REG 1 Flashcards
Nare, an accrual-basis taxpayer, owns a building which was rented to Mott under a ten-year lease expiring August 31, Year 8. On January 2, Year 2, Mott paid $30,000 as consideration for cancelling the lease. On November 1, Year 2, Nare leased the building to Pine under a five-year lease. Pine paid Nare $10,000 rent for the two months of November and December, and an additional $5,000 for the last month’s rent. What amount of rental income should Nare report in its Year 2 income tax return?
a. $10,000 b. $15,000 c. $40,000 d. $45,000
Choice “d” is correct. Prepaid rent is income when received even for an accrual-basis taxpayer. The $30,000 received as consideration for cancelling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month’s rent is also rental income.
With regard to the inclusion of social security benefits in gross income, for the Year 8 tax year, which of the following statements is correct?
a. The social security benefits in excess of modified adjusted gross income are included in gross income. b. The social security benefits in excess of one half the modified adjusted gross income are included in gross income. c. Eighty-five percent of the social security benefits is the maximum amount of benefits to be included in gross income. d. The social security benefits in excess of the modified adjusted gross income over a threshold amount are included in gross income.
Choice “c” is correct. The amount of social security benefits that is taxed is dependent on whether the combined income (AGI plus interest on tax-exempt bonds and 50% of the social security benefits) is greater than a threshold amount. If the combined income is less than the threshold, the amount taxed is the lesser of 1) 50% of the benefits or 2) 50% of the excess of the combined income over the threshold. If the combined income is greater than the threshold, the amount taxed is the lesser of 1) amount calculated above plus 85% of the excess of the combined income over the threshold or 2) 85% of the benefits. Thus, 85% of the benefits is the maximum amount of benefits that may be included in gross income.
DAC Foundation awarded Kent $75,000 in recognition of lifelong literary achievement. Kent was not required to render future services as a condition to receive the $75,000. What condition(s) must have been met for the award to be excluded from Kent’s gross income?
I. Kent was selected for the award by DAC without any action on Kent’s part.
II. Pursuant to Kent’s designation, DAC paid the amount of the award either to a governmental unit or to a charitable organization.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II.
Choice “c” is correct. Generally, the fair market value of prizes and awards is taxable income. However, an exclusion from income for certain prizes and awards applies where the winner is selected for the award without entering into a contest (i.e., without any action on their part) and then assigns the award directly to a governmental unit or charitable organization. Therefore, conditions “I” and “II” must be met in order for Kent to exclude the award from his gross income.
Klein, a master’s degree candidate at Blair University, was awarded a $12,000 scholarship from Blair in Year 8. The scholarship was used to pay Klein’s Year 8 university tuition and fees. Also in Year 8, Klein received $5,000 for teaching two courses at a nearby college. What amount is includable in Klein’s Year 8 gross income?
a. $0 b. $5,000 c. $12,000 d. $17,000
Choice “b” is correct. Scholarships are nontaxable for degree seeking students to the extent that the proceeds are spent on tuition, fees, books and supplies. The $5,000 for teaching courses is taxable compensation for services delivered.
During Year 9, Ash had the following cash receipts:
Wages $ 13,000
Interest income from U.S. Treasury bonds $350
Workers’ compensation following a job-related injury $ 8,500
What is the total amount that must be included in gross income on Ash’s Year 9 income tax return?
a. $13,000
b. $13,350
c. $21,500
d. $21,850
Choice “b” is correct. The total amount that must be included in gross income is $13,350 ($13,000 in wages plus $350 in interest income on U.S. Treasury bonds).
Rule: Wages and interest on U.S. Treasury bonds are includible in gross income and must be reported as part of gross income on a taxpayer’s income tax return.
Rule: Damages for personal injury (i.e., workers’ compensation for a job-related injury) are specifically excluded from gross income.
Which of the following is (are) among the requirements to enable a taxpayer to be classified as a “qualifying widow(er)”?
I. A dependent has lived with the taxpayer for six months.
II. The taxpayer has maintained the cost of the principal residence for six months.
a. Both I and II.
b. Neither I nor II.
c. II only.
d. I only.
Choice “b” is correct. The requirements that enable a taxpayer to be classified as a “qualifying widow(er)” are:
- The taxpayer’s spouse died in one of the two previous years and the taxpayer did not remarry in the current tax year,
- The taxpayer has a child who can be claimed as a dependent,
- This child lived in the taxpayer’s home for all of the current tax year,
- The taxpayer paid over half the cost of keeping up a home for the child,
- The taxpayer could have filed a joint return in the year the spouse died.
Parker, whose spouse died during the preceding year, has not remarried. Parker maintains a home for a dependent child. What is Parker’s most advantageous filing status?
a. Single. b. Head of household. c. Qualifying widow(er) with dependent child. d. Married filing separately.
Choice “c” is correct. A qualifying widow(er) is a taxpayer who may use the joint tax return standard deduction and rates (but not the exemption for the deceased spouse) for each of two taxable years following the year of death of his or her spouse, unless he or she remarries. The surviving spouse must maintain a household that, for the whole entire taxable year, was the principal place of abode of a son, stepson, daughter, or stepdaughter (whether by blood or adoption). The surviving spouse must also be entitled to a dependency exemption for such individual. Parker may file as a qualifying widow(er) since her spouse died in the previous tax year, she did not remarry and she maintained a home for a dependent child. Since qualifying widow(er) is the most advantageous status and Parker qualifies, Parker would file as a qualifying widow(er).
In which of the following situations may taxpayers file as married filing jointly?
a. Taxpayers who were divorced during the year. b. Taxpayers who were legally separated but lived together for the entire year. c. Taxpayers who were married but lived apart during the year. d. Taxpayers who were married but lived under a legal separation agreement at the end of the year.
RULE: In order to file a joint return, the parties must be MARRIED at the end of the year. Exception: If the parties are married but are LEGALLY SEPARATED under the laws of the state in which they reside, they cannot file a joint return (they will file either under the single or head of household filing status).
Choice “c” is correct. Per the above rule, taxpayers who are married but lived apart during the year are allowed to file a joint return for the year. The fact that they did not live together during the year has no bearing on the issue.
A couple filed a joint return in prior tax years. During the current tax year, one spouse died. The couple has no dependent children. What is the filing status available to the surviving spouse for the first subsequent tax year?
a. Head of household. b. Married filing separately. c. Single. d. Surviving spouse.
Choice “c” is correct. For the first subsequent tax year (and all other subsequent tax years) after the death of a spouse with no dependent children, filing status is single.
Choice “d” is incorrect. Filing status is not “surviving spouse” because there are no dependent children.
Choice “b” is incorrect. Filing status is not “married filing separately” in the first subsequent tax year after the death of a spouse since the couple is no longer married.
Choice “a” is incorrect. Filing status is not “head of household” because there are no dependent children and no other qualifying dependents.
A taxpayer’s spouse dies in August of the current year. Which of the following is the taxpayer’s filing status for the current year?
a. Qualified widow(er). b. Single. c. Head of household. d. Married filing jointly.
Choice “d” is correct. The joint return rates apply for two years following the death of a spouse, if the surviving spouse does not remarry and maintains a household for a dependent child. There is nothing in this question that says whether or not the surviving spouse maintains a household for a dependent child. However, since the question is asking about the current year, the surviving spouse is considered to be married (and thus able to file as married filing jointly) for the entire current year even if the spouse dies earlier in the year (in this case in August).
Thompson’s spouse died in Year 1. Thompson did not remarry in Year 2 and lived alone the entire year. What is Thompson’s Year 2 filing status?
a. Surviving spouse. b. Head of household. c. Married filing jointly. d. Single.
Choice “d” is correct. Filing status is determined as of the last day of the year. At the end of Year 2, Thompson is not married and does not qualify for any other filing status. Therefore, his status is single.
Choice “c” is incorrect. When a spouse dies during the year, the surviving spouse can file married filing jointly for that year under an exception to the end-of-year test. But this question is about Year 2, the year after death. Thompson is single for Year 2.
Choice “a” is incorrect. Surviving spouse status, also known as qualifying widow(er), can be claimed for the two years after year of death. However, it requires the presence of a dependent child, which is not part of the facts here. Thompson is single for Year 2.
Choice “b” is incorrect. Head of household status could apply in certain circumstances where there is a dependent and surviving spouse status does not apply. That is not the case here. Thompson is single for Year 2.
Joe and Barb are married, but Barb refuses to sign a Year 12 joint return. On Joe’s separate Year 12 return, an exemption may be claimed for Barb if:
a. Barb attaches a written statement to Joe's income tax return, agreeing to be claimed as an exemption by Joe for Year 12. b. Barb was a full-time student for the entire Year 12 school year. c. Barb had no gross income and was not claimed as another person's dependent in Year 12. d. Barb was under the age of 19.
Choice “c” is correct. If a married individual files a separate return, a personal exemption may be claimed for his or her spouse if the spouse has no gross income and is not claimed as a dependent of another taxpayer.
In Year 1, Smith, a divorced person, provided over one half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During Year 1, Ruth did not live with Smith. She received $9,000 in Social Security benefits. Clay, a 25-year-old full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return for Year 1, owing an additional $500 in taxes on his wife’s income. How many exemptions was Smith entitled to claim on his Year 1 tax return?
a. 4 b. 1 c. 3 d. 2
Choice “d” is correct. Smith is entitled to an exemption for himself. He is also entitled to an exemption for his mother Ruth (qualifying relative). Ruth has $9,000 in Social Security payments during Year 1, but because that is her only income, the Social Security is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent. Clay cannot be taken as a dependent because he filed a joint return with his wife. Because the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay’s wife because she filed a joint return with Clay. Smith is entitled to two exemptions.
Jim and Kay Ross contributed to the support of their two children, Dale and Kim, and Jim’s widowed parent, Grant. For Year 27, Dale, a 19-year-old full-time college student, earned $4,500 as a babysitter. Kim, a 23-year-old bank teller, earned $12,000. Grant received $5,000 in dividend income and $4,000 in nontaxable Social Security benefits. Grant and Kim are U.S. citizens and were over one-half supported by Jim and Kay, but neither of the two currently reside with Jim and Kay. Dale’s main place of residence is with Jim and Kay, and he is currently on a temporary absence to attend school. How many exemptions can Jim and Kay claim on their Year 27 joint income tax return?
a. Three b. Five c. Two d. Four
Choice “a” is correct. Taxpayers are now entitled to an exemption for each qualifying child and qualifying relative (two tests are “CARES” or “SUPORT”). For Dale, he does meet the residency requirement because there is an exception for a temporary absence while attending school. Therefore, he is a qualifying child under the CARES test. Kim does not qualify as a qualifying child (CARES test) because, although she is under age 24, she is not a full-time student. Therefore, the income limitations of the SUPORT test apply, and she does not qualify under that test either. Likewise, Grant’s taxable income of $5,000 exceeds the minimum ($4,050). Thus, 3 total exemptions can be claimed (Jim, Kay, and Dale).
Janet and Ted have two children, Mary (age 10) and Seth (age 12). Janet’s Aunt Martha resides with the family in an apartment over the garage. Martha’s only income is $1,500 a month in Social Security benefits. Janet and Ted receive no rent payments from Martha and provide all remaining support for her living arrangements. How many exemptions are Janet and Ted entitled to in filing their joint tax return?
a. 3 b. 4 c. 5 d. 2
Choice “c” is correct. Janet and Ted are entitled to dependency exemptions for themselves, their two children and Aunt Martha. Aunt Martha is a “qualified relative.” The qualifications to take an exemption for a qualifying relative are found in the “SUPORT” mnemonic:
S upport (over 50%) test
U nder a specific amount of (taxable) gross income test
P recludes dependent filing a joint tax return test
O nly citizens (residents of US/Canada or Mexico) test
R elative test OR
T axpayer lives with individual for whole year test
The two children meet the test for a qualifying child. In addition, Aunt Martha, a relative, qualifies because she does not have any taxable income (social security is not taxed at this low level of income), is not filing a joint tax return with another, is a citizen of the US, and is a qualifying relative. In this instance, note that Martha would not have to reside with the family. Only nonrelative members of a household must reside with the taxpayer for the entire year in order for the taxpayer to be entitled to a dependency exemption for that individual.
Darr, an employee of Sorce C Corporation, is not a shareholder. Which of the following would be included in a taxpayer’s gross income?
a. The dividend income on shares of stock that the taxpayer received for services rendered. b. A $10,000 gift from the taxpayer's grandparents. c. Employer-provided medical insurance coverage under a health plan. d. The fair market value of land that the taxpayer inherited from an uncle.
Choice “a” is correct. An individual receiving common stock for services rendered must recognize the fair market value as ordinary income. Any dividends received on that stock would also result in income recognition.
Adams owns a second residence that is used for both personal and rental purposes. During the current year, Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct?
a. A rental loss may be deducted if rental-related expenses exceed rental income. b. Depreciation may not be deducted on the property under any circumstances. c. All mortgage interest and taxes on the property will be deducted to determine the property's net income or loss. d. Utilities and maintenance on the property must be divided between personal and rental use.
Choice “d” is correct. Because the second property was personally used more than 14 days, any net loss from the rental of the property will be disallowed.
All related expenses must be prorated between the personal use portion and the rental activity portion. Prorated depreciation is permitted for the rental activity.
Which of the following conditions must be present in a post-1984 divorce agreement for a payment to qualify as deductible alimony?
I. Payments must be in cash or its equivalent.
II. The payments must end at the recipient’s death.
a. Neither I nor II.
b. II only.
c. I only.
d. Both I and II.
Choice “d” is correct. Among the requirements for payments to be classified as alimony are the following:
1. Payment must be in cash or its equivalent.
2. Payments cannot extend beyond the death of the payee-spouse.
3. Payments must be legally required pursuant to a written divorce (or separation) agreement.
4. Payments cannot be made to members of the same household.
5. Payments must not be designated as anything other than alimony.
6. The spouses may not file a joint tax return.
Note: The requirements for payments to be considered alimony (income) are the same as for payments to be alimony (deductions).
Which of the following costs is not included in inventory under the Uniform Capitalization rules for goods manufactured by the taxpayer?
a. Warehousing costs. b. Research. c. Quality control. d. Taxes excluding income taxes.
Choice “b” is correct. Uniform Capitalization rules provide guidelines with respect to capitalizing or expensing certain costs. With regard to inventory, direct materials, direct labor, and factory overhead should be capitalized as part of the cost of inventory. Warehousing costs, quality control and taxes, excluding income taxes, are all considered factory overhead items. The research should be expensed.
During Year 9, Ash had the following cash receipts:
Wages $ 13,000
Interest income from U.S. Treasury bonds $350
Workers’ compensation following a job-related injury $8,500
What is the total amount that must be included in gross income on Ash’s Year 9 income tax return?
a. $13,000
b. $13,350
c. $21,850
d. $21,500
b. $13,350
Choice “b” is correct. The total amount that must be included in gross income is $13,350 ($13,000 in wages plus $350 in interest income on U.S. Treasury bonds).
Rule: Wages and interest on U.S. Treasury bonds are includible in gross income and must be reported as part of gross income on a taxpayer’s income tax return.
Rule: Damages for personal injury (i.e., workers’ compensation for a job-related injury) are specifically excluded from gross income.
Baum, an unmarried optometrist and sole proprietor of Optics, buys and maintains a supply of eyeglasses and frames to sell in the ordinary course of business. In the current year, Optics had $350,000 in gross business receipts and its year-end inventory was not subject to the uniform capitalization rules. Baum’s current year adjusted gross income was $90,000 and Baum qualified to itemize deductions. During the year, Baum recorded the following information:
Business expenses: Optics cost of goods sold $ 35,000
Optics rent expense $28,000
Liability insurance premium on Optics $5,250
Other expenditures: Baum’s self-employment tax $ 29,750
Baum’s self-employment health insurance $8,750
Insurance premium on personal residence. In the current year, Baum’s home was totally destroyed by fire. The furniture had an adjusted basis of $14,000 and a fair market value of $11,000. During the year, Baum collected $3,000 in insurance reimbursement and had no casualty gains during the year. $2,625
Qualified mortgage interest on a loan to acquire a personal residence $52,500
Annual interest on a $70,000, 5-year home equity loan. The loan was secured by Baum’s home, obtained January 2 of the current year. The fair market value of the home exceeded the mortgage and the home equity loan by a substantial amount. The proceeds were used to purchase a car for personal use. $3,500
Points prepaid on January 2 of the current year to acquire the home equity loan $1,400
Real estate taxes on personal residence $2,200
Estimated payments of current year federal income taxes $13,500
Local property taxes on the car value, used exclusively for personal use $300
What amount should Baum report as current year net earnings from self-employment?
a. $273,000
b. $281,750
c. $243,250
d. $252,000
Choice “b” is correct. Baum should report $281,750 as current year net earnings from self-employment (line 12 of the Form 1040), calculated as follows:
Gross business receipts $ 350,000
Cost of goods sold (35,000)
Rent expense (28,000)
Liability insurance premium (5,250)
Net earnings on Schedule C $ 281,750
Choices “c”, “d”, and “a” are incorrect. Self-employment tax and self-employment health insurance expenses are adjustments from total gross income. They are not deducted from self-employment earnings (i.e., not reported net on line 12 of the Form 1040).
Note: There are many distracters in this question, all relating to items that are either deductible as part of itemized deductions or not deductible. Be careful to read the requirement of the question before spending unnecessary time on the question. The statement that Baum’s year-end inventory was not subject to the uniform capitalization rules is a distracter as well. There is not enough information given in the facts to apply the rules if he had been subject to them.
Baker, a sole proprietor CPA, has several clients that do business in Spain. While on a four-week vacation in Spain, Baker took a five-day seminar on Spanish business practices that cost $700. Baker’s round-trip airfare to Spain was $600. While in Spain, Baker spent an average of $100 per day on accommodations, local travel, and other incidental expenses, for total expenses of $2,800. What amount of total expense can Baker deduct on Form 1040 Schedule C, “Profit or Loss From Business,” related to this situation?
a. $700 b. $4,100 c. $1,800 d. $1,200
Choice “d” is correct. Baker can deduct $1,200 in total expense on Form 1040 Schedule C, calculated as follows:
Direct educational expenses
$ 700
[cost of the course]
Daily expenses for 5-day seminar
500
[$100 per day × 5]
Total educational expenses
$ 1,200
Rule: If foreign travel is primarily for personal in nature (e.g., a vacation), none of the travel expenses (e.g., round trip airfare) incurred will be allowable business deductions, even if the taxpayer was involved in business activities while in the foreign country.
Note: It does not appear that the examiners are attempting to trick candidates on the classification of the business expenses as travel or educational. It appears that the purpose of the question is to test the candidate’s ability to recognize when expenses are deductible and when they are not deductible business expenses.
On December 1 of the current taxable year, Krest, a self-employed cash basis taxpayer, borrowed $200,000 to use in her business. The loan was to be repaid on November 30 of the following year. Krest paid the entire interest amount of $24,000 on December 1 of the current year. What amount of interest was deductible on Krest’s current year income tax return?
a. $0 b. $22,000 c. $2,000 d. $24,000
Choice “c” is correct. Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on December 1, of the current year, only the interest relating to December of the current year can be deducted in the current year. The question does not give an interest rate, but because the loan is to be repaid in a lump sum at maturity, 1/12 of the interest, or $2,000 applies to each month.
Klein, a master’s degree candidate at Blair University, was awarded a $12,000 scholarship from Blair in Year 8. The scholarship was used to pay Klein’s Year 8 university tuition and fees. Also in Year 8, Klein received $5,000 for teaching two courses at a nearby college. What amount is includable in Klein’s Year 8 gross income?
a. $0 b. $17,000 c. $5,000 d. $12,000
Choice “c” is correct. Scholarships are nontaxable for degree seeking students to the extent that the proceeds are spent on tuition, fees, books and supplies. The $5,000 for teaching courses is taxable compensation for services delivered.
Which payment(s) is (are) included in a recipient’s gross income?
I. Payment to a graduate assistant for a part-time teaching assignment at a university. Teaching is not a requirement toward obtaining the degree.
II. A grant to a Ph.D. candidate for his participation in a university-sponsored research project for the benefit of the university.
a. I only.
b. II only.
c. Neither I nor II.
d. Both I and II.
d. Both I and II
Under the uniform capitalization rules applicable to property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions are met?
Marketing costs…………..Off-site storage costs
a. No…………………..Yes
b. No…………………..No
c. Yes………………….No
d. Yes………………….Yes
a. Marketing Costs: No, Off-site Storage costs: Yes
Choice “a” is correct. Under the uniform capitalization rules, purchasers of inventory for resale may deduct their marketing costs but must capitalize their off-site storage costs.
In a tax year where the taxpayer pays qualified education expenses, interest income on the redemption of qualified U.S. Series EE Bonds may be excluded from gross income. The exclusion is subject to a modified gross income limitation and a limit of aggregate bond proceeds in excess of qualified higher-education expenses. Which of the following is (are) true?
I. The exclusion applies for education expenses incurred by the taxpayer, the taxpayer’s spouse, or any person whom the taxpayer may claim as a dependent for the year.
II. “Otherwise qualified higher-education expenses” must be reduced by qualified scholarships not includible in gross income.
a. Neither I nor II.
b. I only.
c. II only.
d. Both I and II.
Both I and II
Choice “d” is correct. Interest earned on Series EE bonds issued after 1989 may qualify for exclusion. One requirement is that the interest is used to pay tuition and fees for the taxpayer, spouse, or dependent enrolled in higher education. The interest exclusion is reduced by qualified scholarships that are exempt from tax and other nontaxable payments received for educational expenses (other than gifts and inheritances).
During the year Kay received interest income as follows:
On U.S. Treasury certificates
$ 4,000
On refund of prior year’s federal income tax
500
The total amount of interest subject to tax in Kay’s current year tax return is:
a. $500
b. $4,500
c. $0
d. $4,000
b. $4,500
Choice “b” is correct. Interest income from U.S. obligations is generally taxable. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed.
With regard to the inclusion of social security benefits in gross income, for the Year 8 tax year, which of the following statements is correct?
a. Eighty-five percent of the social security benefits is the maximum amount of benefits to be included in gross income. b. The social security benefits in excess of one half the modified adjusted gross income are included in gross income. c. The social security benefits in excess of the modified adjusted gross income over a threshold amount are included in gross income. d. The social security benefits in excess of modified adjusted gross income are included in gross income.
Choice “a” is correct. The amount of social security benefits that is taxed is dependent on whether the combined income (AGI plus interest on tax-exempt bonds and 50% of the social security benefits) is greater than a threshold amount. If the combined income is less than the threshold, the amount taxed is the lesser of 1) 50% of the benefits or 2) 50% of the excess of the combined income over the threshold. If the combined income is greater than the threshold, the amount taxed is the lesser of 1) amount calculated above plus 85% of the excess of the combined income over the threshold or 2) 85% of the benefits. Thus, 85% of the benefits is the maximum amount of benefits that may be included in gross income.
Rich is a cash basis self-employed air-conditioning repairman with current year gross business receipts of $20,000. Rich’s cash disbursements were as follows:
Air conditioning parts $ 2,500
Yellow Pages listing $2,000
Estimated federal income taxes on self-employment income $1,000
Business long-distance telephone calls $400
Charitable contributions $200
What amount should Rich report as net self-employment income?
a. $15,100 b. $13,900 c. $14,900 d. $14,100
Choice "a" is correct. Deductions to arrive at net self-employed income include all necessary and ordinary expenses connected with the business. Estimated federal income tax payments are not an expense. Charitable contributions by an individual are only deductible as an itemized deduction on Schedule A. This assumes the contribution was not made with the "expectation of commensurate financial return." Receipts$ 20,000 Parts (2,500) Listing (2,000) Telephone (400) Net self-employment income $ 15,100
On December 1, Year 1, Michaels, a self-employed cash basis taxpayer, borrowed $100,000 to use in her business. The loan was to be repaid on November 30, Year 2. Michaels paid the entire interest of $12,000 on December 1, Year 1. What amount of interest was deductible on Michaels’ Year 2 income tax return?
a. $12,000 b. $1,000 c. $0 d. $11,000
d. $11,000
Choice “d” is correct. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers. The loan is for 1 month in Year 1 and 11 months in Year 2. Therefore, 1/12 of the interest is deductible in Year 1 and 11/12, or $11,000 is deductible in Year 2.
Perle, a dentist, billed Wood $600 for dental services. Wood paid Perle $200 cash and built a bookcase for Perle’s office in full settlement of the bill. Wood sells comparable bookcases for $350. What amount should Perle include in taxable income as a result of this transaction?
a. $200 b. $550 c. $600 d. $0
b. $550
Choice “b” is correct. The $200 cash received plus the $350 fair value of the bookcase received must be included in income by Perle, for a total of $550. The income is based on the value in money or fair value of property received by Perle, not the $600 billed.
Charles and Marcia are married cash-basis taxpayers. In Year 8, they had interest income as follows:
*$500 interest on federal income tax refund.
*$600 interest on state income tax refund.
*$800 interest on federal government obligations.
*$1,000 interest on state government obligations.
What amount of interest income is taxable on Charles and Marcia’s Year 8 joint income tax return?
a. $2,900
b. $1,100
c. $500
d. $1,900
d. $1,900
Choice “d” is correct. The $500 interest on federal income tax refund, the $600 interest on state income tax refund, and the $800 interest on federal government obligations are taxable, for a total of $1,900. The $1,000 interest on state government obligations is normally not taxable.
Nare, an accrual-basis taxpayer, owns a building which was rented to Mott under a ten-year lease expiring August 31, Year 8. On January 2, Year 2, Mott paid $30,000 as consideration for cancelling the lease. On November 1, Year 2, Nare leased the building to Pine under a five-year lease. Pine paid Nare $10,000 rent for the two months of November and December, and an additional $5,000 for the last month’s rent. What amount of rental income should Nare report in its Year 2 income tax return?
a. $40,000 b. $15,000 c. $45,000 d. $10,000
c. $45,000
Choice “c” is correct. Prepaid rent is income when received even for an accrual-basis taxpayer. The $30,000 received as consideration for cancelling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month’s rent is also rental income.
John and Mary were divorced last year. The divorce decree provides that John pay alimony of $10,000 per year, to be reduced by 20% on their child’s 18th birthday. During the current year, John paid $7,000 directly to Mary and $3,000 to Spring College for Mary’s tuition. What amount of these payments should be reported as income in Mary’s current year income tax return?
a. $10,000 b. $8,000 c. $8,600 d. $5,600
Choice “b” is correct. Alimony would be income to Mary while child support would not. Funds qualify as child support only if 1) a specific amount is fixed or is contingent on the child’s status (e.g., reaching a certain age), 2) it is paid solely for the support of minor children, and 3) it is payable by decree, instrument or agreement. The actual use of the funds is irrelevant to the issue. In this case, $2,000 (20% × $10,000) qualifies as child support. The other $8,000 is alimony, which would be income to Mary.
Clark filed Form 1040EZ for the Year 8 taxable year. In July, Year 9, Clark received a state income tax refund of $900 plus interest of $10, for overpayment of Year 8 state income tax. What amount of the state tax refund and interest is taxable in Clark’s Year 9 federal income tax return?
a. $900 b. $10 c. $910 d. $0
Choice “b” is correct. Except for interest from state and local government bonds, interest income is fully taxable, so the $10 is included in income. Filing Form 1040EZ means that Clark did not itemize in the prior year, and therefore, did not deduct any state income taxes last year. Under the tax benefit rule, the refund is not taxable this year since Clark did not deduct the tax last year.
Freeman, a single individual, reported the following income in the current year:
* Guaranteed payment from services rendered to a partnership $ 50,000
* Ordinary income from an S corporation 20,000
What amount of Freeman’s income is subject to self-employment tax?
a. $50,000
b. $70,000
c. $0
d. $20,000
Choice “a” is correct. Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to self-employment tax. Payments not guaranteed are merely another way to distribute partnership profits. The ordinary income reported from an S corporation is taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).
During the current year, Adler had the following cash receipts:
Wages $ 18,000
Interest income from investments in municipal bonds $400
Unemployment compensation $3,900
What is the total amount that must be included in gross income on Adler’s current year income tax return?
a. $22,300 b. $18,000 c. $18,400 d. $21,900
Choice “d” is correct. The wages of $18,000 and unemployment compensation are both includable in gross income on Adler’s current year income tax return.
DAC Foundation awarded Kent $75,000 in recognition of lifelong literary achievement. Kent was not required to render future services as a condition to receive the $75,000. What condition(s) must have been met for the award to be excluded from Kent’s gross income?
I. Kent was selected for the award by DAC without any action on Kent’s part.
II. Pursuant to Kent’s designation, DAC paid the amount of the award either to a governmental unit or to a charitable organization.
a. Neither I nor II.
b. I only.
c. Both I and II.
d. II only.
c. Both I and II
Choice “c” is correct. Generally, the fair market value of prizes and awards is taxable income. However, an exclusion from income for certain prizes and awards applies where the winner is selected for the award without entering into a contest (i.e., without any action on their part) and then assigns the award directly to a governmental unit or charitable organization. Therefore, conditions “I” and “II” must be met in order for Kent to exclude the award from his gross income.
