INDIVIDUAL - TOTAL INCOME

Question 1

Cash-basis taxpayers are taxed on income when it is reported. True or False?

Answer 1

False.

Cash-basis taxpayers are taxed on income when it is received – this may be “actual” or “constructive” receipt.

Constructive Receipt occurs when the money is made available to the taxpayer without significant restrictions or limitations, regardless of whether or not they choose to get it.

Question 2

Jury Duty pay is not included in gross income. True or False.

Answer 2

False.

Jury duty pay is included in gross income and only deductible for calculating adjusted gross income (AGI) if it is surrendered to the employer in exchange for receiving the salary during the time of jury service.

Question 3

Compensation: Does an Accountable Expense Plan provided by your employer result in compensation income?

Answer 3

NO, so long as these 3 criteria are met:

1. The plan establishes a business connection for the travel, AND
2. The employee substantiates the expenses, AND
3. The employee returns amounts in excess of substantiated expenses.

Question 4

Compensation: Does an Non-accountable Expense Plan provided by your employer result in compensation income?

Answer 4

YES, because all the money given to the employee by the employer can be spent in anyway the employee sees fit.

All payments from the employer to the employee to reimburse travel expenses are taxable compensation income. That is the case even if the employee voluntarily returns unused expense reimbursement payments to the employer.

So don’t ever return Non-accountable Expense Plan funds.

Question 5

Interest income from state and Local government issued debt securities (ie. Municipal Bonds) is tax-exempt. True or False.

Answer 5

True.

An example is Municipal Bonds. Their interest is exempt from federal taxes, and if you buy bonds issued in your state, they’re also exempt from state income taxes.

Question 6

Dividends are taxed as ordinary income. True or False?

Answer 6

True.

Question 7

Dividends that are received on insurance policies are not considered to be a dividend. True or False?

Answer 7

True.

Question 8

Qualified dividends are taxed at a higher tax rate. True or False?

Answer 8

False.

Some dividends (called qualified dividends) are taxed at a lower tax rate – the capital gains tax rates.

They must meet the holding period requirement.

Question 9

State and local Tax Refunds are included as taxable income in the year the refund is received. True or False?

Answer 9

True.

Any item that provided a previous tax deduction and is refunded is includable in taxable income in the year refunded.

Question 10

How is Net Self-Employment income calculated?

Answer 10

Net Self-Employment income is the gross income from the taxpayers business minus the allowable deductions related to that gross business income.

Question 11

A self-employed taxpayer is required to report their gross self-employment income. True or False.

Answer 11

False.

If the taxpayer is self-employed, they must report their NET self-employment income. Not gross SE income.

Question 12

Are Director’s fees considered to be self-employment income. Yes or No?

Answer 12

Yes.

Question 13

What is the limit allowed for bad debt expense deductions for cash-basis taxpayers.

Answer 13

None. Cash-basis taxpayers are not allowed bad debt expense deductions since they do not include receivables in income for tax purpose.

Question 14

Even if a business is illegal, you’re still allowed to deduct marketing expenses, and overhead. True or False?

Answer 14

False.

If the object of the business is illegal, only the cost of merchandise may be deducted from revenues in calculating income.

Question 15

For an individual, capital losses that exceed the limit in a given year can only be carried forward for 5 years. True or False?

Answer 15

False.

Any capital losses that are not deductible because they exceed the limit in the current year can be carried forward indefinitely for an individual.

Question 16

Rent received from real estate is taxable when it is received. True or False?

Answer 16

True.

Side Note: If a residence is used for both personal residence and rental activities, the expenses of the property must be allocated between the residential use and the rental use when calculating net rental income.

Question 17

Any use of a rental property qualifies rental expenses to be deductible. True or False?

Answer 17

False.

The deductibility of vacation home rental expenses depends on the use of the property. If the property is rented for less than 15 days, no rental expenses are deductible, and no rental income is recognized.

Question 18

Unemployment compensation is partially taxable. True or False?

Answer 18

False.

Unemployment compensation is normally fully taxable.

Question 19

The distributive share of partnership or S Corp. income is taxable. True or False.

Answer 19

True.

Since an S-Corp does not pay taxes itself, the IRS requires all income and losses to be allocated to a shareholder, even if the corporation decides to keep some of the profits in the bank to pay for future expenses instead of distributing them to shareholders.

Question 20

Life Insurance proceeds are not taxable. True or False?

Answer 20

False.

Life insurance proceeds are taxable when the beneficiary of the policy and the heir of the estate for the insured person are different people.

This assumes an exchange or a sale of the policy has occurred.

ALSO, The proceeds from the insurance payout in excess of the cost of the policy are income for the taxpayer.

Question 21

When is Jury Duty Pay deductible?

Answer 21

Jury Duty Pay is always included in gross income, but can then be deductible for calculating adjusted gross income (AGI) IF it is surrendered to the employer in exchange for receiving the salary during the time of jury service.

Question 22

How is Jury Duty Pay taxed?

Answer 22

Jury Duty Pay is included in gross income and then deductible for calculating adjusted gross income (AGI) if it is surrendered to the employer in exchange for receiving the salary during the time of jury service.

Question 23

Discharged Indebtedness

Discharged debt is not taxable. True or False?

Answer 23

False.

Income from the discharge of indebtedness is taxable unless the discharge is the result of a bankruptcy or a gift.

Also, if there is a discharge relating to the purchase or improvement of a taxpayer’s primary residence, up to $2 million dollars of discharge can be excluded from income.

Question 24

All rental activities are considered to be passive unless the rental owner actively participates in the rental activity. True or False?

Answer 24

False.

All rental activities are considered to be passive even if the taxpayer actively participates in the rental activity.

Question 25

Define Passive Activity Loss.

Answer 25

Passive Activity Loss is the loss that comes from the conduct of a passive business. One that the taxpayer does not materially participate in.

Any passive activity losses can be carried forward indefinitely, or until the property is sold. When it is sold, the passive losses are recognized.

Rental Activity Exception: If the taxpayer actively participates in the rental activity, $25,000 of rental losses are deductible from regular income.

Real Estate Professional Exception: Real estate professionals are able to offset NO passive income with their rental real estate losses.

Question 26

What are 4 examples of distributions that MAY be taxable?

Answer 26

Health Savings Accounts (HSA)

Archer Medical Savings Accounts (Archer MSA)

Coverdell Education Savings Programs

Qualified Tuition Program (529s)

Question 27

What is the potential penalty for an employee not reporting tips to their employer?

Answer 27

If the employee did not report tips to the employer as required, the employee may be charged a penalty equal to 50% of the Social Security and Medicare tax due on those tips. IRS Form 4137.

Question 28

Tips received in Dec, but reported in January are still considered income from Dec. True or False?

Answer 28

False.

Tips that are reported, as required by the 10th day of the month following the month they were received, are considered income in the month they were reported. Therefore, tips received in December and reported before the 10th of January, are considered income for January.

Question 29

Child support is considered income. True or False?

Answer 29

False.

Child support is excluded from gross income.

Question 30

What is Form 4137 used for in relation to tips earned?

Answer 30

Use Form 4137 only to figure the social security and Medicare tax owed on tips you did not report to your employer, including any allocated tips shown on your Form(s) W-2 that you must report as income.

However, Form 4137 should not be used to report tips received for work covered by the Railroad Retirement Tax Act. In order to get railroad retirement credit, the taxpayer must report these tips to his or her employer.

Question 31

When must an employer assign “Allocated Tips?”

Answer 31

An employer must assign Allocated Tips only if:

1. an employee worked in an establishment (restaurant, cocktail lounge, or similar business) that must allocate tips to employees
2. the tips reported to your employer were less than your share of 8% of food and drink sales
3. an employee did not participate in the employer’s Attributed Tip Income Program (ATIP).

Question 32

What are allocated tips?

1. All tips that you receive.
2. Tips that your employer assigned to you in addition to the tips you reported to your employer for the year.
3. Only tips that you did not report.
4. Tips that you reported to your employer.

Answer 32

2. Tips that your employer assigned to you in addition to the tips you reported to your employer for the year.

Explanation:
Allocated tips are tips that your employer assigned to you in addition to the tips you reported to your employer for the year. Your employer will have done this only if:

1. You worked in an establishment (restaurant, cocktail lounge, or similar business) that must allocate tips to employees
2. The tips you reported to your employer were less than your share of 8% of food and drink sales
3. You did not participate in your employer’s Attributed Tip Income Program (ATIP).

Question 33

Tips not reported to the employer constitute gross income in the year when?

1. Received
2. Reported
3. Realized
4. Recognized

Answer 33

1. Received

Explanation:
Tips the employee did not report to his or her employer on time or did not report at all are considered income in the month actually received. For example, tips received in December 20X1 that are not reported to the employer by January 10, 20X2, are considered income in 20X1 because they were not reported to the employer on time. IRS Form 4137.

Question 34

Marge works as a waitress for less than minimum wage and gets a lot of tips in small change. Which of the following statements is true?

1. Marge’s tips are not subject to social security and Medicare tax.
2. Marge’s tips are subject to social security and Medicare tax.
3. Marge’s tips are hers to keep and do not have to be reported because she does not make minimum wage.
4. Marge only has to report $20 of those tips each month to her employer.

Answer 34

2. Marge’s tips are subject to social security and Medicare tax.

Explanation:
Tip income is subject to social security and Medicare tax. The taxpayer must give his employer a written report of cash and charge tips if he receives $20 or more in tips during a month. A taxpayer uses Form 4137 to figure the social security and Medicare tax owed on tips he did not report to his employer, including any allocated tips shown on Form(s) W-2 that he must report as income.

Question 35

Nancy works two part-time waitressing jobs. Last month her tips at the first restaurant only totaled $15, but they totaled $50 at the second restaurant. Which of the following statements is true?

1. She does not have to report her tips to her employers at all as long as she declares them as income at the end of the year.
2. She needs to report both sets of tips, because the total was more than $20 for the month.
3. She does not have to report the $15 in tips to the first employer, but does have to report the $50 in tips to the second employer.
4. She should ask the employer of the lower-tipping restaurant to report the $15 in tips as allocated tips on her W-2.

Answer 35

3. She does not have to report the $15 in tips to the first employer, but does have to report the $50 in tips to the second employer.

Explanation:
If, in any month, you worked for two or more employers and received tips while working for each, the $20 rule applies separately to the tips you received while working for each employer and not to the total you received.

Question 36

Emilio received tips on December 26 and reported them to his employer on January 9. His employer also reported allocated tips on his Form W-2. Which of the following statements is true?

1. The tips he reported are considered part of his income for December and will go on this year’s tax return and Form 4137.
2. The tips he reported are considered income for January and will go on next year’s tax return and Form 4137.
3. It does not matter when the tips were reported, they are considered income when they are received.
4. Emilio can file Form 4137 to report those tips for either tax year.

Answer 36

2. The tips he reported are considered income for January and will go on next year’s tax return and Form 4137.

Explanation:
Tips that are reported, as required by the 10th day of the month following the month they were received, are considered income in the month they were reported. Therefore, tips received in December and reported before the 10th of January, are considered income for January.

A taxpayer must file Form 4137 if they received cash and charge tips of $20 or more in a calendar month and didn’t report all of those tips to their employer. Taxpayer also must file Form 4137 if their Form(s) W-2, box 8, shows allocated tips that they must report as income.

Question 37

Leighton considers himself an employee of Olivia’s business. However, Leighton did not receive a W-2. Instead, he received a 1099-MISC. Which form should Leighton complete and attach to his tax return?

1. Form 1040
2. Form 4137
3. Form 5130
4. Form 8919

Answer 37

4. Form 8919

Explanation:
If you are an employee and you received Form 1099-MISC, Miscellaneous Income, instead of Form W-2, Wage and Tax Statement, because your employer did not consider you an employee, use Form 8919 to report Uncollected Social Security and Medicare Tax on Wages.

TIPS NOTE:
You must file Form 4137 if you received cash and charge tips of $20 or more in a calendar month and did not report all of those tips to your employer. You must also file Form 4137 if box 8 of your Form(s) W-2 shows allocated tips that you must report as income.

Question 38

Merry got a $10 tip from a customer at the bakery. That was the only tip she received all month. Which of the following statements is true?

1. Unless her employer asks, she does not have to report the $10 tip as income.
2. She does not have to report the tip to her employer if her tips total less than $20 for the month.
3. She can wait until the end of the year to report the tip to her employer.
4. She never has to report tips earned while working in a bakery.

Answer 38

2. She does not have to report the tip to her employer if her tips total less than $20 for the month.

Explanation:
All tips received are income and are subject to federal income tax.

Employees must give their employers a written report of cash and charge tips if they received $20 or more in tips during the month. Employees should use Form 4137 to figure social security and Medicare taxes on tips not reported to the employer.

Question 39

Joyce, a cash basis taxpayer, sells high-end jewelry and works on a commission basis. When business is slow she is allowed to receive advances on her commissions. In June Joyce received an advance of $3,500 and in August she received an advance of $5,000. In addition to these advances, her commissions earned and received during the 20X1 year were $73,000. She paid the advances back on January 3 of the following year after she received her December commissions. How much income should Joyce report for 20X1?

1. $81,500
2. $78,000
3. $73,000
4. $76,500

Answer 39

1. $81,500

Explanation:
Under the cash method, a taxpayer receiving advance commissions or other amounts for future services must include these amounts as income in the year received.

Question 40

When Noelle was fired from her job, she was offered a choice of either $2,000 severance pay or $1000 severance pay and outplacement services. Noelle chose to receive $1,000 and the outplacement services. How much should she report as income for her severance package?

1. $0. Severance pay is not taxable.
2. $1000
3. $1000 plus the fair market value of the outplacement services
4. $2000

Answer 40

4. $2000

Explanation:
A taxpayer must include in income amounts received as severance pay. If the taxpayer chooses to accept a reduced amount of severance pay so she can receive outplacement services (such as training in resume writing and interview techniques), she must include the unreduced amount of the severance pay in income. Noelle must include the full $2,000 severance pay in her income.

Question 41

Lincoln works in a restaurant as a busboy and receives a portion of the tips that are pooled at the end of each evening. His employer reported these as allocated tips on his W-2. Which of the following statements is true?

1. He needs to file Form 4137 for the allocated tips.
2. He does not have to file Form 4137 because the employer reported them on his W-2.
3. He does not have to report tips because the tips were not specifically for his services.
4. He does not have to report those tips as income.

Answer 41

1. He needs to file Form 4137 for the allocated tips.

Explanation:
You must file Form 4137 if box 8 of your Form(s) W-2 shows allocated tips that you must report as income. You must also file Form 4137 if you received cash and charge tips of $20 or more in a calendar month and did not report all of those tips to your employer.

Question 42

Form 8919

Answer 42

Form 8919 is used to report Uncollected Social Security and Medicare Tax on Wages that are reported on a 1099-MISC.

Question 43

Childcare providers, including babysitters, must include their pay in their gross income. True or False?

Answer 43

True.

Taxpayers who are not employees must include payments for services on Schedule C (Form 1040) and complete Schedule 1. This applies to babysitting, even if only periodically or just for relatives.

Question 44

US citizens and resident aliens residing OUTSIDE the United States may be able to exclude all or part of their foreign source earned income. True or False?

Answer 44

True.

Question 45

When are Passive Activity Losses realized?

Answer 45

Any passive activity losses can be carried forward indefinitely, or until the property is sold. When it is sold, the passive losses are recognized.

NOTE: Real Estate Professional Exception: Real estate professionals are NOT able to offset passive income with their rental real estate losses.

Question 46

What is defined as Earned Income? (S, W, T, PF, TS, FG)

Answer 46

Salaries, Wages, tips, professional fees, taxable scholarships, and fellowship grants.

Question 47

What is defined as Unearned Income? (9 categories)

UE, SS, P, A, CD, T, I, D, CG

Answer 47

• Unemployment compensation
• Taxable Social Security benefits
• Taxable Pensions
• Annuity Income
• Cancelled Debt
• Unearned Income from a Trust
• Taxable Interest
• Dividends, and
• Capital gains.

Question 48

Gross Income Threasholds for Standard Deductions

Answer 48

Single = $12,200
Single >65 = $13,850
MFJ both = $24,400
MFJ one > 65 = $25,700
MFJ both >65 = $27,000
MFS = $5
HOH = $18350
HOH >65 = $20,000
QW = $24,400
QW >65 = $25,700

Question 49

Why file a tax return even if you’re not legally obligated to?

Answer 49

To get a refund of any Federal Income Tax withheld.

Or, if you're eligible for any of the following:
EIC (Earned Income Credit)
ACTC (Additional Child Tax Credit)
AOTC (American Opportunity Tax Credit)
PTC (Premium Tax Credit)
HCTC (Health Coverage Tax Credit)
Credit for Federal Taxes Paid on Fuels

Question 50

Tips reported to the employer will be included in the employee’s _________?

1. W-2
2. W-4
3. W-9
4. 1099

Answer 50

1. W-2

EXPLANATION:
Form W-2 will include the tips reported by the employee to his or her employer, as well as the taxes withheld. If there was not enough money to cover the Social Security and Medicare tax (or railroad retirement tax), the Form W-2 will also show the tax due in box 12 with codes A and B. IRS Form 4137.

Question 51

Generally, a taxpayer must report to his or her employer tips received in excess of _________?

1. $20 per month
2. $50 per month
3. $200 per year
4. $500 per year

Answer 51

1. $20 per month

EXPLANATION:
If the taxpayer received cash and charge tips of $20 or more in a calendar month, he or she must report the amount received to the employer. IRS Form 4137.

Question 52

Reportable tips include _________?

1. Cash received from customers
2. Charges distributed by the employer
3. Tip-sharing arrangements
4. All of the above

Answer 52

4. All of the above

EXPLANATION
The taxpayer must report any tip exceeding $20 per month to his or her employer. This includes all tips, including cash tips received from customers, charged tips distributed by the employer, and tips received from other employees under any tip-sharing arrangement. IRS Form 4137.

Question 53

Penny had income from the following sources, which one is excluded from gross income:

1. Hourly wages from her job as a tipped employee
2. Child support from her son’s father
3. Money earned from babysitting her neighbor 2 days per week
4. Severance pay from her first job which downsized due to the economy

Answer 53

2. Child support from her son’s father

EXPLANATION
Child support is excluded from gross income. Wages, even if a tipped employee, babysitting earnings and severance pay are all included in gross income.

Question 54

A taxpayer should use the following form to figure the social security and Medicare tax owed on tips he did not report to his employer:

1. Form 2137
2. Form 3137
3. Form 4137
4. Form 5137

Answer 54

3. Form 4137

EXPLANATION
A taxpayer uses Form 4137 to figure the social security and Medicare tax owed on tips he did not report to his employer, including any allocated tips shown on Form(s) W-2 that he must report as income.

Question 55

Rev. William Wilson is a full-time minister. The church allows him to use a parsonage that has an annual fair rental value of $24,000. The church pays him an annual salary of $67,000, of which $7,500 is designated for utility costs. His actual utility costs during the year were $7,000. What is his income for income tax purposes?

1. $59,500.
2. $60,000.
3. $67,000.
4. $91,000.

Answer 55

2. $60,000.

EXPLANATION
For income tax purposes, Rev. Wilson excludes $31,000 from gross income ($24,000 fair rental value of the parsonage plus $7,000 for utility costs). The portion of salary not designated for utility costs is $59,500. Out of the $7,500 for utility costs he only spends $7,000, and must include the $500 difference in income. For income tax purposes, he reports $60,000 ($59,500 salary plus $500 of unused utility allowance). His income for SE tax purposes is $91,000 ($67,000 + $24,000 fair rental value of the parsonage.)

Question 56

Randy Lee is an ordained minister of a tax-exempt church. Randy receives a salary plus a housing allowance for rent and utilities. Which of the following statements is correct?

1. Randy must claim as income on his return all of his salary and all of his housing allowance. The salary is subject to income tax and self-employment tax but his housing allowance is subject to income tax only.
2. Randy does not have to report any income received from the church because the church is tax exempt.
3. Randy has to pay both income tax and self-employment tax on his salary, but only self-employment tax for the housing allowance. The housing allowance is not subject to income tax.
4. Randy only has to pay the self-employment tax on both his salary and the housing allowance. Neither is subject to income tax.

Answer 56

3. Randy has to pay both income tax and self-employment tax on his salary, but only self-employment tax for the housing allowance. The housing allowance is not subject to income tax.

EXPLANATION
Members of the clergy must include in income any salary and fees received for masses, marriages, baptisms, funerals, etc. Payments to the religious institution are not taxable. The rental value of a home (including utilities) or any designated housing allowance provided is not income. However, the exclusion cannot be more than the reasonable pay for services rendered. Exclude an allowance designated for utility cost only up to the actual utility cost. The home or allowance must be compensation for services rendered as an ordained, licensed, or commissioned minister. However, the rental value of the home or the housing allowance must be included as earnings from self-employment (on Schedule SE) if self-employment tax is applicable.

Question 57

Sarah is a U.S. citizen employed by the International Red Cross and is receiving her paycheck from the headquarters in Geneva, Switzerland, even though she is currently based in the U.S. Which of the following statements is true?

1. Sarah’s income is subject to Swiss tax law, not U.S. tax law.
2. Sarah has to pay Social Security and Medicare employee taxes.
3. Sarah has to pay self-employment taxes on her earnings.
4. Sarah has to pay both self-employment tax and Social Security and Medicare employee taxes.

Answer 57

3. Sarah has to pay self-employment taxes on her earnings.

EXPLANATION
Employees of international organizations or foreign governments within the United States are exempt from Social Security and Medicare employee taxes. However, such an employee must pay self-employment taxes on earnings from services performed in the United States, even though the employee is not self-employed.

Question 58

During the tax year, Reverend Markham was provided free use of a home and free meals from his church. His income for serving as the active minister of the church was $15,000. The rental value of the home was $12,000 and the meals $4,050. The church did not withhold any taxes from his income. On what amount must he pay self-employment taxes?

1. $4,050
2. $12,000
3. $15,000
4. $31,050

Answer 58

4. $31,050

EXPLANATION
This question asks on what amount Reverend Markham must pay self-employment taxes. The amount Reverend Markham must pay self-employment taxes on is $31,050 ($15,000 salary + $12,000 rental value of home + $4,050 meals provided)

In most cases, you must pay SE tax on salaries and other income for services you performed as a minister. You must include the rental value of a home or an allowance for a home furnished to you and the value of meals and lodging provided to you, your spouse, and your dependents. The rental value of the home or the housing allowance must be included as earnings from self-employment (on Schedule SE) if self-employment tax is applicable.

The rental value of a home (including utilities) or any designated housing allowance is excludable from income (for income tax purposes) provided it is not more than reasonable pay for services rendered. Any allowance designated for the cost of utilities is excludable, up to the actual utility cost. The home or allowance must represent compensation for services rendered as an ordained, licensed, or commissioned minister.

Question 59

Emilio is a U.S. citizen and is employed by the Italian Embassy in Washington DC. Which of the following statements is true?

1. Emilio has to pay Social Security and Medicare employee taxes.
2. Emilio has to pay self-employment taxes on his earnings.
3. Emilio’s income is subject to Italian tax law, not U.S. tax law.
4. Emilio has to pay both self-employment tax and Social Security and Medicare employee taxes.

Answer 59

2. Emilio has to pay self-employment taxes on his earnings.

EXPLANATION
While FICA and SECA both pertain to social security and medicare payments, FICA is administered on employer/employee relationships and SECA applies to self-employed taxpayers.

Employees of an international organization or a foreign government in the United States are exempt from Social Security and Medicare employee taxes.

For U.S. citizens the income paid for services rendered to an international organization is reportable as self-employment income on their U.S. federal income tax returns, and is subject to self-employment tax to the extent such services are performed within the United States.

Question 60

Taxable interest is generally reported to a taxpayer on which forms?

1. Form 1099-MISC; Schedule INT
2. Form 1099-I; Schedule D
3. Form 1099-INT; Schedule K-1 for partnerships and S corporations
4. Form 1099-INT; Schedule B

Answer 60

3. Form 1099-INT; Schedule K-1 for partnerships and S corporations

EXPLANATION
A taxpayer must report taxable interest from Form 1099-INT and/or Schedule K-1 for partnerships and S corporations.

Question 61

Stephanie received her tax refund for the tax year 20X1 in November of 20X2. Because there was a delay in issuing the refund, the IRS paid Stephanie $50 interest. How should Stephanie report the interest on her 20X2 tax return?

1. No reporting is required. The IRS does not pay interest.
2. No reporting is required. The interest is part of her refund which is exempt from tax.
3. She reports it with the rest of her taxable interest income on Form 1040.
4. She reports it as Other Income on Form 1040.

Answer 61

3. She reports it with the rest of her taxable interest income on Form 1040.

EXPLANATION
If a taxpayer is due a refund, the IRS may pay interest on it. The interest rates are adjusted quarterly. If the refund is made within 45 days after the due date of the return, no interest will be paid. If the refund is not made within the 45-day period, interest will be paid from the due date of the return or from the date you filed, whichever is later.

Interest received on tax refunds is taxable income. The interest is reported with other taxable interest on Form 1040.

Question 62

Municipality X issues a bond with a face value of $10,000. Municipality X will redeem the bond at face value in five years. In order to obtain the bond from Municipality X, an investor must pay $8,000. What is the (OID) Original Issue Discount in this case?

1. $8,000
2. $2,000
3. $0
   4 $10,000

Answer 62

2. $2,000

EXPLANATION
OID is defined as the difference between the stated redemption price at maturity and the issue price.

$10,000 – $8,000 = $2,000

Question 63

Matthew Kennedy received a dividend from Mayflow Corporation during the current year. Matthew has elected to use Mayflow’s dividend reinvestment plan to purchase additional stock at FMV with the dividend received. The dividend was $1,500 and the FMV of the stock purchased was $1,475. A $25 service charge was applied to this transaction. What must Matthew report as dividend income on his current year tax return?

1. $0
2. $1,500
3. $1,525
4. $1,475

Answer 63

2. $1,500

EXPLANATION
Because Matthew is participating in a dividend reinvestment plan, he must report as dividend income, the fair market value of the stocks as of the day the dividend (along with any related fees paid for purchasing the stocks if paid out of the dividend declared by the company) was received. All $1,500 of the purchase price and service charges were paid out under the dividend reinvestment plan and all $1,500 is reportable as dividend income.

Question 64

A distribution of stock, or rights to acquire stock in the distributing corporation, is not included in the recipient’s gross income unless:

1. Shareholders have the choice to receive cash or other property instead of stock or stock rights
2. The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation’s assets or earnings and profits to other shareholders
3. The distribution is preferred stock for some common shareholders and common stock to other
4. All of the above

Answer 64

4. All of the above

EXPLANATION
Distributions by a corporation of its own stock or stock rights (also known as stock options) are generally not taxable, and a holder of such options need not report them on a return. Distributions of stock dividends and stock rights are taxable if any of the following apply:

Shareholders have the choice to receive cash or other property instead of stock or stock rights.
The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation’s assets or earnings and profits to other shareholders.
The distribution is in convertible preferred stock, resulting in a change of ownership.
The distribution is preferred stock for some common shareholders and common stock to others.
The distribution is on preferred stock.

Question 65

Arena, Inc. decided to distribute shares of its own stock to its employees at year-end as a reward for a profitable year. Each employee was to receive 10 shares with a fair market value of $100 per share. Employees were offered a choice of cash or the stock dividend. What is the tax effect on the employees of this distribution?

1. $0; distributions of stock dividends and stock rights are tax-free to shareholders
2. $1,000 taxable income to the employees who chose to receive cash and no effect on the employees who received stock
3. $1,000 taxable income to each employee
4. None of the above

Answer 65

3. $1,000 taxable income to each employee

EXPLANATION
Distributions of stock dividends and stock rights are taxable if employees have the choice to receive cash or other property instead of stock or stock rights.

Since the employees were offered a choice of cash or the stock dividend, $1,000 is taxable income to each employee.

Question 66

The following statements about dividends received from a dividend reinvestment plan are correct EXCEPT:

1. Reinvested dividends are not taxable if not removed from the plan
2. Reinvested dividends are taxable in the year paid
3. Reinvested dividends are taxable and are added to the basis of the stock or mutual fund
4. Reinvested dividends are treated as ordinary or qualified dividends

Answer 66

1. Reinvested dividends are not taxable if not removed from the plan

EXPLANATION
Dividends are taxable as income when received. The fact that they are re-invested does not matter. The question contains the word EXCEPT, which is intended to trick you. All are correct EXCEPT implies that the answer is the only one that is FALSE. Don’t fall for this trick.

Question 67

Which of the following is NOT a qualified retirement plan?

1. A qualified pension, profit-sharing, or stock bonus plan
2. Modified endowment contracts
3. 401(k)
4. A tax-sheltered annuity contract

Answer 67

2. Modified endowment contracts

EXPLANATION
A qualified retirement plan includes:

A qualified pension, profit-sharing, or stock bonus plan (including 401(k) plan)
Tax-sheltered annuity contract
Qualified annuity plan

NOTE: A modified endowment contract is a life insurance contract.

Question 68

What are Modified Endowment Contract?

Answer 68

Modified Endowment Contracts are life insurance contracts.

They are NOT a Qualified Retirement Plan

Question 69

Ethel is 65 years old. She receives money from her two investment accounts to supplement her retirement income. She withdraws $25,000 from her IRA and $10,000 from her annuity. She received a 1099-R reflecting the amount of the distributions, including $2,500 withheld for taxes by the custodian of her IRA. She is filing a paper Form 1040 return. What should Ethel do with the Form 1099-R’s?

1. Attach each 1099-R to her tax return to report both distributions
2. Keep them for her records. The information is already reported to the IRS, so she does not need to send anything in.
3. Attach only the 1099-R from her IRA because income tax was withheld.
4. Attach only the annuity 1099-R because an IRA custodian already reports IRA distributions to the IRS on Form 1098

Answer 69

3. Attach only the 1099-R from her IRA because income tax was withheld.

EXPLANATION
The recipient of an informational return does not send copies to the IRS unless required. A taxpayer must attach (or transmit if filing electronically) Form W-2 to the front of a Form 1040 series tax return. A taxpayer should also attach (or transmit if filing electronically) Forms W-2G and 1099-R, but only if federal income tax was withheld.

Question 70

Dean and Cathy are married filing a joint tax return for 20X1. They were both 74 years old at the end of that year. Each of them received $7,500 of Social Security benefits in 20X1. In addition, they received taxable pension payments totaling $12,000 for Dean and $6,000 for Cathy. How much of the Social Security benefits received by Dean and Cathy are taxable?

1. $15,000
2. $10,500
3. $7,500
4. $0

Answer 70

4. $0

EXPLANATION
Their total income from sources other than Social Security is $18,000 (taxable pension $12,000 Dean + $6,000 Cathy). Total Social Security income is $15,000 (each received $7,500 Social Security benefits), one-half of which is $7,500. Combine one-half of Social Security benefits and total income from other sources to arrive at provisional income. Social Security benefits are not taxed when provisional income is below $32,000 on a joint tax return. This is the case for Dean and Cathy ($18,000 + $7,500 = $25,500 provisional income), therefore $0 of the Social Security benefits received by Dean and Cathy are taxable.

Question 71

Social Security benefits are not taxed when provisional income is below $32,000 on a joint tax return. True or False?

Answer 71

True.

Question 72

What is Provisional Income and how is it calculated?

Answer 72

Provisional income is a measure used by the IRS to determine whether or not recipients of Social Security are required to pay taxes on their benefits.

Provisional income is calculated by adding up a recipient’s gross income, tax-free interest, and 50% of Social Security benefits.

If Provisional Income is $25,000 or less for a single filer, or $32,000 or less for joint filers, no tax is owed on Social Security benefits.

Question 73

Hector, who is 71 years of age and single, received Social Security benefits of $12,000, wages of $5,000, interest and dividends of $5,500, which included $1,500 of tax-exempt interest. He also received unemployment compensation of $3,000. Calculate Hector’s adjusted gross income.

1. $22,200
2. $25,500
3. $9,600
4. $12,000

Answer 73

4. $12,000

EXPLANATION
Social Security benefits are not taxed if provisional income is less than the lower base amount. For single taxpayers, this threshold is $25,000. Provisional income is one-half of Social Security benefits, plus all other income, including tax-exempt interest.

Hector’s provisional income is less than $25,000, so none of his social security benefits are included in income. His AGI of $12,000 does not include the tax-exempt interest. $5,000 wages + $4,000 taxable interest and dividends (does not include the portion $1,500 that is tax-exempt) + $3,000 unemployment benefits = $12,000.

Question 74

Social Security benefits are not taxed when provisional income is below $25,000 on a single tax return. True or False?

Answer 74

True.

Question 75

To find out if a taxpayer’s Social Security benefits may be taxable, all of the following are taken into account EXCEPT:

1. interest that is tax-exempt.
2. the exclusion for foreign earned income.
3. notary fees received.
4. unemployment benefits.

Answer 75

2. the exclusion for foreign earned income.

EXPLANATION
A taxpayer cannot exclude foreign income from the calculation for Social Security benefits. Thus, the taxpayer does not take into account the “exclusion for foreign earned income”.

A taxpayer must include in income a portion of social security benefits received when provisional income exceeds a specified base amount.

Determine provisional income as follows:

One-half of Social Security benefits, plus
All other income, including tax-exempt interest.
A taxpayer cannot exclude income received from interest from qualified U.S. Savings bonds, employer-provided adoption benefits, foreign earned income or foreign housing or earned as a resident of American Samoa or Puerto Rico.

§86(b)(2); Publication 17

Question 76

Mark Johnson had earned income this year of $68,000. In addition, he also received $4,000 in social security benefits. What is his adjusted gross income?

1. $68,000
2. $70,000
3. $71,400
4. $72,000

Answer 76

3. $71,400

EXPLANATION
At low-income levels, social security benefits payments are tax-free. However, when the taxpayer has a reasonably high-income level (such as Johnson has in this case), social security is 85 percent taxable. Thus, Johnson has to pay tax on 85 percent of $4,000 or $3,400. There is a relatively small transitional level of income where 50 percent of social security is taxable.

His adjusted gross income is $71,400 ($68,000 earned income + $3,400 taxable social security).

Question 77

Which of the following situations requires the individuals named to report the funds received as taxable income?

1. Dean, who is given money for highway tolls by the passengers in his carpool.
2. Marilyn, who is given money by a real estate developer to influence her vote as a city council member for a new municipal football stadium.
3. Joey, who is given a subsidy by a public utility for purchase of energy efficient appliances for his home.
4. Peter, who inherits a 1951 Mickey Mantle baseball card from his deceased uncle.

Answer 77

2. Marilyn, who is given money by a real estate developer to influence her vote as a city council member for a new municipal football stadium.

EXPLANATION
The bribe paid to Marilyn is income. In fact, all income from illegal activities must be reported on a taxpayer’s Form 1040, either on Schedule 1 as Other Income or on Schedule C.
-The money Dean receives from carpool passengers is a reimbursement.
-The subsidy paid to Joey by a public utility for energy conservation is excluded from income.
- Bequests, such as the one Peter receives, are also excluded from income—even if the bequest is cash.

Question 78

Mr. Lucky wins $2,000 from gambling in 20X1. Unfortunately, he also loses $2,700 in other gambling activities. Mr. Lucky is single and has no dependents. He plans to take the standard deduction. What is the impact of his gambling activities on his taxable income for 20X1?

1. Increases taxable income by $2,000
2. Decreases taxable income by $700
3. Has no impact on taxable income
4. Increases taxable income by $2,000 but also decreases it by $2,000.

Answer 78

1. Increases taxable income by $2,000

EXPLANATION
The winnings from gambling activities are reported as taxable income. Losses are shown separately as miscellaneous itemized deductions. However, Mr. Lucky is taking the standard deduction rather than itemizing his deductions. Therefore, the losses have no impact. Only the winnings appear on the tax return for this year.

Question 79

FIT & SE Taxes

Answer 79

Federal Income Tax (FIT) - tax assessed on adjusted gross taxable income.
- Salary/ Wages/ Fees for services

Self-Employment tax (SE) -Social Security and Medicare tax on earnings of self-employed.

• Salary/ Wages/ Fees for services
• Housing Allowance/ parsonage
• Utilities Allowance

Question 80

What is an Annuity?

Answer 80

A series of payments under a contract made at regular intervals over a period of more that 1 year.

Question 81

Mike spends $120,000 for an immediate annuity. The insurance company will pay Mike $600 each month for the next 20 years. What is the tax free portion of each payment?

Answer 81

$120,000 / 240 = $500 is tax free, out of the $600 payment.

Question 82

The maximum rate of tax on Qualified Dividends is:

Answer 82

0% - on any amount that otherwise would be taxed below the 15% rate,

15% - on any amount that otherwise would be taxed at rates between 15% ad 37%,

20% - on any amount that otherwise would be taxed at a 37% rate.

Question 83

To qualify for the maximum tax rate for a Qualified Dividend:

Answer 83

The dividends must be paid by a U.S. corportation or a qualified foreign corp, and the taxpayer must hold the stock for more than the 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Question 84

Ex-Dividend Date is:

Answer 84

The first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment. Instead, the seller will get the dividend.

Question 85

When reinvesting dividends in the purchase of more stock, rather than receiving cash, is the dividend reportable as income?

Answer 85

Yes. Even in this case the dividends must be reported as income.

Question 86

Non-Dividend Distributions

Answer 86

A “Non-Dividend Distribution” is a distribution that in NOT a payment from the earnings and profits of a corporation. This is not a dividend, rather it is a return of an investment in the stock of a company, and it reduces the basis of the stock.

It is NOT taxable until the taxpayer fully recovers their basis.

When the stock basis reaches zero, report any additional non-dividend distribution as a capital gain.

Question 87

Stock Options

Answer 87

A distribution by a corporation of its own stock or stock rights.

Stock Options are generally not taxable and not necessary to report.

Taxable Exceptions:
1. Shareholders have the choice to receive cash or other property instead of stock.

2. If some shareholders get cash and others get stock.
3. The distribution is in convertible preferred stock, resulting in a change of ownership.
4. The distribution is preferred stock for some and common stock for others.
5. The distribution is preferred stock.

Question 88

Interest that is earned should be reported to the taxpayer by the payer of the interest in what form(s)?

Answer 88

Form 1099-INT or

1099-OID.

Question 89

What amount of Capital Loses can an individual deduct?

Answer 89

Individuals can deduct capital losses to the extent of capital gains + $3,000 per year against ordinary income.

Any losses that are not deductible because they exceed the limit in the current year can be carried forward indefinitely.

Question 90

Are Royalties taxable? If so, when?

Answer 90

Yes, Royalties are taxable when received.

Question 91

Are Gambling Winnings taxable?

Are gambling Losses deductible?

Answer 91

Gambling winnings are fully taxable.

Gambling losses are deductible only to the extent of winnings as an itemized deduction.

Question 92

What is the threshold of taxable interest requiring a TP to attach a Schedule B to Form 1040?

Answer 92

A TP with over $1,500 of taxable interest or ordinary dividends must attach Schedule B to Form 1040

Question 93

CD (Certificate of Deposit)

Answer 93

A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions. CDs differ from savings accounts in that the CD has a specific, fixed term (often one, three, or six months, or one to five years) and usually, a fixed interest rate.

Question 94

Series EE Bonds

Answer 94

Series EE Bonds are often referred to as PATRIOT BONDS.

• Series EE Bonds are interest-bearing U.S. government savings bonds guaranteed to at least double in value over their typical 20-year initial terms.
• Some Series EE bonds pay interest beyond the original maturity date, up to 30 years from issuance.
• There is a $25 minimum investment requirement for EE bonds.
• Every investor may purchase up to $10,000 in these bonds each calendar year.
• Interest is credited at maturity. TPs who use the cash-method of accounting may elect to defer reporting interest until maturity; those using the accrual method must report interest on US Savings Bonds each year as it accrues.

Interest may be tax free if used for qualified education expenses.

Question 95

Series I Bonds

Answer 95

Series I Bonds are:

• non-marketable, interest-bearing U.S. government savings bonds
• Series I bonds give investors a return plus protection on their purchasing power and are considered a low-risk investment.
• The bonds cannot be bought or sold in the secondary markets.
• Series I bonds earns are a fixed interest rate for the life of the bond for an inflation rate that is adjusted each May and November.

** In effect, the interest on Series I bonds is variable and changes over time, making it difficult to forecast the value of the bonds years from today.

Series I bonds are considered low risk since they are backed by the full faith and credit of the U.S. government and their redemption value cannot decline. But with this safety comes a low return, comparable to that of a high-interest savings account or certificate of deposit (CD). Corporate and municipal bonds, however, can lose value; with this risk comes a higher return.

Question 96

What is the Education Savings Bond Program?

Answer 96

Interest from Series I or EE bonds may be tax-free is used to pay for qualified education expenses the same year. it is NOT available when MFS.

A TP uses Form 8815 to figure the exclusion and attaches the form to Form 1040.

Question 97

Nominee Distribution

Answer 97

If you receive interest that belongs to another person shown on a Form 1099-INT, report the full amount shown as interest on Schedule B. Below a subtotal of all interest income listed, enter “Nominee Distribution” and the amount of interest income that belongs to the other person.

Anyone who receives interest as a nominee must file Form 1099-INT along with Form 1096 (Annual Summary and Transmittal of U.S. Informations Return” by Feb 28.2020 (March 31 if filing electronically).

When Dividends are received as a nominee, the same process applies, but on Form 1099-DIV.

Question 98

What is Original Issue Discount (OID)?

Answer 98

OID is a form of interest. TPs include a portion of the discount as income as it accrues over the term of the debt instrument.

OID is the difference between the stated redemption price at maturity and the issue price.

The IRS presumes that all debt instruments that do not pay interest before maturity are issued at a discount. Zero-coupon bonds are one example of these instruments.

Question 99

When can a TP treat the OID discount as zero?

Answer 99

A TP can treat the OID as zero if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity.

This small discount is known as “de minimis” OID.

Question 100

OID does NOT apply to the following debt instruments:

Answer 100

• Tax-Exempt Obligations
• U.S. Savings Bonds
• Short Term Debt Instruments
• Obligations inssued by an individual before Marcdh 2, 1984
• Loans between individuals if ALL the following are true:
  1. The lender is not in the business of lending money
  2. All outstanding loans between the same individuals total $10,000 or less.
  3. Avoiding any Federal Tax is not one of the principal purposes of the loan.

Question 101

What is a Dividend?

Answer 101

A Dividend is a distribution of property paid by the corporation to its stockholders.

It is the most common type of corporate distribution.

Dividends are paid out of the earnings and profits of a corp.

Question 102

Where are Dividends generally reported?

Answer 102

On a Schedule K-1.

Question 103

What are the two types of Dividends?

Answer 103

Ordinary Dividends

Qualified Dividends

Question 104

How do you calculate a stocks holding period?

Answer 104

The calculation should include the day the stock was disposed of, but NOT the day acquired.

Question 105

How are amounts received from Money Market Funds to be reported?

Answer 105

Funds from Money market Funds are reported as Dividend Income.

Money Market Funds are a type of MUTUAL FUND, and are not to be confused with Bank Money Market Accounts that pay interest.

Question 106

What is a Qualified Distribution for a Roth IRA and is it taxable?

Answer 106

A qualified distribution is any payment or distribution from a taxpayer’s Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for his benefit, and
2. The payment or distribution is:
   a. Made on or after the date the taxpayer reaches age 59 1/2,
   b. Made because the taxpayer is disabled,
   c. Made to a beneficiary or to the taxpayer’s estate after his death, or
   d. One that meets the requirements for a First home

If it is a qualified distribution, the earnings and contributions are tax free when withdrawn. The text notes that earnings inside of the Roth IRA are tax deferred, and qualified distributions are tax free when removed. Distributions from a Roth IRA are qualified only if made after the 5 year anniversary of establishing and funding the account.

Question 107

A cash dividend on a Life Insurance policy is taxable. true or False?

Answer 107

FALSE.

Dividends on a life insurance policy are not taxable; they are treated as a reduction in the expense of the policy.

Note:
However, Cash Dividends from corporations and mutual funds are taxable even if they are reinvested. Dividends in a company’s own stock are usually tax-free unless the owner also had the option of taking cash instead.

Question 108

Do SOSEPP payments from an IRA incur a 10% penalty for early distribution?

Answer 108

No.

EXPLANATION
The 10% tax will not apply if distributions before age 59.5 are made as part of a series of substantially equal periodic payments (SOSEPP under IRS Rule 72t) beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his designated beneficiary. (Payments, except in the case of death or disability, must continue for at least five years or until the employee reaches age 59.5, whichever is longer.)

Question 109

Form 8606

Answer 109

Filed to report nondeductible contributions to a Traditional IRA.

NOTE:
You can not deduct a contribution to a Traditional IRA if your income exceeds the limit when covered by a retirement plan at work.

Question 110

When does an Annuity Exchange avoid recognition of taxes?

Answer 110

When the exchange takes place during the “accumulation phase” under Section 1035.

Question 111

Guidance for Distributions of IRAs and Qualified Retirement Plans Due To Death.

Answer 111

The surviving spouse may elect to treat an inherited IRA or qualified retirement plan as their own by rolling the account into their name.

All other beneficiaries generally must withdraw the entire balance of the retirement account within 10 YEARS or over a specified period, depending on several factors, including the age of the decedent, age of the beneficiary, and the type of beneficiary (i.e., individual, trust, or estate).

TIP:
A portion of funds within retirement plans or annuities has never been taxed or has accumulated free of tax. This amount, if withdrawn by the original account owner, would be subject to income tax. If the account owner dies this amount becomes “Income In Respect Of A decedent” (IRD) and is taxable to the beneficiary of the account upon withdrawal.

Question 112

A taxpayer must include foreign income in the calculation for Social Security benefits.

True or False?

Answer 112

True.

EXPLANATION
A taxpayer cannot exclude foreign income from the calculation for Social Security benefits. Thus, the taxpayer does not take into account the “exclusion for foreign earned income”.

A taxpayer must include in income a portion of social security benefits received when provisional income exceeds a specified base amount.

Determine provisional income as follows:

1. One-half of Social Security benefits, plus
2. All other income, including tax-exempt interest.

A taxpayer cannot exclude income received from interest from qualified U.S. Savings bonds, employer-provided adoption benefits, foreign earned income or foreign housing or earned as a resident of American Samoa or Puerto Rico.

Question 113

If a spouse files MFS but lives together with their spouse any time during the year, their base amount used to determine the taxability of SS benefits drops to $0. True or False?

Answer 113

True.

The $25,000 MFS threshold does NOT apply if they live together at any time during the year. In that case, 85% of benefits are taxed.

NOTE:
If living apart for the entire year, the base amount for each spouse is the same as that of a taxpayer with a status of single.

Question 114

Gambling winnings are Included in gross income.

True or False?

Answer 114

True.

EXPLANATION
A taxpayer must report gambling winnings as income. A taxpayer may take gambling losses as an itemized deduction on Schedule A but only to the extent of gambling winnings.

Question 115

Are bribes considered income?

Answer 115

Yes.

In fact, all income from illegal activities must be reported on a taxpayer’s Form 1040, either on Schedule 1 as Other Income or on Schedule C.

Question 116

Reimbursement, such at money for tolls for a carpool, are NOT considered taxable income.

True or False?

Answer 116

True.

Question 117

Are Bequests taxable?

ie. a 1951 Mickey Mantle baseball card from a decedent

Answer 117

Usually not

One reason that the recipient of a bequest is usually not taxed on the bequest is because the donor may be taxed on it. Donors of bequests may be taxed through other mechanisms such as federal wealth transfer taxes. Wealth Transfer taxes, however, are usually imposed against only the very wealthy.

Question 118

What is the proper handling of losses from Passive Activity (Rental Real Estate) loss?

Answer 118

Passive losses from rental real estate activities which are not allowed in the current year are carried forward indefinitely until used up.

Question 119

For Rental Properties, the deductible expenses are limited to the amount of rental income received.

True or False?

Answer 119

True.

Question 120

When is painting a rental property NOT a considered a repair?

Answer 120

Painting is typically a repair, but if the taxpayer makes repairs as part of an extensive remodeling or restoration of the property, the whole job is considered an improvement.

Question 121

On what Schedule is Rental Income and Expenses on?

Answer 121

Schedule E

However, if the TP provides substantial services in conjunction with the property, or the rental is part of a trade or business, then the Income and Expenses would be reported on a Schedule C.

NOTE: The big difference when reporting Real Estate Rental on Sch C is that losses are NOT subject to the passive activity limits, AND income is subject to SE tax.

Question 122

When does the IRS treat rental real estate property as a HOME?

Answer 122

The IRS treats rental real estate property as a 2nd home if it is used for personal purposes for more than the greater of 14 days or 10% of the total days rented to others.

Question 123

How is Pre-Paid rent taxed?

Answer 123

The normal rule is that if a taxpayer receives prepaid rent, it is immediately taxable unless it is likely that it will have to be returned. She received $12,000 in Year One and that amount is taxable at that time.

Advance rent is any amount received before the period that it covers. For tax purposes, include advance rent as rental income during the year the taxpayer receives the income, regardless of the period covered or the method of accounting used.

Question 124

A taxpayer can deduct the cost of repairs to rental property, but not the cost of improvements.

True or False?

Answer 124

True.

The cost of improvements is recovered through depreciation. Repainting a property is considered a repair (unless done as part of an extensive remodeling or restoration of the property).

The other items are improvements to the property. Improvements add to the value of the property, prolong its useful life, or adapt it to new use.

Question 125

Section 162(a) in regards to Trade or Business

Answer 125

Allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

NOTE: Section 262, however, provides that NO deduction is allowed for personal, living, or family expenses.

Problem: Section 262 does NOT provide a definition of a trade or business!!

Question 126

4 potential limitations on losses for individual taxpayers.

Answer 126

1. Basis Rules
2. At-Risk Limitations
3. Passive Activity Limitations
4. Excess Business Loss Limitations

Question 127

Basis Rules (Limitation on Losses)

Answer 127

A TP may not claim a loss greater than the adjusted basis of his S Corp or Partnership interest.

The disallowed losses and deductions due to the Basis limit may carry forward indefinitely, and can be deducted subject to the basis limit for that year.

Question 128

At-Risk Limits (Limitation on Losses)

Answer 128

Any loss from an activity subject to the At-Risk Rules is allowed ONLY to the extent of the total amount at risk in the activity at the end of the tax year.

A TP is at-risk in any activity for:

1. The money and adjusted basis of property he contributes to the activity
2. Amounts borrowed for use in the activity if
   - He is personally liable for repayment
   - He pledges property as security for the loan.

Question 129

Passive Activities (Limitation on Losses)

Answer 129

A TP with a loss from a passive activity can offset the loss with income from other passive activities.

Generally a TP is unable to deduct a loss from a passive activity.

Carry forward any excess passive activity loss (PAL) or credit to the next tax year and use to offset only passive income.

Passive Activity Rules apply to:
- Individuals
- Estates
- Trusts (other than grantor trusts)
Personal Service Corporations
- Closely Held Corporations

TIP: Even though the rules don’t apply to Grantor Trusts, Partnerships, and S Corps directly, they do apply to the owners of these entities.

For a Closely Held Corporation, the passive activity loss is the excess of passive activity deductions over the sum of passive activity gross income and net active income.

Question 130

Excess Business Loss (Limitation on Losses)

Answer 130

The TCJA limits the amount of losses from the trades or business of noncorporate TPs that the TPs can claim each year.

TPs can’t deduct overall net business losses that are more than a threshold amount in the current year.

For 2019, the MAXIMUM net business loss an individual TP may deduct is $255,000 ($510,000 MFJ).

The amount of Excess Business loss is treated as a Net Operating Loss Carryforward in the subsequent year.

Question 131

Can you carry forward excess business loss in subsequent years?

Answer 131

Yes.

A TP treats any excess business loss as part of the TP’s Net Operating Loss (NOL) Carryforward in subsequent years.

The IRS now limits the amount of NOL a TP may claim the following year to 80% of taxable income determined without regard to the NOL deductions.

Prior to this new law, a TP could reduce taxable income to zero in subsequent years.

Question 132

NOL

Answer 132

Net Operating Loss

A TP with annual business deductions that exceed business income may have a Net operating Loss.

Some typical losses that may produce a NOL are:

• A trade or business
• A casualty or theft
• Moving Expenses (for Military only)
• Rental property

Question 133

What is the NOL Carryforward period?

Answer 133

A net operation loss may be carried forward indefinitely and used as a deduction in the future period.

TCJA NOTE: The general 2-year net operating loss (NOL) carryback rule does NOT apply to NOLs arising in taxable years beginning after Dec 31, 2017. The TP may carry the loss forward indefinitely. Exceptions apply to certain farming losses (2-year carryback) and NOLs of property and casualty insurance companies.

Question 134

An Excess business Loss is:

Answer 134

An excess business loss is the amount by which the total deductions from taxpayer’s trades or businesses are more than total gross income or gains from taxpayer’s trades or businesses plus the threshold amount.

Question 135

An excess business loss is treated as a net operating loss (NOL) carryover.

True or False?

Answer 135

True