FP 514 Tax Flashcards

Question

Which of the following is NOT a step in the tax calculation process? A) Calculate federal tax on federal taxable income. B) Subtract exclusions from AGI. C) Deduct the greater of itemized deductions or the standard deduction. D) Subtract adjustments to income from total income to get adjusted gross income.

Answer 1

B) Explanation The following are involved in the income tax computation: subtracting adjustments to income from total income to get AGI, and deducting the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. Subtracting exclusions from AGI is not a step in the tax calculation process. Excluded amounts simply do not show up as income on the return. LO 1.1.2

Answer 2

A) Explanation Total (gross) income minus adjustments to income equals adjusted gross income (AGI). AGI minus standard or itemized deduction(s) equals federal taxable income.

Answer 3

D) Explanation The following are involved in the income tax computation: subtracting adjustments to income from total income to get adjusted gross income, subtracting tax withholdings from total tax liability, and deducting the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. Credits are applied to tax liability. The calculation of federal tax is on federal taxable income. LO 1.1.2

Answer 4

B) Explanation Tax liability minus tax credits equals total tax liability or refund. LO 1.1.2

Answer 5

D) Explanation The $140,000 salary is reduced by the $10,000 self-employment loss and increased by the unemployment compensation of $2,000. The inheritance is excluded. The IRA contribution is a potential adjustment to income, as is the student loan interest. Thus, those items do not affect the total income. Remember that total income is the figure approximately two-thirds of the way down the front of the 1040. It is the figure from which allowable adjustments to income are subtracted. LO 1.2.1

Answer 6

B) Explanation Lindsey owes no federal income taxes in 2020. Municipal bond interest income is not taxable. The $900 in other interest income is less than Lindsey's $1,100 standard deduction amount. LO 1.2.1

Answer 7

C) Explanation Gambling winnings and interest on federal obligations are includible in an individual's gross income for income tax purposes. The other items are not subject to income taxation. LO 1.2.1

Answer 8

D) Explanation Remember that the total income is the amount shown about two-thirds of the way down the front of the Form 1040. It is the amount before the deduction for adjustments to income. Certain deductions are allowed in the computation of total income, such as the deduction for sole proprietorship losses or net capital losses up to $3,000. Charitable contributions are an itemized deduction. LO 1.2.1

Answer 9

B) Explanation Jane's AGI is $52,000 ($55,000 ‒ $3,000). Jane's $3,000 capital loss is a deduction for calculating AGI. Roth IRA contributions are never deductible from gross income. Municipal bond interest is not included in income. The unreimbursed business expenses are not deductible. LO 1.3.1

Answer 10

C) Explanation A taxpayer may deduct one-half of his self-employment tax liability as an "above the line" adjustment to income. The wage base is adjusted annually for cost of living increases. Net earnings from self-employment are determined under the same accounting method as that used for income tax purposes. Self-employed taxpayers are not subject to employer withholding. LO 1.3.1

Answer 11

A) Explanation Medical expenses are an itemized (below-the-line) deduction. LO 1.3.1

Answer 12

A) Explanation The total itemized deduction amount is $35,700. Note that the tax preparation fee and the unreimbursed employee business expenses are not deductible. The medical expenses are deductible only to the extent that they exceed 7.5% of AGI for 2020, which they do not. The deduction for the state income taxes and the property taxes is capped at $10,000. Taxes of $10,000, mortgage interest of $19,500, and charitable contributions of $6,200 total $35,700. LO 1.3.2

Answer 13

B) Explanation Unreimbursed employee expenses are no longer deductible since the Tax Cuts and Jobs Act (TCJA). The medical expenses are deductible only to the extent that they exceed 7.5% of AGI (for 2020), which they do not. The sales taxes would only be deductible in lieu of state income taxes. The overall deduction for taxes (state, local, and property) is limited to $10,000 as a result of TCJA. Home mortgage interest $12,000 State, local, and property taxes $10,000 Charitable contributions $2,250 Total itemized deductions $24,250 LO 1.3.2

Answer 14

D) Explanation The salaries combined with the income from the investments total $185,860. This is reduced by the $3,000 net capital loss to leave an AGI of $182,860. Remember that only $3,000 of net capital loss may be deducted in a given tax year. The AGI is then reduced by the greater of the itemized deductions ($14,000) or the standard deduction ($24,800 in 2020). The deduction for personal and dependency exemptions was repealed by Tax Cuts and Jobs Act (TCJA). LO 1.4.1

Answer 15

C) Explanation The marginal tax rate is found by finding the tax bracket that contains the taxable income amount; it is the amount at which all subsequent taxable amounts will be taxed (until entering the next tax bracket). The effective tax rate is calculated by dividing the calculated tax by total (gross) income, not taxable income. LO 1.4.2

Answer 16

D) Explanation The effective tax rate is found by dividing total tax by taxable income. LO 1.4.2

Answer 17

C) Explanation Neil may not deduct alimony paid to his former spouse because the deduction is disallowed for alimony under divorce decrees in 2019 and thereafter. He may invest in municipal bonds to receive tax-free income. There is no investment tax credit for equipment purposes. Some students confuse this with the Section 179 expense election, but that provision provides a deduction, not a credit. Child support payments are specifically nondeductible. LO 1.5.1

Answer 18

B) Explanation The maximum amount of qualifying expenditures on which the credit may be based is $3,000 per child, or $6,000 for two or more children. In this situation, they spent $5,000. This is multiplied by 20% for taxpayers with an AGI greater than $43,000. Thus, $5,000 × 20% = $1,000. LO 1.5.1

Answer 19

B) Explanation $1,200 divided by the 22% marginal income tax bracket gives us $5,455. LO 1.5.1

Answer 20

B) Explanation In a 35% tax bracket, a $15,100 loss deduction will save $5,285. Thus, $5,200 is the closest answer. LO 1.5.1

Answer 21

D) Explanation The exclusion ratio for a fixed annuity contract is not calculated by dividing the total expected return by the investment in the contract. It is calculated by dividing the investment in the contract by the total expected return. LO 2.1.2

Answer 22

A) Explanation The only time that the gifted asset takes the sale price as the basis is when the fair market value on the date of the gift is less than the donor's basis and the asset is sold at a price between the fair market value on the date of the gift and the donor's basis. LO 2.1.3

Answer 23

D) Explanation Investment interest expense is deductible up to the amount of net investment income, which is $9,000. The net investment income is simply the investment income (interest and short-term capital gains) of $9,000. Remember that the investment adviser fees were a Tier II miscellaneous itemized deduction, which are no longer deductible under the TCJA. The commissions are not a deductible item. The commissions increase the basis of the securities upon purchase and reduce the gain realized upon sale. LO 2.2.1 PREV

Answer 24

A) Explanation When the fair market value on the date of the gift is less than the donor's basis in the asset and the sale price is less than the fair market value on the date of the gift, then the fair market value on the date of the gift is used as the donee's basis. LO 2.1.3

Answer 25

A) Explanation Hardship withdrawals are typically allowed for medical expenses, college tuition and fees, the purchase of a principal residence, burial expenses for a spouse or dependents, and to prevent eviction from one's principal residence or foreclosure on the mortgage of such residence. LO 2.4.1

Answer 26

D) Explanation Dividends retained by the insurer to pay premiums are not treated as distributions from a MEC. LO 2.1.1

Answer 27

A) Explanation The IRS does not allow taxpayers to deduct interest on borrowed funds when those funds are used to generate tax-exempt income. Because Martha used $20,000 of the loan to purchase taxable securities, the interest on that $20,000 is deductible as an investment interest expense. LO 2.2.1

Answer 28

B) Explanation The deduction for self-employment tax paid is generally limited to the calculated employer share, or 50%, not 100%. LO 2.4.1

Answer 29

A) Explanation The long-term gain and loss are netted, leaving a long-term gain of $5,800. Short-term gains and losses are netted, leaving a short-term gain of $800. These are left separate due to the disparate tax treatment of short-term versus long-term gains. LO 2.1.3

Answer 30

A) To be classified as a MEC, a policy must encompass all of the choices: be a life insurance policy under state law; meet either the cash value accumulation test or the guideline premium and cash value corridor test; be a contract that was entered into on or after June 21, 1988; and fail to meet the seven-pay test. ## Footnote LO 2.1.1

Answer 31

B) Explanation Selective, quick, or sustained annuities are not recognized categories of annuities. Fixed, variable, immediate, and deferred are all categories of annuities. LO 2.1.2

Answer 32

B) Explanation The interest on the municipal bond continues to be tax exempt. There is no deduction allowed for the interest on funds borrowed to purchase tax-exempt securities. LO 2.2.1

Answer 33

B) Explanation Interest and dividends are portfolio income. Salary is active income. LO 2.2.2

Answer 34

C) Explanation The exclusion ratio for a fixed annuity contract is calculated by dividing the investment in the contract by the total expected return. For a variable annuity, the exclusion amount is calculated by dividing the investment in the contract by the number of expected payments. LO 2.1.2

Answer 35

D) Explanation Marge's 2020 self-employment tax is calculated as follows: Self-employment income$150,000.00 Less $150,000 × 0.0765($11,475.00) Equals net earnings$138,525.00 Less 2020 taxable wage base($137,700) Equals SE income subject to Medicare tax$825 Multiplied by 0.029× 0.029 Equals Medicare portion of SE tax$24 Add $137,700 × 0.153$21,068 Total self-employment tax$21,092 LO 2.3.1

Answer 36

B) Explanation A selective annuity is not a recognized category of annuities. LO 2.1.2

Answer 37

C) Explanation Self-employed individuals, such as a sole proprietor or general partner in a partnership, generate self-employment income. In turn, such individuals must pay both portions of the FICA (Federal Insurance Contributions Act) payroll tax. A general partner reports the income from the Schedule K-1 form provided by the partnership on Schedule E of Form 1040. A shareholder who receives a Schedule K-1 from an S corporation does not pay self-employment tax on the income. The Additional Medicare Tax of 0.9% also applies to self-employed individuals who have a combined income greater than $200,000 if single and $250,000 if MFJ. The tax is levied on the net earnings from self-employment of the sole proprietor or partner and consists of the gross income derived from any trade or business, less allowable deductions attributable to this trade or business (generally Schedule C); or the taxpayer's distributive share of the ordinary income or loss of a partnership (not an S corporation) engaged in a trade or business (Schedule K-1). LO 2.3.1

Answer 38

B) Explanation Statements II and III are correct. Any qualified dividends on the stock will be taxed at LTCG rates. A sale of the stock or the investment painting after the 18-month holding period will generate either a LTCG or a LTCL depending on the sale price. Rental income is taxed at the ordinary income tax rate. A speedboat for personal use will not generate any income and will likely decrease in FMV 18 months later. LO 2.2.2

Answer 39

Explanation The wash sale rules do not apply to taxpayers who are brokers or dealers of financial instruments. LO 2.1.3

Answer 40

C) Explanation The interest expense is not tax deductible because interest on a loan incurred to purchase personal life insurance protection is considered personal interest, which is not deductible. Personal loan interest is not tax deductible, regardless of whether the lender is a bank or a life insurance company. LO 2.1.1

Answer 41

B) Explanation Without a death benefit, a contract does not meet the legal definition of life insurance. There are currently two tests—only one of which must be met—in order to classify a product as life insurance for federal income tax purposes: (1) the cash value accumulation test and (2) the cash guideline premium test and corridor test. **There is no premium value test.** LO 2.1.1

Answer 42

D) Explanation Accumulations of cash value within a life insurance policy grow on a **tax-deferred** basis during the insured's lifetime. LO 2.1.1

Answer 43

C) Explanation Amounts borrowed on a single premium whole life policy issued on or after June 21, 1988 (a MEC), are taxable on a last-in, first-out basis; thus, the earnings would be taxable. A medical expense deduction will be allowed regardless of the source of the funds, since the payment would be for a valid medical expense. LO 2.1.1

Answer 44

A) Explanation The premiums paid are a taxable benefit to the employee. The main benefit to the employee is in the event of their premature demise, their survivors will still receive ample retirement benefits. LO 2.1.1

Answer 45

D) Explanation The pre-August 14, 1982, annuity retains first-in, first-out (FIFO) treatment. Thus, the basis of $50,000 is treated as being withdrawn first and is tax free. The remaining $25,000 is taxable. If this were a post-August 13, 1982, contract, it would be treated on a last-in, first-out (LIFO) basis. LO 2.1.2

Answer 46

A) Explanation With a fixed annuity contract, there is no ability to select the investment options; the payments are fixed. Fixed annuity contracts are generally tax advantaged (tax deferred), unless a corporation owns the annuity contract, in which case the earnings are currently taxable. Such is also the case with a variable annuity. LO 2.1.2

Answer 47

C) Explanation Allison is expected to receive $82,500 ($275 × 12 × 25). Her investment in the contract ($40,000) is then divided by the total expected return ($82,500) to determine the excludable portion of each payment. The exclusion ratio is the $40,000 divided by $82,500, which equals 48.48%. 48.48% of $275 = $133 excludable from each payment. LO 2.1.2

Answer 48

D) Explanation Net long-term capital gains (LTCG) (from other than unrecaptured Section 1250 income and collectibles) are taxed at rates of 0%, 15%, or 20%. For married couples filing jointly, the 0% long-term capital gain rate ends at $80,000 of taxable income. For long-term capital gains falling between the $80,000 breakpoint and $496,600 of taxable income (again, for married couples filing jointly), the rate is 15%. For long-term capital gains falling into taxable income levels above $496,600 (MFJ), the rate is 20%. The table shows the breakpoints for LTCG and qualified dividend preferential rates. LTCG Rates Based on Taxable Income Filing Status0% rate15% rate20% rate SingleUnder $40,000$40,000–$441,450Over $441,450 Head of householdUnder $53,600$53,600–$469,050Over $469,050 Married filing jointlyUnder $80,000$80,000–$496,600Over $496,600 Estates and trustsUnder $2,650$2,650–$13,150Over $13,150 Special rates apply to the sale of real estate or collectibles—25% (the maximum rate for gain attributable to straight-line depreciation on real estate), or 28% (maximum rate in the case of collectibles). Net capital losses, the capital losses remaining after netting against capital gains, are deductible up to $3,000 per year with an indefinite carryforward. LO 2.1.3

Answer 49

B) Explanation A telephone transfer is the same as a sale or other taxable redemption of the fund. Therefore, gain or loss will be recognized based on the difference in the redemption proceeds and the basis in the shares redeemed. This is true even if the transfer is made between two funds in the same fund family. LO 2.1.3

Answer 50

D) Explanation Qualified dividends are generally taxed at a 15% rate (or 20% for taxpayers with higher income levels). All of the other options produce interest income, which is taxable as ordinary income, at the marginal rate of the taxpayer. LO 2.1.3

Answer 51

B) Explanation The wash sale rule disallows a loss if substantially identical securities are purchased prior to 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the amount of the disallowed loss. **The S&P 500 mutual fund should not be substantially identical to the small-cap ETF because the funds track very different indices and because of the difference in the way ETFs trade compared with mutual funds.** LO 2.1.3

Answer 52

A) Explanation Investment interest expense is limited to the taxpayer's net investment income of $3,500. LO 2.2.1

Answer 53

B) Explanation Excess investment interest expense can be carried forward into succeeding tax years. Investment interest expense is deductible up to the amount of net investment income. The interest on funds borrowed to purchase tax-exempt investments is not deductible. The net investment income is typically interest, nonqualified dividends, and short-term capital gains. Long-term capital gains and qualified dividends may be included at the taxpayer's election, but the taxpayer must forgo the preferential tax rates on these items. LO 2.2.1

Answer 54

B) Explanation Investment interest expense is deductible up to the amount of investment income. The investment income is the interest income of $8,000. However, the deduction cannot exceed the actual investment interest expense of $7,000. Historically, the adviser fees would impact the calculation, but the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the Tier II miscellaneous itemized deductions. LO 2.2.1

Answer 55

C) Explanation Investment interest expense is deductible up to the amount of net investment income. The problem tells us that the net investment income is $20,000; thus that is the maximum deduction. The fact that the dividends are included in the net investment income indicates that the taxpayer elected to include them in investment income and is forgoing the preferential rates associated with qualified dividends. The AGI has no bearing on the answer. LO 2.2.2

Answer 56

B) Explanation The qualified dividends straddle the $441,450 breakpoint (for 2020). Thus, a portion fall into the $40,001 to $441,450 range and are taxed at 15%. The dividends above the $441,450 breakpoint are taxed at 20%. LO 2.2.2

Answer 57

B) Explanation Life insurance dividends are considered a return of premium paid (provided the cumulative dividends received over the life of the policy do not exceed the basis in the policy) and thus are not taxable. The other choices listed are taxable. Qualified dividends are eligible for long term capital gains rates. REIT dividends may qualify for a QBI deduction but nonetheless will still be taxable. LO 2.2.2

Answer 58

C) Explanation Lindsey is in the 10% marginal income tax bracket. She can use the long-term capital gains tax rate on qualified dividends received. At her income and filing status, that capital gain tax rate is 0%. LO 2.2.2

Answer 59

C) Explanation Qualified Roth distributions are not subject to the Medicare contribution tax. Only taxable items, such as net capital gains, net rental income, annuity income and dividends, for example, are subject to the Medicare contribution tax. LO 2.3.1

Answer 60

A) Explanation Statements I and IV are correct. The additional Medicare tax rate is .9%. An individual is liable for the additional Medicare tax if the individual taxpayer's wages, other compensation, or self-employment income (combined with a spouse if filing as married filing jointly) exceeds the thresholds for the taxpayer's filing status of a combined income greater than $200,000 if single and $250,000 if married filing jointly. LO 2.3.1

Answer 61

A) Explanation Terry and Jan will pay the 3.8% Medicare contribution tax on $60,000. This is **the lesser of the net investment income ($90,000) or the AGI in excess of the threshold amount** ($310,000 – $250,000, or $60,000). In this situation, only $60,000 of the net investment income is subject to the Medicare contribution tax and calculates to $2,280 (60,000 × 0.038). LO 2.3.1

Answer 62

C) Explanation She will pay the 3.8% Medicare contribution tax on $35,000. This is the lesser of the net investment income ($50,000) or the AGI in excess of the threshold amount ($235,000 – $200,000, or $35,000). In this situation, only $35,000 of the net investment income is subject to the Medicare contribution tax. Clare will pay a $1,330 Medicare contribution tax (3.8% on $35,000). LO 2.3.1

Answer 63

D) Explanation Proceeds from EE savings bonds may be exempt if the proceeds are used for qualified higher-education expenses of the taxpayer, spouse, or dependent. There is an AGI phaseout, which for 2020 is approximately $82,350‒$97,350 (2020) for a single taxpayer. (The actual phaseouts are provided on the exam.) All the other options generate currently taxable income. The Treasury bills and GNMA funds both produce taxable income on the federal return (Treasury bill interest would typically be tax exempt on her state return). The zero Treasury also produces taxable income each year as the amortized discount is added to taxable income, even though no cash income is received. LO 2.4.1

Answer 64

A) Explanation Tim qualifies for the Lifetime Learning Credit. His AGI is under the phaseout range. He is pursuing a degree at an eligible institution. The felony drug conviction would preclude the use of the American Opportunity Tax Credit but not the Lifetime Learning Credit. There is no exclusion available for EE bonds unless they are held by the individual who purchases the bonds or unless they are held jointly with a spouse. A bond that has been gifted to another taxpayer does not qualify for the exclusion. The American Opportunity Tax Credit and the Lifetime Learning Credit may not be claimed in the same year for the same student. LO 2.4.1

Answer 65

D) Explanation The exclusion for EE bond interest redeemed to pay for qualifying higher-education expenses applies only to bonds purchased by an individual age 24 or older, and held in that person's name, or jointly with a spouse. Karen is 27 years old; the bonds were purchased 7 years ago, when Karen was approximately 20. Because Karen does not qualify for the exclusion of the interest income because she was not age 24 or older at the time of purchase. All the interest is taxable in the year the bonds are redeemed. Remember that the interest of EE bonds is deferred until maturity, unless an election has been made to have the interest taxed each year as it accrues. Also, the interest income from EE bonds (and other federal government obligations) is generally not subject to state income tax. LO 2.4.1

Answer 66

C). Explanation The EE bond exclusion (for educational purposes) is phased out (for married couples filing jointly) between $123,550 and $153,550 of AGI in 2020. There is no exclusion available when AGI exceeds $153,550. It is not necessary to memorize the exact phaseout amounts because they will be provided on the exam. To qualify for the exclusion, the bonds must be purchased by an individual age 24 or older and held in that person's name, or jointly with a spouse. EE bonds are not taxable at the state level. LO 2.4.1

Answer 67

B) Explanation The predominant benefit of the Coverdell ESA is distributions may also be used to pay for K-12 expenses. This is unlike the 529 plan which is designed primarily to pay for college expenses (Note: a limited amount of $10,000 may now be withdrawn from a 529 for K-12 expenses per the TCJA). LO 2.4.1

Answer 68

B) Explanation Undergraduate and graduate education assistance is excluded from an employee's income in any one year period, up to a maximum of $5,250. The other options are fully taxable. LO 2.4.1

Answer 69

A) Explanation The couple have a recognized short-term capital gain of $300. Separately, they have donated property with a value of $3,500 to the church. LO 3.2.2

Answer 70

B) Explanation Caroline's standard deduction for earned income is $12,400 (for 2020), whereas her standard deduction for unearned income is only a maximum of $1,100 (limited to the $750 of actual unearned income in this instance). Caroline would, therefore, elect to offset her total income of $19,355 by the greater of the standard deductions, which is $12,400 in 2020. LO 3.2.1

Answer 71

C) Explanation Statements II and III are correct. Statement I is incorrect. The ISO bargain element is not an exclusion item; it is a deferral item. LO 3.3.2

Answer 72

D) Explanation A grantor trust is a trust whose income is taxed to the grantor. LO 3.1.1

Answer 73

B) Explanation Statement I is correct. Statements II and III are incorrect. Excluded Section 1202 gain and percentage depletion treated as a tax preference for AMT are exclusion items. LO 3.3.2

Answer 74

A) Explanation Of the itemized deductions listed, only the qualifying home mortgage interest of $15,950, the charitable contributions of $2,000, the gambling losses to the extent of winnings of $500, and the $6,193 of medical expenses are allowable for purposes of the AMT. The medical expenses are deductible to the extent they exceed 7.5% of AGI for both regular and AMT purposes. LO 3.3.2

Answer 75

B) Explanation Of the listed donations, the $100,000 to the orphanage is nondeductible because it is a charity located in France. The $50,000 given to the gubernatorial campaign is a nondeductible political donation. The $30,000 given to the church, the $10,000 given to the United Way, and the $15,000 given to the nonprofit organization are deductible donations. LO 3.2.2

Answer 76

A) Explanation The answer is gift the equipment to Jarod and then lease it back from him as the most appropriate intrafamily transfer technique. LO 3.3.1

Answer 77

D) Explanation Abby's taxable unearned income in 2020 is $0 ($750 unearned income − $1,100 standard deduction for unearned income). The standard deduction cannot create a negative amount. LO 3.2.1 PREV

Answer 78

A) Explanation Because the artwork is appreciated property held for less than one year, its sale would result in a short-term capital gain. Consequently, the deduction is limited to the lesser of the fair market value or the basis of the gifted property. LO 3.2.2 PREV

Answer 79

A) Explanation Individual cash donations to qualified public charities are limited to 60% of adjusted gross income, but excess amounts may be carried over in subsequent tax years. Sixty percent of Maxine's Year 1 AGI was $90,000. In Year 1, she can deduct $90,000 of the gift. In Year 2, she can deduct the remainder of $10,000. LO 3.2.2

Answer 80

D) Explanation Because RELPs are nonpublicly traded passive activities, the trust can net the $15,000 loss against the $25,000 income. Trusts may participate in the investment in passive activities and the passive activity rules apply to trusts that own such investments. LO 3.1.1

Answer 81

B) Explanation Floyd's liability is $446. This is computed as follows: $5,000 (1,100)limited standard deduction (1,100)taxed at child's rate of 10%$1,100 ×10% =$110.00 $2,800taxed at parent's marginal rate of 12%= $336.00 $446.00 The income earned is taxable, even if the income was not distributed. LO 3.2.1

Answer 82

D) Explanation The AMT credit created in any one year may be used as a credit against regular income tax in a future year. It may be carried forward indefinitely. LO 3.3.2 PREV

Answer 83

C) Explanation The trust income will be taxed to the grantor, as the trust is revocable. A revocable trust is treated as a grantor trust. LO 3.1.1

Answer 84

C) Explanation Some of Molly's unearned income is taxed at her parents' rate and is calculated as follows: $10,000 UI – $1,100 (standard deduction) – $1,100 (greater of $1,100 for 2020 or amount of allowable itemized deductions directly connected with the production of the unearned income) = $7,800 LO 3.1.1

Answer 85

B) Explanation Because Julie waited past age 23 when she had the right to revoke the trust, she is responsible for taxes on the trust given to her. LO 3.1.1

Answer 86

D) Explanation Alicia owes no federal income taxes in 2020. Municipal bond interest income is not taxable. The $900 in other interest income is less than Alicia's $1,100 standard deduction amount (for 2020). LO 3.2.1

Answer 87

B) Explanation Floyd's liability is $782. This is computed as follows: $5,000 ($1,100)limited standard deduction ($1,100)taxed at child's rate of 10%$1,100×10%=$110.00 $2,800taxed at parents' rate of 24%=$672.00 $782.00 LO 3.2.1

Answer 88

C) Explanation Statement IV is the only correct statement. The kiddie tax applies to children under 19 years of age. It also applies to children under age 24 if they are full-time students. The kiddie tax does not apply if the child's earned income exceeds one-half of the child's support. Thus, I and II are incorrect. There is no requirement that the proceeds of a future sale be reported on the donor's return. As a result of TCJA, the net unearned income is taxed at the parents' marginal tax rates. LO 3.2.1

Answer 89

C) Explanation The standard deduction for an individual eligible to be claimed, or treated, as a dependent is the greater of the limited standard deduction of $1,100 or the amount of earned income plus $350, not to exceed the full standard deduction amount of $12,400 (for 2020). $12,500 + $350 = $12,850, but the deduction is limited to the full standard deduction amount of $12,400. LO 3.2.1

Answer 90

A) Explanation Nancy is the only child up to and including age 18 with unearned income in excess of $2,200 for 2020. Earned income is not subject to taxation at the parental rate. Jennifer is not subject because she is not a full-time student. The kiddie tax applies to children under 19 years of age. It also applies to children under age 24 if they are full-time students. The kiddie tax does not apply if the child's earned income exceeds one-half of the child's support. A full-time student is an individual who is a full-time student for at least five calendar months during the tax year. LO 3.2.1

Answer 91

B) Explanation Both statements are correct. The kiddie tax applies to unearned income for children under the age of 19 and full-time students until they reach age 24. LO 3.2.1

Answer 92

D) Explanation When applying the kiddie tax, the parents' marginal tax rate is always used (regardless of the source of the property generating the unearned income). Therefore, none of the income is taxed to Paul using the uncle's tax rate. The $400 of income ($2,600 − $2,200) is taxed to Paul at his parents' marginal tax. LO 3.2.1

Answer 93

C) Explanation The gift of long-term capital gain (LTCG) property is generally based on the fair market value of the property. The university is a 50% organization, a public charity. LTCG property contributed to a 50% organization involves a 30% of AGI limitation, and 30% of $120,000 is $36,000. There is also a $44,000 carryforward for up to five years. Jim could have made a 50% election to maximize the current-year deduction, but that would have reduced his overall deductions. If Jim had made a 50% election, he could have deducted $55,000 in the current year. By forgoing the 50% election, he is allowed to deduct the full $80,000 fair market value—$36,000 this year and $44,000 over the next several years. LO 3.2.2

Answer 94

B) Explanation If Frank makes a 50% election, he must utilize the basis of the property but may deduct up to 50% of AGI. This yields a $40,000 current-year deduction with a $10,000 carryforward. If no 50% election were made, the deduction would be based on the fair market value of the property but would be limited to 30% of AGI, which is $24,000, with a $46,000 carryforward. LO 3.2.2

Answer 95

B) Explanation The painting would be considered use-unrelated tangible personalty. The deduction for use-unrelated tangible personalty is limited to basis, with a 50% of AGI limitation. Thus, the current-year deduction is $35,000. If the painting had been donated to an art museum, for example, the contribution would be of use-related tangible personalty. Since the painting had been held for the long-term holding period, the deduction would have been $30,000 (long-term capital gain property to a 50% organization uses FMV with a 30% of AGI limitation) with a $20,000 carryforward. LO 3.2.2

Answer 96

D) Explanation The answer is $38,000. Since this is use-unrelated property, the allowable deduction is limited to his basis. LO 3.2.2

Answer 97

B) Explanation Statement II is incorrect because the charitable deduction is limited to a maximum of 10% of the corporation's adjusted taxable income. LO 3.2.2

Answer 98

D). Explanation Jeff's maximum valuation for deduction purposes available for the current year is $47,000 as follows: Inventory: $6,000 (as ordinary income property, limited to lesser of basis or FMV) Stock in ABC Co.: $40,000 (the maximum possible deduction is FMV for this long-term capital gain property) Personal coin collection: $1,000 (tangible personal property depends on dedicated use of property from standpoint of the charity; this is use-unrelated property because it was given to the Boy Scouts also limited to the lesser of basis or FMV) LO 3.2.2

Answer 99

A) Explanation In a gift loan, the amount of the imputed interest constitutes a gift from the lender to the borrower. For gift loans greater than $10,000 and less than or equal to $100,000, no interest is imputed if the borrower's investment income for the year does not exceed $1,000. For a gift loan of more than $100,000, the prevailing federal rate of interest will be imputed. For this loan, Richard's investment income exceeds $1,000 and interest will be imputed. LO 3.3.1

Answer 100

C) Explanation In a gift loan, the amount of the imputed interest constitutes a gift from the lender to the borrower. For gift loans greater than $10,000 and less than or equal to $100,000, no interest is imputed if the borrower's investment income for the year does not exceed $1,000. For a gift loan of more than $100,000, the prevailing federal rate of interest will be imputed. LO 3.3.1

Answer 101

C) Explanation A gift of long-term capital gain property to a 50% organization is based on the FMV of the property, with the deduction for the current year limited to 30% of AGI. LO 3.2.2

Answer 102

B) Explanation The portrait is related-use, capital gain property. Claudia may deduct an amount up to 50% of her AGI if she uses the basis of the painting and 30% of AGI if she uses FMV. As long as Claudia's AGI is greater than $6,667, she can deduct the FMV of the portrait. LO 3.2.2

Answer 103

B) Explanation The donor-taxpayer must have a canceled check, bank record, or a receipt from the donee organization to substantiate the deduction. The documentation must have the amount of cash or description of property, the name of the receiving charitable organization, the date of the contribution, and the amount of the donation. An appraisal is not required for noncash property over $500 and less than or equal to $5,000. However, taxpayers may wish to get an independent appraisal to support the deduction claimed. LO 3.2.2

Answer 104

B) Explanation Of the itemized deductions listed, only the qualifying home mortgage interest of $15,950, the charitable contributions of $2,000, and the gambling losses to the extent of winnings of $500, and the $230 of medical expenses are allowable for purposes of the AMT. The medical expenses are deductible to the extent they exceed 7.5% of AGI for both regular and AMT purposes. LO 3.3.2

Answer 105

C) Explanation By definition, the only listed item that is not an AMT preference item or adjustment is the cost depletion deduction. Note that interest on private-activity municipal bonds issued in 2009 and 2010 is not a preference item for the AMT. LO 3.3.2

Answer 106

B) Explanation By definition, investment interest expense in excess of net investment income and qualified housing interest are not preference items or adjustments for purposes of the alternative minimum tax. Remember that interest on qualified private-activity municipal bonds issued in 2009 and 2010 is not a preference item. LO 3.3.2

Answer 107

D) Explanation Statement IV, property taxes, is the only itemized deduction listed that is not allowed for AMT purposes. State and local income taxes are also disallowed. LO 3.3.2

Answer 108

B) Explanation Statement I is incorrect because casualty losses are deductible for both regular tax and AMT; no adjustment is necessary. Statement II is correct because state taxes are not deductible for AMT purposes. Statement III is correct because the standard deduction is a positive adjustment when calculating AMT income. Statement IV is incorrect because charitable contributions are deductible for both regular income tax and AMT; no adjustment is necessary. LO 3.3.2

Answer 109

C) Explanation Tax-exempt income from a general obligation municipal bond is not a preference for AMT. All of the other items are tax preference items for AMT purposes. LO 3.3.2

Answer 110

A) Explanation Tax-exempt income from a municipal revenue bond is not a preference for AMT. All of the other items are preferences for AMT purposes. LO 3.3.2

Answer 111

C) Explanation The IRS notes that the starting point for determining AMTI is taxable income as reported for regular income tax purposes on a taxpayer's IRS Form 1040. Because real estate taxes are not deductible for AMT purposes, it is generally advantageous to defer the payment of such taxes to a year when AMT will probably not be payable. Also, if AMT will be payable in the current year, it is generally advantageous to increase the amount of regular taxable income (e.g., by accelerating ordinary income into the current year) because the total tax payable will likely not be affected by doing so. LO 3.3.2

Answer 112

D) Explanation Statement I is correct. In additional, the taxpayer must be in receipt of this documentation by the due date of the return or when the return is filed. Statement II is incorrect because it reads "all" donations of stock must have a qualified appraisal. A qualified appraisal is not required for closely held stock if the amount donated is less than $10,000. The appraisal itself is not attached to the tax return. LO 3.2.2

Answer 113

D) Explanation All statements are required for legally married spouses to file a joint income tax return. LO 4.1.1 PREV

Answer 114

A) Explanation To make a determination on whether or not Lisa's parents are her dependents, the planner needs complete information of how much Lisa has paid, if anything, in addition to the foregone rent for their support and what percentage that is of her parents' total support. LO 4.2.1 PREV

Answer 115

A) Explanation The parent with custody for a greater portion of the year is treated as providing more than half of a child's support, where the child receives more than half of his total support for the year from either or both parents who are divorced. LO 4.2.3 PREV

Answer 116

A) Explanation To be valid, a prenuptial agreement must be in writing, witnessed, and reviewed by an attorney. Each party should obtain independent counsel. LO 4.1.2 PREV

Answer 117

C) Explanation The present value of the installment option is $41,698. Jane would therefore be better off accepting the payments over the next five years. As a wasting asset, it is highly unlikely Jane could sell the car for its original fair market value of $50,000. Property settlements incident to a divorce are not subject to income tax. LO 4.2.2

Answer 118

B) Explanation The present value of the installment option is $83,397. Shawn would therefore be better off accepting the payments over the next five years. As a wasting asset, it is highly unlikely Shawn could sell the car for its original fair market value of $100,000. Property settlements incident to a divorce are not subject to income tax. LO 4.2.2 PREV

Answer 119

B) Explanation Beginning in 2019, alimony payments are no longer deductible by the payor. LO 4.2.3 PREV

Answer 120

C) Explanation Under the rule of joint and several liability, each spouse owes 100% of the tax liability, no matter who earned the income or in what proportion. LO 4.1.1 PREV

Answer 121

D) Explanation A premarital agreement cannot be signed under duress. The age disparity of the signatories is not in and of itself relevant. It must include full disclosure of assets. It cannot include contractual obligations, such as who is responsible for house cleaning. LO 4.1.2 PREV

Answer 122

D) Explanation Payments for child support are not deductible by the payor and are not included in gross income for the payee. LO 4.2.3 PREV

Answer 123

D) Explanation Because Mark and Beth have different fiscal years to accommodate their businesses, their tax years do not begin on the same date, and they may not file as MFJ. In order to use the MFJ status, a couple must be legally married on the final day of the tax year. LO 4.1.1

Answer 124

D) Explanation A married couple may file a joint return even though one spouse has no income or deductions if they are not legally separated or divorced on the last day of the tax year. LO 4.1.1

Answer 125

A) Explanation When filing in this manner, spouses have joint and several liability for the payment of tax, meaning each spouse is responsible for the entire tax and not just half. LO 4.1.1

Answer 126

C) Explanation Because Lisa's spouse died earlier in the year, she may use married filing jointly status for 2020. She cannot use the head of household filing status because she does not maintain a household for a qualifying child or relative. LO 4.1.1

Answer 127

B) Explanation If married to a U.S. citizen or resident alien, the nonresident alien can elect to be treated as a resident alien for tax purposes only. Tax status does not necessarily reflect immigration status. If this election is made, the couple must pay U.S. taxes on their worldwide income. In this situation, the nonresident alien spouse should obtain an Individual Tax Identification Number (ITIN). Depending on their individual situation and intentions, they may apply for a Social Security number with the Social Security Administration. LO 4.1.1

Answer 128

A) Explanation To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party's financial situation. It may not be used to regulate an award of alimony. LO 4.1.2

Answer 129

A) Explanation To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party's financial situation. It may not be used to regulate an award of alimony. LO 4.1.2

Answer 130

C) Explanation The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party). LO 4.1.2

Answer 131

B) Explanation The maximum amount of qualifying expenditures on which the credit may be based is $3,000 per child, or $6,000 for two or more children. This is multiplied by 20% for taxpayers with an AGI greater than $43,000. Thus, $6,000 × 20% = $1,200. LO 4.2.1

Answer 132

C) Explanation Max is entitled to both the standard deduction amount for the head of household filing status and the child and dependent care tax credit, subject to the limits based on Max's AGI. LO 4.2.1

Answer 133

B) Explanation Statement I is correct. If all of his sister's support is paid for by funds she receives from the trust, she cannot be a dependent of Joseph. Statement II is incorrect. Simply not living with Joseph does not preclude him from listing his sister as a dependent. If Joseph provided more than half of the support for his sister, he would be allowed to list her as a dependent and take any tax credits that may be available. LO 4.2.1

Answer 134

D) Explanation School attendance does not affect the availability of the credit. The $1,600 in expenses incurred each month to enable Max to work outside the home do not have to be divided between child care and housekeeping services. LO 4.2.1

Answer 135

C) Explanation Because the trust pays for all of Diane's support, Trudy's income tax return is unaffected and she will file as single. LO 4.2.1

Answer 136

D) Explanation Because Leon provided all of Macy's support this year, he can claim her as a dependent and claim head of household status. LO 4.2.1

Answer 137

A) Explanation A dependent may not have more than $4,300 (2020) of gross income. Social Security income is excluded from the test if that is the elder's only source of income. The taxpayer must also provide over 50% of the dependent's support to claim them. Coincidentally, as long as all the tests are met, a person who dies during the year may still be identified as a dependent. LO 4.2.1

Answer 138

C) Explanation Statement I is incorrect; the transfer-for-value rule does not apply when a life insurance policy is transferred from one spouse to the other under a property settlement incident to divorce. Statement II is correct. LO 4.2.2

Answer 139

D) Explanation A common issue that arises in the settlement of divorce proceedings is how payments are best structured in resolution of marital obligations. As a general rule, it is usually in the best interest of the payor to spread the amount of payments over as many years as possible to take advantage of the time value of money. Alternately, the payee's best interests are served by immediately receiving as much money as possible rather than receiving payments over a longer period. LO 4.2.2

Answer 140

A) Explanation Although the transfer itself is tax free, Alex should roll the assets distributed from Judy's IRA within 60 days into his own IRA or retirement plan. Because he failed to do so, he owes ordinary income tax on the entire distribution. When incident to a divorce, domestic relations orders (DROs) are however not subject to gift tax or early withdrawal penalties. LO 4.2.2

Answer 141

C) Explanation Clark is underinsured given his legal obligations. Lawyers are not financial planners and generally are not trained to calculate life insurance coverage needs. Consequently, they often settle for an amount of life insurance that is too low. Term policies do not have cash value. If Clark leaves his employer, the term policy will most likely be canceled, which would compel Lois to take Clark back to court. LO 4.2.2

Answer 142

D). Explanation Cash payment of the payee spouse's mortgage, rent, tuition, or tax liability made by the payor spouse as required by the divorce or separation instrument may qualify as alimony. Payments to maintain property used by the payee spouse, but owned by the payor spouse, do not qualify as alimony, even if required under the instrument. Payments made with respect to jointly owned property are considered one-half alimony. These property-related expenditures may include mortgage payments, real estate taxes, and homeowners insurance. LO 4.2.3

Answer 143

D) Explanation Single (S) filing status is used by an unmarried, legally separated, or divorced individual who does not qualify for any other filing status. LO 4.2.3

Answer 144

C) Explanation The requirement that the payments be in cash means that the payments may not be in the form of property. Payments are not necessarily deductible just because they are a result of a court order; there are other requirements that must be met as well. One of those requirements to have qualifying alimony is that the taxpayers must not be living together at the time of payment. The payments do not need to be equal each year. However, unequal and declining payments can trigger the alimony recapture (excess front-loading) rules. LO 4.2.3

Answer 145

B) Explanation Payments that fluctuate because of a continuing liability to pay a fixed portion of income from business, property, or services are not subject to the excess front-loading rules. LO 4.2.3

Answer 146

A) Explanation The $135,000 in salaries is reduced by the alimony payment of $9,600 and Larry's IRA contribution of $6,000 to give an AGI of $119,400. The AGI is reduced by the greater of the itemized deductions ($15,000) or the standard deduction ($24,800 in 2020) to leave $94,600. Pam's IRA contribution is nondeductible because the MAGI exceeds the phaseout range of $104,000 to $124,000. Because the MAGI is less than $196,000, Larry may still deduct his full IRA contribution. Note that the MAGI ($125,400 in this situation) is the AGI computed without regard to the IRA deduction itself. The AGI phaseout limits for active participants will be provided on the exam. LO 4.2.3

Answer 147

B) Explanation The $145,350 in salaries is reduced by the alimony payment of $20,000 to give an AGI of $125,350. The AGI is reduced by the greater of the itemized deductions ($9,000) or the standard deduction ($24,800 in 2020) to equal $100,550. The child support paid is not a deductible item. LO 4.2.3

Answer 148

D) Explanation If there is an obligation to continue to make payments after the death of the ex-spouse, the payments are not treated as alimony. LO 4.2.3

Answer 149

D) Explanation Payments to former spouses are no longer deductible and are considered alimony only if the payments are made in cash (and not property); the decree does not specify that the payments are not alimony for federal income tax purposes; the payor and payee are not members of the same household at the time that the payments are made; and there is no liability to make the payments for any period after the death of the payee. LO 4.2.3

Answer 150

B) Explanation When there is a transfer of property incident to divorce, the basis simply carries over to the other spouse. The transfer is not a taxable event. Pat will likely owe capital gains tax when disposing of the property. LO 4.2.3

Answer 151

C) Explanation Statement IV is incorrect. The transfer-for-value income tax rule does not apply in situations when a life insurance policy is transferred from one spouse to another as a result of a property settlement. LO 4.2.3

Answer 152

Explanation D) There are two components to this question. What is the basis, and is there tacking of the holding period? When the fair market value on the date of the gift is less than the donor's basis in the asset, the donee's basis in the asset for purposes of determining a loss is the asset's FMV on the date of the gift. In this situation, the $9 per-share value on the date of the gift would be Lynnette's basis. The next issue is the "tacking" of the holding period. In a situation where the donee uses the FMV as the basis, there is no tacking of the holding period. In this situation, Lynnette used the FMV; thus, she uses her own holding period of 11 months. If the donee uses the donor's basis, then the holding period is tacked. In other words, the donor's holding period is added to ("tacked") the donee's holding period. LO 6.1.1

Answer 153

B) Explanation The land may not be depreciated, as only "wasting" assets are subject to depreciation. The Section 179 expense election generally applies to personalty only, and is not available for most real estate. The cost of the building may not be currently deducted; it must be capitalized and depreciated because it has a useful life of over one year. LO 6.1.1

Answer 154

A) Explanation If the fair market value on the date of the gift is greater than the donor's adjusted basis, the donor's adjusted basis is used as the recipient's basis. Note that the donor's holding period would be tacked to the donee's holding period. LO 6.1.2

Answer 155

B) Explanation Jane is paying $750 plus the adjusted basis of $1,500 ($2,250); compared to the fair market value of the property received of $1,750, thus yielding a $500 loss. There is no loss recognized in a like-kind exchange. This exchange is simply treated as a sale of the asset. A loss on a Section 1231 asset may be recognized in the year of the loss. The Tax Cuts and Jobs Act (TCJA) restricted the like-kind exchange rules to real estate only. Personalty no longer qualifies for like-kind exchange treatment. LO 6.1.2

Answer 156

D) Explanation In the case of an asset received as a gift, where the fair market value on the date of the gift is greater than the donor's adjusted basis, the recipient has a carryover basis. In this case, Uncle Carl had purchased the stock for $12 per share and had gifted it to Susan when the fair market value was $15 per share. Susan subsequently sold the stock for $19 per share. Thus, the carryover basis from Uncle Carl would be $12 per share. In a situation where the recipient of the gift takes the donor's basis, the holding period is tacked. In other words, the donor's holding period is added to the donee's holding period. Thus, Susan is treated as holding the stock for over 15 years. LO 6.1.2

Answer 157

B) Explanation The seller's adjusted basis is the $80,000 purchase price, decreased by the $40,000 of straight-line depreciation. The mortgage has no bearing on the basis of the property. LO 6.1.2

Answer 158

C) Explanation The fact pattern indicates that Judy is in the lowest marginal bracket for three years, and will be in the highest marginal bracket after that. It makes no sense to maximize the depreciation deduction in years when Judy is in the lowest marginal brackets. By forgoing bonus depreciation and using straight-line, more deductions are pushed into the last five years of the depreciation schedule, when Judy will be in the highest marginal bracket. Remember that because of the half-year convention, seven-year property is depreciated over eight years. Under TCJA, 100% bonus depreciation is allowed for all personalty. In other words, 100% of the cost is deducted in the first year. LO 6.1.3

Answer 159

D) Explanation The installation charges of $1,200 and the sales taxes of $550 must be capitalized—that is, added to the cost of the copier to give a total basis of $10,000. A copier is five-year property. (Copiers, cars, computers, and computer peripherals are five-year properties; furniture and other equipment are seven-year properties.) The straight-line rate for five-year property is 20% (100% divided by five), but the half-year convention limits the deduction to half of a full year's depreciation in the year of acquisition. Thus, $10,000 times 10% equals $1,000. If Bryan had not opted out of bonus depreciation, the entire $10,000 would be depreciated in the first year. LO 6.1.3

Answer 160

B) Explanation The fact pattern indicates that Jerry is in the highest marginal bracket for three years, and then will be in the lowest marginal bracket after that. It makes sense to maximize the depreciation deduction this year when Jerry is in the highest marginal bracket. By using the bonus depreciation provision, the entire $730,000 may be deducted in the year of acquisition. LO 6.1.3

Answer 161

B) Explanation The entire gain of $69,000 is treated as Section 1231 gain, because there is no excess depreciation on the use of the straight-line method. So, $35,000 of the gain is subject to a maximum rate of 25%, as unrecaptured Section 1250 income, and the remaining $34,000 of gain is subject to the maximum regular long-term rate of 20%. The 20% long-term capital gain rate applies, as his taxable income is over the $425,800 breakpoint for the 20% rate. Note that Section 1250 recapture (ordinary income treatment) applies only to excess depreciation—in other words, the excess of an accelerated method over what would have been deducted if straight-line had been used. All realty placed in service after 1986 is depreciated using straight-line, and there is NO recapture (ordinary income) where straight-line depreciation was used. LO 6.1.4

Answer 162

C) Explanation A sale of Section 1245 property at a gain will result in Section 1245 recapture. None of the other choices are considered taxable dispositions that would trigger recapture of depreciation (cost recovery) deductions. LO 6.1.4

Answer 163

D) Explanation Statement II is incorrect. When Section 1231 property is sold at a loss, the loss is treated as an ordinary loss, not a capital loss. LO 6.1.4

Answer 164

A) Explanation The building and land sold when Blake's business moved to a new location qualify under Section 1231 as depreciable personal or real property used in business or for the production of income. The building portion of the property was depreciable property. While they are not considered capital assets, under Section 1231 they are taxed using capital gain rates, subject to the Section 1245 and 1250 rules for depreciation recapture rules. Losses are always ordinary and not subject to the $3,000 ($1,500 for MFS) ordinary loss limitation. Accounts receivable, inventory, and copyrights and other creative works held by the creator are all ordinary assets that would result in ordinary income tax (not capital gain) if sold at a gain. LO 6.1.4

Answer 165

C) Explanation The Section 179 expense election is limited to the taxable (earned) income of the taxpayer. For purposes of Section 179, salary or wages received as an employee, even from a completely unrelated source, are also considered to be from the active conduct of the trade or business. Thus, the total taxable (earned) income in this situation is $122,000. The maximum Section 179 expense election is $1.04 million (for 2020), but for Bob, it is limited to his earned or taxable income of $122,000 (increased by the Tax Cuts and Jobs Act, or TCJA). LO 6.1.5

Answer 166

D) Explanation Land is not a depreciable asset—only "wasting" assets are subject to depreciation. The building must be capitalized and depreciated over a period of 39 years. Section 179 generally does not apply to realty; it applies to tangible personalty used in the active conduct of a trade or business. LO 6.1.5

Answer 167

A) Explanation Long-term transactions are netted together, as are short-term transactions. The net long-term capital gain is $4,200 ($6,400 – $2,200). The net short-term capital loss is $3,200 ($2,300 – $5,500). The net short-term capital loss is netted with the net long-term capital gain ($4,200 – $3,200) to result in a net long-term capital gain of $1,000. LO 6.2.1

Answer 168

D) Explanation The long-term items are netted, leaving a long-term capital loss of $4,800. The short-term items are netted, leaving a short-term capital gain of $2,200. These are netted, leaving a net long-term capital loss of $2,600. LO 6.2.1

Answer 169

D) Explanation Fay can apply her short-term capital loss carryover to all current short-term capital gains, which results in a net short-term capital gain for this year of $1,000 ($6,000 gain − $5,000 carryover). She is then left with a net long-term capital loss of $35,000 ($5,000 gain − $40,000 carryover). To calculate net capital gains for the year, aggregate the long-term and short-term gains or losses, which in this case equals $35,000 long-term loss − $1,000 short-term gain, or a $34,000 net capital loss. She has no net gain and, as such, pays no taxes on any of the capital transactions she made this year. LO 6.2.1

Answer 170

C) Explanation The realized gain in Parcel A is $50,000 and the recognized gain (the lesser of the gain realized or the boot received) is $20,000. The realized loss in Parcel B is $15,000. However, there is no loss recognized (deducted) in a like-kind exchange. LO 6.2.2

Answer 171

C) Explanation In a like-kind exchange, the gain recognized is always the lesser of the gain realized or the boot received. If there is no boot received, there is no gain recognized. Inventory is not eligible for like-kind exchange treatment—thus, gain would be recognized. The basis in the acquired property is the FMV of the acquired property, reduced by the gain realized but not recognized (the deferred gain). LO 6.2.2

Answer 172

D) Explanation Jim is receiving an FMV of $240,000 for the duplex. He is giving up an adjusted basis of $85,000 plus $15,000 cash. The difference between the $240,000 received and the $100,000 given up is the realized gain of $140,000. The gain recognized (the taxable amount reported on the income tax return) in a like-kind exchange is the lesser of gain realized ($140,000) or boot received ($0). The substitute basis in an asset acquired in a like-kind exchange is the FMV of the qualifying property received ($240,000) reduced by the gain realized, but not recognized ($140,000 – $0 = $140,000). Thus, $240,000 – $140,000 = $100,000. LO 6.2.2

Answer 173

C) Explanation As a result of the Tax Cuts and Jobs Act (TCJA), casualty losses are only allowed for damages sustained within a federally declared disaster area. Thus, there is no deduction for this loss. If the loss had been incurred in a federally declared disaster area (as a result of the disaster), the deductible casualty loss computation would begin with the lesser of the decrease in fair market value ($15,000 decrease in FMV) or the adjusted basis in the property. In this situation, the adjusted basis of $12,000 must be reduced by a $100 floor, the insurance of $6,000, and further reduced by 10% of the adjusted gross income. Thus, $12,000 reduced by $100, $6,000 insurance, and further reduced by $4,250, equals $1,650. LO 6.2.3

Answer 174

B) Explanation Marcus's deferred gain on the new ring is $4,000. His new basis is the FMV of the property at acquisition minus the deferred gain ($20,000 − $4,000 = $16,000). LO 6.2.3

Answer 175

B) Explanation Statement II is incorrect. The taxpayer use test provides more flexibility than the functional use test. LO 6.2.3

Answer 176

A). Explanation The profit on the sale was $30,000 divided by the $100,000 contract price, which equals a 30% gross profit percentage. This is multiplied by the $40,000 of payments received during the year to calculate the amount of gain recognized, $12,000. The $38,000 of restoration costs are capitalized, added to basis, to give us the $70,000 basis. LO 6.2.4

Answer 177

C) Explanation Statement I is correct. Gain recaptured under Section 1245 (depreciable personal property used in a trade or business) is taxed as ordinary income and is not eligible for installment sale treatment. Therefore, these amounts are fully recognized (taxable) as ordinary income in the year of sale. Unrecaptured Section 1250 depreciation occurs only on depreciable real property (real estate) used in a trade or business. LO 6.2.4

Answer 178

B) Explanation The installment sale method cannot be used for inventory or securities traded in the secondary market. LO 6.2.4

Answer 179

A) Explanation Step 1: Calculate gross profit percentage: profit divided by sale price. $90,000$120,000=75%$90,000$120,000=75% Step 2: Calculate payments received in current year. $12,000 down payment + (10 × $5,000) = $12,000 + $50,000 = $62,000 (payments received) Step 3: Calculate gain recognized for current year. gross profit percentage×payments received=gain recognized 75%×$62,000=$46,500 LO 6.2.4

Answer 180

B) Explanation Jody's gain realized (the actual economic gain) from the sale is $353,560 ($538,000 of sales proceeds reduced by the adjusted basis of $184,400). Of this $353,560 of gain, the first $54,000 is recognized as unrecaptured Section 1250 gain, taxed at 25%. Unrecaptured Section 1250 gain is the gain created by the straight-line depreciation. This leaves $299,560 of gain to account for. Jody used the condo as her principal residence for two full years—thus, she is eligible to exclude $250,000 under Section 121. This leaves $49,560 of long-term capital gain to be recognized at a 20% rate (because she is in the highest marginal income tax bracket, her taxable income exceeds the $425,800 breakpoint for the 20% LTCG rate). The recognized gain is the gain on which Jody will pay taxes. Note that the nonqualified use provision does not come into play here as there was no nonqualified use after 2008. LO 6.2.5

Answer 181

C) Explanation Currently, Section 121 allows for a gain exclusion, of up to $500,000 for taxpayers married filing jointly, to any taxpayer who satisfies certain tests, known as the ownership test and the use test. To satisfy the ownership test, the home must have been owned and used as a principal residence for at least two of the five years preceding the date of sale. (Note: These years do not have to be consecutive; they only have to add up to at least two years.) Either spouse can meet the ownership test, but both must meet the use (two-out-of-five-year) test. This is likely not difficult for most married couples (applies even to those living in the house and then getting married), but it can be burdensome for individuals who are divorced or in the process of a divorce. LO 6.2.5

Answer 182

B) Explanation Active participation rental real estate investment operating losses are deductible against active or portfolio income up to $25,000 per year, assuming the investor's AGI is $100,000 or less. LO 7.2.3

Answer 183

B) Explanation The consulting income is included, meaning $84,000 is correct. The rental loss is allowable and used to calculate total income (Schedule E). The short term capital loss is capped at $3,000. LO 7.2.1

Answer 184

D) Explanation General partnerships, limited partnerships, and S corporations may all be tax conduits. LO 7.1.1

Answer 185

D) Explanation In an LLP, the general partners are not liable for the acts of other partners. In addition, some states will protect the general partners from the claims that arise from obligations of the partnership, but this typically extends only to claims arising out of tort law, not contract law. LO 7.1.1

Answer 186

D) Explanation The answer is I, III, and IV. II is false because the phase out range for the active participation real estate deduction is $100,000 to $150,000. LO 7.2.1

Answer 187

A) Explanation At the beginning of this year, Geoff had capital at risk of $89,000 ($70,000 initial investment + $19,000 allocated profit). At the end of the current year, Geoff's capital at risk is $61,000 ($89,000 beginning capital at risk – $28,000 allocated loss). LO 7.1.2

Answer 188

C) Explanation The partnership business form allows for special allocations. Partners are still subject to at-risk rules and AMT. LO 7.2.2

Answer 189

C) Explanation The partnership business form allows for special allocations. Partners are still subject to at-risk rules and AMT. LO 7.2.2

Answer 190

A) Explanation A vacation home can be classified as a personal residence, a rental property, or a mixed-use property. A personal residence is a property that is rented out for less than 15 days per year. Because the beach house was rented for 11 weeks, it will be classified as either a rental property or a mixed-use property. The determination is based on the number of days the taxpayer used the residence for personal use. To qualify as rental property, the personal use cannot exceed the greater of 14 days per year or 10% of rental days. The property was used for personal use for 16 days, so the vacation home will be considered a mixed-use property. Expenses incurred on a mixed-use property must be allocated between rental use and personal use. The rental expenses on a mixed-use property are only deductible to the extent of rental income received (i.e., the taxpayer cannot claim a loss). The expenses not deducted in the current year may be carried forward. LO 7.2.4

Answer 191

B) Explanation Because he will rent the home for 190 days, Mack can use it as a personal residence for up to 19 days (the greater of 14 days or 10% of rental use) without jeopardizing the property's status as a rental property. LO 7.2.4

Answer 192

A) Explanation Total income = $60,000. Adjustments = $6,000 + $12,000 + ($8,478 ÷ 2) = $22,239. $60,000 – $22,239 = $37,761. The passive loss is suspended because Natalia has no passive income to offset. LO 7.2.2

Answer 193

C) Explanation Partnerships are never subject to federal income tax. They are pass-through entities. C corporations and individuals are separately taxed, and certain S corporation transactions are taxed at the entity level. LO 7.1.1

Answer 194

A) Explanation The taxpayer's nonpublicly traded passive losses and nonpublicly traded passive income are aggregated for purposes of the limitation so that losses from one nonpublicly traded passive activity may offset income from another nonpublicly traded passive activity. LO 7.1.2

Answer 195

D) Explanation Both of these statements are correct. LO 7.1.1

Answer 196

D) Explanation The partnership and sole proprietorship income are included. The S corp distribution is treated as a dividend not subject to SE tax. ($26,500 x .9235) x .153 = $3,744 LO 7.2.1

Answer 197

C) Explanation An investment in an oil and gas working interest may reduce Jimmy's tax liability. LO 7.1.2

Answer 198

D) Explanation If the taxpayers file with the MFS status, the deduction is limited to $12,500. All other statements are true. LO 7.2.3

Answer 199

A) Explanation This problem requires the calculation of the net present value of the cash flows as compared to the $100,000 initial cash outlay. The net present value of the $12,500 received at the end of each of the first four years is first calculated. The present value of these four payments is $39,623. The calculation of present value of the amount received at the end of year five of $112,500 ($12,500 + $100,000) using a 10% rate yields $69,854. The $69,854 combined with the $39,623 results in a combined present value of all payments of $109,477. Subtracting the initial cash outlay of $100,000 results in a net present value of $9,477. Note that no tax liability would result from the cash flows as they would be "sheltered" by the passive losses. LO 7.1.1

Answer 200

A) Explanation A special allocation allows an allocation of items in a manner that differs from the "normal" pro rata allocation of deduction, income, credit, etc. LO 7.1.1

Answer 201

C) Explanation A partner's tax basis in a partnership interest is affected by items of income or loss, which are passed through to the partner on a proportionate basis. Items of income, as well as capital contributions, increase basis; deductions, as well as distributions, decrease basis. LO 7.1.1

Answer 202

D) Explanation Both of these statements are correct. LO 7.1.1

Answer 203

A) Explanation Passive loss rules apply to all passive activities, not just real estate transactions. Passive losses may be deducted against passive gains. If the investor has excess passive losses, the losses are carried forward and may be used in future years to offset future passive gains. LO 7.1.1

Answer 204

C) Explanation The AMT is paid when the AMT tax calculation produces a higher amount of tax than the regular tax calculation and the AMT payable is the difference between the two. LO 7.1.1

Answer 205

B) Explanation The tax advantages provided by direct participation programs are founded upon the principle that most types of business organizations function as tax conduits. Therefore, a closely held C corporation cannot qualify, as there is no flow through of gains and losses. LO 7.1.1

Answer 206

B) Explanation The passive activity loss limitation is not a permanent disallowance rule. When a taxpayer disposes of his entire interest in a fully taxable transaction to an unrelated purchaser (not a related party), his suspended losses from that activity, including any losses incurred in the year of disposition, are generally deductible in full. LO 7.1.2

Answer 207

C) Explanation Of the listed choices, option II is the only option to which the passive activity loss rules do not apply. The passive activity loss rules specifically do not apply to C corporations that are not closely held. LO 7.1.2

Answer 208

B) Explanation Passive losses are only deductible against passive income. She has passive income of $15,000 from the limited partnership, thus she could deduct up to $15,000 of passive losses from the equipment-leasing limited partnership. LO 7.1.2

Answer 209

B) Explanation The suspended passive losses are "freed up" and deductible only to the extent that the losses exceed the step-up in basis. In this situation, the step-up in basis equals $17,000 (from $1,000 to $18,000). The losses of $25,000 exceed the step-up amount by $8,000. LO 7.1.2

Answer 210

A) Explanation Special allocation rules, such as the substantial economic effect doctrine, limit the ability to utilize special allocations in a partnership. The at-risk rule limits the ability to utilize leverage by attacking the use of nonrecourse financing. The passive activity loss rule limits the ability to deduct losses from activities in which the taxpayer does not materially participate. The direct participation program simply refers to a tax conduit. LO 7.1.2

Answer 211

A) Explanation The active participation deduction is eliminated at $150,000 of AGI. The oil and gas limited partnership and the equipment-leasing limited partnership would produce more passive losses that are nondeductible. Therefore, none of the options are viable. LO 7.1.2

Answer 212

D) Explanation A partner's share of nonrecourse financing established basis in the partnership, but is not treated as an amount at risk. Remember that nonrecourse financing is debt that is secured by the property, but for which no individual has personal liability. LO 7.1.2

Answer 213

B) Explanation Options I and III are specific requirements that must be met in order for a taxpayer to able to deduct any losses from a real estate trade or business. The amount of the individual's net assets used in the business is not relevant. LO 7.2.1

Answer 214

C) Explanation Dwight is allowed to deduct $21,000 of losses in 2020. The $15,000 carryforward losses are treated as if they occurred in 2020. The $6,000 current losses plus the $15,000 carryover losses total $21,000. This loss would be fully deductible as the AGI is under $100,000. LO 7.2.1

Answer 215

A) Explanation The answer is $2,000, the suspended losses ($12,000) minus the basis ($10,000). LO 7.2.1

Answer 216

D) Explanation Of the $10,000 passive loss carryforward from the Beta limited partnership, only $6,000 may be utilized in the current year due to the $6,000 of current year passive income. A total of $11,000 in losses from the Alpha limited partnership may be utilized against the $11,000 of income from the Gamma limited partnership in the current year because both are nonpublicly traded. Thus, the total of passive losses that are allowed for the current year is $17,000. LO 7.2.2

Answer 217

B) Explanation The general rule is that passive losses are deductible only against passive income. However, passive income from a publicly traded partnership cannot be offset by passive losses arising from any other source. Thus, the passive losses from the new partnership will not be deductible. LO 7.2.2

Answer 218

C) I and IV Explanation Income from active participation rental activities is considered passive income. The nonpublicly traded limited partnership losses may not offset income from a publicly traded partnership (the MLP) or portfolio income. LO 7.2.2

Answer 219

A) Explanation Publicly traded partnership (PTP) income may only be offset by prior year losses from the same partnership. Thus, the $10,000 XYZ carryforward is deductible. Nonpublicly traded income ($18,000) may be offset by current losses ($14,000) or carryforward losses ($6,000) from any nonpublicly traded activities. Thus, the $10,000 XYZ loss and the $18,000 nonpublicly traded loss total $28,000. LO 7.2.2

Answer 220

D) Explanation Losses from a non-PTP may be deducted up to the amount of income from a non-PTP. In this situation, the passive loss of $9,000 may be deducted in full against the $17,000 of passive income. The income from a PTP may not be offset by passive losses arising from any other source, and the losses from a PTP must be held in suspense until that same partnership generates income. LO 7.2.2

Answer 221

C) Explanation III and IV are the only choices that are correct, by definition. The interest in the property may not, by definition, be held through a limited partnership, and up to $25,000 refers to losses that may be deducted, not credits that may be taken. The deduction-equivalent tax credits mentioned in option II are relevant with respect to low-income housing and historic rehabilitation passive activities. LO 7.2.3

Answer 222

A) Explanation Statement I is correct. Statement II is incorrect. If a loss is not allowed because of the at-risk limitations, the loss is a suspended loss and is not eligible for deduction as a disposition of a passive activity. LO 7.2.3

Answer 223

A) Explanation Jean receives the house on a tax-free basis because inheritances and gifts are not taxable to the recipient. However, any income generated by the house, such as rental income, is subject to taxation. LO 7.2.3

Answer 224

A) Explanation Statements II, III, and IV are correct. Only the real estate professional's activities are not considered passive. In statement IV, the taxpayer owns less than 10% of the activity, so it is considered passive. This taxpayer is barred from using the real estate exception for losses because the taxpayer owns less than 10% of the activity. LO 7.2.3

Answer 225

C) Explanation The rental real estate loss allowance is not available to taxpayers who file as MFS and have lived together at any time during the tax year. LO 7.2.3

Answer 226

D) Explanation In the Tax Code, the at-risk rules are defined as the maximum deductible loss for an investment limited to the amount that the taxpayer-investor has at risk at the end of the current year (i.e., the amount of potential economic loss). A partner may deduct losses only to the extent of the amount that they have "at risk." The amount at risk equals the sum of the following: The money invested (except to the extent the money invested was borrowed and was secured only by the investment) The adjusted basis of other property contributed to the partnership Amounts borrowed for use in the activity, but only to the extent that the partners are personally liable for repayment of the debt (recourse indebtedness) The partner's share of income, less the partner's share of losses or withdrawals from the partnership The proportionate share of qualified nonrecourse financing in a real estate activity ONLY Essentially, the only difference between the amount at risk and the basis in a partnership interest is the treatment of nonrecourse financing. LO 7.2.3

Answer 227

A) Explanation Income from rentals for fewer than 15 days during the year are not required to be included in gross income. However, no deductions attributable solely to the rental are allowed, either. The home mortgage interest and property taxes are still deductible in full as itemized deductions. LO 7.2.4

Answer 228

C) Explanation If property is rented fewer than 15 days per year, the full amount of home mortgage interest, taxes, and casualty losses are permitted as an itemized deduction (not expenses, though); in addition, rental income can be excluded from gross income. LO 7.2.4

Answer 229

D) Explanation Treasury Regulations have the full force and effect of law. A Private Letter Ruling is never precedential, and Revenue Rulings and Revenue Procedures are merely administrative interpretations of the statutory tax law with lower authority than Regulations. LO 8.1.1

Answer 230

D) Explanation Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. The primary purpose of the regulations is to explain and interpret particular IRS Code sections. LO 8.1.1

Answer 231

A) Explanation Regulations are a direct extension of the lawmaking powers of Congress, whereas revenue rulings are an application of the administrative powers of the Internal Revenue Service. LO 8.1.1

Answer 232

C) Explanation Regulations can be classified into three groups: (1) legislative, (2) interpretive, and (3) procedural. LO 8.1.1

Answer 233

C) Explanation A notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. The guidance is often substantial but again, ultimately it only points to higher regulations. Notices in and of themselves do not carry the weight of law. LO 8.1.1

Answer 234

C) Explanation Technical Advice Memoranda normally take place during an audit or during the appeals process of the audit; they give both the taxpayer and the revenue agent an opportunity to resolve a dispute over a technical question. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. A Notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. Announcements often summarize code sections in layman's terms, or notify taxpayers of impending deadlines; they have only short-term value. LO 8.1.1

Answer 235

D) Explanation The Federal Reserve System controls monetary policy. Income tax policy is used to influence all of the other goals. LO 8.1.2

Answer 236

A) Explanation The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes; taxation of taxpayers living abroad is not a main source of federal tax revenue. LO 8.1.2

Answer 237

C) Explanation The first, and perhaps most important, goal of the economic objective is price stability. As a social objective, JGTRRA and TCJA significantly increased the Section 179 expense limit and the amount of depreciation deductions (bonus depreciation) that may be claimed in the first year in an attempt to stimulate purchases of business assets. Revenue raising through corporate, individual, and payroll taxes is an important objective of the federal taxation system. LO 8.1.2

Answer 238

A) Explanation The reduction of taxes in order to stimulate the economy is due to the economic objective, as are restricting spending and promoting full employment. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home. LO 8.1.2

Answer 239

D) Explanation The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes. Individual income tax accounts for approximately 40% of the total tax revenue collected by the federal government. The federal estate tax and gift tax actually compose only a small percentage of annual tax revenues. LO 8.1.2

Answer 240

C) Explanation The following actions would constitute a tax return preparer's failure subject to a tax penalty: failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return. LO 8.2.1

Answer 241

A) Explanation Both clients and tax professionals alike may be held accountable for tax reporting errors. Financial planners should also be aware that a tax return preparer might be subject to certain penalties. These penalties include failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return. LO 8.2.1

Answer 242

C) Explanation Employers are required to withhold amounts from an employee's paycheck for Social Security taxes and federal income taxes. If the employer fails to do so or fails to pay such amounts to the IRS, they or any other responsible person will be subject to the 100% penalty, which is simply having to pay 100% of the amount they should have collected, accounted for, and paid; they are not subject to any additional penalty. LO 8.2.1

Answer 243

C) Explanation The determination of whether someone is a responsible person is a test of facts and circumstances. Some of the questions the IRS usually asks in determining responsibility are as follows: Was the individual an officer or director? Was the individual a shareholder? Was the individual a member of a board of directors? Did the individual have the authority to sign checks? Was the individual responsible for hiring and firing employees? Did the individual have actual authority or merely an impressive title? LO 8.2.1

Answer 244

D) Explanation The three types of tax audit performed by the IRS are as follows: a correspondence audit, which is usually performed through the mail because the disputed tax issue is minor; an office audit, which is usually restricted in scope to a specific item or items and is performed at the IRS office by an office auditor; and a field audit, which is an examination of numerous items and is usually performed on the premises of the taxpayer (such as a business office) by a revenue agent. LO 8.2.2

Answer 245

C) Explanation The National Research Program audit is the only random audit that the IRS conducts. The NRP is, in effect, the replacement for the old Taxpayer Compliance Measurement Program audit. The Discriminant Functions System Program (DIF) compares the information on each return to a set of norms, weighs each item, and ranks the return for audit-worthiness. The Document Matching Program allows the IRS to detect discrepancies between the amounts reported on a tax return and the amounts shown on information documents (e.g., W–2 forms, 1099 forms). Under the Targeted Program Audit, the IRS "targets" particular taxpayers in particular situations. LO 8.2.2

Answer 246

D) Explanation After the statute of limitations has passed, except in cases of fraud, the IRS cannot audit a return. The statutes to be aware of are as follows: three years from the filing date of the return or due date if later, six years if 25% of gross income is unreported, and no statute of limitations for failure to file or if a fraudulent return is filed. LO 8.2.2

Answer 247

D) Explanation The Form 4868 provides an automatic six-month extension of time to file the Form 1040. The return would be due April 15 without regard to extensions. With the six-month extension, the due date is October 15. LO 8.2.2

Answer 248

C) Explanation Darrell was only notified in December of the amount of the bonus that would be paid. No check was issued and the funds were not available until January of the following year. The check to Martha constitutes constructive receipt, whether or not she picks up the check in December. LO 8.2.3

Answer 249

B) Explanation The safe harbor is 90% of the current year's tax liability or 110% of the prior year's tax liability if the taxpayer's prior-year AGI exceeded $150,000. LO 8.2.3

Answer 250

B) Explanation A sale that is not bona fide and made for the sole purpose of realizing a loss from the transaction would be considered a sham transaction. LO 8.2.3

Answer 251

C) Explanation The negligence penalty is likely to be imposed, due to the failure to make a reasonable effort to comply with the requirements of the Code. This carries a penalty of 20% of the deficiency. LO 8.2.3

Answer 252

D) Explanation The safe harbor for avoiding the underpayment penalty is the lesser of 90% of the current year tax liability or 100% of the prior year tax liability (110% if the prior year's AGI was over $150,000). 100% of the prior year tax liability is $32,100. 90% of the current year tax liability of $38,000 is $34,200. The smaller of these numbers, reduced by the $5,000 withholding, equals $27,100. LO 8.2.3

Answer 253

D) Explanation The common exception for avoiding estimated tax penalties generally is 90% of the current year's tax or 100% of the prior year's tax. However, if the prior year's AGI exceeds $150,000, then the requirement is 90% of the current year tax or 110% of the prior year's tax liability. LO 8.2.3

Answer 254

C) Explanation Taxes must be paid on accrued interest on zero-coupon Treasury bonds even though no cash income is received. The other choices are legitimate tax avoidance techniques. LO 8.2.3

Answer 255

B) Explanation The fact that Gil retains ownership of the property and merely assigns the income to someone else is a potential tax trap for him. The assignment of income doctrine serves to tax the person who actually owns the property producing the income. The income cannot merely be assigned to another in order to generate tax advantages. LO 8.2.3

Answer 256

D) Explanation Statement II is incorrect. The 90%/100% underpayment criteria will still apply even though Brandon did not file in a timely manner. All of the other statements are correct. LO 8.2.3

Answer 257

B) B) Explanation For the cash method of accounting, all income actually received during the tax year is included in gross income (e.g., dividends, interest, wages). Income received constructively during the year, even though actual receipt is delayed, is includible for the tax year. Bonuses declared but not yet payable until the next tax year are not includible for the prior tax year because there was no constructive receipt. LO 8.2.3

Answer 258

A) Explanation This is essentially taxpayer fraud that does not rise to the level of criminal fraud (most of the income was declared), but is willful. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud. LO 8.2.3

Answer 259

A) Explanation This rule converts otherwise nontaxable receipts into taxable income. The most common example is when a taxpayer is reimbursed in a subsequent year for medical expenses paid and deducted in a previous year. LO 8.1.2

Answer 260

D) Explanation The negligence penalty is imposed if any part of the underpayment of tax is due to taxpayer neglect or a disregard for the tax rules and regulations, without the intent to defraud. The penalty is 20% of the portion of the underpayment attributable to negligence, which is $1,200 in this case. LO 8.2.3

Answer 261

D) Explanation Maria is attempting to intentionally deceive the IRS, which will likely result in a civil fraud penalty. LO 8.2.1

Answer 262

A) Explanation Congress has authorized the Secretary of the Treasury to prescribe and issue all rules and regulations needed for enforcement of the Code. Regulations can be classified into three groups: (1) legislative (Treasury Regulation), (2) interpretive (Tax Court opinion), and (3) procedural (United States Supreme Court opinion). LO 8.1.1 PREV

Answer 263

D) Explanation The answer is $400. The negligence penalty is 20% of the deficiency due to the taxpayer's negligence. For the $2,000 tax deficiency, 20% results in a negligence penalty of $400. It may be argued that the failure to report the income was fraud, but the fact pattern states that the act was merely negligent. LO 4.3.2

Answer 264

B) Explanation The tax benefit rule converts otherwise nontaxable receipts into taxable income. The most common example is when a taxpayer is reimbursed in a subsequent year for medical expenses paid and deducted in a previous year. LO 8.1.2

Answer 265

A) Explanation The tax benefit rule or doctrine converts an otherwise nontaxable receipt—in this case, the $200 state income tax refund—into taxable income. Melanie received a tax benefit by deducting the state income taxes the prior year, and any portion refunded to her would be taxable in the year it is received. LO 8.2.3

Answer 266

A) Explanation Wayne is attempting to deliberately deceive the IRS. This is civil fraud—essentially taxpayer fraud that does not rise to the level of criminal fraud. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud. LO 8.2.1

Answer 267

D) Explanation The IRS uses a targeted programs approach for approximately 25% of all returns audited. Targeted Program audits are not so much a revenue-raising device as they are a voluntary compliance device. When a particular problem area is singled out, the word quickly spreads, and voluntary compliance is greatly increased. LO 8.2.2

Answer 268

B) Explanation The negligence penalty is imposed if any part of the underpayment of tax is due to taxpayer neglect or a disregard for the tax rules and regulations, without the intent to defraud. The penalty is 20% of the portion of the underpayment attributable to negligence, which is $1,000 in this case. LO 8.2.2

Answer 269

A) Explanation A revenue ruling is an administrative interpretation of statutory tax law that is generally related to specific circumstances of fact. LO 8.1.1

Answer 270

A= itemized deductions B= interest & ordinary dividends C= sole proprietorship- profit or loss from business D= capital gains or losses E= S Corps, Partnerships, Rental RE SE= Self Employment tax

Answer 271

C) Explanation None; the payments to Susan are not deductible alimony. Child support comprises $300 of the monthly payments, and because there is a liability to continue making payments after Susan's death, the balance of the monthly payments do not qualify as deductible alimony. LO 9.2.1

Answer 272

A) Sale price$80,000 Basis($48,000) Long-term capital gain$32,000 LO 9.1.2

Answer 273

A) Explanation Property received by bequest generally receives a stepped-up basis to its fair market value (FMV) at the date of death. Claudia's basis in the art collection is $40,000. LO 9.3.1

Answer 274

B) Explanation The Turners would report a $6,394 loss on Schedule E for 2020, calculated as follows: Income net of management fees$14,000 Mortgage interest\*($12,594) Operating costs($1,400) Taxes($1,000) Association dues($4,400) Insurance premiums($1,000) Net loss($6,394) \*Assumed mortgage interest calculation Mortgage payments$17,244 Principal reduction Beginning balance (after 24 payments)$122,040 LO 9.1.2

Answer 275

A) Explanation Yes, both children meet the requirement of a qualifying child under IRS regulations. For a qualifying child, a taxpayer may claim an individual as a dependent if the individual satisfies all of the following requirements: The individual must meet one of the following relationships: Child, stepchild, foster child, or adopted child of the taxpayer Brother, sister, stepbrother, or stepsister of the taxpayer Descendants of any of the individuals listed above The individual must live with the taxpayer for more than half of the taxable year. The individual must pass an age test by meeting one of the following: Individual is under age 19 at the close of the tax year. Individual is a full-time student and under the age of 24 at the close of the tax year. Individual is totally and permanently disabled at any time during the tax year. The individual must not have provided more than half of her own support during the tax year. The individual cannot claim any other individual as a dependent. The individual may not file a joint return for the tax year (unless the only reason a return was filed was to obtain a refund of tax withheld). The individual generally must also be a US citizen, US national, or a resident of the United States, Canada, or Mexico. The child must be younger than the taxpayer. LO 9.3.1

Answer 276

D) Explanation Alice is subject to the kiddie tax rules. Alice Unearned income (UI)$4,000 Earned income (EI)$1,000 Gross income$5,000 Standard deduction($1,350)(earned income plus$350) Taxable income$3,650 UI taxed at her parents rate($1,800)($4,000 – $2,200) Income taxed at child's rate$1,850 LO 9.2.2

Answer 277

B) Explanation Bobby Fair market value of property received $85,000 Cash (boot) paid($45,000) $40,000 Adjusted basis in asset surrendered($15,000) Equals: Realized Gain$25,000 LO 9.1.2

Answer 278

C) Explanation Bobby paid boot; he did not receive it. Therefore, he has no recognized gain on the like-kind exchange. LO 9.3.2

Answer 279

B) Explanation A taxpayer who sells a principal residence can exclude up to $250,000 of gain ($500,000 if married) if he owned the home and used it as a principal residence for at least 2 out of the 5 years preceding the sale. Because both Claudia's mother and father have used the home as a principal residence for at least 2 of the last 5 years, the entire gain of $285,000 would be excluded from their income. LO 9.2.2

Answer 280

D) Explanation The portrait is related-use, capital gain property. Claudia may deduct an amount up to 50% of their AGI if she uses the basis of the painting and 30% of AGI if she uses FMV. As long as Claudia's AGI is greater than $6,667, she can deduct the FMV of the portrait. LO 9.2.1

Answer 281

D) Explanation Christopher may only file as a single taxpayer. He has no dependent children or other dependents in his household and does not qualify for either qualifying widower or head of household status. LO 1.1.1

Answer 282

A) Explanation Philip's AGI, after considering the passive investment (and loss), is $175,000. This consists of $140,000 of active income and $35,000 of portfolio income. Philip cannot deduct the passive loss of $25,000 against either active or portfolio income. In addition, he is further restricted to a total possible loss of only $15,000 because of the at-risk rules. LO 1.1.2

Answer 283

D) Explanation Total income is basically the starting point of the income tax calculation. The gambling winnings of $45,000, the unemployment compensation of $5,000, and the royalties of $10,000 are all included in income. Gambling losses are an itemized deduction, to the extent of gambling winnings; thus, they do not affect the total income. The life insurance proceeds received by reason of death of the insured are excluded from income. The IRA contribution is a potential adjustment to income, and does not affect the total income. Job-related moving expenses are only deductible for active duty military personnel who are undergoing a change of station. LO 1.2.1

Answer 284

B) Explanation The salaries of $125,000 reduced by the $24,000 of alimony payments equals $101,000. This is further reduced by $3,000 of net capital losses. Remember that only $3,000 of net capital losses are deductible in a given year, with an indefinite carryforward of the excess. The $12,000 of IRA contributions is also deductible. Even though both spouses are active participants in company-maintained retirement plans, their MAGI (AGI without the IRA contributions) is only $98,000. This is under $104,000 (for 2020)—the beginning of the phaseout range for married couples filing jointly, when both spouses are active participants. The property taxes are an itemized deduction, and do not affect the AGI. LO 1.3.1

Answer 285

B) Explanation The itemized deductions total $20,930. This is composed of the qualified home mortgage interest of $11,890, the real estate tax paid of $1,840, the investment interest expense of $3,500, the charitable contributions of $2,975, the state and local income taxes of $1,625, and the gambling losses to the extent of gambling winnings ($4,100). Note that the unreimbursed employee business expenses are not deductible because of TCJA. Also, the medical expenses are not deductible because they do not exceed 7.5% of adjusted gross income. Also note that in this situation the investment interest expense of $4,925 is deductible only up to the amount of net investment income, which in this situation is $3,500 (the interest income). Consumer interest (interest on personal auto loans, credit card debt, etc.) is nondeductible. Home mortgage interest$11,890 Property taxes$1,840 Investment interest expense$3,500 Charitable contributions$2,975 State and local income taxes$1,625 Gambling losses (to extent of winnings)$4,100 Allowable itemized deductions$25,930 LO 1.3.2

Answer 286

B) Explanation To compute the taxable income, we subtract the greater of the standard deduction (including the additional standard deduction for elderly or blind) or the itemized deductions from AGI. We also subtract the qualified business income (QBI) deduction, if any, to arrive at the taxable income. Exclusions are not reported on the return, so they don't need to be subtracted. Tax credits are deducted from the tax liability. LO 1.4.1

Answer 287

D) Explanation The effective income tax rate is the amount of income tax ($112,865) divided by the taxable income of $466,500. This gives us 24.2%. Taxable income$466,500 Less (from tax rate schedule)(414,700) Amount over $414,700$51,800 Times (marginal rate, from tax rate schedule)35% Tax on amount over $414,700$18,130 Plus (from tax rate schedule)94,735 Total Tax$112,865 LO 1.4.2

Answer 288

C) Explanation Qualifying expenses generally include only tuition. Amounts paid for books and supplies may be included only if required to be paid to the education institution as a condition of enrollment. The credit is available annually for an unlimited number of years. The credit is equal to 20% of qualified tuition expenses up to $10,000. All of the listed options, except for the phaseout limits, accurately describe the American Opportunity tax credit. LO 1.5.1

Answer 289

C) Explanation A MEC is a life insurance contract—it must meet one of the two Internal Revenue Code tests for life insurance, and the state law definition. The MEC is a life insurance contract that fails to meet the seven-pay test. LO 2.1.1

Answer 290

A) Explanation A nonperiodic distribution or withdrawal from a post-August 13, 1982 annuity contract is treated on a LIFO basis. In other words, to the extent that the cash surrender value exceeds the investment in the contract, taxable interest income is treated as being withdrawn first. The earnings on the investment in a commercial annuity are deferred—there is no current taxation on the earnings within the contract as long as an individual is the owner (or treated as an owner) of the contract. LO 2.1.2

Answer 291

C) Explanation The $13,000 short-term capital loss is first used against the collectibles gain—the gain that would be taxed at the highest rate (28%). This eliminates the collectibles gain. The remaining $3,000 short-term capital loss is then used against the $14,000 long-term capital gain from the sale of securities. This leaves $11,000 of long-term capital gain, taxed at 15%. We know the long-term capital gain is taxed at 15%, as the top of the 32% MITB is $207,350 (2020) for a single taxpayer, and the 20% LTCG rate doesn't kick in until $441,450 for a single taxpayer. LO 2.1.3

Answer 292

C) Explanation The investment interest expense ($7,700) is deductible up to the amount of the net investment income. The net investment income is simply the investment income of $9,000. Investment interest expense may be deducted up to the amount of investment income—$7,700 in this situation. The broker's commissions do not enter into this calculation, nor do the advisor's fees. They are not a deductible expense, and they are not part of the investment income. LO 2.2.1

Answer 293

B) Explanation The dividend from a life insurance policy is typically tax exempt. However, the dividend is taxable to the extent that the dividends received exceed the investment in the contract. The dividend is also taxable if it is from a MEC and received in cash, or is used to pay a loan. LO 2.2.2

Answer 294

C) Explanation They will pay the 3.8% Medicare contribution tax on $80,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($360,000 – $250,000, or $110,000). The net investment income is the investment income of $90,000, reduced by the investment expenses of $10,000. In this situation, the $80,000 of net investment income is subject to the Medicare contribution tax. Carl and Janet will pay a $3,040 Medicare contribution tax (3.8% on $80,000). LO 2.3.1

Answer 295

A) Explanation The deduction may only be claimed by the taxpayer legally obligated to make the loan payments. If the loan is in the student's name, the parents may not claim the deduction, even if they make the payments. The deduction is taken as an adjustment to income. There is a $140,000 to $170,000 AGI phaseout for a married couple filing jointly. An individual who is eligible to be claimed as a dependent may not take the deduction. LO 2.4.1

Answer 296

B) Explanation Of the listed choices, only option II is not an example of income shifting or splitting. The transfer of property to a grantor trust, by definition, involves the income being taxed back to the grantor. Thus, there would be no income shifting or splitting. LO 3.1.1

Answer 297

C) Explanation Alice is subject to the kiddie tax rules. Alice Unearned income (UI)$4,000 Earned income (EI)1,000 Gross income$5,000 Standard deduction(1,350) (earned income plus $350) Taxable income$3,650 UI taxed at parent's marginal rate (net unearned income)(1,800) ($4,000 – $2,200) Income taxed at child's rate$1,850 LO 3.2.1

Answer 298

D) Explanation The current deduction for a contribution of long-term capital gain property to a 50% organization is based on FMV but is limited to 30% of AGI. This results in a $30,000 current year deduction with a $20,000 carryforward. LO 3.2.2

Answer 299

D) Explanation Statement I describes a compensation-related loan between an employer-lender and an employee-borrower. Because the loan is in excess of $10,000 and is between a corporation and an individual, it is not eligible for treatment as a loan between individuals would be. New Media, Inc. will have interest income and compensation expense in the amount of the imputed interest. In Statement III, Faith's father will have imputed interest income because the loan is in excess of $100,000 and Faith's investment income for the year exceeds $1,000. In Statement II, the loan is not in excess of $10,000, so no interest is imputed. LO 3.3.1

Answer 300

C) Explanation "Investment interest in excess of investment income" is a made-up phrase. The other choices are all preference items or adjustments. Remember that interest from private-activity municipal bonds issued in 2009 and 2010 is not a preference item. LO 3.3.2

Answer 301

D) Explanation Spouses who file a joint return have joint and several liability for the payment of any tax due. This means each spouse is responsible for the entire tax liability and not just one-half. LO 4.1.1

Answer 302

D) Explanation The purpose of the premarital agreement is to limit the presumed effect of the marriage on property acquired prior to, or during, the marriage. The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party). State law does not impact federal income tax liability. The origin of the ring is irrelevant. LO 4.1.2

Answer 303

A) Explanation It would take $5,000 of deductions to equal the benefit of a $1,200 tax credit. This is determined by simply dividing the $1,200 of credit (savings) by the marginal income tax bracket of 24%. LO 4.2.1

Answer 304

A) Explanation To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party's financial situation. Enforceability requirements vary from state to state. It cannot be intentionally used to facilitate a divorce. LO 4.2.2

Answer 305

D) Explanation The salaries of $170,000 reduced by the $3,000 of net capital losses leaves $167,000 of total income. The $12,000 of IRA contributions is also deductible, as neither spouse is an active participant in a company-maintained retirement plan. After subtracting the $12,000 of IRA contributions, they are left with an AGI of $155,000. Even though they both have a 401(k), neither they, nor their employers, made contributions to the plans during the year, so neither spouse is treated as an active participant. The home mortgage interest is an itemized deduction and does not affect the AGI. Child support payments are not deductible. LO 4.2.3

Answer 306

C) Explanation The accrual method of accounting is often mandatory when inventory constitutes a significant income-producing factor. However, Carol's business qualifies for the small business exception, as average annual gross receipts are under $26 million. The hybrid method is incorrect because there is no indication that service constitutes a significant portion of the business. Also, the installment sale method is not available for sales of inventory or sales with revolving credit terms. The accrual method may always be used, but it lacks any flexibility. LO 5.1.1

Answer 307

B) Explanation Because 50% of the preferred dividends (and other dividends from stock) received by a corporation are exempt from federal income taxes, a corporation gains a tax advantage. The government and nonprofit organizations pay no income taxes. Mutual funds are also exempt from taxation. (TCJA reduced the dividend-received deduction to 50%.) LO 5.2.1

Answer 308

D) Explanation The S corporation is the best choice. This would allow the losses to flow through to the owners and would provide liability protection. The general partnership would not provide liability protection, and to form a limited partnership, there must be a general partner with unlimited liability, so neither of these options would be viable. The C corporation would not allow losses to flow through to the owners. LO 5.2.2

Answer 309

D) Explanation The S corporation will allow the potential losses to flow through to offset other individual income. Also, the use of the S corporation would allow for protection from lawsuits or business failure. Although the general partnership and the limited partnership would both allow for the flow-through of losses, the general partnership would not provide protection from personal liability. There is no indication that either party wants to be a general partner in a limited partnership, so general partnership is not correct. The use of a C corporation would not be appropriate because it is a separate taxable entity, and start-up losses would not flow through. LO 5.2.3

Answer 310

D) Explanation Self-employment income$45,000.00 Less 7.65% of $45,000(3,442.50) $41,557.50 Times tax rate15.3% Self-employment tax$6,358.30 Neither the interest income nor the capital gain is subject to the self-employment tax. LO 5.3.1

Answer 311

D) Explanation The home office expense deduction is limited to the earned income from the business. In other words, the home office expense deduction, in general, can neither create nor add to a loss. The only expenses that may create or add to a loss are the allocated amounts of home mortgage interest and property taxes. In this situation, the $24,000 of gross income is reduced by the $22,000 of business expenses not associated with the home office, to leave $2,000 of earned income. Thus, of the $2,750 of home office expenses, only $2,000 would be deductible in the current year. Note that the remaining $750 of home office expenses would be subject to a carryforward. LO 5.4.1

Answer 312

B) Explanation There is no recapture of depreciation on the sale of Section 1231 real estate. The gain created by the straight-line depreciation is referred to as unrecaptured Section 1250 income, which is a type of long-term capital gain that is taxed at a maximum rate of 25%. If the taxpayer's marginal tax rate is less than 25%, the unrecaptured Section 1250 gain will be taxed at that lower rate. LO 6.1.3

Answer 313

A) Explanation The gain realized and recognized is the difference between the $73,000 amount realized from the sale and the adjusted basis of $19,065. Thus, the total gain is $53,935. The Section 1245 cost recovery recapture is the lesser of the cost recovery deductions taken ($40,935) or the gain realized ($53,935). Thus, the Section 1245 income (cost recovery recapture) is $40,935. The remaining $13,000 of gain is attributable to actual appreciation of the asset; therefore, there is $13,000 of Section 1231 gain. The other way to look at this—the gain created by the depreciation deductions ($40,935) is treated as ordinary income, and the gain attributable to the actual appreciation of the asset ($13,000) is potential long-term capital gain under Section 1231. Remember that the installation is a cost associated with the acquisition of an asset and must be capitalized (added to basis). Thus, the original cost basis was $60,000. LO 6.1.4

Answer 314

C) Explanation The long-term gain and loss are netted, leaving a long-term gain of $5,800. Short-term gains and losses are netted, leaving a short-term loss of $200. Because there is a positive and a negative, these are netted to leave a net long-term capital gain of $5,600. LO 6.2.1

Answer 315

B) Explanation In a like-kind exchange, real estate must be exchanged for other real estate. Thus, the shopping center and the vacant lot are the only assets that would be qualifying property in a like-kind exchange of realty. The land-grading equipment is personalty and thus cannot be considered like-kind property. The interest in a limited partnership is specifically not allowed as qualifying property. Remember that like-kind exchange treatment is limited to realty for realty, as a result of TCJA. LO 6.2.2

Answer 316

A). Explanation Statement III is incorrect. No special certification is required for real estate investors. LO 7.1.1

Answer 317

D) Explanation The NRP audit is the only random audit listed here that the IRS conducts. This program essentially replaced the Taxpayer Compliance Measurement Program audit. LO 8.2.2

Answer 318

D) Explanation The long-term capital loss from the securities sale is netted first against the gain that would be taxed at the highest rate. After completely offsetting the collectibles gain (potential 28% rate), the remaining $12,000 is then netted against the unrecaptured Section 1250 income, leaving $6,000 unrecaptured Section 1250 income, to be taxed at 25%. LO 6.2.1

Answer 319

D) Explanation Gain is determined by the difference between the sales price of the shares held and the basis of the shares held. Basis is (200 × $15) + ($0.50 × 200), or $3,100. This represents the original cost of the 200 shares plus the reinvested dividends of $100. The number of shares owned must first be determined. The reinvested dividend of $100 is divided by the purchase price and added to the originally purchased shares. $100 ÷ $15 = 6.67 shares + 200 = 206.67 shares (these shares are then multiplied by the sales price of $16 to arrive at a total sales price of $3,307). $3,307 – $3,100 = $207 total gain on the sale. LO 2.1.3

Answer 320

C) Explanation This is computed as follows: Gain realized: Amount realized: Cash$100,000 Mortgage assumed by buyer85,000 Selling expenses(9,200) Total amount realized$175,800 Less adjusted basis ($120,000 + $80,000)(200,000) Loss realized(24,200) If a loss is realized on the sale of a principal residence, it is not deductible (recognized). LO 6.2.5

Answer 321

C) Explanation We must first compute the gain realized and then the gain recognized. To compute the gain realized (the actual economic gain), use the fair market value of the property received of $125,000 ($100,000 duplex plus $25,000 cash) minus the adjusted basis of the property given up ($62,000 warehouse) to equal a gain realized of $63,000. Next, we compute the gain recognized (the gain that is subject to taxation). The gain recognized is the lesser of the gain realized ($63,000) or boot received ($25,000). Thus, the gain recognized is $25,000. To compute the substitute basis in the acquired duplex, start with the fair market value of the qualifying property received (the $100,000 duplex). This is then reduced by the amount of the gain realized but not recognized (the untaxed, or deferred, gain of $38,000). The FMV of the qualifying property received ($100,000 duplex) reduced by the deferred gain of $38,000 equals the new basis of $62,000. LO 6.2.2

Answer 322

A) Explanation The premium for the first $50,000 of group term life insurance is not included in Michael's income from Asher Bank & Trust, but the Section 79 premium for the life insurance in excess of $50,000 is included. Michael must include 10 × $0.15 (Section 79 monthly cost per $1,000 of life insurance) × 12 months = $18.00. LO 9.1.2

FP 514 Tax Flashcards

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