual dues$ 5,400
Initiation fees1,200
Charges for personal meals with his family3,100
Meal and entertainment charges related to business use4,000

Assuming the business meals and entertainment qualify as deductible entertainment expenses, Joe may deduct

A) $2,000.

B) $4,700.

C) $5,300.

D) $4,000.

Answer:  A

Explanation:  A) He gets no deduction for the dues, initiation, or the personal meals. Business meals are 50% deductible. ($4000 × .50) = $2,000

Page Ref.:  I:9-15; Example I:9-32

Objective:  4

70) Brett, an employee, makes the following gifts, none of which are reimbursed:

Brett’s supervisor$30
Brett’s secretary40
4 customers ($27 each)108
Gift wrapping customer gifts10

What amount of the gifts is deductible before application of the 2% of AGI floor for miscellaneous itemized deductions?

A) $135

B) $150

C) $170

D) $180

Answer:  A

Explanation:  A) $25 (secretary) + $100 (4 × $25 for customers) + $10 = $135. The gift to the supervisor is not deductible. Deductible gifts are limited to $25 per donee plus wrapping.

Page Ref.:  I:9-16; Example I:9-33

Objective:  4

71) Steven is a representative for a textbook publishing company. Steven attends a convention which will also be attended by many potential customers. During the week of the convention, Steven incurs the following costs in entertaining potential customers.

Meal costs$ 1,500
Entertainment of customers3,500

Having recently been to a company seminar on the new tax laws, Steven makes sure that business is discussed at the various dinners, and that the entertainment is on the same day as the different dinners. Steven is reimbursed $2,000 by his employer under an accountable plan. Steven’s AGI for the year is $50,000, and while he itemizes deductions, he has no other miscellaneous itemized deductions. What is the amount and character of Steven’s deduction after any limitations?

A) $500 from AGI

B) $500 for AGI

C) $2,000 from AGI

D) $2,000 for AGI

Answer:  A

Explanation:  A) Since there was an accountable plan, no amount is included in income. Excess costs are deducted from AGI as a miscellaneous itemized deduction. The excess expenses are first subject to the 50% limitation and then subject to the 2% nondeductible floor.

Eligible expenses ($5,000 – $2,000) × 0.50$1,500
Minus: 2% of AGI  1,000
Deduction from AGI$   500

Page Ref.:  I:9-17; Examples I:9-35 and I:9-37

Objective:  5

72) Matt is a sales representative for a local company.  He entertains customers as part of his job.  During the current year he spends $3,000 on business entertainment.  The company provides him an expense allowance of $2,000 under a nonaccountable plan.  How will Matt treat the $2,000 partial reimbursement and the $3,000 entertainment expense?

A) He will deduct the $1,000 net expense as a miscellaneous itemized deduction, subject to the 2% of AGI floor.

B) He will deduct $500 of the net expense as a miscellaneous itemized deduction, subject to the 2% of AGI floor.

C) He will recognize $2,000 of income and deduct $3,000 as a miscellaneous itemized deduction, subject to the 2% of AGI floor.

D) He will recognize $2,000 of income and deduct $1,500 as a miscellaneous itemized deduction, subject to the 2% of AGI floor.

Answer:  D

Explanation:  D) Under a nonaccountable plan, the employee must include reimbursements in income.  The qualifying expenditure can be deducted as an itemized deduction, but entertainment expense is reduced by 50% and then the 2% of AGI floor will apply to his total miscellaneous deductions.

Page Ref.:  I:9-18; Example I:9-38

Objective:  5

73) Donald takes a new job and moves to a new residence. The distances are as follows:

Old residence to new job70 miles
Old residence to old job8 miles

By how many miles does the move exceed the minimum distance requirement for the moving expense deduction?

A) 12 miles

B) 20 miles

C) 62 miles

D) none of the above

Answer:  A

Explanation:  A) 70 – 8 = 62 old commute – 50 required incremental miles in qualifying move = 12 excess miles in move.

Page Ref.:  I:9-19; Example I:9-41

Objective:  6

74) In which of the following situations is the taxpayer not allowed a deduction for moving expenses?

A) Pam moves from Phoenix to Los Angeles to take a new job. She works at the Los Angeles job for 45 weeks before starting a new job in Las Vegas.

B) Paul moves from Boston to Miami to start a new business selling t-shirts. The business is not successful and Paul returns to Boston after 52 weeks.

C) Phyllis opens a coffee bar after moving from Seattle to San Francisco. She still owns the coffee bar and lives in San Francisco 90 weeks after her move.

D) Marva moves from Dallas to Washington D.C. in her job as an IRS agent. She is still working at the IRS Washington office after one year.

Answer:  B

Explanation:  B) Paul does not meet the 78 weeks of residence requirement applicable to self-employed taxpayers.

Page Ref.:  I:9-19

Objective:  6

75) Bill obtained a new job in Boston. He incurred the following moving expenses:

Transportation of household goods and personal effects$2,600
Cost of transporting Bill’s family2,000
House-hunting trip1,700
Payments to lessor to cancel a lease500

Assuming Bill is entitled to deduct moving expenses, what is the amount of the deduction?

A) $2,600

B) $4,600

C) $6,300

D) $6,800

Answer:  B

Explanation:  B) Direct expenses:

Transportation of household goods$2,600
Cost of transporting Bill’s family  2,000
Deductible moving expenses$4,600

Page Ref.:  I:9-19 through I:9-21; Example I:9-43

Objective:  6

76) Ron obtained a new job and moved from Houston to Washington. He incurred the following moving expenses:

Transportation of household goods$3,200
House-hunting trips1,500
Temporary living expenses (20 days)3,400
Commissions on new lease500
Costs of settling old lease250
Mileage for personal automobile1,400 miles

Assuming Ron is eligible to deduct his moving expenses, what is the amount of the deduction?

A) $3,536

B) $6,600

C) $6,922

D) $3,991

Answer:  A

Explanation:  A) Direct expenses:

Transportation of goods$3,200
Mileage (1,400 × .24)  336
Deductible moving expenses$3,536

Page Ref.:  I:9-19 through I:9-21; Example I:9-43

Objective:  6

77) Edward incurs the following moving expenses:

Direct moving expenses$4,000
Indirect moving expense6,000

The employer reimburses Edward for the full $10,000. What is the amount to be reported as income by Edward?

A) $0

B) $4,000

C) $6,000

D) $10,000

Answer:  C

Explanation:  C) Only the $4,000 direct moving expenses are allowed against the $10,000 reimbursement. Therefore, Edward must report income in the amount of the excess reimbursement of $6,000 ($10,000 – $4,000).

Page Ref.:  I:9-21; Example I:9-45

Objective:  6

78) All of the following may deduct education expenses except

A) Richard is a self-employed dentist who incurs expenses to attend a convention on new techniques in oral surgery.

B) Paige is an accountant who incurs expenses to take a CPA exam review course.

C) Hope is a business executive who incurs expenses to pursue an MBA degree.

D) Marvin is a high school teacher who incurs expenses for education courses to meet new course requirements to maintain his job.

Answer:  B

Explanation:  B) None of Paige’s expenses are deductible because they are incurred to meet the minimum educational standards for qualification in her accounting position.

Page Ref.:  I:9-23 and I:9-24

Objective:  7

79) The following individuals maintained offices in their home:

(1)     Dr. Austin is a self-employed surgeon who performs surgery at four hospitals. He uses his home for administrative duties as he does not have an office in any of the hospitals.

(2)     June, who is a self-employed plumber, earns her living in her customer’s homes. She maintains an office at home where she bills clients and does other paperwork related to her plumbing business.

(3)     Cassie, who is an employee of Montgomery Electrical, is provided an office at the work but does significant administrative work at home. Her employer does not require her to do extra work but she feels it is necessary.

Who is entitled to a home office deduction?

A) Dr Austin

B) Dr. Austin and June

C) Cassie and June

D) All of the taxpayers are entitled to a deduction.

Answer:  B

Explanation:  B) Only Dr. Austin and June get deductions. In order for an employee, Cassie, to take the deduction, the office in home must be for the convenience of her employer in addition to the other requirements.

Page Ref.:  I:9-24 and I:9-25; Examples I:9-51, I:9-52, and I:9-53

Objective:  8

80) Alex is a self-employed dentist who operates a qualifying office in his home. Alex has $180,000 gross income from his practice and $160,000 of expenses directly related to the business, i.e., non-home office expenses. Alex’s allocable home office expenses for mortgage interest expenses and property taxes are $14,000 and other home office expenses are $9,000. What is Alex’s total allowable home office deduction?

A) $9,000

B) $14,000

C) $20,000

D) $23,000

Answer:  C

Explanation:  C) Expenses directly related to the business are all deducted before other (indirect) home office expenses. The other home office expenses are then deductible only if there is still net income ($180,000 – $160,000 = $20,000) from the business after the first expenses are deducted.

Page Ref.:  I:9-25 and I:9-26; Example I:9-54

Objective:  8

81) Charles is a self-employed CPA who maintains a qualifying office in his home. Charles has $110,000 gross income from his practice and incurs $88,000 in salaries, supplies, computer services, etc. Charles’s mortgage interest and real estate taxes allocable to the office total $10,000. Other expenses total $14,000 and consist of depreciation, utilities, insurance, and maintenance. What is Charles’ total home office expense deduction?

A) $10,000

B) $14,000

C) $22,000

D) $24,000

Answer:  C

Explanation:  C) Allowable home office expenses limited to:

Gross income$110,000
Minus: Salaries, etc.( 88,000)
Equals: limit on remaining expenses$22,000

There were $24,000 of home office expenses, but the deduction is limited to $22,000.

Page Ref.:  I:9-25 and I:9-26; Example I:9-54

Objective:  8

82) In a contributory defined contribution pension plan, all of the following are true with the exception of

A) a separate account is established for each participant.

B) both the employee and employer can make contributions to the plan.

C) amounts are contributed to the plan based upon a specific formula.

D) retirement benefits are a fixed amount based on the level of compensation earned by the employee during the working years.

Answer:  D

Explanation:  D) Benefits are based on the value of the participant’s account at the time of retirement.

Page Ref.:  I:9-28

Objective:  9

83) Characteristics of profit-sharing plans include all of the following with the exception of

A) a predetermined formula is used to allocate employer contributions to individual employees and to establish benefit payments.

B) forfeitures of benefits under the plan may be reallocated to the remaining participants.

C) the company must make contributions to the plan if it has profits during the year.

D) annual employer contributions are not required, but substantial, recurring contributions must be made to satisfy the requirement that the plan be permanent.

Answer:  C

Explanation:  C) Annual employer contributions are not required under a profit-sharing plan.

Page Ref.:  I:9-29

Objective:  9

84) Ross works for Houston Corporation, which has a contributory defined contribution pension plan. The employer’s monthly contribution to the plan is 8 percent of each participating employee’s monthly salary, while the employee contributes only 6 percent. Ross’s monthly salary is $3,000. Which of the following statements best describes the benefits of the plan?

A) Houston receives a deduction for its contributions to the plan when Ross receives a distribution from the plan.

B) While Ross is taxed on the employer’s contributions to the plan, his own contributions are not taxed until he receives a distribution from the plan.

C) Ross may deduct his own contributions to the pension plan, and Ross reports income from the plan each year until he receives distributions from the plan.

D) The earnings on amounts contributed to the plan are not taxed to Ross until he retires or receives a distribution from the plan.

Answer:  D

Explanation:  D) Amounts paid into a plan by or for an employee are not taxable until the pension payments are received, normally at retirement.

Page Ref.:  I:9-28 through I:9-30

Objective:  9

85) Sam retired last year and will receive annuity payments for life from his employer’s qualified

retirement plan of $30,000 per year starting this year. During his years of employment, Sam contributed $130,000 to the plan on an after-tax basis.  Based on IRS tables, his life expectancy is 260 months. All of the contributions were on a pre-tax basis. This year, Sam will include what amount in income?

A) 0

B) $6,000

C) $24,000

D) $30,000

Answer:  C

Explanation:  C) $130,000/260 months = $500 per month is excluded.  $30,000 – ($500 × 12) = $24,000

Page Ref.:  I:9-31; Example I:9-58

Objective:  9

86) Hunter retired last year and will receive annuity payments for life from his employer’s qualified retirement plan of $30,000 per year starting this year. During his years of employment, Hunter contributed $130,000 to the plan.  Based on IRS tables, his life expectancy is 260 months. All of the contributions were on a pre-tax basis. This year, Hunter will include what amount in income?

A) $0

B) $6,000

C) $24,000

D) $30,000

Answer:  D

Explanation:  D) If amounts are contributed on a pre-tax basis, Hunter received a tax benefit when the contribution was made so all amounts are taxable.

Page Ref.:  I:9-31; Example I:9-59

Objective:  9

87) Tobey receives 1,000 shares of YouDog! stock as part of his compensation package. Tobey’s employment contract with YouDog!, Inc. states that if he leaves before completion of three years of employment, he will forfeit the stock. The stock currently has a fair market value of $12 per share. Which of the following statements regarding Tobey’s choices is not true?

A) Tobey does not have to recognize any income from receiving the stock until his rights to the stock are fully vested.

B) Tobey must report $12,000 as income due to the receipt of the stock in the current year.

C) Tobey may elect to report the $12,000 FMV of the stock as ordinary income in the current year.

D) If Tobey elects to report $12,000 as income in the current year and the stock price falls to $5 per share when his rights to the stock are vested, Tobey is not allowed to deduct a loss.

Answer:  B

Explanation:  B) The ownership of the stock is substantially restricted (i.e. it will be forfeited if he leaves employment prior to three years).  Unless he makes an appropriate election under Sec. 83, the income will not be recognized until his rights are fully vested.

Page Ref.:  I:9-33 and I:9-34; Examples I:9-62 and I:9-63

Objective:  9

88) All of the following characteristics are true of an incentive stock option with the exception of

A) the option price must be equal to or greater than the stock’s FMV on the option’s grant date.

B) the employee cannot own more than ten percent of the voting power of the employer corporation’s stock immediately prior to the option’s grant date.

C) the option must be granted within ten years from the date the plan is adopted and the employee must exercise the stock option within ten years from the grant date.

D) there is no limit to the value of the options that become exercisable to an employee in a single year.

Answer:  D

Explanation:  D) The value of the options that become exercisable in a single year cannot exceed $100,000.

Page Ref.:  I:9-35

Objective:  9

89) Wilson Corporation granted an incentive stock option to Reva on January 1, two years ago. The option price was $300, and the FMV of the Wilson stock was also $300 on the grant date. The option allowed Reva to purchase 150 shares of Wilson stock. Reva exercised the option on August 1, this year, when the stock’s FMV was $400. Unless otherwise stated, assume Reva is a qualifying employee. The results of the above transactions to Reva will be

A) no income to Reva on the grant date or exercise date but there is an alternative minimum tax adjustment item to Reva of $15,000.

B) no income tax or alternative minimum tax effect for Reva.

C) ordinary income to Reva on the exercise date of $15,000.

D) capital gain to Reva on the exercise date of $15,000.

Answer:  A

Explanation:  A) While no income is recognized on the grant date or the exercise date, $15,000 [($400 – $300) × 150 shares] is an adjustment for the AMT.

Page Ref.:  I:9-35; Example I:9-64

Objective:  9

90) Mirasol Corporation granted an incentive stock option to employee Josephine two years ago. The option price was $150 and the FMV of the Mirasol stock was also $150 on the grant date. The option allowed Josephine to purchase 160 shares of Mirasol stock. Josephine exercised the option this year when the stock’s FMV was $250. Unless otherwise stated, assume Josephine is a qualifying employee. The results of the above transactions to Mirasol Corporation will be

A) no compensation deduction.

B) a compensation deduction of $16,000 on the grant date.

C) a tax preference item of $16,000 on the exercise date.

D) a compensation deduction of $16,000 on the exercise date.

Answer:  A

Explanation:  A) Mirasol Corporation is not entitled to a compensation deduction in any year.

Page Ref.:  I:9-35; Example I:9-64

Objective:  9

91) Martin Corporation granted an incentive stock option to employee Caroline on January 1, 2010. The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 160 shares of Martin stock. Caroline exercised the option on August 1, 2012 when the stock’s FMV was $250. Unless otherwise stated, assume Caroline is a qualifying employee. If Caroline sells the stock on September 5, 2013 for $350 per share, she must recognize (ignore alternative minimum tax)

A) -0-. No gain or loss is recognized at exercise or sale with incentive stock options.

B) long-term capital gain of $16,000 in 2013.

C) ordinary income of $16,000 on the exercise date and a long-term capital gain of $16,000 in 2013.

D) long-term capital gain of $32,000 in 2013.

Answer:  D

Explanation:  D)

Sales price of stock ($350 × 160 shares)$56,000
– Basis ($150 × 160 shares)– 24,000
Long-term capital gain$32,000

Page Ref.:  I:9-35; Example I:9-64

Objective:  9

92) Jackson Corporation granted an incentive stock option to employee Caroline on January 1, two years ago. The option price was $150, and the FMV of the Jackson stock was also $150 on the grant date. The option allowed Caroline to purchase 160 shares of Jackson stock. Caroline exercised the option on August 1, 2012, when the stock’s FMV was $250. Unless otherwise stated, assume Caroline is a qualifying employee. If Caroline sells the stock on July 5, 2013 for $400 per share, she must recognize

A) long-term capital gain of $40,000 in the year of sale.

B) long-term capital gain of $24,000 in the year of sale.

C) ordinary income of $16,000 on the exercise date and a long-term capital gain of $24,000 in the year of sale.

D) ordinary income of $16,000 and a short-term capital gain of $24,000 in the year of sale.

Answer:  D

Explanation:  D) There is part ordinary income, part short-term capital gain since she didn’t hold the stock the required holding period.

Spread [160 shares × ($250 – $150) is ordinary income$16,000
Short term capital gain [160 shares × ($400 – $250)]  24,000
Total$40,000

Page Ref.:  I:9-35; Example I:9-64

Objective:  9

93) Martin Corporation granted a nonqualified stock option to employee Caroline on January 1, 2011.   The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 1,000 shares of Martin stock.  The option itself does not have a readily ascertainable FMV.  Caroline exercised the option on August 1, 2013 when the stock’s FMV was $250. If Caroline sells the stock on September 5, 2014 for $300 per share, she must recognize

A)

20132014
$100,000 ordinary income$50,000 LTCG

B)

20132014
-0-$150,000 LTCG

C)

20132014
$100,000 ordinary income$50,000 ordinary income

D)

20132014
-0-$150,000 ordinary income

Answer:  A

Explanation:  A) On the exercise date, the employee recognizes ordinary income equal to the spread between the FMV and the option price. Any future appreciation in value is capital gain recognized at the sale date.

Page Ref.:  I:9-36; Table I:9-4

Objective:  9

94) Martin Corporation granted a nonqualified stock option to employee Caroline on January 1, 2011.   The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 1,000 shares of Martin stock.  The option itself does not have a readily ascertainable FMV.  Caroline exercised the option on August 1, 2013 when the stock’s FMV was $250.  Caroline sells the stock on September 5, 2014 for $300 per share.  Martin Corporation will be allowed a deduction of

A) $150,000 in 2011.

B) $100,000 in 2013.

C) $50,000 in 2014.

D) $100,000 in 2013 and $50,000 in 2014.

Answer:  B

Explanation:  B) The employer is allowed a deduction equal to the employee income recognized on the exercise date (i.e. the spread between the FMV at exercise and the exercise price).

Page Ref.:  I:9-36

Objective:  9

95) Frank is a self-employed CPA whose 2012 net earnings from his trade or business (before the H.R. 10 plan contribution but after the deduction for one-half of self-employment taxes) is $240,000. What is the maximum contribution that Frank can make on his behalf to his H.R. 10 (Keogh) plan in 2013?

A) $62,500

B) $48,000

C) $51,000

D) $60,000

Answer:  B

Explanation:  B) The maximum earned income to be considered is $255,000. The maximum contribution is the lesser of $51,000 or 25% of the earned income from self-employment activities after taking the Keogh deduction into account. To achieve this result, the formula is reduced to 20%; thus, the maximum amount in this problem is the lesser of $51,000 or $48,000 ($240,000 × .20).

Page Ref.:  I:9-37; Example I:9-66

Objective:  9

96) Tessa is a self-employed CPA whose 2013 net earnings from her business (before the H.R. 10

plan contribution but after the deduction for one-half of self-employment taxes) is $400,000. What is the maximum contribution that Tessa can make on her behalf to her H.R. 10 (Keogh) plan in 2013?

A) $100,000

B) $80,000

C) $62,500

D) $51,000

Answer:  D

Explanation:  D) For 2013, the maximum earned income taken into account is $255,000 at a 20% net contribution rate results in a $51,000 maximum contribution.

Page Ref.:  I:9-37; Example I:9-67

Objective:  9

97) Which of the following is true about H.R.10 (Keogh) plans?

A) The plan must be established before the end of the tax year, and contributions must be made before the due date of the tax return, plus extensions.

B) The plan must be established and contributions must be made before the end of the tax year.

C) The plan must be established and contributions must be made before April 1.

D) The plan must be established and contributions must be made before the due date of the tax return, plus extensions.

Answer:  A

Explanation:  A) While an H.R. 10 plan must be established before the end of the tax year, contributions may be made up to the due date for the tax return (including extensions).

Page Ref.:  I:9-38

Objective:  9

98) Tyne is a 48-year-old an unmarried taxpayer who is not an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $61,000 in 2013. What is the maximum amount she may contribute to a tax deductible IRA?

A) $ -0-

B) $4,400

C) $5,500

D) $6,500

Answer:  C

Explanation:  C) Tyne is not an active participant in an employer-sponsored qualified retirement plan and therefore may deduct the full $5,500 limit.

Page Ref.:  I:9-38; Example I:9-68

Objective:  9

99) Hannah is a 52-year-old an unmarried taxpayer who is not an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $61,000 in 2013. What is the maximum amount she may contribute to a tax deductible IRA?

A) $4,400

B) $5,200

C) $5,500

D) $6,500

Answer:  D

Explanation:  D) Hannah is not an active participant in an employer-sponsored qualified retirement plan and therefore may deduct the full $5,500 limit plus $1,000 because she is over 50 years old.

Page Ref.:  I:9-38 and I:9-39

Objective:  9

100) H (age 50) and W (age 48) are married but only W is employed. She is not covered by a retirement plan at work. She earns $75,000 during the year and they have combined AGI of $78,000 before any IRA contribution. In 2013, the maximum amount together they may contribute to tax deductible IRAs is

A) $5,500.

B) $6,500.

C) $11,000.

D) $12,000.

Answer:  D

Explanation:  D) Since neither is in a retirement plan at work, they may each contribute $5,500 (a nonworking spouse may contribute $5,500 per year). Since H is age 50, he may contribute an additional $1,500. [($5,500 × 2) + $1,000] = $12,000.

Page Ref.:  I:9-38 and I:9-39

Objective:  9

101) Tyler (age 50) and Connie (age 48) are a married couple. Tyler is covered under a qualified retirement plan at his job and earned $175,000 in 2013. Connie is employed as a lab technician and earned $30,000 but is not covered under a qualified retirement plan. They file a joint return; have interest and dividend income of $30,000. What is their maximum for AGI deduction for contributions to a traditional IRA?

A) $0

B) $5,500

C) $6,500

D) $12,000

Answer:  A

Explanation:  A) Because their AGI exceeds $188,000, neither Tyler nor Connie may make tax deductible contributions to a traditional IRA.

Page Ref.:  I:9-39; Example I:9-71

Objective:  9

102) Tucker (age 52) and Elizabeth (age 48) are a married couple. Tucker is covered under a qualified retirement plan at his job and earned $90,000 in 2013. Elizabeth is employed as a lab technician and earned $30,000 but is not covered under a qualified retirement plan. They file a joint return; have interest and dividend income of $25,000. What is the maximum amount of tax deductible contributions may be made to a traditional IRA?

A) $0

B) $11,000

C) $5,500

D) $12,000

Answer:  C

Explanation:  C) Elizabeth may contribute and deduct $5,500 to a traditional IRA because their AGI is less than $178,000. However, Tucker may not make a deductible contribution because he is covered under a qualified plan and their AGI exceeds $115,000.

Page Ref.:  I:9-39; Example I:9-72

Objective:  9

103) During 2013, Marcia, who is single and is covered under a pension plan at work, contributes $5,500 into a Roth IRA. If her AGI is $63,000, which of the following is true?

A) All of the contribution is deductible.

B) None of the contribution is deductible.

C) She must withdraw all of the contribution immediately since she is covered under a plan at work.

D) Only 60% of the contribution is deductible since her AGI exceeds $59,000 by $4,000 and her maximum contribution is phased out by 40%.

Answer:  B

Explanation:  B) A contribution to a Roth IRA is not tax deductible in any circumstances.

Page Ref.:  I:9-40

Objective:  9

104) Feng, a single 40 year old lawyer, is covered by a qualified retirement at work.  His salary is $109,000, and his total AGI is $121,000.  The maximum contribution he can make to a Roth IRA is

A) -0-.

B) $3,300.

C) $2,200.

D) $5,500.

Answer:  C

Explanation:  C) $5,500 – ($5,500 × ($121,000 – 112,000)/15,000).  Participation in a retirement plan at work is not relevant to a Roth.  Only AGI is relevant.

Page Ref.:  I:9-40

Objective:  9

105) Which of the following is true about future qualified distributions from a Roth IRA by a person who will be 65 years old at the time the distributions begin? Assume the individual opened the account before age 60.

A) The entire amount of the distributions will be tax-free.

B) Only the accumulated earnings will be tax-free.

C) Only the previous contributions will be tax-free.

D) The entire amount of the distribution will be taxable.

Answer:  A

Explanation:  A) Withdrawals from a Roth IRA after age 59 1/2 are tax-free, assuming the first Roth contribution was made at least five years earlier.

Page Ref.:  I:9-40

Objective:  9

106) All of the following are true with regard to a Roth IRA except

A) contributions to Roth IRAs are subject to special modified AGI limitations that are higher than those for traditional IRAs.

B) contributions to Roth IRAs are never tax deductible.

C) contributions to Roth IRAs must cease after the owner has reached age 70 1/2.

D) contributions to existing Roth IRAs must be made by the due date of the return.

Answer:  C

Explanation:  C) Contributions to a Roth IRA can be made after the owner has reached age 70 1/2.

Page Ref.:  I:9-41

Objective:  9

107) Which of the following statements regarding Coverdell Education Savings Accounts is incorrect, disregarding any AGI limits?

A) Distributions cannot be used for elementary and secondary education expenses.

B) Distributions to the beneficiary are not taxable as long as they are used for tuition, fees, room and board.

C) Contributions can be made until the beneficiary reaches 18.

D) Contributors can make nondeductible contributions of up to $2,000 for each beneficiary.

Answer:  A

Explanation:  A) Distributions can be used for elementary and secondary school expenses.

Page Ref.:  I:9-42

Objective:  9

108) Which of the following statements regarding Health Savings Accounts is incorrect?

A) Taxpayers are allowed to deduct contributions to a health savings account for AGI.

B) All taxpayers are eligible to establish a health savings account.

C) Distributions from a health savings account are excluded from gross income if used to pay qualified medical expenses.

D) Health savings account contributions are limited to the lesser of 100% of annual deductible under high deductible health plan or $3,250 for taxpayers without family coverage.

Answer:  B

Explanation:  B) In order to establish a Health Savings Account, the individual must be covered by a high-deductible health plan and not be covered under any other health plan that is not a high-deductible plan.

Page Ref.:  I:9-43

Objective:  9

109) Richard traveled from New Orleans to New York for both business and vacation. He spent 4 days conducting business and some days vacationing. He incurred the following expenses:

Airfare                                                                         $460

Lodging-per day                                                        175

Meals-per day                                                             100

Business Entertainment                                          800

What is his miscellaneous itemized deduction (before the floor), assuming Richard is an employee and is not reimbursed, under the following two circumstances?

a.    He spends three days on vacation, in addition to the business days.

b.    He spends six days on vacation, in addition to the business days.

Answer: 

 a. Primarily Businessb. Primarily Personal
Airfare$460$     0
Lodging $175 × 4 days700700
Meals $100 × 4 × 50%200200
Business Entertainment $800 × 50%400400
Total, before AGI floor$1,760$1,300

Page Ref.:  I:9-8; Examples I:9-10 and I:9-11

Objective:  2

110) David acquired an automobile for $30,000 for use in his unincorporated business in 2011 and used the standard mileage rate method in 2011 and 2012. He switches to the actual expense method for 2013.  The automobile was used 25,000 miles in 2011 and 20,000 miles in 2012. What is the amount of the adjusted basis of the automobile for purposes of computing depreciation in 2013?

Answer:  The adjusted basis is as follows:

Cost                                                                         $30,000

Less:    25,000 miles × .22                                   ( 5,500)

             20,000 miles × .23                                   ( 4,600)

Adjusted basis                                                     $19,900

Page Ref.:  I:9-11 and I:9-12; Example I:9-22

Objective:  3

111) Sarah purchased a new car at the beginning of the year.  She makes an adequate accounting to her employer and receives a $2,400 (12,000 miles × 20 cents per mile) reimbursement in 2013 for employment-related business miles. She incurs the following expenses related to both business and personal use:

Gas and oil                                                             $6,000

Repairs and maintenance                                   2,500

Depreciation                                                            3,000

Insurance                                                                  1,800

Total                                                                       $13,300

She also spent $200 on parking and tolls that were related to business. During the year she drove a total 20,000 miles.

What are the possible amounts of Sarah’s deductible transportation expenses?

Answer: 

Actual expense method:

Business portion of operating expenses $13,300 × 12,000/20,000 miles =          $7,980

Business tolls and parking                                                                                                      200

Less reimbursement                                                                                                             -2,400

Deduction under actual expense method                                                                     $5,780

Standard mileage method:

12,000 miles × .565 per mile =                                                                                         $6,780

Business tolls and parking                                                                                                     200

Less reimbursement                                                                                                             -2,400

Deduction under standard mileage method                                                               $4,580

She may take the greater of the two. In this situation, the actual expense method will provide the greater deduction.  The deduction will be part of her miscellaneous itemized deductions subject to the 2% of AGI floor.

Page Ref.:  I:9-11 and I:9-12; Example I:9-24

Objective:  3

112) Rita, a single employee with AGI of $100,000 before consideration of the items below, incurred the following expenses during the year, all of which were unreimbursed unless otherwise indicated:

Transportation expenses for business trip                                                                                   $3,000

Registration fees for business conference                                                                                           700

Business-related meals and entertainment                                                                                       700

Country club dues (used 60% for business)                                                                                   4,000

Local meals eaten alone during regular business hours after visiting client                          400

Qualified moving expenses                                                                                                                 1,000

Tax return preparation fees                                                                                                                    900

Safe deposit box rental for stock certificates                                                                                         50

In addition, Rita paid $300 for dues to her professional business association.  The company reimbursed her after she submitted the appropriate documentation.  What is Rita’s net miscellaneous itemized deduction for the year  after application of all relevant limitations?

Answer: 

Transportation expenses for business trip                                         $3,000

Registration fees for business conference                                                  700

Business-related meals and entertainment (700 × .50)                          350

Tax return preparation fees                                                                           900

Safe deposit box rental for stock certificates                                               50

Total miscellaneous itemized deductions                                           $5,000

Less: 2% × $100,000                                                                                    – 2,000

Net miscellaneous itemized deductions                                             $ 3,000

The country club dues are not deductible, regardless of business use.  The business association dues are reimbursed so will be deducted by the employer.  The moving expenses are deductible for AGI.

Page Ref.:  I:9-13 through I:9-15

Objective:  4

113) Ellie, a CPA, incurred the following deductible education expenses to maintain or improve her skills:

Travel and transportation                                                  $1,700

Tuition                                                                                        6,000

Books                                                                                              800

Ellie’s AGI for the year is $60,000.

a.     If Ellie is self-employed, what are the amount of and the nature of the deduction for these expenses?

b.     If, instead, Ellie is an employee who is not reimbursed by his employer, what are the amount of and the nature of the deduction for these expenses (after limitations)?

Answer: 
a.     $1,700 + $6,000 + $800 = $8,500 is a for AGI deduction.

b.     ($1,700 + $6,000 + $800) – ($60,000 × .02) = $7,300 is a from AGI deduction (miscellaneous itemized deduction).

Page Ref.:  I:9-22 and I:9-23

Objective:  7

114) Dighi, an artist, uses a room in his home (250 square feet) as a studio exclusively to paint.  The studio meets the requirements for a home office deduction. (Painting is considered his trade or business.) The following information appears in Dighi’s records:

Revenue from sale of paintings                                                                               $4,000

Expenses attributable to business of painting such as supplies                      1,800

Expenses related to home office:

      Property taxes on portion of home where he paints                                          900

      Utilities, insurance, etc                                                                                               700

      Depreciation of portion of home                                                                              800

(a) What is the amount of Dighi’s home office deduction if he is self-employed? 

(b) If some amount is not allowed under the tax law, how is the disallowed amount treated?

(c) Assume all of Dighi’s records of expenses relating to the room were destroyed in a major paint spill.  How much of a home office deduction, if any, will he be allowed?

Answer: 

(a) Allowable home office expenses ($900 + 700 + 800)         $2,400

Limited to:

Gross income                                                                                      $4,000

Minus: Painting supplies, etc.                                                        ( 1,800)

Equals: limit on remaining expenses                                          $ 2,200

$2,200 will be deducted in the current year.

(b) The excess $200 ($2,400 allowable expenses – $2,200 net income ceiling on deduction) will carry over to next year.

(c) The IRS now allows a safe harbor deduction of $5 per square foot.  The allowable deduction will be $1,250 ($5 × 250 square feet).

Page Ref.:  I:9-25 and I:9-26

Objective:  8

115) Ruby Corporation grants stock options to Iris on February 1, 2012.  The options do not have a readily ascertainable value.  The option price is $100, and the FMV of the Ruby stock is also $100 on the grant date. The option allows Iris to purchase 200 shares of Ruby stock. Iris exercises the option on August 1, 2013, when the stock’s FMV is $150.  Iris sells the stock on December 5, 2014 for $400.  Determine the amount and character (i.e. ordinary, LTCG or STCG) of income recognized by Iris and the deduction allowed Ruby Corporation in 2012, 2013 and 2014 under the following assumptions:

a.    The stock option is an incentive stock option.

b.    The stock option is a nonqualified stock option.

Answer: 
a. Incentive stock option

 Iris’ IncomeRuby’s Deduction
2012 option grant-0--0-
2013 option exercise-0--0-
2014 stock sale$60,000 LTCG 200 shares × 300 spread-0-

b. Non-qualified stock option

 Iris’ IncomeRuby’s Deduction
2012 option grant-0--0-
2013 option exercise$10,000 ordinary income$10,000
2014 stock sale$50,000 LTCG 200 shares × ($400 – 150)-0-

Page Ref.:  I:9-34 through I:9-36; Example I:9-64

Objective:  9

116) Tia is a 52-year-old an unmarried taxpayer who is an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $63,000 in 2013.

a.    What is the maximum amount she can contribute and the maximum deduction she can receive for a contribution to a traditional IRA?

b.    What is the maximum amount she can contribute and the maximum deduction she can receive for a contribution to a Roth IRA?

Answer: 
a.    Tia is allowed to contribute up to $6,500 to a traditional IRA because she is over age 50.  She is an active participant in an employer-sponsored qualified retirement plan so her deductible contribution is subject to a phase-out. Her AGI of $63,000 is $4,000 over the $59,000 beginning of the phase-out. Therefore, $4,000/$10,000 or 40% of her allowable deduction is disallowed. $6,500 ($5,500 maximum plus $1,000 for over age 50) × (1 – .40) = $3,900 deduction.

b.    Because Tia’s AGI is below $112,000, she can contribute the $6,500 ($5,500 maximum plus $1,000 for over age 50) to a Roth IRA.  Her participation in a qualified plan is not relevant to the ability to contribute to a Roth IRA, only AGI counts.  Contributions to a Roth IRA are never deductible.

Page Ref.:  I:9-38 through I:9-40

Objective:  9

117) Jack takes a $7,000 distribution from his Health Savings Account.  $2,000 is used to pay for X-rays and dental surgery.  The other $5,000 to make a down payment on a new car. What are the tax consequences to Jack?

Answer:  Jack will exclude the $2,000 distribution because it was used for qualifying medical expenses.  Jack must include the $5,000 in income as it is not a withdrawal for qualified medical expenses. In addition, Jack must pay a $500 ($5,000 × 10%) penalty on the withdrawal.

Page Ref.:  I:9-43

Objective:  9

118) What factors are considered in determining whether an expense is a deductible travel expense?

Answer:  Factors to consider include:

1.    Whether the individual is away from his tax home for a temporary period, usually less than one year, and whether it is practical to return to the tax home each day.

2.    Whether the individual maintains a family residence at a location that requires lengthy travel to the place of employment. In such a case, the individual is not away from his tax home.

3.    Whether living expenses are duplicated due to a change in work assignment.

4.    Whether the individual continually moves his residence to the same location as the job assignment.

5.    Whether or not the travel is related to trade or business.

Page Ref.:  I:9-6 and I:9-7

Objective:  2

119) What two conditions are necessary for moving expenses to be deductible?

Answer:  Two requirements must be met:

1.     The new job location must be at least 50 miles farther from the taxpayer’s old residence than the old residence was from the former place of employment. If the individual has no former place of employment, the new job must be at least 50 miles from the old residence.

2.     The employee must be employed on a full-time basis at the new location for 39 weeks during the 12-month period immediately following the move. A self-employed individual is subject to a 78-week minimum work period during the first two years following the move. At least 39 of the 78 weeks must be in the first 12-month period.

Page Ref.:  I:9-19

Objective:  6

120) Explain when educational expenses are deductible for an employee.

Answer:  Educational expenses are deductible if the following requirements are met:

1.     The expenditure is incurred to maintain or improve skills required by the individual in his employment, trade, or business; and

2.     The expenditure is incurred to meet requirements imposed by law or by the employer for retention of employment.

However, if the taxpayer qualifies for a new trade or business as a result of the education, the expenses are not tax deductible.

Page Ref.:  I:9-23

Objective:  7

121) When are home-office expenses deductible?

Answer:  Office-in-home expenses are deductible if any of the following conditions is met:

1.     The office is used exclusively on a regular basis as the principal place of business for any trade or business of the taxpayer.

2.     The office is used as a place for meeting or dealing with patients, clients, or customers in the normal course of business.

3.     The office is used for administrative or management activities of the trade or business, and there is no other fixed location where those activities are conducted.

In addition to satisfying one of the above conditions, if the taxpayer is an employee, the home office must be for the convenience of the employer.

Page Ref.:  I:9-24 and I:9-25

Objective:  8

122) Gina is an instructor at State University in Birmingham. Her university has asked her if she would be interested in taking a temporary assignment at their Montgomery campus. In addition to her salary, the University would pay her living expenses while in Montgomery. What should Gina consider with regard to taxes in deciding whether or not to accept the offer?

Answer:  With regard to the tax consequences, Gina must first ascertain the tax status of the living expenses. That is, are the living expenses in Montgomery deductible as travel expenses if they are not reimbursed; are they includible in income if they are reimbursed under an accountable plan? What is critical is whether or not the assignment is considered temporary for tax purposes. If the assignment is one year or less, generally the assignment would be considered temporary and the expenses would be deductible if not reimbursed. Further, the reimbursements under an accountable plan would not taxable to Gina.

Page Ref.:  I:9-6 through I:9-8 and I:9-17

Objective:  2 and 5

123) Fiona is about to graduate college with a management degree. She has been offered a job as a sales representative for a pharmaceutical company. The job will require significant travel and entertainment expenses for which she will be given a salary supplement. What tax issues should Fiona consider in her decision?

Answer:  Will she be considered an independent contractor or employee? If she is an employee, she will only be able to deduct unreimbursed business expenses to the extent they exceed 2% of AGI (assuming she is able to itemize deductions).

Does the employer have an accountable plan for reimbursing expenses? If she receives a salary supplement, it will be added to her gross income. From a tax standpoint, she would prefer having her employer reimburse her actual expenses to an increase in income (assuming the reimbursement is equal to the salary supplement).

Is the salary supplement greater than the amount of anticipated expenses to help Fiona pay her increased taxes?

Will she have any itemized deductions?

What does she estimate to be her AGI for purposes of the 2% floor?

If she is an independent contractor, she will be subject to self-employment tax.

She will bear the impact of the 50% reduction in meals and entertainment expenses if she receives a salary supplement rather than reimbursement under an accountable plan.

Page Ref.:  I:9-2 through I:9-4; I:9-17 through I:9-19

Objective:  1 and 5

124) Chuck, who is self-employed, is scheduled to fly from Minneapolis to London on a business trip. His flight schedule included a connection through New York City. When Chuck arrived in New York City, he learned that his flight to London had been cancelled due to a volcanic eruption in Iceland. All air travel to Europe was delayed for five days because of significant amounts of ash in the air, causing Chuck to incur costs for hotel and meals in New York City. Since Chuck had never been to New York City before, he spent the time sightseeing. What tax issues are present?

Answer:  Are the days in New York City considered business or personal? Will these days affect the classification of the airfare to London as business or personal travel?

Page Ref.:  I:9-7 and I:9-8

Objective:  2

125) Josiah is a human resources manager of a large software company. He is considering asking for a leave of absence to pursue an MBA degree. Josiah will pay for his MBA tuition of $45,000 a year without any employer assistance. Josiah will incur a large debt if he pursues an MBA. Upon completing his MBA, he would want to consider various job opportunities. Discuss the tax issues affecting Josiah’s decision?

Answer:  Josiah should consider whether the education will maintain and improve the skills in his current trade or business.  If instead the MBA will qualify him for a new profession, the MBA tuition will not be deductible. Josiah should also consider whether he will be able to claim Lifetime Learning Credits for the tuition. When Josiah repays the student loan, he will potentially eligible to deduct student loan interest.

Page Ref.:  I:9-21 through I:9-23

Objective:  7

126) Daniel has accepted a new job and is reviewing the retirement plan information. He has a choice of participating in the company’s conventional Sec. 401(k) plan or a Roth 401(k) plan. Explain the difference between the two plans in terms of employee contributions and retirement distributions from the plan.

Answer:  Under the conventional Sec. 401(k) plan, Daniel’s contributions will be a salary reduction so he will pay less taxes in the year of contribution. The investment income earned in his account will be tax-deferred. When he retires and receives distributions, the full distribution will be taxable. Under a Roth 401(k), Daniel will contribute after-tax dollars (i.e. no salary reduction). When he retires, his distribution will be tax-free, including the portion of the distribution attributable to the investment income. With the conventional Sec. 401(k) plan, the tax savings are frontloaded; with the Roth 401(k), the tax savings are backloaded.

Page Ref.:  I:9-29 and I:9-31

Objective:  9

127) Discuss the tax treatment of a nonqualified stock option plan.

Answer:  The tax treatment of a nonqualified stock option plan is based on whether the stock option has a readily ascertainable fair market value or whether the stock option has no ascertainable fair market value.

If a nonqualified stock option has a readily ascertainable FMV, the employee recognizes ordinary income on the grant date equal to the difference between the FMV and the option price. The employer receives a compensation deduction on the grant date equal to the same amount. No tax consequences occur on the exercise date, and the employee recognizes capital gain or loss upon the sale or disposition of the stock.

If a nonqualified stock option has no ascertainable FMV, no tax consequences occur on the grant date. On the exercise date the employee recognizes ordinary income equal to the difference between the FMV and the option price, and the employer receives a corresponding compensation deduction. When the option is exercised, the employee’s basis in the stock is equal to the option price plus the amount that is reported as ordinary income on the exercise date.

Page Ref.:  I:9-36

Objective:  9

128) Johanna is single and self-employed as a technology consultant. She wants to set money aside for her retirement. What tax and financial issues should she consider?

Answer:  What is Johanna’s self-employment income before any retirement contributions?

Does she have any employees? Does she want to provide a retirement plan for them?

Is she 50 or over and eligible for a larger IRA contribution?

What is her current tax rate?

What does she anticipate her tax rate being during retirement?

Does she prefer receiving a tax deduction now or receiving tax-free distributions in the future?

Page Ref.:  I:9-37 through I:9-39

Objective:  9

129) Why did Congress establish Health Savings Accounts (HSAs)? How do HSAs operate?

Answer:  The purpose of HSAs is to enable individuals to accumulate funds on a tax-free basis to pay qualified medical expenses currently or in the future. HSAs operate as follows:

1.     The individual must be covered by a high-deductible health insurance plan and not covered under any other health plan that is not a high-deductible health plan.

2.     The taxpayer contributes money into a HSA with a qualified trustee or custodian. The taxpayer must be an eligible individual and the contributions are subject to limitations.

3.     The taxpayer is allowed a for AGI deduction in the year the contributions are made.

4.     Distributions from the HSA that are used exclusively to pay for qualified medical expenses, but not health insurance premiums, are excludable from gross income. Any amount of the distribution that is not used to pay qualified medical expenses is includable in the gross income of the taxpayer and subject to an additional 10% penalty.

A high-deductible health plan has an annual deductible in 2013 of at least $1,250 and annual out-of-pocket expenses (other than premiums) required to be paid not exceeding $6,250. For family coverage, these amounts are $2,500 and $12,500.

Page Ref.:  I:9-43

Objective:  9

Chapter I10 

1) On its tax return, a corporation will use the same depreciation, amortization and depletion methods used in its financial statements issued to shareholders.

Answer:  FALSE

Explanation:  While they follow the same concept of spreading the cost over asset lives, unique tax rules apply.

Page Ref.:  I:10-2

Objective:  1

2) Recovery property includes business, investment, and personal-use assets.

Answer:  FALSE

Explanation:  Recovery property does not include personal-use assets.

Page Ref.:  I:10-2

Objective:  1

3) In order for an asset to be depreciated in the year of purchase, it must be placed in service before year’s end.

Answer:  TRUE

Explanation:  Purchase of an asset is not sufficient.  It must be put into use.

Page Ref.:  I:10-3

Objective:  1

4) The basis of an asset must be reduced by the depreciation allowable.

Answer:  TRUE

Explanation:  If the taxpayer fails to take depreciation, the basis is nonetheless reduced by the depreciation allowable.

Page Ref.:  I:10-3

Objective:  1

5) Land, buildings, equipment, and stock are examples of tangible property.

Answer:  FALSE

Explanation:  Stock is intangible property.

Page Ref.:  I:10-3

Objective:  1

6) If personal-use property is converted to trade or business use, the basis for depreciation is the lesser of adjusted basis or FMV on the date of conversion.

Answer:  TRUE

Explanation:  This lower of cost or market rule prevents taxpayers from taking deductions for loss on a personal asset.

Page Ref.:  I:10-3

Objective:  1

7) Under the MACRS rules, salvage value is not considered in the computation of the cost-recovery or depreciation amount.

Answer:  TRUE

Page Ref.:  I:10-4

Objective:  1

8) Under the MACRS system, depreciation rates for real property must always use the mid-month convention in the year of acquisition.

Answer:  TRUE

Page Ref.:  I:10-4

Objective:  1

9) Under MACRS, tangible personal property used in trade or business purchased and placed into service on March 1, 2013 should be depreciated for 10 months in 2013. Assume the business uses a calendar tax year.

Answer:  FALSE

Explanation:  The half-year convention, which assumes that all asset acquisitions occur at midpoint of the tax year, is used.

Page Ref.:  I:10-4; Example I:10-3

Objective:  1

10) MACRS recovery property includes tangible personal and real property that is used in a trade or business.

Answer:  TRUE

Page Ref.:  I:10-5

Objective:  1

11) Under the MACRS system, automobiles and computers are classified as seven-year property.

Answer:  FALSE

Explanation:  Automobiles and computers are five-year property.

Page Ref.:  I:10-5

Objective:  1

12) In computing MACRS depreciation in the year of disposition of personal property used in a trade or business, the half-year convention must be applied to the amounts in the tables if the half-year convention was used in the year the asset was placed into service.

Answer:  TRUE

Explanation:  The half-year convention applies in the year the asset is placed in service and the year it is taken out of service.

Page Ref.:  I:10-5

Objective:  1

13) Intangible assets are subject to MACRS depreciation.

Answer:  FALSE

Page Ref.:  I:10-5

Objective:  1

14) Section 179 allows taxpayers to immediately expense up to $500,000 (for 2013), subject to limitations, of the cost of real and personal property placed into service in a trade or business.

Answer:  FALSE

Explanation:  Section 179 does generally apply to real estate.

Page Ref.:  I:10-6

Objective:  1

15) The Section 179 expensing election is available on an annual basis for property purchased during the year.

Answer:  TRUE

Page Ref.:  I:10-6

Objective:  1

16) Personal property used in a rental activity held for investment qualifies for the Section 179 expensing election.

Answer:  FALSE

Explanation:  Only property used in a trade or business qualifies.

Page Ref.:  I:10-7

Objective:  1

17) Sec. 179 tax benefits are recaptured if at any time an asset is converted to personal use.

Answer:  TRUE

Page Ref.:  I:10-7

Objective:  1

18) Any Section 179 deduction that is not allowed currently due to the taxable income limitation may be carried over and deducted in future years.

Answer:  TRUE

Page Ref.:  I:10-7

Objective:  1

19) Under the MACRS system, if the aggregate basis of all personal property placed in service during the last three months of the year exceeds 40% of the cost of all personal property placed in service during the tax year, the mid-quarter convention is required.

Answer:  TRUE

Page Ref.:  I:10-8

Objective:  1

20) The mid-quarter convention applies to personal and real property.

Answer:  FALSE

Explanation:  The mid-quarter convention does not apply to real property.

Page Ref.:  I:10-8

Objective:  1

21) Under the MACRS system, the same convention that applies in the year of acquisition (e.g., half-year, mid-quarter, or mid-month) also applies in the year of disposition.

Answer:  TRUE

Page Ref.:  I:10-9

Objective:  1

22) Residential rental property is defined as property from which more than 80% of the gross rental income is rental income from dwelling units.

Answer:  TRUE

Page Ref.:  I:10-10

Objective:  1

23) The MACRS system requires that residential real property and nonresidential rental property be depreciated using the straight-line method.

Answer:  TRUE

Page Ref.:  I:10-10

Objective:  1

24) Capital improvements to real property must be depreciated over the remaining life of the property on which the improvements were made.

Answer:  FALSE

Explanation:  Capital improvements are depreciated over the full life of the improvement.

Page Ref.:  I:10-10

Objective:  1

25) Expenditures that enlarge a building, any elevator or escalator, any structural component that benefits a common area or the internal structural framework are not considered qualified leasehold improvement property.

Answer:  TRUE

Page Ref.:  I:10-10

Objective:  1

26) The straight-line method may be elected for depreciating tangible personal property placed in service after 1986.

Answer:  TRUE

Page Ref.:  I:10-11

Objective:  1

27) The election to use ADS is made on a year-by-year, property-class by property-class basis for real and personal property.

Answer:  FALSE

Explanation:  The election for real property is made on a property-by-property basis.

Page Ref.:  I:10-11

Objective:  1

28) If the business use of listed property is 50% or less of the total usage, the alternative depreciation system must be used.

Answer:  TRUE

Explanation:  Business use of listed property must exceed 50% to enjoy the more accelerated depreciation provisions.

Page Ref.:  I:10-12

Objective:  1

29) If the business use of listed property decreases to 50% or less of the total usage, the property is subject to depreciation recapture.

Answer:  TRUE

Page Ref.:  I:10-13

Objective:  1

30) Once the business use of listed property falls to 50% or below, the alternative depreciation system must be used for the current year and all subsequent years, even if the business use percentage increases to more than 50% in a subsequent year.

Answer:  TRUE

Page Ref.:  I:10-13

Objective:  1

31) If a new luxury automobile is used 100% for business and placed in service in 2013, the maximum MACRS depreciation on the vehicle for 2013 is $11,160.

Answer:  TRUE

Page Ref.:  I:10-13 and I:10-14; Example I:10-23

Objective:  1

32) MACRS depreciation on an SUV weighing over 6,000 pounds is limited to $3,160 for the first year placed in service.

Answer:  FALSE

Explanation:  The limit in 2013 is $3,360 for the large SUVs or $11,360 if the SUV is eligible for bonus depreciation.

Page Ref.:  I:10-16

Objective:  1

33) When a taxpayer leases an automobile for 100% business purposes, the entire lease payment is deductible.

Answer:  FALSE

Explanation:  The deduction will be reduced by the lease inclusion amount.

Page Ref.:  I:10-16

Objective:  1

34) If a company acquires goodwill in connection with the acquisition of a business, the goodwill is amortizable over a 60-month period.

Answer:  FALSE

Explanation:  Goodwill is amortizable over a 15-year period.

Page Ref.:  I:10-18; Example I:10-29

Objective:  2

35) Amounts paid in connection with the acquisition of a business which represent a covenant not to compete are amortizable over the covenant’s remaining life.

Answer:  FALSE

Explanation:  The covenant must be amortized over 15 years even if the remaining life is less than 15 years.

Page Ref.:  I:10-18

Objective:  2

36) Unless an election is made to expense or defer and amortize research and experimental expenditures, these costs must be capitalized.

Answer:  TRUE

Page Ref.:  I:10-19

Objective:  2

37) Most taxpayers elect to expense R&E expenditures because of the immediate tax benefit.

Answer:  TRUE

Page Ref.:  I:10-19

Objective:  2

38) Off-the-shelf computer software that is purchased for use in the taxpayer’s trade or business is amortized over 36 months, or it can be immediately expensed under a Sec. 179 election.

Answer:  TRUE

Page Ref.:  I:10-21

Objective:  2

39) Taxpayers are entitled to a depletion deduction if they have an economic interest in the natural resource property.

Answer:  TRUE

Page Ref.:  I:10-22

Objective:  3

40) A taxpayer owns an economic interest in an oil and gas property.  She is allowed to deduct the smaller of cost depletion or percentage depletion.

Answer:  FALSE

Explanation:  A taxpayer can deduct the larger of cost or percentage depletion.

Page Ref.:  I:10-22

Objective:  3

41) Intangible drilling and development costs (IDCs) may be deducted as an expense or may be capitalized.

Answer:  TRUE

Page Ref.:  I:10-23

Objective:  3

42) Joan bought a business machine for $15,000 on January 1, 2012, and later sold the machine for $12,800 when the total allowable depreciation is $8,500. The depreciation actually taken on the tax returns totaled $8,000. Joan must recognize a gain (or loss) of

A) no gain or loss.

B) ($3,200).

C) $6,800.

D) $6,300.

Answer:  D

Explanation:  D)

Selling Price (Amount Realized) $12,800
Cost$15,000  
Minus: Depreciation allowed or allowable( 8,500)  
Equals: Adjusted Basis ( 6,500)
Gain $6,300

Page Ref.:  I:10-3; Example I:10-1

Objective:  1

43) In April 2013, Emma acquired a machine for $60,000 for use in her business. The machine is classified as 7-year property. Emma does not expense the asset under Sec. 179, and the asset is not eligible for bonus depreciation. Emma’s depreciation on the machine this year is

A) $30,000.

B) $60,000.

C) $6,428.

D) $8,574.

Answer:  D

Explanation:  D) $60,000 × .1429 = $8,574. 

Page Ref.:  I:10-5; Example I:10-6

Objective:  1

44) In May 2013, Cassie acquired a machine for $30,000 to use in her business. The machine is classified as 5-year property. Cassie does not expense the property under Sec. 179, and the property does not qualify for bonus depreciation. Cassie’s depreciation on the machine this year is

A) $3,000.

B) $6,000.

C) $12,000.

D) $15,000.

Answer:  B

Explanation:  B) $30,000 × .20 = $6,000.

Page Ref.:  I:10-5

Objective:  1

45) On January 3, 2010, John acquired and placed into service business tools costing $10,000. The tools have a 3-year class life. No other assets were purchased during that year. The depreciation in 2013 for those tools is (Sec. 179 and bonus depreciation were not applied)

A) $-0-.

B) $741.

C) $1,920.

D) $3,333.

Answer:  B

Explanation:  B) (0.0741 × $10,000) = $741 per MACRS tables

Page Ref.:  I:10-5; Example I:10-6

Objective:  1

46) When depreciating 5-year property, the final year of depreciation will be year

A) 3.

B) 4.

C) 5.

D) 6.

Answer:  D

Explanation:  D) Because, under the half-year convention, an asset is depreciated half-year in the year it is purchased and placed into service, the last “half-year’s” depreciation extends into an additional year.

Page Ref.:  I:10-6

Objective:  1

47) In August of 2013, David acquires and places into service business equipment costing $550,000. The equipment is classified as 5-year recovery property. No other acquisitions are made during the year. The property is not eligible for bonus depreciation. David elects to expense the maximum amount under Sec. 179. David’s total deductions for the year (including Sec. 179 and depreciation) are

A) $110,000.

B) $550,000.

C) $500,000.

D) $510,000.

Answer:  D

Explanation:  D)

Section 179 immediate expensing$500,000
MACRS depreciation:    Basis for depreciation: ($550,000 cost – $500,000 Sec. 179) × .20    10,000
Total depreciation$510,000

Page Ref.:  I:10-6; Example I:10-7

Objective:  1

48) Ted purchases and places in service in 2013 personal property costing $2,050,000. What is the maximum Sec. 179 deduction that Ted can deduct, ignoring any taxable income limitation?

A) $0

B) $500,000

C) $450,000

D) $2,050,000

Answer:  C

Explanation:  C) $2,050,000 – $2,000,000 limitation on property placed in service equals $50,000 reduction in Sec. 179 deduction. $500,000 – $50,000 equals $450,000 maximum deduction.

Page Ref.:  I:10-7; Example I:10-8

Objective:  1

49) Cate purchases and places in service property costing $150,000 in 2013. She wants to elect the maximum Sec. 179 deduction allowed. Her business income is $50,000. What is the amount of her allowable Sec. 179 deduction and carryover, if any?

A)

179 deductionCarryover
$500,0000

B)

179 deductionCarryover
$150,0000

C)

179 deductionCarryover
$50,000$450,000

D)

179 deductionCarryover
$50,000$100,000

Answer:  D

Explanation:  D) The current year 179 potential deduction is $150,000, but it is limited to Cate’s business income.

Page Ref.:  I:10-7

Objective:  1

50) Elaine owns an unincorporated manufacturing business. In 2013, she purchases and places in service $2,060,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $431,000. Elaine takes the maximum allowable deduction under section 179. Which of the following statements is true regarding the Sec. 179 election?

A) Elaine can deduct $500,000 as a section 179 deduction in 2013 with no carryover to next year.

B) Elaine can deduct $440,000 as a section 179 deduction in 2013.

C) Elaine can deduct $431,000 as a section 179 deduction in 2013; $9,000 may be carried over to next year.

D) Elaine can deduct $431,000 as a section 179 deduction in 2013 with no carryover to next year.

Answer:  C

Explanation:  C) The maximum potential Sec. 179 deduction is $440,000 ($500,000 – ($2,060,000 – 2,000,000), but it is further limited to Elaine’s taxable income from the business. She has a carryover of $9,000 ($440,000 – 431,000).

Page Ref.:  I:10-7; Example I:10-8

Objective:  1

51) Terra Corporation, a calendar-year taxpayer, purchases and places into service machinery with a 7-year life that cost $518,000. The mid-quarter convention does not apply, and the property is not eligible for bonus depreciation. Terra elects to depreciate the maximum under Sec. 179. Terra’s taxable income for the year before the Sec. 179 deduction is $700,000. What is Terra’s total depreciation deduction related to this property?

A) $74,022

B) $518,435

C) $500,000

D) $502,572

Answer:  D

Explanation:  D)

Maximum Sect. 179 deduction$500,000
MACRS Depreciation [($518,000 – $500,000) × .1429] =     2,572
Total depreciation$502,572

Page Ref.:  I:10-6; Example I:10-7

Objective:  1

52) Tanya owns an unincorporated manufacturing business. In 2013, she purchases and places in service $2,020,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $461,000. Tanya elects to expense the maximum under Sec. 179. The asset is not eligible for bonus depreciation. What is Tanya’s maximum total cost recovery deduction for 2013?

A) $788,000

B) $769,000

C) $480,000

D) $461,000

Answer:  B

Explanation:  B)

Maximum Sec, 179 immediate expensing for 2013$500,000 
Less: Limit one ($2,020,000 – $2,000,000)(  20,000)
Sec. 179 after Limit one$480,000
Limit two: Taxable income—Sec. 179 currently allowed  461,000 
Sec. 179 carryover to subsequent year$  19,000  
Sec. 179 immediate expensing$  461,000  

MACRS depreciation:

   Basis for depreciation:  Cost$2,020,000
   Basis for depreciation: Sec. 179 deduction      (including carryover)( 480,000)
   Basis for depreciation: Minus: Basis to depreciate$1,540,000 
Depreciation ($1,540,000 × 0.20)$308,000

Total deductions ($461,000 + $308,000) =                                                                        $769,000

Page Ref.:  I:10-7; Example I:10-8

Objective:  1

53) Which of the following statements regarding Sec. 179 is true?

A) If a taxpayer places in service property costing more than the Sec. 179 ceiling on the amount of property placed in service, the excess can be carried over to subsequent years.

B) Amounts of the Sec. 179 election in excess of the taxable income limitation are carried forward.

C) Sec. 179 carryforwards expire after five years.

D) All of the above statements are true.

Answer:  B

Explanation:  B) Sec. 179 allows an unlimited carryforward for amounts exceeding the taxable income limitation for the year.

Page Ref.:  I:10-7

Objective:  1

54) Lunar Corporation purchased and placed in service new five-year MACRS equipment costing $700,000 on January 5, 2013.  Lunar is the original user of this equipment.  Assume Lunar had no other additions this year, has high taxable income and wishes to maximize the 2013 total cost recovery deduction.  How much can it deduct this year? 

A) $620,000

B) $350,000

C) $500,000

D) $140,000

Answer:  A

Explanation:  A)

Sec. 179$500,000
50% bonus on remaining basis ($700,000 – 500,000)100,000
Depreciation on depreciable basis: 
     $700,000 – 500,000 – 100,000 = $100,000 × .2020,000
Maximum cost recovery deduction$620,000

Page Ref.:  I:10-7 and I:10-8; Example I:10-9

Objective:  1

55) In November 2013, Kendall purchases a computer for $4,000. She does not use Sec. 179 or bonus depreciation. She only uses the most accelerated depreciation method possible. The computer is the only personal property which she places in service during the year. What is her total depreciation deduction for 2013?

A) $200

B) $572

C) $800

D) $1,000

Answer:  A

Explanation:  A) MACRS depreciation is $200 (4,000 × .05) since the computer was placed in service during the 4th quarter and was the only personal property placed in service for the year.

Page Ref.:  I:10-8 and I:10-9; Example I:10-11

Objective:  1

56) OnOctober 2, 2013, Dave acquired and placed into service 5-year business equipment costing $70,000. No other acquisitions were made during the year. Dave does not use Sec. 179 or bonus depreciation. The depreciation for this year is using the most accelerated method possible is

A) $0.

B) $3,500.

C) $7,000.

D) $10,003.

Answer:  B

Explanation:  B) 0.05 × $70,000 = $3,500. (Mid-quarter convention).

Page Ref.:  I:10-8 and I:10-9; Example I:10-11

Objective:  1

57) On November 3, this year, Kerry acquired and placed into service 7-year business equipment costing $80,000. In addition, on May 5th of this year, Kerry had also placed in business use 5-year recovery property costing $15,000. Kerry did not elect Sec. 179 immediate expensing, and the assets are not eligible for bonus depreciation. No other assets were purchased during the year. The depreciation for this year is

A) $3,606.

B) $6,606.

C) $13,576.

D) $14,432.

Answer:  B

Explanation:  B) Equipment placed in service in last 3 months of year: $80,000/$95,000 = 84% of all equipment; therefore, the mid-quarter convention must be used on all personal property placed in service during the year.

7-year equipment:  $80,000 × .0357 =$2,856
5-year property:  $15,000 × .25 =3,750
Total Depreciation$6,606

Page Ref.:  I:10-8 and I:10-9; Example I:10-11

Objective:  1

58) Paul bought a computer for $15,000 for business use on March 18, 2011. This was his only purchase for that year. Paul used the most accelerated depreciation method available, but did not elect Sec. 179. Bonus depreciation was not available. Paul sells the machine in 2013. The depreciation on the computer for 2013 is

A) $0.

B) $1,440.

C) $1,500.

D) $2,880.

Answer:  B

Explanation:  B) [.1920 × $15,000 × 1/2 year] = $1,440

Page Ref.:  I:10-9 and I:10-10; Example I:10-13

Objective:  1

59) On April 12, 2012, Suzanne bought a computer for $20,000 for business use. This was the only purchase for that year. Suzanne used the most accelerated depreciation method available and did not use Sec. 179. Bonus depreciation was not available. Suzanne sells the machine in 2013. The depreciation on the computer for 2013 is

A) $2,000.

B) $3,200.

C) $4,000.

D) $6,400.

Answer:  B

Explanation:  B) [0.32 × $20,000 × 1/2 year] = $3,200

Page Ref.:  I:10-9 and I:10-10; Example I:10-13

Objective:  1

60) Harrison acquires $65,000 of 5-year property in June 2011 that is required to be depreciated using the mid-quarter convention (because of other purchases that year). He did not elect Sec. 179 immediate expensing. Bonus depreciation was not available. If Harrison sells the property on August 23, 2013, what is the amount of depreciation claimed in 2013?

A) $6,500.00

B) $7,312.50

C) $11,700.00

D) $9,289.00

Answer:  B

Explanation:  B) [$65,000 × .18 × 2.5/4] = $7,312.50

Page Ref.:  I:10-9; Example I:10-14

Objective:  1

61) For real property placed in service after 1986, depreciation under the MACRS system is calculated using the

A) straight-line method and a half-year convention in the year of acquisition and in the year of disposition.

B) straight-line method and a mid-month convention in the year of acquisition and in the year of disposition.

C) 200% DB method and a mid-month convention in the year of acquisition and in the year of disposition.

D) 200% DB method and a half-year convention in the year of acquisition and in the year of disposition.

Answer:  B

Explanation:  B) Real property is depreciated using the straight-line method and the mid-month convention.

Page Ref.:  I:10-10

Objective:  1

62) On August 11, 2013, Nancy acquired and placed into service residential rental property, which cost $430,000; the cost of the land has been excluded. Nancy annually elects the maximum allowed Sec. 179 deduction. The total depreciation for the year is (rounded)

A) $5,865.

B) $4,141.

C) $5,117.

D) $15,636.

Answer:  A

Explanation:  A) $430,000 × .01364 = $5,865. Real property is not eligible for Sec. 179 depreciation.

Page Ref.:  I:10-10

Objective:  1

63) Lincoln purchases nonresidential real property costing $300,000 and places it in service in March 2012. What is Lincoln’s 2013 depreciation on the property?

A) $6,099

B) $7,692

C) $8,637

D) $10,908

Answer:  B

Explanation:  B) Depreciation for the second year on 39-year property is .02564 × $300,000 = $7,692

Page Ref.:  I:10-10

Objective:  1

64) Atiqa took out of service and sold a residential rental property on October 31 of this year.  She had originally acquired the property ten years ago.  The building (excluding the value of the land) cost $1,000,000.  How much is her current year depreciation deduction?

A) $30,300

B) $36,360

C) $18,182

D) $28,785

Answer:  D

Explanation:  D) $1,000,000 × .03636 × 9.5/12 = $28,785

Page Ref.:  I:10-9 and I:10-10

Objective:  1

65) All of the following are true with regard to the alternative depreciation system except

A) the principal type of property for which ADS is required is any tangible property which is used predominantly outside of the United States.

B) the ADS election is available to real property on a property by property basis.

C) the ADS election is available to personal property on a property by property basis.

D) once the ADS election is made for specified property, it is irrevocable.

Answer:  C

Explanation:  C) For personal property, the ADS election applies to all property within a class.

Page Ref.:  I:10-11

Objective:  1

66) If the business usage of listed property is less than or equal to 50% of its total usage, depreciation is calculated using the

A) regular MACRS tables.

B) alternative depreciation system.

C) it may not be depreciated.

D) regular MACRS tables and a mid-month convention.

Answer:  B

Explanation:  B) ADS straight-line must be used for listed property which is not used more than 50% in the trade or business.

Page Ref.:  I:10-12

Objective:  1

67) Eric is a self-employed consultant.  In May of the current year, Eric acquired a computer system (5-year property) for $6,000 and used the computer 80% for business and 20% for personal purposes. Eric does not take any Sec. 179 deduction or bonus depreciation. The maximum depreciation deduction for is

A) $600.

B) $800.

C) $960.

D) $1,200.

Answer:  C

Explanation:  C) Although the computer is listed property, since it is used more than 50% in trade or business, MACRS depreciation may be used. Depreciation is $6,000 × .20 × .80 = $960. Only the portion used for trade or business is depreciable.

Page Ref.:  I:10-12; Example I:10-19

Objective:  1

68) Eric is a self-employed consultant.  In May of the current year, Eric acquired a computer system (5-year property) for $7,000 and used the computer 30% for business. Eric does not use Sec. 179. The maximum depreciation deduction for is

A) $210.

B) $420.

C) $700.

D) $2,100.

Answer:  A

Explanation:  A) Because the computer is listed property which is not used more than 50% in trade or business, ADS straight-line must be used. Depreciation is $7,000 × .10 × .30 = $210.

Page Ref.:  I:10-12; Example I:10-20

Objective:  1

69) In the current year George, a college professor, acquired a computer system (5-year property) for $1,000 and used the computer 80% for teaching and research-related activities and the remaining 20% for personal use. Because George’s employer provides him with a computer in his office at the university, the employer does not require him to have a computer at home. No election was made regarding Sec. 179. The maximum depreciation deduction is

A) $0.

B) $200.

C) $160.

D) $800.

Answer:  A

Explanation:  A) In order for an employee to take a deduction for listed property used in employment-related activities, the property must be used more than 50% for trade or business and must be for the convenience of the employer and be required as a condition of employment. Since George is not required to purchase a computer for home, no depreciation is allowed.

Page Ref.:  I:10-12 and I:10-13; Example I:10-21

Objective:  1

70) In April of 2012, Brandon acquired five-year listed property (not an automobile) for $30,000 and used it 70% for business. No election was made regarding Sec. 179 and bonus depreciation was not available. In 2013, his business use of the property dropped to 40%. Which of the following statements is true?

A) The change does not affect Brandon’s previous depreciation.

B) Brandon must recapture $2,100 as ordinary income.

C) Brandon must recapture $4,200 as ordinary income.

D) Brandon must amend the previous tax return and recompute depreciation.

Answer:  B

Explanation:  B) The 2012 depreciation taken was:

Regular MACRS depreciation assuming 100% business use            $30,000 × .20 = Total depreciation if 100% business use$6,000
Business-use percentage      .70
Total depreciation at 70% business use$4,200
Depreciation under ADS straight-line:*           $30,000 × .10 × .70 =   2,100
Recapture of excess depreciation in 2013$ 2,100

*Must use ADS straight-line because the computer is listed property used 50% or less in trade or business.

Page Ref.:  I:10-13; Example I:10-22

Objective:  1

71) In July of 2013, Pat acquired a new automobile for $28,000 and used the automobile 80% for business. No election is made regarding Sec. 179. Assuming her business use remains at 80%, Pat can take a maximum depreciation deduction in 2013 of

A) $2,528.

B) $3,160.

C) $8,928.

D) $11,160.

Answer:  C

Explanation:  C) $11,160 maximum depreciation (including bonus) × .80 = $8,928

Page Ref.:  I:10-13 and I:10-14; Example I:10-24

Objective:  1

72) On January l Grace leases and places into service an automobile with a FMV of $50,000. The business use of the automobile is 60%. The “inclusion amount” for the initial year of the lease from the IRS tables is $20. The annual lease payments are $8,000. What are the tax consequences of this lease?

A) deduction for lease payments of $4,782

B) deduction for lease payments of $4,800

C) deduction for lease payments of $6,000

D) deduction for lease payment of $8,982

Answer:  A

Explanation:  A) Lease payments of $8,000 × .60 = $4,800 are initially allowed. The inclusion amount is $20 × .60 = $12. $4,800 – $12 = $4,782.

Page Ref.:  I:10-16; Example I:10-27

Objective:  1

73) On January 1, 2013, Charlie Corporation acquires all of the net assets of Rocky Corporation for $2,000,000. The following intangible assets are included in the purchase agreement:

AssetsAcquisition Cost
Goodwill and going concern value$105,000
Licenses$ 45,000
Patents$ 60,000
Covenant not to compete for five years$120,000

What is the total amount of amortization allowed in 2013?

A) $15,000

B) $22,000

C) $31,000

D) $38,000

Answer:  B

Explanation:  B) All of the intangible assets qualify as Section 197 intangible assets and are amortizable over 15 years. The 15-year amortization period applies to the covenant not to compete even though the covenant is only for five years. The total is computed as follows: ($105,000 + $45,000 + $60,000 + $120,000)/15 years = $22,000.

Page Ref.:  I:10-18; Example I:10-29

Objective:  2

74) In accounting for research and experimental expenditures, all of the following alternatives are available with the exception of

A) expense R&E costs in the year paid or incurred.

B) expense R&E costs in the year in which a product or process becomes marketable.

C) defer and amortize R&E costs as a ratable deduction over a period of 60 months or more.

D) capitalize and write off R&E costs only when the research project is abandoned or is worthless.

Answer:  B

Explanation:  B) In the year paid or incurred, the expenditures may be expensed, capitalized and amortized over 60 months, or capitalized.

Page Ref.:  I:10-19

Objective:  2

75) Costs that qualify as research and experimental expenditures include all of the following except

A) depreciation of laboratory equipment.

B) management studies.

C) costs incurred in developing product improvements.

D) costs of obtaining a patent such as attorney fees.

Answer:  B

Explanation:  B) Management studies are specifically listed as items that do not qualify.

Page Ref.:  I:10-20; Table I:10-4

Objective:  2

76) This year Bauer Corporation incurs the following costs in development of new products:

Laboratory supplies$ 55,000
Laboratory equipment purchased    (5-year recovery property)50,000
Salaries (lab personnel)90,000
Utilities  20,000
Total$215,000

No benefits are realized from the research expenditures until next year. If Bauer Corporation elects to expense the research expenditures, the deduction is

A) $10,000 this year and $175,000 next year.

B) $175,000 next year.

C) $175,000 this year.

D) $215,000 this year.

Answer:  C

Explanation:  C) Deductible costs include:

Laboratory supplies$ 55,000
Laboratory equipment ($50,000 × 0.20)10,000
Salaries90,000
Utilities    20,000
Total$175,000

Page Ref.:  I:10-20; Example I:10-32

Objective:  2

77) Galaxy Corporation purchases specialty software from a software development firm for use in its business as of January 1 of the current year at a cost of $90,000.  No hardware was acquired.  How much of the cost can Galaxy deduct this year?

A) $18,000

B) $15,000

C) $30,000

D) $90,000

Answer:  C

Explanation:  C) Purchased software that is not (1) acquired in connection with hardware or (2) is not a Sec. 197 intangible is amortized over 36 months.  $90,000 × 12/36 = $30,000.  Sec. 179 is not available because it is not off-the-shelf software.

Page Ref.:  I:10-20

Objective:  2

78) In calculating depletion of natural resources each period,

A) cost depletion must be used.

B) percentage depletion must be used.

C) the greater of cost depletion or percentage depletion must be used.

D) the smaller of cost depletion or percentage depletion must be used.

Answer:  C

Explanation:  C) The method that is used in any year is the one that results in the largest deduction.

Page Ref.:  I:10-22

Objective:  3

79) J.R. acquires an oil and gas property interest for $300,000. J.R. expects to recover 50,000 barrels of oil. Intangible drilling and development costs are $80,000 and are charged to expense. Other expenses are $20,000. During the year, 13,000 barrels of oil are sold for $170,000. J.R.’s depletion deduction is

A) $25,500.

B) $35,000.

C) $70,000.

D) $78,000.

Answer:  D

Explanation:  D) Larger of cost depletion or percentage depletion:

Cost depletion = $300,000/50,000 barrels = $6 per barrel. Total Cost Depletion = $6 × 13,000 barrels =$78,000

Percentage depletion calculation:

Percentage Depletion:      $170,000 × 0.15 =  $25,500 
but not greater than gross income ceiling: Gross income$170,000 
Minus: IDCs and expenses( 100,000) 
Taxable income before depletion$  70,000$ 25,500

The taxpayer must use the greater of cost or percentage depletion so the $78,000 cost depletion will be deducted.

Page Ref.:  I:10-22 and I:10-23; Examples I:10-35 and I:10-36

Objective:  3