Chapter 5

Question 1

In Year 1, Farb, a cash-basis individual taxpayer, received an $8,000 invoice for personal property taxes. Believing the amount to be overstated by $5,000, Farb paid the invoiced amount under protest and immediately started legal action to recover the overstatement. In November Year 2, the matter was resolved in Farb’s favor, and he received a $5,000 refund. Farb itemizes deductions on his tax returns. Which of the following statements is true regarding the deductibility of the property taxes?

A. Farb should not deduct any amount in his Year 1 income tax return when originally filed, and he should file an amended Year 1 income tax return in Year 2.
B. Farb should deduct $3,000 in his Year 1 income tax return.
C. Farb should deduct $3,000 in his Year 2 income tax return.
D. Farb should deduct $8,000 in his Year 1 income tax return and report the $5,000 refund as income in his Year 2 income tax return

Answer 1

D. Farb should deduct $8,000 in his Year 1 income tax return and report the $5,000 refund as income in his Year 2 income tax return.
Answer (D) is correct.
Property taxes are deductible when paid by a cash-basis taxpayer. Because Farb itemizes deductions, the taxes deducted reduce Year 1 tax liability. A taxpayer may exclude recovered items only to the extent that deduction of the item in a prior year did not produce a tax benefit. Thus, Farb should report as income that portion of the $5,000 recovered, the deduction of which resulted in lower Year 1 tax liability.
Author’s note: This is intended as an example of a question that will appear on the exam that you have not prepared for. Do your best. Expect the unexpected and maximize your score.

Question 2

Hall paid the following expenses in 2014 pertaining to her home: realty taxes, $3,400; mortgage interest, $7,000; casualty insurance, $490; assessment by city for construction of a sewer system, $910; interest of $1,000 on a personal, unsecured bank loan, the proceeds of which were used for home improvements. Hall does not rent out any portion of the home. The casualty insurance premium of $490 is

A. Allowed as an itemized deduction subject to the $100 floor and the 10%-of-adjusted-gross-income floor.

B. Allowed as an itemized deduction subject to the 2%-of-gross-income floor.

C. Not deductible.

D. Deductible in arriving at adjusted gross income

Answer 2

C. Not deductible.
Answer (C) is correct.
The cost of insurance on personal use assets is a personal expenditure. Deduction of personal, family, and living expenses is not allowed. Also, special assessments are not deductible as tax expenses; they are treated as additions to the basis of the property

Question 3

In 2014, Alex Burgos, who is 24 years old, paid $600 to Rita, his ex-wife, for child support. Under the terms of his 2014 divorce decree, Alex claims the exemption for his 3-year-old son, William, who lived with Rita for the entire year. Alex’s only income in 2014 was from wages of $17,000, resulting in an income tax of $290. How much is Alex’s Earned Income Credit for 2014?

A. $496
B. $3,305
C. $5,460
D. $0

Answer 3

D. $0
Answer (D) is correct.
Alex does not have a qualifying child since his son does not live with him for more than one-half of the tax year. An individual eligible for the Earned Income Credit without a qualifying child is one who meets three qualifications: (1) The individual has a principal place of abode in the United States for more than one-half of the tax year; (2) the individual is at least 25 years old and not more than 64 at the end of the tax year; and (3) the individual cannot be claimed as a dependent of another taxpayer for the year the credit is being claimed. Since Alex is only 24, he does not meet the qualifications.

Question 4

Don Wolf became a general partner in Gata Associates on January 1, 2014, with a 5% interest in Gata’s profits, losses, and capital. Gata is a distributor of auto parts. Wolf does not materially participate in the partnership business. For the year ended December 31, 2014, Gata had an operating loss of $100,000. In addition, Gata earned interest of $20,000 on a temporary investment while awaiting delivery of equipment that is presently on order. The principal will be used to pay for this equipment. Wolf’s passive loss for 2014 is

A. $4,000
B. $5,000
C. $6,000
D. $0

Answer 4

B. $5,000
Answer (B) is correct.
In general, losses arising from one passive activity may be used to offset income from other passive activities but may not be used to offset active or portfolio income. Wolf’s $5,000 operating loss ($100,000 × 5%) may not be used to offset his $1,000 portfolio income ($20,000 × 5%); i.e., interest and dividends are portfolio income. Therefore, his passive loss for 2014 is his $5,000 operating loss. The losses may be carried forward indefinitely or until the entire interest is disposed of.

Question 5

Jimet, an unmarried taxpayer, qualified to itemize 2014 deductions. Jimet’s 2014 adjusted gross income was $30,000, and he made a $2,000 cash donation directly to a needy family. In 2014, Jimet also donated stock, valued at $3,000, to his church. Jimet had purchased the stock 4 months earlier for $1,500. What was the maximum amount of the charitable contribution allowable as an itemized deduction on Jimet’s 2014 income tax return?

A. $2,000
B. $5,000
C. $0
D. $1,500

Answer 5

D. $1,500
Answer (D) is correct.
A deduction is allowed for contributions to a qualified organization. Therefore, no deduction is allowed for the contribution to the family. However, a deduction is available for the donation of stock in the amount of $1,500. Since the stock has not been held long term, it is ordinary income property, and the deduction is equal to the lesser of FMV or AB.

Question 6

Carmella is divorced and has two children, ages 3 and 9. For 2014, her adjusted gross income is $30,000, all of which is earned income. Carmella’s younger child stays at her employer’s on-site child-care center while she works. The benefits from this child-care center qualify to be excluded from her income. Carmella’s employer reports the value of this service as $3,000 for the year. This amount is shown in box 10 of Carmella’s Form W-2, but is not included in taxable wages in box 1. A neighbor cares for Carmella’s older child after school, on holidays, and during the summer. Carmella pays her neighbor $2,400 for this care. What is Carmella’s Child Care Credit for 2014?

A. $480
B. $648
C. $720
D. $600

Answer 6

B. $648
Answer (B) is correct.
A credit equal to the applicable percentage of employment-related expenses is allowed. The applicable percentage is 35%, reduced (but not below 20%) by one percentage point for each $2,000 (or fraction thereof) by which adjusted gross income exceeds $15,000. Carmella’s adjusted gross income of $30,000 exceeded $15,000 by $15,000. The amount by which to reduce the applicable percentage is calculated by dividing 15,000 by 2,000, which is equal to 7.5, and must be rounded up to 8. Thus, the applicable percentage is 27% (35% – 8%).
Because Carmella has two qualifying children, she may apply the credit up to $5,400 (the expenses paid) of her child care expenses less the excludable employer dependent-related expenses of $3,000. Therefore, Carmella’s maximum credit is $648 [($5,400 – $3,000) × 27%].

Question 7

Kent qualified for the Earned Income Credit in 2014. This credit could result in a

A. Subtraction from adjusted gross income to arrive at taxable income.

B. Refund only if Kent had tax withheld from wages.

C. Refund even if Kent had no tax withheld from wages.

D. Carryback or carry-forward for any unused portion.

Answer 7

C. Refund even if Kent had no tax withheld from wages.
Answer (C) is correct.
The Earned Income Credit is a refundable credit for low-income taxpayers. Having taxes withheld from wages is not a requirement for using the Earned Income Credit.

Question 8

Lane, a single taxpayer, received $160,000 in salary, $15,000 in income from an S corporation in which Lane does not materially participate, and a $35,000 passive loss from a real estate rental activity in which Lane materially participated. Lane’s modified adjusted gross income was $165,000. What amount of the real estate rental activity loss was deductible?

A. $25,000
B. $15,000
C. $35,000
D. $0

Answer 8

B. $15,000
Answer (B) is correct.
The amount of a loss attributable to a person’s passive activities is allowable as a deduction or credit only against, and to the extent of, gross income or tax attributable to those passive activities. All rental activity is passive, but a person who actively participates in a rental real estate activity is entitled to deduct up to $25,000 of losses from the passive activity from other than passive income. However, this exception of the general passive activity loss limitation rule is completely phased out when the taxpayer has modified adjusted gross income of at least $150,000. Although Lane actively participated in the rental real estate activity, Lane’s modified adjusted gross income exceeded $150,000, so she can only deduct passive activity losses against passive activity income. Lane had passive activity income from an S corporation of $15,000 and can therefore only deduct $15,000 of the real estate rental activity loss.

Question 9

Mr. and Mrs. Bucknell had adjusted gross income of $166,000 in 2014. Their daughter’s eligible education expenses for her first year of college were $5,000 in 2014. What is the amount of American Opportunity Credit that Mr. and Mrs. Bucknell may use in 2014?

A. $1,750
B. $0
C. $2,500
D. $750

Answer 9

A. $1,750
Answer (A) is correct.
The American Opportunity Credit allows taxpayers a 100% credit for the first $2,000 of tuition and fees incurred and a 25% credit for the second $2,000 of tuition and fees incurred. However, the credit is phased out when modified AGI exceeds $160,000 for joint filers. The credit phaseout is complete when modified AGI exceeds $180,000. Therefore, the allowable credit for 2014 is reduced by $750 [$2,500 × ($166,000 – $160,000) ÷ $20,000]. The credit that can be claimed is $1,750.

Question 10

Alex and Myra Burg, married and filing joint income tax returns, derive their entire income from the operation of their retail candy shop. Their 2014 adjusted gross income was $50,000. The Burgs itemized their deductions on Schedule A for 2014. The following unreimbursed cash expenditures were among those made by the Burgs during 2014:

Repair and maintenance of motorized wheelchair for
physically handicapped dependent child $ 300

Tuition, meals, and lodging at special school for physically handicapped dependent child in the institution primarily for the availability of medical care, with meals and lodging furnished as necessary incidents to that care 4,000

Without regard to the adjusted gross income percentage threshold, what amount may the Burgs claim in their 2014 return as qualifying medical expenses?

A. $4,300
B. $0
C. $4,000
D. $300

Answer 10

A. $4,300
Answer (A) is correct.
Medical care expenses of a taxpayer, a spouse, or a dependent are deductible only to the extent they exceed 10% of AGI. Supplies purchased to alleviate a physical defect or provide relief from an ailment qualify as medical expense. Capital expenditures for qualified medical costs are also deductible. If so, the cost of repair and maintenance is also deductible. If the principal reason an individual is in an institution other than a hospital, such as a special school for the handicapped, is the need for, and availability of, the medical care furnished by the institution, the full costs of meals, lodging, and other services necessary for furnishing the medical care are all qualified medical expenditures.

Question 11

On their joint tax return, Sam and Joann, both age 70, 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. $38,750
B. $21,750
C. $23,750
D. $35,000

Answer 11

A. $38,750
Answer (A) is correct.
Certain adjustments must be made to regular taxable income to arrive at AMT taxable income. These adjustments include adding back home equity interest not applied to the acquisition of the home. Sam and Joann used the loan to purchase a motor home. Other adjustments include all miscellaneous itemized deductions (i.e., the gross amount in excess of the 2%-of-AGI floor), state income and real property taxes, and medical expense between 10% of AGI and the 7.5% (age 65 and over) AGI floor for regular tax. Sam and Joann’s total adjustments are $38,750:

Home equity interest $15,000
Real estate and state income taxes 18,000
Medical expenses 3,750
= [$15,000 – ($150,000 × 7.5%)]
Miscellaneous itemized deductions 2,000
= [$5,000 – ($150,000 × 2%)]
Total adjustments $38,750

Question 12

Phil and Joan Crawley made the following payments during 2014:

Interest on bank loan (loan proceeds used to purchase U.S. Series HH savings bonds) $4,000

Interest on installment charge accounts $500

Interest on home mortgage for period April 1 to December 31, 2014 $2,700

Points paid to obtain conventional mortgage loan on April 1, 2014 $900

The Crawleys had net investment income of $3,000 for the year. What is the maximum amount that the Crawleys can deduct as interest expense in calculating itemized deductions for 2014?

A. $6,600
B. $7,100
C. $7,600
D. $3,600

Answer 12

A. $6,600
Answer (A) is correct.
The interest on U.S. savings bonds is taxable, and interest is deductible on the loan to purchase them. Investment interest expense is deductible only to the extent of net investment income. The interest on the installment charge accounts is personal interest, none of which is deductible. The home mortgage interest is deductible assuming it is qualified residence interest. The points on a conventional mortgage loan are deductible even though the points represent prepaid interest. The Crawleys’ maximum interest deduction is

Interest on bank loan $3,000
Interest on home mortgage 2,700
Points 900
Interest deduction $6,600

Question 13

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 $2,000

What are Farr’s total allowable itemized deductions for computing alternative minimum taxable income?

A. $0
B. $11,000
C. $2,000
D. $13,000

Answer 13

B. $11,000
Answer (B) is correct.
Only certain itemized deductions are allowed in calculating the AMT. Miscellaneous itemized deductions are not allowed, so the only allowable itemized deduction for computing Farr’s AMT is the $11,000 home mortgage interest on a loan to acquire a principal residence.

Question 14

An individual taxpayer reports the following information:

U.S. Treasury bond income $ 100
Municipal bond income 200
Rental income 500
Investment interest expense 1,000

What amount of investment interest can the taxpayer deduct in the current year?

A. $100
B. $800
C. $1,000
D. $300

Answer 14

A. $100
Answer (A) is correct.
Investment interest expense is only deductible to the extent of taxable investment income. Taxable investment income does not include tax-exempt municipal bond interest or rental income (which is accounted for separately). Because the $100 from U.S. Treasury bond income is the only taxable investment income, only $100 of the investment interest expense may be deducted in the current year.

Question 15

Which items are subject to the phase-out of the amount of certain itemized deductions that may be claimed by high-income individuals?

A. Medical costs.
B. Nonbusiness casualty losses.
C. Investment interest deductions.
D. Charitable contributions.

Answer 15

D. Charitable contributions.
Answer (D) is correct.
Itemized deductions are subject to the phaseout for high income taxpayers. The phaseout applies to all deductions with certain exceptions including medical expenses, casualty losses, and investment interest expenses.

Question 16

Which of the following is not a deduction to arrive at adjusted gross income?

A. Trade or business expenses.
B. Unreimbursed employee business expenses.
C. Capital losses in excess of capital gains.
D. Alimony payments.

Answer 16

B. Unreimbursed employee business expenses.
Answer (B) is correct.
Unreimbursed employee expenses are a deduction from AGI, as an itemized deduction (below-the-line).

Question 17

In 2014, Wood’s residence had an adjusted basis of $150,000, and it was destroyed by a tornado. An appraiser valued the decline in market value at $175,000. Later that same year, Wood received $130,000 from his insurance company for the property loss and did not elect to deduct the casualty loss in an earlier year. Wood’s 2014 adjusted gross income was $60,000, and he did not have any casualty gains. What total amount can Wood deduct as a 2014 itemized deduction for the casualty loss, after the application of the threshold limitations?

A. $13,900
B. $38,900
C. $19,900
D. $39,000

Answer 17

A. $13,900
Answer (A) is correct.
The amount of a personal casualty loss is equal to the lesser of adjusted basis or the decline in FMV due to the casualty. Therefore, Wood’s loss is equal to $150,000. Additionally, several limits apply. First, the loss must be reduced by any insurance recovery. Additionally, the loss must be reduced by $100 per casualty and is only deductible to the extent that it exceeds 10% of AGI. Therefore, Wood’s deductible loss is

Adjusted basis $150,000
Less: Insurance (130,000)
$100 floor (100)
10% of AGI (6,000)
Deductible loss $ 13,900

Question 18

Which of the following is a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor?

A. Real estate tax.
B. Medical expenses.
C. Employee business expenses.
D. Gambling losses up to the amount of gambling winnings.

Answer 18

Answer (C) is correct.
Miscellaneous itemized deductions are subject to a 2%-of-AGI exclusion. Only that portion of the aggregate amount of allowable second-tier itemized deductions that exceeds the threshold amount of 2% of AGI may be deducted from AGI. Any surplus cannot be carried forward to a succeeding year. The three categories of miscellaneous itemized deductions are employee expenses, tax determination expenses, and other expenses.

Question 19

Dietz is a passive investor in three activities which have been profitable in previous years. The profit and losses for the current year are as follows:

                                             Gain (Loss)  Activity X                                  $(30,000) Activity Y                                    (50,000)  Activity Z                                      20,000   Total                                         $(60,000) 

What amount of suspended loss should Dietz allocate to Activity X?

A. $30,000
B. $20,000
C. $22,500
D. $18,000

Answer 19

C. $22,500
Answer (C) is correct.
The passive activity income is allocated pro rata between the two activities with passive losses. As Activity X accounts for 37.5% ($30,000 ÷ $80,000 total loss) of the passive losses, it is allocated $7,500 ($20,000 × 37.5%) of the passive activity income. This results in a net $22,500 ($30,000 – $7,500) passive activity loss allocable to Activity X.
D. $18,000

Question 20

What is the tax treatment of net losses in excess of the at-risk amount for an activity?

A. Any loss in excess of the at-risk amount is suspended and is deductible in the year in which the activity is disposed of in full.

B. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity.

C. Any losses in excess of the at-risk amount are carried back 2 years against activities with income and then carried forward for 20 years.

D. Any losses in excess of the at-risk amount are deducted currently against income from other activities; the remaining loss, if any, is carried forward without expiration.

Answer 20

Answer (B) is correct.

The losses are carried forward without expiration and are deductible against income in future years from that activity.

Question 21

Mr. Klein is 67 years old, single, and retired. During 2014, he received a taxable pension from his former employer in the amount of $4,000. His adjusted gross income is $12,450, and he received $500 of nontaxable Social Security benefits. His tax before credits is $75. What is Mr. Klein’s credit for the elderly?

A. $379
B. $304
C. $0
D. $75

Answer 21

D. $75
Answer (D) is correct.
An individual who has attained age 65 is allowed a credit equal to 15% of the individual’s reduced base amount. For a single individual, the initial base amount is $5,000, reduced by any amounts received as Social Security benefits or otherwise excluded from gross income. The base amount is also reduced by one-half of the excess of AGI over $7,500 (for a single individual).

Initial base amount $5,000
Less AGI limitation
[($12,450 – $7,500) × 50%] (2,475)
Less Social Security benefits (500)
Reduced base amount $2,025
× .15
Klein’s credit for the elderly $ 304

Since the taxpayer’s tax before credits is $75, only $75 of the credit can be claimed.

Question 22

Rachael, a single filer, has taxable income of $89,000. She has tax preferences and adjustments totaling $39,800. Assume her regular income tax liability is $18,213. What is the amount of Rachael’s alternative minimum tax liability?

A. $15,275
B. $0
C. $1,547
D. $2,295

Answer 22

D. $2,295
Answer (D) is correct.
The AMT exemption for a single filer is $52,800. This exemption is phased out by 25% of the amount of AMTI over $117,300 for single filers. AMTI is $128,800 ($89,000 + $39,800). The phase-out amount is $2,875 [($128,800 – 117,300) × 25%]. The exemption is $49,925 ($52,800 – $2,875). The tentative minimum tax is $20,508 ($78,875 × 26%). The AMT is $2,295 ($20,508 tentative minimum tax – $18,213 regular tax liability).

Question 23

The following information pertains to Cole’s personal residence, which sustained casualty fire damage in 2014:

Adjusted basis $150,000
Fair market value immediately before the fire 200,000
Fair market value immediately after the fire 180,000
Fire damage repairs paid for by Cole in 2014 10,000

The house was uninsured. Before consideration of any “floor” or other limitation on tax deductibility, the amount of this 2014 casualty loss was

A. $0
B. $20,000
C. $10,000
D. $30,000

Answer 23

B. $20,000
Answer (B) is correct.
The amount of a personal casualty loss is the lesser of the decrease in the fair market value of the property resulting from the casualty or the taxpayer’s adjusted basis in the property. The decrease in the fair market value of Cole’s residence is $20,000 ($200,000 – $180,000). This is less than the adjusted basis, so the casualty loss is $20,000.

Question 24

All of the following child and dependent care expenses may qualify as work-related for purposes of the Child and Dependent Care Credit except

A. The cost of sending a child to school if the child is in a grade below the first grade and the cost is incident to and cannot be separated from the cost of care.

B. The cost of household services that are partly for the well-being of a qualifying person.

C. The cost of care provided to a qualifying person outside the home.

D. The cost of getting a qualifying person from the home to the care location and back.

Answer 24

D. The cost of getting a qualifying person from the home to the care location and back.
Answer (D) is correct.
Employment-related expenses are paid for household services and for the care of a qualifying individual. Expenses are only classified as work-related if they are incurred to enable the taxpayer to be gainfully employed. The cost of transporting a qualifying individual to a place where care is provided is not considered to be incurred for the individual’s care.

Question 25

Mary files as head of household and has three dependent children, ages 15, 16, and 19. Mary and the children are U.S. citizens. Her only income is a salary of $77,500. Her tax is $13,121. How much Child Tax Credit is she allowed in 2014? A. $150 B. $1,850 C. $2,000 D. $3,000

Answer 25

B. $1,850 Answer (B) is correct. For purposes of eligibility for the Child Tax Credit, a qualifying child is a child, descendant, stepchild, or eligible foster child. The child must also be under the age of 17 and be claimed as a dependent by the taxpayer. The credit is for $1,000 per qualifying child. However, the credit begins to phase out when modified AGI reaches $75,000 for single filers. The credit is reduced by $50 for each $1,000, or fraction thereof, of modified AGI above the thresholds. Accordingly, Mary is allowed a Child Tax Credit of $2,000 before the credit is reduced by the threshold, because only two of her children are qualified dependents. Her credit is reduced by $150 [($77,500 – $75,000) ÷ $1,000 = 2.5 (rounded to 3) × $50], thus allowing Mary a credit of $1,850 ($2,000 – $150).

Question 26

Hall, a divorced person and custodian of her 12-year-old child, filed her 2014 federal income tax return as head of household. She submitted the following information to the CPA who prepared her 2014 return: •The divorce agreement, executed in 2003, provides for Hall to receive $3,000 per month, of which $600 is designated as child support. After the child reaches 18, the monthly payments are to be reduced to $2,400 and are to continue until remarriage or death. However, for 2014, Hall received a total of only $5,000 from her former husband. Hall paid an attorney $2,000 in 2014 in a suit to collect the alimony owed. The $2,000 legal fee that Hall paid to collect alimony should be treated as a(n) A. Deduction in arriving at AGI. B. Nondeductible personal expense. C. Itemized deduction subject to the 2%-of-AGI floor. D. Itemized deduction not subject to the 2%-of-AGI floor

Answer 26

C. Itemized deduction subject to the 2%-of-AGI floor. Answer (C) is correct. Fees to collect alimony are considered expenditures for the production of income, deductible as a miscellaneous itemized deduction subject to the 2%-of-AGI exclusion.

Question 27

Mr. and Mrs. Baker, who file a joint tax return, have an adjusted gross income (AGI) of $100,000 for 2014. Their son, Tony, began his first year of graduate school on July 15, 2013. The Bakers’ expenses incurred in 2014 were $6,000 for tuition. What is the amount of Lifetime Learning Credit the Bakers may claim in 2014? A. $1,200 B. $2,000 C. $6,000 D. $2,500

Answer 27

A. $1,200 Answer (A) is correct. A Lifetime Learning Credit is limited to the amount of 20% of the first $10,000 of tuition paid. The Lifetime Learning Credit is available in years the American Opportunity Credit is not claimed. The Bakers’ credit for 2014 will be $1,200 ($6,000 × 20%). There is no phaseout of the Lifetime Learning Credit for the Bakers since the credit phaseout for married taxpayers filing jointly commences when modified AGI is $108,000 and ends at $128,000.

Question 28

Ruth Lewis has adjusted gross income of $100,000 for 2014 and itemizes her deductions. On September 1, 2014, she made a contribution to a private nonoperating foundation (not a 50% charity) of stock held for investment for 2 years that cost $25,000 and had a fair market value of $70,000. The foundation sold the stock for $70,000 on the same date. Assume that Lewis made no other contributions during 2014. How much should Lewis claim as a charitable contribution deduction for 2014? A. $25,000 B. $50,000 C. $20,000 D. $30,000

Answer 28

C. $20,000 Answer (C) is correct. Generally, contributions to private operating foundations are limited to 30% of the taxpayer’s AGI. But contributions of long-term capital gain property to private nonoperating foundations are limited to 20% of the taxpayer’s AGI. Lewis’s charitable contribution deduction should be limited to $20,000 ($100,000 × 20%). The total charitable contribution is equal to $25,000 (lower of FMV or AB) because it is being made to a private nonoperating foundation. $20,000 can be deducted in 2014 because of the 20% limit. The remaining $5,000 can be carried forward for up to 5 years. D. $30,000

Question 29

In 2014, Joan Frazer’s residence was totally destroyed by fire. The property had an adjusted basis and a fair market value of $130,000 before the fire. During 2014, Frazer received insurance reimbursement of $120,000 for the destruction of her home. Frazer’s 2014 adjusted gross income was $70,000. Frazer had no casualty gains during the year. What amount of the fire loss was Frazer entitled to claim as an itemized deduction on her 2014 tax return? A. $10,000 B. $9,900 C. $3,000 D. $2,900

Answer 29

D. $2,900 Answer (D) is correct. A personal casualty loss is limited to the amount of the loss exceeding 10% of AGI and a $100 nondeductible floor. The casualty loss is $10,000 ($130,000 FMV – $120,000 reimbursement). The itemized deduction is $2,900 ($10,000 loss – $7,000 10% of AGI limit – $100 floor).

Question 30

Which of the following statements about the Child and Dependent Care Credit is correct? A. The maximum credit is $600. B. The child must be a direct descendant of the taxpayer. C. The credit is nonrefundable. D. The child must be under the age of 18 years.

Answer 30

C. The credit is nonrefundable. Answer (C) is correct. A nonrefundable tax credit is allowed for child and dependent care expenses incurred to enable the taxpayer to be gainfully employed. To qualify, the taxpayer must provide more than half the cost of maintaining a household for a dependent under age 13 or an incapacitated spouse or dependent. The maximum credit is equal to 35% of up to $3,000 of child and dependent care expenses for one qualifying individual ($6,000 for two or more individuals). D. The child must be under the age of 18 years.

Question 31

For regular tax purposes, with regard to the itemized deduction for qualified residence interest, home equity indebtedness incurred A. Is limited to $100,000 on a joint income tax return. B. Includes acquisition indebtedness secured by a qualified residence. C. Must exceed the taxpayer’s net equity in the residence. D. May exceed the fair market value of the residence.

Answer 31

A. Is limited to $100,000 on a joint income tax return. Answer (A) is correct. Qualified residence interest is deductible in full, subject to limitations. There are two categories of qualified residence interest. Acquisition indebtedness is debt used to purchase, build, or substantially improve the residence. The limit on acquisition indebtedness is $1,000,000. Home equity indebtedness is any debt secured by the residence other than acquisition indebtedness. Home equity indebtedness is limited to the lesser of $100,000 or the excess FMV of the residence over any acquisition indebtedness.

Question 32

For the current year, for purposes of the Earned Income Credit, all of the following amounts qualify as earned income except A. Unemployment compensation. B. Earnings from self-employment. C. Excluded combat-zone pay. D. Value of meals or lodging provided by an employer for the convenience of the employer.

Answer 32

A. Unemployment compensation. Answer (A) is correct. Earned income includes all wages, salaries, tips, and other employee compensation (including union strike benefits), plus the amount of the taxpayer’s net earnings from self-employment. For purposes of the Earned Income Credit, earned income also includes nontaxable compensation such as the basic quarters and subsistence allowances for the military, parsonage allowances, the value of meals and lodging furnished for the convenience of the employer, and excludable employer-provided dependent care benefits. Earned income does not include interest and dividends, welfare benefits, veterans’ benefits, pensions or annuities, alimony, Social Security benefits, workers’ compensation, unemployment compensation, or taxable scholarships or fellowships.

Question 33

Luis and Rosa, citizens of Costa Rica, moved to the United States in Year 1 where they both lived and worked. In Year 3, they provided the total support for their four young children (all under the age of 10). Two children lived with Luis and Rosa in the U.S., one child lived with his aunt in Mexico, and one child lived with her grandmother in Costa Rica. None of the children earned any income. All of the children were citizens of Costa Rica. The child in Mexico was a resident of Mexico, and the child in Costa Rica was a resident of Costa Rica. How many total exemptions (personal exemptions plus exemptions for dependents) may Luis and Rosa claim on their Year 3 joint income tax return? A. 6 B. 5 C. 4 D. 2

Answer 33

B. 5 Answer (B) is correct. In order to qualify as a dependent, an individual must be a citizen, national, or resident of the United States or a resident of Canada or Mexico at some time during the calendar year in which the tax year of the taxpayer begins. Therefore, Luis and Rosa may claim themselves, the two children living in the United States, and the child living in Mexico as dependents for a total of five exemptions.

Question 34

Education expenses may be deductible as a miscellaneous itemized deduction as well as any related travel and transportation expenses. Which of the following may also be true concerning education expenses? A. Education expenses are for the most part deductible as long as the taxpayer has already met the minimum requirements for the taxpayer’s established employment, trade, or business, the education does not qualify one for a new trade or business, and the education is necessary to keep a present job status or pay rate. B. As long as the taxpayer has met the minimum knowledge or skill requirements for the taxpayer’s established employment, trade, or business, all additional expenses are deductible. C. The education expense is deductible, even though it may qualify the taxpayer for an additional trade or business, as long as it improves one’s skills in an established trade or business. D. The expenses related to education are deductible if the education is primarily to bring the taxpayer up to the minimum level of knowledge or skills required by the employer.

Answer 34

A. Education expenses are for the most part deductible as long as the taxpayer has already met the minimum requirements for the taxpayer’s established employment, trade, or business, the education does not qualify one for a new trade or business, and the education is necessary to keep a present job status or pay rate. Answer (A) is correct. Expenditures made by an individual for education include amounts spent on correspondence courses, travel and transportation costs, supplies and books, and tuition. They are deductible as miscellaneous itemized deductions if the education maintains or improves skills required of the individual in his or her employment or other trade or business, or if it meets the express requirements of the individual’s employer or the requirements of applicable law or regulations imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation. Note that travel itself as a form of education is not a deductible expense.

Question 35

Brenda, employed full time, makes beaded jewelry as a hobby. In Year 2, Brenda’s hobby generated $2,000 of sales, and she incurred $3,000 of travel expenses. What is the proper reporting of the income and expenses related to the activity? A. Sales and expenses are netted and deducted for AGI. B. Sales of $2,000 are reported in gross income, and $2,000 of expenses are reported as an itemized deduction subject to the 2% limitation. C. Sales and expenses are netted, and the net loss of $1,000 is reported as an itemized deduction not subject to the 2% limitation. D. Sales of $2,000 are reported in gross income, and $3,000 of expenses are reported as an itemized deduction subject to the 2% limitation.

Answer 35

Answer (B) is correct. A hobby is an activity for which profit is not a primary motive. Some hobbies, however, do generate income. Hobby expenses may be deducted, but only to the extent of the hobby’s income. Since travel expenses are not deductible even if not incurred in a trade, business, or investment activity, these expenses are miscellaneous itemized deductions subject to the 2%-of-AGI floor. Therefore, the sales of $2,000 is reported in gross income and $2,000 of expenses are reported as an itemized deduction subject to the 2% limitation. C. Sales and expenses are netted, and the net loss of $1,000 is reported as an itemized deduction not subject to the 2% limitation. D. Sales of $2,000 are reported in gross income, and $3,000 of expenses are reported as an itemized deduction subject to the 2% limitation.

Question 36

During 2014, Hall spent a total of $1,000 for state lottery tickets. Her lottery winnings for 2014 totaled $200. Hall’s lottery transactions should be reported as follows: Other Schedule A -- Itemized Deductions Income Subject to Not Subject to on Page 1 2% AGI Floor 2% AGI Floor A. $200 $0 $200 B. $200 $200 $0 C. $200 $0 $0 D. $0 $0 $0

Answer 36

Answer (A) is correct. Gambling losses are deductible to the extent of gambling winnings as an itemized deduction not subject to the 2%-of-AGI floor. B. $200 $0 $200

Question 37

Destry, a single taxpayer, age 35, reported the following on his 2014 Form 1040, U.S. Individual Income Tax Return: Income: Wages $ 5,000 Interest on savings account 1,000 Net rental income 4,000 Deductions: Personal exemption $ 3,950 Standard deduction 6,200 Net business loss 16,000 Net short-term capital loss 2,000 What is Destry’s net operating loss that is available for carryback or carryforward? A. $9,000 B. $17,150 C. $7,000 D. $16,000

Answer 37

C. $7,000 Answer (C) is correct. A net operating loss is defined as the excess of allowable deductions (as modified) over gross income. A NOL generally includes only items which represent business income or loss. Personal casualty losses and wage or salary income are included as business items. Nonbusiness deductions in excess of nonbusiness income must be excluded. Interest and dividends are not business income. Net business loss $(16,000) Wages 5,000 Net rental income 4,000 Net operating loss $ (7,000) The nonbusiness capital loss cannot be deducted. The nonbusiness deductions (the standard deduction) exceed the nonbusiness income (interest), and both items are excluded from the NOL calculation. No deduction is allowed for the personal exemption in arriving at the NOL.

Question 38

Alternative minimum tax preferences include Tax-Exempt Charitable Interest from Private Contributions of Activity Bonds Appreciated Capital Issued during 2014 Gain Property A. No Yes B. Yes Yes C. Yes No D. No No

Answer 38

C. Yes No Answer (C) is correct. AMT preferences are items that are allowed relatively favorable treatment in determining regular taxable income. These preferences are added back to TI to find AMTI. Tax-exempt interest from private activity bonds is an AMT preference item. A charitable contribution of appreciated capital gain property is not an AMT preference item.

Question 39

All of the following individuals, who meet the income and residency requirements, qualify for the Earned Income Credit in 2014 except A. A 19-year-old head of household with a qualifying child. B. A 60-year-old married individual. C. A 22-year-old married individual whose spouse is 18 years old. D. A 45-year-old single individual.

Answer 39

Answer (C) is correct. A taxpayer can be eligible for the Earned Income Credit by having a qualifying child or meeting three qualifications: 1.The individual must have his or her principal place of abode in the United States for more than one-half of the taxable year; 2.(S)he must be at least 25 years old and not more than 64 years old at the end of the taxable year; and 3.The individual can’t be claimed as a dependent of another taxpayer for any tax year beginning in the year the credit is being claimed. A 22-year-old who is married to an 18-year-old without a qualifying child does not meet the requirements for the Earned Income Credit.

Question 40

Alex and Myra Burg, married and filing joint income tax returns, derive their entire income from the operation of their retail candy shop. Their 2014 adjusted gross income was $50,000. The Burgs itemized their deductions on Schedule A for 2014. The following unreimbursed cash expenditures were among those made by the Burgs during 2014: State income tax $1,200 Self-employment tax 7,650 What amount should the Burgs deduct for taxes in their itemized deductions on Schedule A for 2014? A. $7,650 B. $1,200 C. $5,025 D. $3,825

Answer 40

B. $1,200 Answer (B) is correct. State income taxes are deductible as an itemized deduction and are reported on Schedule A. Self-employed individuals may deduct half of the self-employment taxes paid as an above-the-line business deduction, which is not on Schedule A.

Question 41

Spencer, who itemizes deductions, had adjusted gross income of $60,000 in 2014. The following additional information is available for 2014: Cash contribution to church $4,000 Purchase of art object at church bazaar (with a fair market value of $800 on the date of purchase) 1,200 Donation of used clothing to Salvation Army (fair value evidenced by receipt received) 600 What is the maximum amount Spencer can claim as a deduction for charitable contributions in 2014? A. $5,000 B. $5,200 C. $5,400 D. $4,400

Answer 41

A. $5,000 Answer (A) is correct. The cash contribution to the church is fully deductible. The clothing donation is $600. The amount of the contribution with respect to the art object is the excess of what was given over what was received, or $400.

Question 42

An individual taxpayer earned $10,000 in investment income, $8,000 in noninterest investment expenses, and $5,000 in investment interest expense. How much is the taxpayer allowed to deduct on the current year’s tax return for investment interest expenses? A. $0 B. $5,000 C. $2,000 D. $3,000

Answer 42

C. $2,000 Answer (C) is correct. Investment interest may be deducted only to the extent of net investment income, which is any excess of investment income over investment expense. Net investment income equals $2,000 ($10,000 investment income – $8,000 noninterest investment expenses), therefore, only $2,000 of interest expense may be deducted.

Question 43

Sam was involved in a car crash in 2014. Damage to his automobile was estimated at $10,000. Original cost was $20,000. His insurance company reimbursed him $9,000. His adjusted gross income was $70,000. What amount can be deducted as a casualty loss on his 2014 return? A. $0 B. $3,000 C. $10,000 D. $1,000

Answer 43

A. $0 Answer (A) is correct. Personal casualty losses are allowed only to the extent that each loss exceeds $100 and aggregate losses exceed 10% of AGI. Furthermore, losses must be reduced by insurance reimbursements. Sam’s deduction is computed as follows: Loss $10,000 Less: Insurance proceeds (9,000) $100 per casualty (100) 10% of AGI (7,000) Deductible casualty loss $0

Question 44

In 2014, Don Mills, a single taxpayer, had $70,000 in taxable income before personal exemptions. 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. $72,000 C. $77,000 D. $83,000

Answer 44

C. $77,000 Answer (C) is correct. The itemized deduction for state and local income taxes and miscellaneous itemized deductions exceeding the 2%-of-AGI floor are AMT adjustment items that must be added back to TI to find AMTI. Therefore, AMTI is $77,000 ($70,000 TI + $5,000 + $2,000).

Question 45

Robert, age 70, 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. $21,500 B. $25,500 C. $17,000 D. $19,500

Answer 45

C. $17,000 Answer (C) is correct. Individuals are entitled to claim itemized deductions in calculating AMT with certain adjustments. The following itemized deductions are not allowed: 1.Miscellaneous itemized deductions, 2.State, local, and foreign income taxes, and 3.Real and personal property taxes. Deductions claimed for medical expenses are allowed but the expenses must exceed 10% of AGI for AMT instead of the usual 7.5% for taxpayers age 65 and over. Qualified housing interest is deductible which is similar to the qualified residence interest deduction that is allowed against regular tax. The allowable itemized deductions for AMT are $2,000 of medical expenses, $10,000 of qualified housing interest, and $5,000 of charitable contributions.

Question 46

Karen, filing as head of household, and her son James and daughter Julia are all in graduate school. James and Julia are not dependents on Karen’s return, although they live with her and she pays all of their education expenses. Karen paid $6,000 in qualified tuition expenses for herself in January 2014 for the term starting in January 2014. She also paid $2,500 in qualified tuition expenses for James and another $2,500 for Julia in July 2014 for the terms starting in July 2014. Her adjusted gross income is $65,000. Which of the following is true for tax year 2014? A. Karen may claim no American Opportunity Credit and $1,000 Lifetime Learning Credit. B. Karen may claim neither the American Opportunity nor the Lifetime Learning Credit. C. Karen may claim no American Opportunity Credit and $2,000 Lifetime Learning Credit. D. Karen may claim $5,000 American Opportunity Credit and $1,000 Lifetime Learning Credit.

Answer 46

B. Karen may claim neither the American Opportunity nor the Lifetime Learning Credit. Answer (B) is correct. The American Opportunity Credit and Lifetime Learning Credit may not be claimed at the same time. The American Opportunity Credit is available during a student’s first 4 years in college. Since Karen is in graduate school, she does not qualify for the American Opportunity Credit. The Lifetime Learning Credit is available in years that the American Opportunity Credit is not taken (for example, graduate school). However, the Lifetime Learning Credit phases out for single filers whose AGI is between $54,000 and $64,000 in 2014. Since Karen’s AGI is $65,000, the Lifetime Learning Credit is completely phased out.

Question 47

Jones Corporation hired a new employee on March 12, 2013. The new employee was a long-term family assistance recipient and received qualified first-year wages in the amount of $12,000 during 2013. An additional $3,500 of wages was earned between January 1 and March 11, 2014. In 2014, Jones paid this employee $15,000 of wages. Only $11,500 of the wages were attributable to the portion of the calendar year after March 11. What is Jones Corporation’s allowable Work Opportunity Tax Credit for 2014? A. $7,500 B. $5,000 C. $5,250 D. $4,000

Answer 47

B. $5,000 Answer (B) is correct. Employers are allowed a credit in the amount of 50% of the first $10,000 of qualified second-year wages paid to employees who are long-term family assistance recipients. Therefore, Jones Corporation is allowed a credit of $5,000 for 2014. Note that the combined credit for the 2 years may not exceed $9,000 per qualified employee.

Question 48

During 2014, Jack and Mary Bronson paid the following taxes: Taxes on residence (for period January 1 to September 30, 2014) $2,700 State motor vehicle tax on value of the car 360 The Bronsons sold their house on June 30, 2014, under an agreement in which the real estate taxes were not prorated between the buyer and sellers. What amount should the Bronsons deduct as taxes in calculating itemized deductions for 2014? A. $2,700 B. $1,800 C. $2,160 D. $3,060

Answer 48

C. $2,160 Answer (C) is correct. A deduction is allowed for state, local, and foreign real property taxes, and for state and local personal property taxes. Real estate taxes must be apportioned between the buyer and seller on the basis of the number of days the property was held by each in the year of sale, regardless of an agreement not to prorate them. The taxpayers held the property for 6 months of the 9-month period the taxes covered. The amount of the taxes apportioned to the Bronsons is $1,800 [$2,700 × (6 months ÷ 9 months)]. The state motor vehicle tax on the value of the car is a tax on the value of personal property, so the $360 may also be deducted. The taxpayers may deduct a total of $2,160 as taxes in calculating their itemized deductions.

Question 49

Generally, in computing the alternative minimum tax for individuals, which one of the following is not an adjustment or tax preference for alternative minimum tax purposes? A. Contributions to an Individual Retirement B. Tax-exempt interest on certain private activity bonds. C. Standard deduction. D. Personal exemptions.

Answer 49

A. Contributions to an Individual Retirement Arrangement (IRA). Answer (A) is correct. Taxable income must be adjusted to arrive at alternative minimum taxable income (AMTI). The adjustments are described in Secs. 56 and 58 with tax preferences in Sec. 57. The adjustments with respect to itemized deductions of an individual are contained in Sec. 56(b)(1). Contributions to an IRA have no effect on AMTI.

Question 50

Moore, a single taxpayer, had $50,000 in adjusted gross income for 2014. During 2014, she contributed $18,000 to her church. She had a $10,000 charitable contribution carryover from her 2013 church contribution. What was the maximum amount of properly substantiated charitable contributions that Moore could claim as an itemized deduction for 2014? A. $18,000 B. $25,000 C. $28,000 D. $10,000

Answer 50

B. $25,000 Answer (B) is correct. Properly substantiated cash contributions by individuals to qualified charities are limited to 50% of the taxpayer’s AGI, or $25,000 in this case. The carryover is deductible this year to the extent that the total deduction does not exceed the 50%-of-AGI limit, or $7,000 ($25,000 – $18,000).

Question 51

For 2014, Mr. Gill, a construction worker, had adjusted gross income of $20,000. He incurred the following employment-related and investment-related miscellaneous expenses: Safety shoes $100 Union initiation fees 2,000 Union dues 300 Life insurance 800 Jeans & flannel shirts used for work 200 Management fees on taxable income- producing investments 1,200 Legal expenses for drafting a will 100 He was not reimbursed for any of the employment-related expenses. What is the amount of his miscellaneous expense deduction after any limitations? A. $3,200 B. $4,000 C. $3,400 D. $3,600

Answer 51

A. $3,200 Answer (A) is correct. Dues and initiation fees paid for union membership and the cost of safety shoes are unreimbursed employee business expenses and are deductible subject to the 2%-of-AGI exclusion. Management fees on investments producing taxable income are other expenses also deductible subject to the 2%-of-AGI exclusion. The cost of life insurance, clothing suitable for normal wear (jeans and flannel shirts), and legal expenses for drafting a will are all personal expenditures and may not be included in itemized deductions. Mr. Gill’s deduction is calculated as follows: Safety shoes $100 Union initiation fees 2,000 Union dues 300 Management fees on investments 1,200 $3,600 Less AGI limitation ($20,000 × .02) (400) Misc. expense deduction after limitation $3,200

Question 52

Joe and Mary Day’s daughter, Julie, is a first-year student in college during 2014. Joe and Mary had an adjusted gross income (AGI) of $124,000, and Julie’s eligible expenses were $9,000. What is the amount of the American Opportunity Credit that the Days may use in 2014? A. $2,000 B. $2,500 C. $0 D. $9,000

Answer 52

B. $2,500 Answer (B) is correct. The American Opportunity Credit allows taxpayers a 100% credit for the first $2,000 of tuition expenses and a 25% credit for the second $2,000 of tuition expenses. The credit is reduced subject to income limits. The phaseout range begins when AGI exceeds $160,000 for joint filers in 2014. Therefore, the Days may use the entire $2,500 credit.

Question 53

Ms. Gower is 58 years old, single, and files Form 1040A. In 2011, she retired on permanent and total disability, and she is still permanently and totally disabled. She filed the required physician’s statement with her 2012 return and, for 2014, she will check the box in Part II of Schedule 3, Form 1040A, affirming that she is disabled and unable to engage in any substantial gainful activity. Ms. Gower received the following income for 2014: Nontaxable Social Security $5,000 Interest (taxable) 100 Taxable disability pension 8,400 What is Ms. Gower’s credit for the disabled in 2014? A. $0 B. $450 C. $1,260 D. $225

Answer 53

A. $0 Answer (A) is correct. A 15% tax credit applies to citizens or residents who are permanently and totally disabled when they retire (Sec. 22). The initial amount of allowable credit for single individuals is $5,000. For permanently and totally disabled individuals under age 65, the applicable initial amount noted above may not exceed the amount of disability income. The Sec. 22 amount is equal to an initial amount of $5,000 reduced by any amounts received as tax-exempt Social Security benefits and also reduced by one-half of the excess of adjusted gross income (AGI) over $7,500 for single individuals. Initial Sec. 22 amount $5,000 Less Social Security (5,000) Less AGI limitation [($8,500 – $7,500) × 50%] (500) Sec. 22 amount (500) × .15 Ms. Gower’s credit for the elderly $ 0

Question 54

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

Answer 54

C. Casualty losses. Answer (C) is correct. Casualty losses are allowed as deductions against alternative minimum taxable income (AMTI), subject to limitations.

Question 55

Bob Rogers is single and has taxable income in 2014 of $165,000. His only tax preference item is on the sale of qualified small business stock, which he has held since January 2005. He sold the stock on December 31, 2014. The gain realized on the sale was $35,000. However, Bob was able to exclude 50% of this gain. Bob has no other adjustments or loss limitations. What is Bob’s gross AMTI? A. $165,000 B. $200,000 C. $163,775 D. $166,225

Answer 55

D. $166,225 Answer (D) is correct. Generally, gross AMTI is taxable income after amounts are added or subtracted for tax preferences, adjustments, and loss limitations. Tax preference items allow relatively favorable treatment in determining regular tax. An amount reflecting the relative preference is added to taxable income in computing AMTI. Bob’s gross AMTI would be $166,225 [$165,000 + ($35,000 × 50% × 7%)]. The 7% is the amount of preference added back for AMTI, not the entire 50% gain exclusion.

Question 56

For the year ending December 31, 2014, David Roth, a married taxpayer filing a joint return, reported the following: Investment income from dividends and interest $24,000 Long-term capital gains on stock held for investment 25,000 Investment expenses 4,000 Interest expense on funds borrowed in 2014 to purchase investment property 70,000 What amount can Roth deduct in 2014 as investment interest expense if he elects to pay his capital gains on stock at an ordinary tax rate? A. $70,000 B. $45,000 C. $20,000 D. $49,000

Answer 56

B. $45,000 Answer (B) is correct. The deduction for investment interest is limited to the amount of net investment income. Investment income includes gross income from property held for investment and any net gain attributable to the disposition of property held for investment, to the extent that such amounts are not derived from the conduct of a trade or business. Capital gain from disposition of investment property is generally not considered investment income. However, individuals may elect to treat the gain as investment income by paying taxes at the ordinary rate. Roth had investment income of $49,000 ($24,000 + $25,000) and investment expenses of $4,000, or net investment income of $45,000. His investment interest deduction is limited to $45,000. The $25,000 of disallowed investment interest ($70,000 – $45,000) may be carried over and treated as investment interest paid or accrued in the succeeding taxable year.

Question 57

Mr. and Mrs. Sloan incurred the following expenses on December 15, 2014, when they adopted a child: Child’s medical expenses $5,000 Legal expenses 8,000 Agency fee 2,000 Before consideration of any “floor” or other limitation on deductibility, what amount of the above expenses may the Sloans deduct on their 2014 joint income tax return? A. $13,000 B. $10,000 C. $5,000 D. $15,000

Answer 57

C. $5,000 Answer (C) is correct. Medical expenses for medical care of the taxpayer, spouse, and dependents are deductible to the extent the expenses exceed 10% of AGI. A legally adopted child or one placed with the taxpayer for adoption has the same dependent status as a natural born child. Adoption expenses are personal in nature, and deduction for personal, family, and living expenses is disallowed.

Question 58

Smith has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities. What amount of the rental losses may Smith deduct in determining taxable income? A. $20,000 B. $0 C. $15,000 D. $40,000

Answer 58

C. $15,000 Answer (C) is correct. A person who actively participates in rental real estate activity is entitled to deduct up to $25,000 in losses from the passive activity against other than passive income. However, the $25,000 limit is reduced by 50% of that person’s MAGI (AGI without regard to passive activity losses, Social Security benefits, and other qualified retirement contributions) over $100,000. Smith has $20,000 of MAGI over $100,000. Accordingly, the $25,000 loss deduction must be reduced by $10,000 ($20,000 MAGI excess × 50%), resulting in $15,000 of deductible loss limitation.

Question 59

Anna is a 22-year-old student with earned income of $4,000 from a summer job and dividend income of $1,100. Her parents claim her as a dependent on their tax return. What is Anna’s basic standard deduction amount? A. $1,000 B. $6,200 C. $4,350 D. $5,100

Answer 59

C. $4,350 Answer (C) is correct. The basic standard deduction amount of a student under age 24 who is claimed as a dependent on another individual’s income tax return is limited to the greater of either $1,000 or the dependent’s earned income for the year plus $350 up to the otherwise applicable basic standard deduction amount. Earned income does not include either dividends or capital gains from the sale of stock. Since Anna’s earned income of $4,000 exceeds $1,000 and is less than the otherwise applicable standard deduction amount of $6,200, Anna’s applicable standard deduction is $4,350 ($4,000 earned income + $350).

Question 60

Wilson, CPA, uses a commercial tax software package to prepare clients’ individual income tax returns. Upon reviewing a client’s computer-generated Year 1 itemized deductions, Wilson discovers that the schedule’s deductible investment interest expense is less than the amount paid by the taxpayer and the amount that Wilson entered into the computer. After analyzing the entire tax return, Wilson determines that the computer-generated investment interest expense deduction is correct. Why is the computer-generated investment interest expense deduction correct? I.The client’s investment interest expense exceeds net investment income. II.The client’s qualified residence interest expense reduces the deductible amount of investment interest expense. A. Both I and II. B. II only. C. I only. D. Neither I nor II.

Answer 60

C. I only. Answer (C) is correct. The IRC allows the deduction of a limited amount of investment interest as an itemized deduction. The limit is to the extent of net investment income.

Question 61

Four years ago, an individual taxpayer purchased silver coins at face value for $200. The coins were stolen in the current year, when their fair market value was $1,000. The coins were not covered by insurance. Without considering the limit based on AGI, what is the maximum amount of loss that the taxpayer can deduct on the current-year’s tax return? A. $100 B. $1,000 C. $900 D. $200

Answer 61

A. $100 Answer (A) is correct. The amount of the casualty loss is equal to the amount of the adjusted basis of the stolen property over the $100 limitation. Therefore, only $100 is deductible as a casualty loss ($200 adjusted basis – $100 limit).

Question 62

Jim and Nancy Walton, both age 55, had adjusted gross income of $25,000 in 2014. During the year, they paid the following medical-related expenses: Over-the-counter medicines $400 Prescription drugs 300 Doctor fees 830 Health club membership (recommended by the family doctor for general health care) 800 Medical care insurance 280 How much may the Waltons use as medical expenses in calculating itemized deductions for 2014? A. $110 B. $1,090 C. $0 D. $1,410

Answer 62

C. $0 Answer (C) is correct. The cost of the health club membership is not included in the computation of the medical expense deduction since the cost is incurred for the purpose of improving the taxpayers’ general health, not for curing a specific ailment or disease. Only prescription drugs and insulin are deductible, so the over-the-counter medicines are not included. Medical care insurance $ 280 Doctor fees 830 Prescription drugs 300 Total expenses $1,410 Less 10% of AGI (2,500) Allowable medical expense deduction $ 0

Question 63

In computing an individual’s net operating loss, which of the following is not considered business income or deduction(s)? A. Wages. B. Gain on sale of investment property. C. Personal casualty loss. D. Gain on sale of business property

Answer 63

B. Gain on sale of investment property. Answer (B) is correct. Business and nonbusiness income and deductions need to be distinguished because nonbusiness deductions are deductible in computing a NOL only to the extent of nonbusiness income. Nonbusiness deductions and income are those that are not attributable to, or derived from, a taxpayer’s trade or business. Also, capital losses are only deductible to the extent of capital gains. A gain on the sale of investment property is a capital gain and not business income.

Question 64

On June 1, 2014, Toni Painta hired an economically disadvantaged Vietnam veteran to perform duties related to her business. Toni Painta paid the employee a total of $6,500 during 2014. The employee worked a total of 800 hours during the year. What is the amount Toni Painta may claim as a Work Opportunity Tax Credit? A. $3,000 B. $2,400 C. $0 D. $2,600

Answer 64

B. $2,400 Answer (B) is correct. The amount of the Work Opportunity Tax Credit is equal to 40% of the first $6,000 of wages paid to a qualified employee in his or her first year of service. Painta paid the employee $6,500, so the credit is limited to $2,400 ($6,000 × 40%). To be eligible for the Work Opportunity Tax Credit, the employee must have completed a minimum of 120 hours of service. If the employee meets or exceeds the 120-hour minimum requirement but does not perform 400 or more hours of service, the employer is entitled to a credit of 25%. For employees performing 400 or more hours of service, the appropriate percentage is 40%.

Question 65

The Rites are married, file a joint income tax return, and qualify to itemize their deductions in the current year. Their adjusted gross income for the year was $55,000, and during the year they paid the following taxes: Real estate tax on personal residence $2,000 Ad valorem tax on personal automobile 500 Current-year state and city income taxes withheld from paycheck 1,000 What total amount of the expense should the Rites claim as an itemized deduction on their current-year joint income tax return? A. $3,500 B. $2,500 C. $3,000 D. $1,000

Answer 65

A. $3,500 Answer (A) is correct. Under the IRC, only nonbusiness related taxes may be claimed as itemized deductions. Itemized deductible taxes include taxes on real property, personal property, income (except for federal), excess profits, generation-skipping transfer (imposed on income distributions), and general sales (deductible in lieu of income taxes). Three requirements exist for claiming a deduction for personal property tax. The first is an ad valorem requirement, meaning the tax must be in proportion to the value of the property. Secondly, the tax is deductible if imposed on an annual basis. The final requirement is that the tax be imposed on personal property. All three taxes paid by the Rites are deductible as itemized deductions for a total itemized deduction of $3,500 ($2,000 + $500 + $1,000).

Question 66

Which of the following is not a miscellaneous itemized deduction? A. An individual’s subscription to professional journals. B. Custodial fees for a brokerage account. C. An individual’s tax return preparation fee. D. Education expense to meet minimum entry-level education requirements at an individual’s place of employment.

Answer 66

D. Education expense to meet minimum entry-level education requirements at an individual’s place of employment. Answer (D) is correct. Tax return preparation fees, fees for business publications, and the fees for the brokerage account are allowable as miscellaneous itemized deductions. The education expense is not deductible because one of the requirements for education expense to be deductible as a miscellaneous itemized deduction is to have already met the minimum level of education or skill required for employment.

Question 67

Under a written agreement between Mrs. Norma Lowe and an approved religious exempt organization, a 10-year-old girl from Vietnam came to live in Mrs. Lowe’s home on August 1, 2014, in order to be able to start school in the U.S. on September 3, 2014. Mrs. Lowe actually spent $500 for food, clothing, and school supplies for the student during 2014, without receiving any compensation or reimbursement of costs. What portion of the $500 may Mrs. Lowe deduct on her 2014 income tax return as a charitable contribution? A. $0 B. $500 C. $200 D. $250

Answer 67

C. $200 Answer (C) is correct. Amounts paid by a taxpayer to maintain an individual other than a dependent as a member of his or her household under a written agreement between the taxpayer and a qualified organization to provide educational opportunity for pupils or students in private homes are deductible up to $50 per month. The student must attend full-time in the 12th or any lower grade of a qualified educational organization located in the United States. The deduction is only available for the months the child is a full-time student, which is 4 months in this case: September-December. Mrs. Lowe’s expenditures qualify under this provision as a charitable contribution deduction of $200 ($50 × 4 months in 2014).

Question 68

The unreimbursed 2014 employee travel expenses of an outside salesperson are A. Fully deductible from gross income in arriving at adjusted gross income. B. Fully deductible only as miscellaneous itemized deductions. C. Deductible only as miscellaneous itemized deductions subject to a 2% floor. D. Not deductible.

Answer 68

C. Deductible only as miscellaneous itemized deductions subject to a 2% floor. Answer (C) is correct. A deduction is allowed for travel expenses, including amounts spent for meals and lodging, while away from home in the performance of services as an employee. They are subject to the 2%-of-adjusted gross income exclusion.

Question 69

Liz incurred qualified adoption expenses of $16,000 in 2014. Liz’s AGI for 2014 was $87,000. What is the amount of the credit Liz can take in 2014 for the adoption expenses she incurred? A. $13,190 B. $0 C. $6,595 D. $16,000

Answer 69

A. $13,190 Answer (A) is correct. A credit is allowed for qualified adoption expenses incurred after 1996. The maximum credit is $13,190 per child.

Question 70

The 2014 deduction by an individual taxpayer for interest on investment indebtedness is A. Limited to the taxpayer’s 2014 interest income. B. Limited to investment interest paid in 2014. C. Limited to the taxpayer’s 2014 net investment income. D. Not limited.

Answer 70

C. Limited to the taxpayer’s 2014 net investment income. Answer (C) is correct. The deduction for interest on investment indebtedness is limited to the amount of net investment income for the taxable year. Any disallowed investment interest may be carried over and treated as investment interest paid or accrued in the succeeding taxable year.

Question 71

An individual taxpayer reports the following items for the current year: Ordinary income from Partnership A, operating a movie theater in which the taxpayer materially participates $70,000 Net loss from Partnership B, operating an equipment rental business in which the taxpayer does not materially participate (9,000) Rental income from building rented to a third party 7,000 Short-term capital gain from sale of stock 4,000 What is the taxpayer’s adjusted gross income for the year? A. $72,000 B. $70,000 C. $77,000 D. $74,000

Answer 71

D. $74,000 Answer (D) is correct. The taxpayer has active income of $74,000 ($70,000 ordinary income from Partnership A + $4,000 short-term capital gain). The amount of loss attributable to a person’s passive activities is allowable as a deduction only against, and to the extent of, gross income or tax attributable to those passive activities (in the aggregate). Therefore, although the taxpayer has gross income from passive activities of $7,000, this income is offset by $7,000 of passive activity loss from Partnership B. The excess $2,000 passive activity loss ($9,000 – $7,000) is deductible or creditable in a future year, subject to the same limits. Since all of the taxpayer’s passive activity income is offset by the passive activity loss, the taxpayer’s adjusted gross income for the year is $74,000.

Question 72

For 2014, Dole’s adjusted gross income exceeds $500,000. After the application of any other limitation, itemized deductions are reduced by which of the following? A. The greater of 3% of the excess of adjusted gross income over the applicable amount or 80% of certain itemized deductions. B. The greater of 3% of the excess of adjusted gross income over the applicable amount or 80% of all itemized deductions. C. The lesser of 3% of the excess of adjusted gross income over the applicable amount or 80% of all itemized deductions. D. The lesser of 3% of the excess of adjusted gross income over the applicable amount or 80% of certain itemized deductions.

Answer 72

D. The lesser of 3% of the excess of adjusted gross income over the applicable amount or 80% of certain itemized deductions. Answer (D) is correct. An individual whose adjusted gross income exceeds $305,050 ($152,525 if married filing separately) must reduce the aggregate of itemized deductions by the lesser of 80% of otherwise allowable itemized deductions or 3% of the excess. The overall limitation, however, does not apply to deductions for medical expenses, investment interest expenses, casualty or theft losses, or gambling losses (to the extent of gains).

Question 73

Which of the following may not be deducted in the computation of alternative minimum taxable income (AMTI) of an individual? A. Personal exemptions. B. One-half of the self-employment tax deduction. C. Charitable contributions. D. Traditional IRA account contribution.

Answer 73

A. Personal exemptions. Answer (A) is correct. Personal exemptions are added back to taxable income when calculating the Alternative Minimum Tax. Therefore, no deduction is allowed for personal exemptions in the computation of AMTI.

Question 74

Which of the following is treated as personal interest of Individual A? A. Interest incurred on an ordinary bank loan if the funds are used to provide medical care for a dependent of A. B. Interest incurred by a limited partnership in which A is a limited partner. C. Interest incurred on refinancing A’s home if the funds are used for a vacation. D. Interest incurred to purchase bonds as an investment.

Answer 74

A. Interest incurred on an ordinary bank loan if the funds are used to provide medical care for a dependent of A. Answer (A) is correct. Personal interest (no longer deductible) is any interest other than qualified residence interest, investment interest, interest taken into account in computing income or loss from a passive activity, interest in connection with a business, and interest during certain extensions of time to pay the estate tax. Interest on an ordinary bank loan incurred for medical care is personal interest.

Question 75

Pat, a single taxpayer, has adjusted gross income of $40,000 in the current year. During the year, a hurricane causes $4,100 damage to Pat’s personal use car on which Pat has no insurance. Pat purchased the car for $20,000. Immediately before the hurricane, the car’s fair market value was $11,000 and immediately after the hurricane its fair market value was $6,900. What amount should Pat deduct as a casualty loss for the current year after all threshold limitations are applied? A. $4,000 B. $100 C. $0 D. $4,100

Answer 75

C. $0 Answer (C) is correct. Only casualty losses in excess of 10% of AGI may be deducted after applying the $100 floor. Generally, casualty losses are deductible to the extent of the lesser of the decline in FMV or adjusted basis (less insurance reimbursements) due to the event. In this case, both the amount of the damage and the decline in FMV are $4,100. After applying the $100 floor, the remaining casualty loss is $4,000. Subject to the 10% AGI limitation, the loss is reduced by $4,000 ($40,000 × 10%) to $0.