Chapter 2 - Individual Taxation and Other taxes (AMT) and Other Items Flashcards Preview

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Flashcards in Chapter 2 - Individual Taxation and Other taxes (AMT) and Other Items Deck (41):
1

Alternative Minimum Tax (AMT)

AMT is a tax designed to ensure that taxpayers who take a large number of tax preference deductions pay a minimum amount of tax on their income.

AMT is the excess of the tentative AMT over the regular tax.

2

AMT and AMTI formula and tax rate

AMT is mandatory if it exceeds the regular tax.

Taxable income
+/- certain adjustments
+ tax preferences
- exemption allowance
= AMTI (AMT tax base/taxable excess)
x tax rate ( 26% first $184,500 and 28% on anything over)
= Tentative AMT tax
-
= Tentative minimum tax
-
= AMT Tax (the greater of AMT or regular tax is the total tax liability).


AMTI in excess of $185,400 the tax rate on the excess is 28%


3

What are the exemption amounts for AMT?

The exemption amount is phased out by 25 cents per dollar of AMTI above $158,900 for MFJ, $119,200 for single, $79,450 MFS.
exemption allowance:
$83,400 MFJ LESS 25% (AMTI-$$158,900)
$53,600 Single LESS 25% (AMTI-$119,200)
$41,700 MFS LESS 25% (AMTI-$79,450)

The exemption can never be less than 0.

AMTI
-
= excess over threshold
x 25%
= reduction to exemption amount

Exemption
-
= AMT Exemption allowable

4

Adjustments for AMTI calculations

May increase or decrease AMT because the tax treatment of the item is different for AMT purposes than regular tax purposes.

Some adjustments include:

Items 1-5 are timing differences (temporary differences) and may increase or decrease AMTI based on the timing:
1) Passive activity losses
2) Accelerated depreciation
3) Net operating loss of the individual taxpayer
4) installment income of a dealer
5) contracts - percentage completion versus completed contract method

Items 6-10 are items that may be included in deductions for regular tax purposes, but not for AMT purposes and will only increase AMTI (permanent differences):
6) Tax deductions - (permanent)
7) Interest deductions on some home equity loans - (permanent)
8) Medical deductions (limited to excess over 10% AGI; adjustment for taxpayers age 65 and over) - (permanent)
9) Miscellaneous deductions not allowed - (permanent)
10) Exemptions (personal) and standard deduction - (permanent)



5

What are some tax preference items for AMTI calculations?

Tax preference items are always add backs (+).

These items will result in more income or less deductions being recognized for AMT vs. Regular tax. Theses include:
1) Private activity bond interest income (on certain bonds) - (permanent)
2) percentage depletion, the excess over adjusted basis of property - (permanent)
3) Pre-1987 accelerated depreciation

6

Credits for prior year minimum tax (AMT Credits)/ What credits are allowed against AMT?

- AMT paid in a certain year may be carried over as a credit to subsequent taxable years. It may only reduce regular tax, not future AMT.

- This carry forward of the credit is forever.

Some credits include:
1) Foreign Tax credit
2) Adoption credit
3) Child tax credit
4) Contributions to retirements plans credit
5) Earned income credit
6) Small business health care tax credit

- AMT created by permanent differences cannot be carried forward as a credit. Therefore, if AMT is paid because of these items, it is never recovered.


7

AMTI calculation:

regular taxable income
+/- Adjustments
- (Passive activity losses are added back or recalculated)
- (Accelerated depreciation adjustment - on real property it is the difference between reg tax depreciation and straight line using a 40 year life and for personal property it is the difference between reg tax depreciation and 150% declining balance with switch to straight line - if declining balance used for reg tax then no AMT adjustment for depreciation)
- Net operating loss must be recomputed
- installment method may not be used by dealer for property sales
- Long term contracts ( difference between % completion and completed contract method or any other method of accounting is an adjustment)

- Itemized deductions (adjustments that always add to regular taxable income) include:
- taxes reduced by taxable refunds are added back (if refund meets tax benefit rules)
- Mortgage interest not used to build/improve home is added back.
- investment interest must be recalculated
- Medical expenses must exceed 10% AGI (65 and over) - no adjustment needed for taxpayers under 65.
- Miscellaneous deductions subject to the 2% floor are not allowed (are added back)
- Exemptions - personal and standard may not be claimed (are added back)

Other AMT Adjustments:
- incentive stock options
- recalculate gain or loss on sale of depreciable assets
- pollution control facilities
- mining exploration and development costs
- circulation expenses
- research and experimental expenditures
- passive tax shelter farm activities

Tax preference items (always added back) :
- Private activity bond tax exempt interest
- Pre-1987 accelerated depreciation on real and leased personal property
- percentage depletion deduction (excess over adjusted basis)


Subtract AMT credits to reduce AMT
Some credits include:
1) Foreign Tax credit
2) Adoption credit
3) Child tax credit
4) Contributions to retirements plans credit
5) Earned income credit
6) Small business health care tax credit

Taxpayers can reduce their AMT by the full amount of their nonrefundable personal tax credits

- Any amounts of medicare tax withheld by the employer in excess of $250,000 MFJ, $125,000 MFS, $200,000 for other taxpayers can be claimed as a credit on the taxpayers income tax return

- Tax penalty for individuals not covered by health insurance
- the tax is the lesser of $325 per person or 1% of family income with max income of $975
- children assessed at 50% of min penalty
- no penalty for a gap in coverage of 3 months or less
- certain low income taxpayers are exempt
- penalty is prorated by month


8

What is the statute of limitations for an assessment?

Period during which the government can assess an additional tax

Generally three years later of:
1) the due date of the return
2) date the return is filed

25% understatement of gross income:
six years from the later of:
1) the due date of the return
2) date the return is filed

Reopen closed tax years if taxpayer finds a deduction in an open tax year that was erroneously taken in a closed tax year, IRS may disallow the deduction in the closed tax year also

Fraud and False returns have no statute of limitations

9

What is the statute of limitations for a refund?

Period which a taxpayer can claim and receive a refund.

The later of:
1) Three years from the original due date of the return OR
2) Three years from the date the return was filed OR
3) two years form the time the tax was paid (if not when the return was filed)

For bad debts and worthless securities:
7 years from the later of:
1) the due date of the return
2) date the return is filed

10

Tax (pre) payements

A taxpayer typically makes prepayements of tax during the year.

These payment reduce the amount shown as total tax on the reutnr and reuslt in the calculation of tax due to the IRS or refund due to the taxpayer
Payments include:
1) taxed withheld from paychecks
2) estimated taxes paid (quarterly or applied from another year)
3) excess social security tax withheld (from 2 or more employers)

11

Who must make estimated payments (quarterly tax payments)?

Taxpayers with:
1) $1,000 or more tax liability (excess of tax liability over withholding)
and
The taxpayer's withholding is less than the lesser of:
1) 90% of current years tax, OR
2) 100% of last years tax, even if 0 tax liability in prior year [110% is used if the taxpayers AGI > $150,000 ($75,000 MFS)]

12

Failure to pay estimated taxes

Results in an assessed penalty.

There is no penalty if the balance of tax due at filing is under $1,000 .

IRS may waive penalty if failure to pay was due to casualty, disaster, illness or death of the taxpayer.

13

Withholding tax treated as estimated payments

If estimated payments have been insufficient to avoid a penalty, a taxpayer can increase withholding from wages before year end and the withholding will be considered to have been paid evenly throughout the period.

14

Don Mills, a single taxpayer, had $70,000 in taxable income before personal exemptions in the current year. Mills had no tax preferences. His itemized deductions were as follows:
State and local income taxes - $ 5,000
Home mortgage interest on loan to acquire residence - $6,000
Miscellaneous deductions that exceed 2% of adjusted gross income - $2,000
What amount did Mills report as alternative minimum taxable income before the AMT exemption?
a.$75,000
b.$83,000
c.$77,000
d.$72,000

$77,000.

Explanation:
Choice "c" is correct. Mills' alternative minimum taxable income starts with his taxable income ($70,000). This is increased by state and local taxes paid ($5,000) and miscellaneous deductions that exceed 2% of adjusted gross income ($2,000) for a total of $77,000. The home mortgage interest on a loan to acquire the residence ($6,000) does not increase alternative minimum taxable income.

Choice "d" is incorrect. State and local income taxes must be added back to Mills' taxable income in calculating alternative minimum taxable income.
Choice "a" is incorrect. Miscellaneous deductions that exceed 2% of AGI must be added back to Mills' taxable income in calculating alternative minimum taxable income.
Choice "b" is incorrect. Home mortgage interest is not added back to Mills' taxable income to calculate alternative minimum taxable income.

15

Alternative minimum tax preferences include:
Tax exempt Charitable contributions of
interest from private appreciated capital
activity bonds gain property
a. Yes Yes
b. No No
c. Yes No
d. No Yes

Yes, No.

Explanation:
Choice "c" is correct. Tax exempt interest from private activity bonds (generally) and accelerated depletion, depreciation, or amortization are alternative minimum tax preference items. Charitable contributions of appreciated capital gain property are not alternative minimum tax preferences.

16

The credit for prior year alternative minimum tax liability may be carried:
a.Forward indefinitely.
b.Back to the 3 preceding years or carried forward for a maximum of 5 years.
c.Back to the 3 preceding years.
d.Forward for a maximum of 5 years.

Forward indefinitely.

Explanation:
Choice "a" is correct. Alternative minimum tax (AMT) paid can be claimed as a credit against other years if the tax was paid on items that increased AMT that year but will reverse in later years. The concept is the same as deferred taxes for financial accounting purposes. The credit is carried forward indefinitely.

17

The alternative minimum tax (AMT) is computed as the:
a.Excess of the regular tax over the tentative AMT.
b.The tentative AMT plus the regular tax.
c.Lesser of the tentative AMT or the regular tax.
d.Excess of the tentative AMT over the regular tax.

Excess of the tentative AMT over the regular tax.

Explanation:
Choice "d" is correct. The alternative minimum tax (AMT) is computed as the excess of tentative AMT over the regular tax.
Choice "a" is incorrect. The alternative minimum tax (AMT) is the excess of the tentative AMT over the regular tax, not the other way around.
Choice "b" is incorrect. The alternative minimum tax (AMT) is the excess of the tentative AMT over the regular tax, not the sum of the tentative AMT plus the regular tax.
Choice "c" is incorrect. The alternative minimum tax (AMT) is the excess of the tentative AMT over the regular tax, not the lesser of AMT or regular tax.

18

Robert had current-year adjusted gross income of $100,000 and potential itemized deductions as follows:
Medical expenses (before percentage limitations) - $12,000
State income taxes - $4,000
Real estate taxes - $3,500
Qualified housing and residence mortgage interest - $10,000
Home equity mortgage interest (used to consolidate personal debts) - $4,500
Charitable contributions (cash) - $5,000
What are Robert's itemized deductions for alternative minimum tax?
a.$25,500
b.$19,500
c.$17,000
d.$21,500

$17,000.

Explanation:
Choice "c" is correct. Robert's itemized deductions for alternative minimum tax purposes are calculated as follows:
Medical expenses (exceeding 10% of AGI) - $2,000
State income taxes (not allowed) −
Real estate taxes (not allowed) −
Qualified housing and residence interest - $10,000
Home equity mortgage interest (not used to buy, build, or improve the home-not allowed) −
Charitable contributions (no difference) 5,000
Alternative Minimum Itemized deductions = $ 17,000

Choices "b", "d", and "a" are incorrect, per the above calculation.

19

Farr, an unmarried taxpayer, had $70,000 of adjusted gross income and the following deductions for regular income tax purposes:
Home mortgage interest on a loan to acquire a principal residence - $ 11,000
Miscellaneous itemized deductions above the threshold limitation - R2,000
What are Farr's total allowable itemized deductions for computing alternative minimum taxable income?
a.$2,000
b.$11,000
c.$0
d.$13,000

$11,000.

Explanation:
Choice "b" is correct. Both mortgage interest and miscellaneous itemized deductions are deductible for regular (schedule A) tax purposes. However, miscellaneous itemized deductions are "adjustments" and, therefore, are not allowed as deductions for alternative minimum tax (AMT) purposes.

Choice "c" is incorrect. Mortgage interest is allowed as a deduction for AMT purposes.
Choice "a" is incorrect. Miscellaneous itemized deductions are not allowed for AMT purposes
Choice "d" is incorrect. The $2,000 miscellaneous itemized deductions are an add back for AMT purposes.

20

Which of the following is not an adjustment or preference to arrive at alternative minimum taxable income?
a.Passive activity losses.
b.Individual taxpayer net operating losses.
c.Deductible contributions to individual retirement accounts.
d.Deductible medical expenses.

Deductible contributions to individual retirement accounts.

Explanation:
Choice "c" is correct. Deductible contributions to individual retirement accounts are not an adjustment or preference in calculating a taxpayer's alternative minimum taxable income. They are an adjustment in calculating adjusted gross income for regular (not alternative minimum) tax purposes.

Choices "b", "a", and "d" are incorrect. Adjustments to arrive at AMTI include individual net operating losses, passive activity losses, and medical expenses (to the extent they do not exceed 10% of AGI).

21

On their joint tax return, Sam and Joann, who are both over age 65, had adjusted gross income (AGI) of $150,000 and claimed the following itemized deductions:
- Interest of $15,000 on a $100,000 home equity loan to purchase a motor home
- Real estate tax and state income taxes of $18,000
- Unreimbursed medical expenses of $15,000 (prior to AGI limitation)
- Miscellaneous itemized deductions of $5,000 (prior to AGI limitation)
Based on these deductions, what would be the amount of AMT add-back adjustment in computing alternative minimum taxable income?
a.$35,000
b.$23,750
c.$21,750
d.$38,750

$38,750.

Explanation:
Choice "d" is correct. Per the mnemonic "PANIC TIMME," for purposes of calculating alterative minimum taxable income, the taxpayer must add back, among other things, the following itemized deductions:
Taxes reduced by taxable refunds,
Home mortgage interest when the mortgage loan proceeds were not used to buy, build, or improve the taxpayer's qualified dwelling (house, condominium, apartment, or mobile home not used on a transient basis),
Medical expenses not exceeding 10% of AGI, and
Miscellaneous deductions subject to the 2% of AGI floor.
The "PANIC TIMME" add-back is as follows:
Taxes $ 18,000
Home mortgage interest not used to buy, build, or improve a qualified dwelling (the motor home is not a qualified dwelling) $ 15,000
Medical expenses in excess of 7.5% AGI but not in excess of 10% of AGI (7.5% AGI is still used for taxpayers age 65 and over) $3,750
Deductible miscellaneous expenses in excess of 2% of AGI
$2,000
Total "PANIC TIMME" add-back $ 38,750

22

Differences between AMT and Regular tax

1) Limitation on Overall Itemized Deductions
The overall limitation on itemized deductions, is an adjustment for AMT.

2) Miscellaneous Itemized Deductions
For AMT, an individual taxpayer cannot deduct miscellaneous itemized deductions subject to the 2% of AGI floor (as defined in Code Sec. 67(b)). Therefore, an individual taxpayer must add back these deductions in calculating AMTI. The miscellaneous itemized deductions subject to the 2% of AGI floor include (but are not limited to):
- Unreimbursed employee business expenses.
- Tax return preparation fees.
- Expenses paid to collect or produce taxable income or to manage or protect property held to earn taxable income.
- An individual taxpayer reports the AMT adjustment amount for these items


4) State, Local, and Foreign Taxes
No deduction is allowed in calculating AMTI for the taxes listed in Code Secs. 164(a) and 164(b)(5)(A). Therefore, an individual taxpayer must add back deductions for these taxes in calculating AMTI. These taxes include:
- State, local, and foreign income, war profits, and excise taxes.
- State, local, and foreign real property taxes.
- State and local personal property taxes.
- State, local, and foreign taxes paid or accrued in carrying on a trade or business or an activity for the production of income.
- State and local sales taxes deducted in lieu of income taxes.

5) Standard Deduction and Personal Exemptions
The basic and additional standard deduction and the deduction for personal exemptions are not allowed for AMT. Because the calculation of AMTI starts
with adjusted gross income (AGI) for individual taxpayers taking the standard deduction (AGI less itemized deductions for taxpayers who itemize), no entry is necessary on Form 6251 to take into account the adjustments for the standard deduction and the personal exemption.


6) Medical Expenses
- Medical and dental expenses are deductible in calculating AMTI to the extent that they exceed 10% of AGI.
- For 2013 and later years, the deduction will be the same for regular tax and AMT, so no adjustment will generally be necessary. However, in 2013 through 2016, a transitional rule in Code Section 213(f) allows taxpayers 65 years and older to continue deducting medical and dental expenses in excess of 7.5% of AGI for regular tax purposes. However, this rule will not apply in determining the AMT deduction. Therefore, taxpayers affected by Code Section 213(f) will have an AMT adjustment for medical and dental expenses in those years.

7) Interest Expenses:

a) Mortgage interest: The rules for deducting mortgage interest are more restrictive for AMT than for regular tax. If a taxpayer can deduct more mortgage interest for regular tax than for AMT, the difference is an adjustment that the taxpayer adds back in calculating AMTI.

- For the regular tax, individual taxpayers can deduct interest on a mortgage loan that the taxpayer used to purchase a qualified residence (i.e., the taxpayer’s principal residence and one other residence selected by the taxpayer that the taxpayer uses as a personal residence) or refinance an existing loan that was used to purchase a qualified residence, to the extent the refinancing loan does not exceed the original mortgage loan.
- The taxpayer may also deduct interest on a home equity loan or line of credit. For the AMT, an individual may only deduct interest on a mortgage loan used in acquiring, constructing, or substantially improving a principal residence or qualified dwelling.

- Because of the “acquiring, constructing, or substantially improving” rule, and the lack of an AMT provision for deducting home equity interest, interest on a home equity loan or line of credit will not be deductible for AMT if a taxpayer uses the proceeds from the loan or line of credit for purposes unrelated to the home.

- For the regular tax, a qualified residence (in the case of the taxpayer’s principal residence and an elected second residence) includes a house, mobile home, condominium, houseboat, house trailer, and stock held by a tenant-stockholder in a cooperative housing corporation. For AMT, this is also the case for the taxpayer’s principal residence. However, for AMT purposes, the second residence can only be a home, apartment, condominium, or a mobile home not used on a transient basis.

- An individual taxpayer adds back the amount of the adjustment for mortgage interest in calculating AMTI on Form 6251, line 4.

EXAMPLE: T owns a home and a boat that qualifies as a residence for purposes of the regular tax mortgage interest deduction. T has an original mortgage loan used to purchase the home, a home equity line of credit on the home that he has used solely to pay for several vacations, and a loan secured by the boat that he used to purchase the boat. For regular tax purposes, T will be able to deduct the interest on all three of these loans. For AMT purposes, he will only be able to deduct the interest on the original home mortgage loan. T must add back the interest on the home equity line of credit and the boat loan in calculating his AMTI.

b) Investment interest: For regular tax purposes, an individual taxpayer can deduct investment interest to the extent of his or her net investment income. A taxpayer also can deduct investment interest to the extent of net investment income for AMT purposes, but the taxpayer must take AMT adjustment and preference items and the AMT loss disallowances under Code Sec. 58 into account in determining the amount of investment interest expense that is deductible in computing AMTI.

- Investment interest that a taxpayer cannot deduct in the current year due to the net investment income limitation can be carried forward and deducted (subject to the limitation) in the next tax year. The difference between the regular tax deduction for investment interest and the AMT deduction for investment interest is an AMT adjustment that is included on Form 6251, Line 8.

Interest on a mortgage loan that is deductible under the AMT rules for home mortgage interest described above is not investment interest. However, where the taxpayer uses the proceeds of a mortgage loan to purchase investment property, the interest on the loan is deductible investment interest for AMT purposes if it is not deductible under the home mortgage interest rules.

Interest on borrowed funds used to purchase private activity bonds are investment interest for AMT because the interest from private activity bonds is included in AMTI. Likewise, the interest on private activity bonds is included in investment income.

8) Incentive Stock Options

- For regular tax, under Code Section 421, a taxpayer that exercises an incentive stock option is not required to include the difference between the option price and the fair market value of the underlying stock at the time of exercise in income in the year of exercise. For AMT, this difference must be included in income in the year of exercise. Thus, the amount of the difference is an AMT adjustment added back in calculating AMTI on Form 6251, line 14.

NOTE: This adjustment does not apply if the taxpayer sells the stock received in the ISO exercise in the same tax year he or she exercises the ISO.

EXAMPLE: R exercises 100 ISOs in 2015 when the FMV of the stock underlying the options is $10 per share. R pays $5 per share when she exercises the ISOs. R does not recognize any income for regular tax in 2015 due to the exercise of the ISOs. In calculating AMTI, R must add back $500, the difference between the amount when she exercised the ISOs and the FMV of the stock she receives.

For AMT purposes, a taxpayer adds the amount of the adjustment to the basis of the stock.

EXAMPLE: The facts are the same as in the preceding example. R has a regular tax basis of $500 in the stock she receives when she exercises the ISOs, the price she paid to exercise the options. Her AMT basis in the stock is $1000, the price she paid to exercise the options plus the amount of her AMT adjustment.

The difference in basis caused by the ISO adjustment will usually cause an AMT adjustment on the disposition of the stock in the year the stock is sold. The AMT adjustment for the disposition of property is discussed below.

9) Depreciation

- In general, unless a taxpayer elects to use the same method of calculating depreciation for regular tax and AMT on post-1986 assets, depreciation is calculated differently for regular tax and for AMT on those assets. In most cases, the differences in the depreciation rules for the two systems results in a greater depreciation deduction for a particular asset for regular tax in the earlier years of the asset’s recovery period and a lower deduction for regular tax in the later years. The difference between the aggregate amount of depreciation deductions for regular tax and for AMT is an adjustment that is added back or subtracted in the calculation of AMTI on Form 6251, line 18.

NOTE: See the instructions for Form 6251, under the heading “Post-1986 Depreciation” for more information on the specific differences in the calculation of regular tax and AMT depreciation.

For a taxpayer that owns an interest in a partnership or shares in an S corporation, the K-1 the taxpayer receives from the partnership or S corporation frequently includes a passthrough of an AMT depreciation adjustment amount. On a partnership K-1, the adjustment is reported on line 17 (Code A). On an S corporation K-1, the adjustment is reported on line 15 (Code A).

10) Disposition of Property

The gain or loss recognized on the disposition of property may be different for regular tax and AMT because the property the taxpayer disposes of has a different basis for regular tax and AMT. This can occur for a number of reasons, including differences in depreciation deductions taken under the two systems for the property and in the case of stock received through the exercise of an ISO, the difference in basis caused by the ISO AMT adjustment discussed above. Because basis may be higher or lower for regular tax than it is for AMT, this adjustment may be positive or negative. The taxpayer includes the adjustment in calculating AMTI on Form 6251, line 17.

NOTE: It is important to remember that the $3,000 limitation on the deduction of capital losses that applies to individual taxpayers for regular tax also applies for AMT.

11) Alternative Tax Net Operating Losses, Amortization Expenses of Pollution Control Facilities, Circulation Costs, Long-Term Contract Expenses, Mining Costs, Research and Experimental Costs

Except for adjustments passed through from partnerships, LLCs, and S corporations, these are all comparatively rare adjustments for individuals. More detail on these adjustments can be found in the instructions for Form 6251.

23

Which of the following may not be deducted in the computation of alternative minimum taxable income of an individual?
a.One-half of the self-employment tax deduction.
b.Charitable contributions.
c.Traditional IRA account contribution.
d.Personal exemptions.

Personal exemptions, are add backs and therefore not deductible.

Explanation:
Choice "d" is correct. Alternative minimum tax will add back various deductions to arrive at alternative minimum taxable income. If an item is not added back, then it is allowed to be deducted. Personal exemptions are added back. Therefore, they are not deducted to arrive at alternative minimum taxable income.

Choice "c" is incorrect. Alternative minimum tax will add back various deductions to arrive at alternative minimum taxable income. If an item is not added back, then it is allowed to be deducted. Traditional IRA contributions are not added back. Therefore, they are deducted to arrive at Alternative minimum taxable income.
Choice "a" is incorrect. Alternative minimum tax will add back various deductions to arrive at alternative minimum taxable income. If an item is not added back, then it is allowed to be deducted. One half of the self-employment tax deduction is not added back. Therefore, it is deducted to arrive at alternative minimum taxable income.
Choice "b" is incorrect. Alternative minimum tax will add back various deductions to arrive at alternative minimum taxable income. If an item is not added back, then it is allowed to be deducted. Charitable contributions are not added back. Therefore, they are deducted to arrive at alternative minimum taxable income.

24

When computing alternative minimum tax, the individual taxpayer may take a deduction for which of the following items?
a.State income taxes.
b.Miscellaneous itemized deductions in excess of 2% of adjusted gross income floor.
c.Personal and dependency exemptions.
d.Casualty losses.

Casualty losses, are not add backs and therefore are deductible.

Explanation:
Choice "d" is correct. Casualty losses are not added back in the alternative minimum tax (AMT) calculation. Therefore, they are allowed as a deduction.
Choice "a" is incorrect. State income taxes are added back in the AMT calculation. Therefore, they are not allowed as a deduction.
Choice "c" is incorrect. Personal and dependency exemptions are added back in the AMT calculation. Therefore, they are not allowed as a deduction.
Choice "b" is incorrect. Miscellaneous itemized deductions in excess of 2% of AGI are added back in the AMT calculation. Therefore, they are not allowed as a deduction.

25

Krete, an unmarried taxpayer with income exclusively from wages, filed her initial income tax return for Year 8. By December 31, Year 8, Krete's employer had withheld $16,000 in federal income taxes and Krete had made no estimated tax payments. On April 15, Year 9, Krete timely filed an extension request to file her individual tax return and paid $300 of additional taxes. Krete's Year 8 income tax liability was $16,500 when she timely filed her return on April 30, Year 9, and paid the remaining income tax liability balance.
What amount would be subject to the penalty for the underpayment of estimated taxes?
a.$500
b.$16,500
c.$0
d.$200

$0.

Explanation:
Choice "c" is correct. Provided the taxes due after withholdings were not over $1,000, there is no penalty for underpayment of estimated taxes. Note that there would be a failure to pay penalty on the $200 that was not paid until April 30, but this is a separate penalty.

Choice "d" is incorrect. This $200 would be subject to a failure to pay penalty, but if the balance due after withholdings is not over $1,000, there is no penalty for underpayment of estimated taxes.
Choice "a" is incorrect. If the balance of tax due after withholdings is not over $1,000, there is no penalty for underpayment of estimated taxes.
Choice "b" is incorrect. The penalty for underpayment of estimated taxes is not assessed on the full amount of the income tax liability, only the unpaid amount after withholdings to the extent it exceeds $1,000.

26

Chris Baker's adjusted gross income on her current year tax return was $160,000. The amount covered a 12-month period. For the next tax year, Baker may avoid the penalty for the underpayment of estimated tax if the timely estimated tax payments equal the required annual amount of:
I. 90% of the tax on the return for the current year paid in four equal installments.
II. 110% of prior year's tax liability paid in four equal installments.
a.Neither I nor II.
b.II only.
c.Both I and II.
d.I only.

Both I and II.

Explanation:
Choice "c" is correct. Both I and II.

I. Payment of 90% of the tax on the return for the current year avoids the penalty for underpayment of estimated tax.

II. Generally, payment of 110% of the prior year's tax liability avoids the penalty for underpayment of estimated tax when the taxpayer's AGI from the prior year exceeds $150,000.

Note: Payment of the lesser of the two above will provide "safe harbor" to the taxpayer.

27

A claim for refund of erroneously paid income taxes, filed by an individual before the statute of limitations expires, must be submitted on Form:
a.1045
b.1139
c.843
d.1040X

1040X.

Explanation:
Choice "d" is correct. An individual submits a claim for refund of erroneously paid income taxes on Form 1040X.

Choice "b" is incorrect. Form 1139 is used for refund of corporate, not individual, income taxes.
Choice "a" is incorrect. Form 1045 is used for a quick refund of individual income taxes due to the carry back of a net operating loss, not for refund of erroneously paid income tax.
Choice "c" is incorrect. Form 843 is used to request a refund of taxes other than income tax.

28

A calendar-year taxpayer files an individual tax return for Year 2 on March 20, Year 3. The taxpayer neither committed fraud nor omitted amounts in excess of 25% of gross income on the tax return. What is the latest date that the Internal Revenue Service can assess tax and assert a notice of deficiency?
a.March 20, Year 6.
b.March 20, Year 5.
c.April 15, Year 6.
d.April 15, Year 5.

April 15, year 6.

Explanation:
Choice "c" is correct. When the return is filed early, the latest date the IRS can assess tax is 3 years from the date the return is due (April 15, Year 6 in this case).

Generally three years later of:
1) the due date of the return
2) date the return is filed

29

A CPA's adjusted gross income (AGI) for the preceding 12-month tax year exceeds $150,000. Which of the following methods is (are) available to the CPA to compute the required annual payment of estimated tax for the current year in order to make timely estimated tax payments and avoid the underpayment of estimated tax penalty?
I. The annualization method.
II. The seasonal method.
a.Neither I nor II.
b.Both I and II.
c.I only.
d.II only.

I only.

Explanation:
Choice "c" is correct. In computing the amount of estimated payments due, an individual taxpayer may choose between the annualized method (90% of current year's tax), or the prior year method (100% of last year's tax) unless the taxpayer's adjusted gross income exceeds $150,000 then they must use 110% of last year's tax. Therefore, the taxpayer in this example can use the annualized method. The seasonal method is not permitted.

Choices "d", "b", and "a" are incorrect, per the above explanation.

30

Martinsen, a calendar-year individual, files a year 1 tax return on March 31, Year 2. Martinsen reports $20,000 of gross income. Martinsen inadvertently omits $500 interest income. The IRS may assess additional tax up until which of the following dates?
a.April 15, Year 8.
b.March 31, Year 5.
c.April 15, Year 5.
d.March 31, Year 8.
Explanation
Choice "c" is correct. Generally, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). The IRS has up to six years to assess additional tax if the misstatement is an understatement of 25% or more of gross income originally reported. In this case, the misstatement is $500 on $20,000 of gross income, or 2.5%. Therefore, the statute of limitations for Martinsen is the general rule. In this case, the due date of the return was April 15, Year 2. Martinson filed on March 31, Year 2. Under the general rule, the IRS has until three years from April 15, Year 2 (or, April 15, Year 5) to assess additional tax.
Choice "b" is incorrect. In this case, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). March 31 is the earlier of the two dates.
Choice "d" is incorrect. Please refer to the discussion for the correct choice "c". This answer choice is incorrect because it uses the earlier of the two dates and the improper number of six years as the statute of limitations.
Choice "a" is incorrect. Please refer to the discussion for the correct choice "c". This answer choice is incorrect because it uses the improper number of six years as the statute of limitations.

April 15, Year 5.

Explanation:
Choice "c" is correct. Generally, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). The IRS has up to six years to assess additional tax if the misstatement is an understatement of 25% or more of gross income originally reported. In this case, the misstatement is $500 on $20,000 of gross income, or 2.5%. Therefore, the statute of limitations for Martinsen is the general rule. In this case, the due date of the return was April 15, Year 2. Martinson filed on March 31, Year 2. Under the general rule, the IRS has until three years from April 15, Year 2 (or, April 15, Year 5) to assess additional tax.

Choice "b" is incorrect. In this case, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). March 31 is the earlier of the two dates.
Choice "d" is incorrect. Please refer to the discussion for the correct choice "c". This answer choice is incorrect because it uses the earlier of the two dates and the improper number of six years as the statute of limitations.
Choice "a" is incorrect. Please refer to the discussion for the correct choice "c". This answer choice is incorrect because it uses the improper number of six years as the statute of limitations.

31

Martin filed a timely return on April 15. Martin inadvertently omitted income that amounted to 30% of his gross income stated on the return. The statute of limitations for Martin's return would end after how many years?
a.3 years.
b.7 years.
c.6 years.
d.Unlimited.

6 years.

Explanation:
Choice "c" is correct. For a 30% understatement of gross income (anything over 25%), the statute of limitations is 6 years.

Choice "a" is incorrect. For a 25% (or less) understatement of gross income, the statute of limitations is 3 years.
Choice "b" is incorrect. There is no 7-year statute of limitations for an understatement of gross income.
Choice "d" is incorrect. The statute of limitations is unlimited for fraud and filing false returns, but not for understatements of income. There is no fraud in this question because the omission was inadvertent.

32

Dawn White's adjusted gross income on her Year 1 tax return was $100,000. The amount covered a 12-month period. For the Year 2 tax year, the minimum payments required from White to avoid the penalty for the underpayment of estimated tax is:
a.90% of the current tax on the return for the current year paid in four equal installments or 110% of the prior year's tax liability paid in four equal installments.
b.90% of the current tax on the return for the current year paid in four equal installments or 100% of the prior year's tax liability paid in four equal installments.
c.110% of the prior year's tax liability paid in four equal installments only.
d.100% of the prior year's tax liability paid in four equal installments only.

.90% of the current tax on the return for the current year paid in four equal installments or 100% of the prior year's tax liability paid in four equal installments.

Explanation:
Choice "b" is correct. The requirement is 90% of the current tax on the return for the current year paid in four equal installments or 100% of the prior year's tax liability paid in four equal installments.

Choice "a" is incorrect. 110% of the prior year's tax liability is only required if AGI is in excess of $150,000.
Choices "c" and "d" are incorrect. There is always an option to pay 90% of the current year's tax.

33

A calendar-year individual filed an income tax return on April 1. This return can be amended no later than:
a.Four months and 15 days after the end of the calendar year.
b.Three years, three months, and 15 days after the end of the calendar year.
c.Three years after the return was filed.
d.Ten months and 15 days after the end of the calendar year.

Three years, three months, and 15 days after the end of the calendar year.

Explanation:
Rule: An individual may file an amended tax return (Form 1040X) within three (3) years of the date the original return was filed or within two (2) years of the date the tax was paid, whichever is later. An original return filed early is considered filed on the due date of the return.
Choice "b" is correct. In this question, the return was filed early (April 1), so the return is considered filed as of the due date, on April 15. There is no information on when the tax was paid, but it can be reasonably assumed that the tax was properly paid on April 1 with the return. So the latter of the two dates is three years. The question that arises is "three years from when," and here the question falls somewhat short.
Three of the answers to this question are worded in terms of "the" calendar year. These answers have to mean the prior calendar year. Three years from April 15 (when the return was considered to be filed) would be three years, three months, and 15 days from the end of the prior calendar year.

Choice "a" is incorrect. The date is not four months and 15 days after the end of the (prior) calendar year. This answer ignores the three years. It appears to be trying to trick candidates into thinking that April is four months. However, that would mean that the last day that an amended return could be filed was the date of the filing of the original return.
Choice "d" is incorrect. The date is not ten months and 15 days after the end of the (prior) calendar year.
Choice "c" is incorrect. The date is not three years after the (original) return was filed. This answer looks good at first glance, but note that the return was actually filed on April 1. The Rule above considers an original return filed early to be filed on the due date of the return. However, the answer says "after the return was filed" and not "after the return was considered to be filed."

34

Sam's year 2 taxable income was $175,000 with a corresponding tax liability of $30,000. For year 3, Sam expects taxable income of $250,000 and a tax liability of $50,000. In order to avoid a penalty for underpayment of estimated tax, what is the minimum amount of year 3 estimated tax payments that Sam can make?
a.$33,000
b.$30,000
c.$45,000
d.$50,000

$33,000.

Explanation
Choice "a" is correct. To avoid penalties, if a taxpayer owes $1,000 or more in tax payments beyond withholdings, such taxpayer will need to have paid in for taxes the lesser of:
- 90% of the current year's tax ($50,000 x 90%) = $45,000, or
- 100% of the previous year's tax ($30,000 x 100%) = $30,000 or
- 110% of (if AGI is over $150,000) Previous year's tax $30,000 x 110% = $33,000.

However, if the taxpayer had adjusted gross income in excess of $150,000 in the prior year, 110% of the prior year's tax liability is used to compute the safe harbor for estimated payments. (Previous year's tax $30,000 x 110% = $33,000).

Choice "b" is incorrect. $30,000 is 100% of last year's tax. This would be sufficient if the previous year's income were $150,000 or less.
Choice "c" is incorrect. $45,000 is 90% of this year's tax, which is sufficient, but we are looking for the minimum amount.
Choice "d" is incorrect. $50,000 is 100% of the current year's tax, which is sufficient, but more than required.

35

An individual taxpayer agreed to a finding of fraud on an income tax return filed two years ago. What is the maximum time limitation, if any, after which the IRS may not assess any additional taxes against the taxpayer for this tax return?
a.Three years.
b.One year.
c.There is no time limitation.
d.Two years.

There is no time limitation.

Explanation:
Choice "c" is correct. There is no statute of limitations for fraud or filing false tax returns.

Choice "b" is incorrect. There is no one year statute of limitations for assessment of tax.
Choice "d" is incorrect. There is no two year statute of limitations for assessment of tax.
Choice "a" is incorrect. The three year statute of limitations will apply to good faith mistakes with an understatement of income of less than 25%.

36

Keen, a calendar-year taxpayer, reported a gross income of $100,000 on his 20X1 income tax return. Inadvertently omitted from gross income was a $20,000 commission that should have been included in 20X1. Keen filed his 20X1 return on March 15, 20X2. To collect the tax on the $20,000 omission, the Internal Revenue Service must assert a notice of deficiency no later than:
a.March 15, 20X8.
b.March 15, 20X5.
c.April 15, 20X8.
d.April 15, 20X5.

April 15, 20X5.

Explanation:
Choice "d" is correct. April 15, 20X5.
Rule: Ordinarily, a tax must be assessed within three years after a return is filed. The assessment period begins from the due date of the return if the return is filed prior to the due date or "filing date" if the return is filed later (e.g., with an extension). The assessment period is extended to six years for returns that omit more than 25% of the gross income originally reported. That is not the case here ($20,000 ÷ $100,000 = 20%).

Choice "b" is incorrect. The return was filed prior to its April 15 deadline.
Choice "a" is incorrect. The return was filed prior to its April 15 deadline and the omission of gross income was not more than 25%.
Choice "c" is incorrect. The omission from gross income was not more than 25%.

37

If an individual paid income tax in the current year but did not file a current year return because his income was insufficient to require the filing of a return, the deadline for filing a refund claim is:
a.Two years from the date a return would have been due.
b.Two years from the date the tax was paid.
c.Three years from the date the tax was paid.
d.Three years from the date a return would have been due.

Two years from the date the tax was paid.

Explanation:
Choice "b" is correct. Two years from the date the tax was paid.
Rule: A taxpayer may file a claim for refund within three years from the time the return was filed, or two years from the time the tax was paid, whichever is later. Since no return has been filed, the refund claim must be filed within two years from the time the tax was paid.

Choices "a", "c", and "d" are incorrect, per the above rule.

38

On April 15, Year 2, a married couple filed their joint Year 1 calendar-year return showing gross income of $120,000. Their return had been prepared by a professional tax preparer who mistakenly omitted $45,000 of income, which the preparer in good faith considered to be nontaxable. No information with regard to this omitted income was disclosed on the return or attached statements. By what date must the lnternal Revenue Service assert a notice of deficiency before the statute of limitations expires?
a.December 31, Year 7.
b.December 31, Year 4.
c.April 15, Year 8.
d.April 15, Year 5.

April 15, Year 8.

Explanation:
Choice "c" is correct. April 15, Year 8 is the last day for IRS to assert a notice of deficiency before the statute of limitations expires, six years after due date because gross income was underreported by more than 25% (45,000 ÷ 120,000).
Rule: Ordinarily, a tax must be assessed within three years after a return is filed. The assessment period begins from the due date of the return if the return is filed prior to the due date or "filing date" if the return is filed later, e.g., with an extension. The assessment period is extended to six years for returns that omit more than 25% of the gross income originally reported.

Choices "a" and "b" are incorrect. Required IRS assessment is 3 or 6 years after due date―not end of tax year.
Choice "d" is incorrect. Not 3 years after due date because omission was more than 25% of gross income reported.

39

Ms. Marsh filed her 20X0 individual income tax return on February 15, 20X1. All her tax was paid during the year through withholding. The return was due on April 15, 20X1. During January 20X2, she discovered that she had not taken a properly substantiated charitable contribution that would have reduced her total tax by $250 on her 20X0 tax return. By what date must she file her amended return to claim a refund of the tax paid?
a.April 15, 20X4.
b.December 31, 20X2.
c.December 31, 20X3.
d.February 15, 20X4.

.April 15, 20X4.

Explanation:
Choice "a" is correct. A taxpayer can file a claim for refund by the later of three years from the time the return was filed, 3 years from the original due date of the return, or two years from the time the tax was paid (if not when the return was filed). Three years from the time the return was filed is February 15, 20X4, 3 years from the original due date of the return is April 15, 20X4, and two years from the time the tax was paid would be December 31, 20X2 (all withholding is deemed paid ratably over the year so the last dollars would be deemed paid December 31, 20X0). The later date is April 15, 20X4.

Choice "d" is incorrect. This date is earlier than three years from the date the 20X0 tax return was due.
Choice "c" is incorrect. This date is three years from the date the last tax was paid.
Choice "b" is incorrect. This is two years from the date the last tax was paid but the claim must be filed by the later of this date, three years from the date the return was filed, or 3 years from the original due date of the return.

40

An individual paid taxes 27 months ago, but did not file a tax return for that year. Now the individual wants to file a claim for refund of federal income taxes that were paid at that time. The individual must file the claim for refund within which of the following time periods after those taxes were paid?
a.Two years.
b.One year.
c.Three years.
d.Four years.

Two years.

Explanation:
Choice "a" is correct. When a tax return has not been filed, any claim for refund must be made within two years from the time the tax was paid.

Choices "b", "c", and "d" are incorrect per the above explanation.

41

A taxpayer has had one issue under audit by the Internal Revenue Service for several years. Unless the taxpayer agrees otherwise, the IRS has at most how many years to assess taxes after the taxpayer's return was filed?
a.Three.
b.Seven.
c.Four.
d.Five.

Three.

Explanation:
Choice "a" is correct. The statute of limitation on assessments is the statutory period during which the government can assess an additional tax. The statute of limitations applies to all taxable entities. Absent fraud, a 25 percent understatement of gross income, or agreement from the taxpayer, the statute of limitations is three years from the later of the original due date of the return or the date the return is filed.

Choices "c", "d", and "b" are incorrect, per the above rule.