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Flashcards in Module 1 Deck (21)
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Ethan is reviewing the file for his client, Landon, whose wife died in March of last year. Landon filed a joint income tax return for last year, and Ethan is reviewing scenarios that could impact this year’s income tax return filing—particularly those regarding Landon’s filing status. Landon has not remarried and continues to maintain a home for his two dependent children. Which of the following filing statuses would be best for the year after the death of Landon’s wife?

A. Single. He is no longer married.
B. Married filing separately. Because his wife died last year, he can still file as married, but it must be MFS.
C. Head of household. He did not remarry and has continued to maintain a home for his two dependent children.
D. Qualifying widower. He did not remarry and has continued to maintain a home for his two dependent children.


Landon should file as a qualifying widower with dependent child for the two years after his wife’s death. This assumes he continues to meet the tests for claiming his children as tax dependents throughout this period.


The basic income tax formula is

A. income (broadly conceived) less exclusions from gross income and less adjustments for AGI, less the greater of the standard deduction or itemized deduction, less allowable tax credits to equal taxable income.
B. income (broadly conceived) less adjustments for AGI and less the greater of the standard deduction or the itemized deduction to equal taxable income.
C. income (broadly conceived) less exclusions from gross income, less tax credits, and less adjustments for AGI to equal taxable income.
D. income (broadly conceived) less exclusions from gross income, less adjustments for AGI and the greater of the standard deduction or the itemized deduction to equal taxable income.


Income (broadly conceived) less exclusions from gross income and subtract adjustments for AGI, and the greater of the standard deduction or the itemized deduction to equal taxable income.


It is September, and Jonah is meeting with his client, Cade, for year-end tax planning. He has prepared interim financial statements and projected a tax liability for the current year based on what Cade said his expenses will be through the end of the year. Jonah has reviewed cash inflows and outflows for the entire year and notes that some expenses paid in the current year could have been paid in the prior year, to some tax advantage. What should Jonah recommend to Cade?

I. Jonah should identify those expenses that can be paid this year instead of next year and explain the tax advantages of paying them before this year ends.
II. Because Cade has already paid expenses this year that could have been paid last year, Jonah should not recommend deduction clustering this year.

The answer is I only. Even though expenses that could have been advantageous to pay last year were paid this year, Jonah may still recommend that Cade take advantage of deduction clustering this year.


Which of the following types of income is considered net earnings from self-employment and is subject to self-employment tax?
I. Net Schedule C income
II. K-1 distributions from a general partnership
III. K-1 distributions from an S corporation

I & II

Only K-1 distributions from an S corporation are not treated as self-employment income subject to self-employment tax. Net Schedule C income is income from a sole proprietorship, and general partnership K-1 distributions are treated as self-employment income. General partners are considered self-employed for tax purposes.


On January 1 of this year, Joshua loaned his daughter, Georgia, $80,000 interest free to purchase a new personal residence. There were no other loans outstanding between Joshua and Georgia at this time. Georgia’s only income was her salary of $45,000 and $3,000 of interest income. Joshua had investment income of $50,000. If the relevant federal interest rate for this year was 6%, which of the following statements regarding this loan is CORRECT?

A. Joshua must recognize imputed interest income of $3,000.
B. Joshua must recognize imputed interest income of $4,800.
C. Georgia is allowed a deduction for an imputed interest expense of $4,800.
D. Georgia must include $4,800 of imputed interest income on the loan.


The imputed interest income inclusion is limited to Georgia’s NII of $3,000 because the loan is not more than $100,000 and is made between individuals. The federal rate inclusion is $4,800 ($80,000 × 0.06), which is more than Georgia’s NII. Joshua also makes a gift to Georgia of the $3,000 amount of imputed interest.


On July 1 of this year, Michael is in need of $12,000 to resolve some emergency plumbing repairs for his home. His supervisor, Tom, recommends to their employer, Waterworks, Inc., that the company lend Michael the cash he needs so the repairs may be made quickly. The loan is approved with a 2% interest rate at a time when the federal interest rate is 4.5%. At the end of the year, Michael reports to Waterworks, Inc., that he has investment income of $750. Which of the following statements is CORRECT?

A. Waterworks, Inc., has made a gift loan to Michael.
B. Michael has imputed interest income equal to his investment income of $750.
C. Waterworks, Inc., has $270 of interest income and $150 of compensation expense.
D. Because Michael’s investment income is less than $1,000, Waterworks, Inc., does not have to recognize interest income or compensation expense relative to this loan.


Waterworks, Inc., and Michael have entered into a below-market compensation-related loan. Because this loan is more than $10,000, the lender-employer has interest income for the last half of the tax year of $270 [($12,000 × 0.045) ÷ 2]. Because Michael pays 2% interest for six months, [($12,000 × 0.02) ÷ 2 = $120], the employer has a compensation expense of $150 ($270 − $120), and Michael has compensation income of $150. A below-market loan from an employer is a compensation-related loan, not a gift loan. The amount of Michael’s investment income has no bearing on the amount of interest imputed on this below-market loan, as this is not a gift loan between individuals.


On January 20 of this year, Amanda brings her tax records to Erin, a CFP® professional, to prepare her annual income tax return for the last tax year. As Erin reviews the documents, she notices that there is no earned interest reported by the bank on a sizable savings deposit Amanda has with the institution. When Erin questioned Amanda, she said she did not have to report interest income in the last tax year because she did not receive anything from the bank last year advising her that she earned any interest. What should Erin tell Amanda about the interest income on the savings deposit at the bank?

A. The constructive receipt rule does not apply to bank savings accounts.
B. Because the bank has not notified Amanda of the interest earned on her savings deposit, she does not have to report it.
C. Amanda received the interest when it was earned on her deposit last year, and it is includable in her income for last year.
D. Amanda is required to report the interest earned last year on her savings deposit on her current-year income tax return because she will receive notice of the amount this year on a Form 1099 from the bank.


Amanda must report the interest earned on her savings account on her last year’s tax return. If she does not have the exact amount when she files her return, she can simply call the bank to get it. The interest was constructively received last year. If Amanda had closed her account last year, she would have received her original deposit plus the interest earned up to the date of withdrawal because it was credited to her account.


Your client, Esmerelda, was in an automobile accident at the beginning of the year. She and her husband, Diego, were passengers in a SUV when the driver fell asleep at the wheel and caused a multiple-car pile-up on the interstate. Both Diego and the driver were killed, and Esmerelda filed a wrongful death suit for damages against both the driver’s insurer and his estate. Esmerelda and Diego were properly restrained, but the driver was not. Both the estate and the insurer have offered a settlement, and you and Esmerelda are meeting with her attorney to consider her options. The proposed settlement contains both punitive and compensatory damages. Which of the following would be good options for Esmerelda?

I. The punitive damages offered for Diego’s death may be income tax free.
II. All damages are required to be paid to Esmerelda in the form of a structured settlement providing her with a lifetime annuity.

I only

If the state law permits it, punitive damages received in a wrongful death suit are income tax free. Statement II is incorrect. The Periodic Payment Settlement Act of 1982 allows, but does not require, that the damages be paid out periodically, usually in the form of an annuity.


In 2021, a taxpayer completing an income tax return for tax year 2020 would include all of the following in the calculation of the taxpayer’s gross income except

A. gifts received.
B. gambling winnings.
C. prizes won in a contest.
D. unemployment compensation.


Gifts received are not included in the calculation of a taxpayer’s gross income. However, interest generated from the gifted property (once earned) is included in the donee’s income.


It is the last week of December, and you are meeting with your clients, Pa and Blong. The couple has had a very difficult two years. Pa was in an auto accident two years ago, which was settled this tax year. She was awarded $500,000 in punitive damages. Earlier this year, Blong was unemployed and received 10 weeks of unemployment compensation. In September, Pa was injured at work and was paid workers’ compensation. These payments are expected to continue into next year. Which of the following is generally excluded from gross income?

A. Unemployment compensation
B. Workers’ compensation benefits
C. Punitive damages
D. All of these

Workers’ compensation benefits are excluded from gross income. Unemployment compensation in lieu of salary is considered wage replacement and is taxable. Punitive damages go beyond making one whole and are taxable.


Dave is a small-business owner and has employees. It is year-end, and Dave has brought his records to Julie, his tax preparer and financial advisor. After reviewing the documents, which of the following fringe benefits would be excluded from an employee’s gross income?

I. Dave paid for business magazine subscriptions in the names of rank-and-file employees.
II. Dave gave football season tickets to an employee as a performance award.
III. Dave paid for parking in a nearby commercial parking lot near the business for his employees.
IV. Dave, who believes in a healthy lifestyle, converted a large room in his warehouse to an on-premises athletic facility for his employees and their dependents.

All of the fringe benefits mentioned would be excluded from income, with the exception of the season tickets. Only occasional tickets may be excluded from income.


A client, Svetlana, is a single individual with significant income and potential deductions. She has provided her CFP® professional with the following information for the year 2021:

Salary: $100,000
Dividends: $5,000
Long-term capital gains: $10,000
Long-term capital losses: $13,000
Municipal bond interest: $8,000

On the basis of the data given, what is Svetlana’s adjusted gross income (AGI)?

A. $96,000
B. $102,000
C. $104,000
D. $110,000


Svetlana’s AGI is $102,000 ($100,000 of salary + $5,000 of dividends – $3,000 capital loss). The municipal bond interest is not taxable. The net long-term capital loss of $3,000 (LTCG $10,000 – LTCL $13,000 = net LTCL $3,000) reduces gross income to $102,000.


Your client, Charlene, who is single, 66 years old, and blind, is in your office for your December meeting. She began collecting Social Security benefits in October but is still gainfully employed. She brought all of her tax records, including documentation on her Social Security benefit. She is concerned about this additional income and its effect on her tax liability. Which of the following statements is CORRECT?

A. Because she has earned income this tax year, all of her Social Security benefits are fully taxable.
B. Charlene is only eligible for the standard deduction amount plus $1,700 as an additional standard deduction amount because she is blind.
C. Charlene can file her income taxes using IRA Form 1041.
D. Because she is age 66 and blind, her total standard deduction is $15,950.


The 2021 standard deduction amount for Charlene is $15,950, or $12,550 basic standard deduction amount plus $3,400 in additional standard deduction amounts ($1,700 × 2). Social Security benefits may be taxable up to 85% depending on whether the taxpayer meets certain thresholds. She is not able to use the IRS Form 1041, which is for estates and trusts. She may use IRS Form 1040.


John and Cheryl, married taxpayers filing jointly, bought a residence in 2016 by financing $900,000 of acquisition debt. Several years later, when the principal amount of the loan is $780,000, they refinance in order to obtain a better interest rate. They also want to pull some cash out to pay off an auto note and credit card debt. The new loan has a principal amount of $850,000. The couple is allowed to deduct interest on what amount?

A. $70,000
B. $780,000
C. $850,000
D. $900,000


Only the interest on the first $780,000 of debt will continue to be treated as acquisition debt. Because they still fall under the old debt rules, the interest on the full $780,000 is deductible, but the remaining loan principal amount of $70,000 (the amount above the refinanced principal) is not treated as acquisition debt and is not deductible.


Which of the following includes casualty losses for income tax purposes?

I. Soil erosion due to wind or rain
II. Termite infestation discovered this year and treated
III. Unreimbursed losses due to a hurricane declared by the federal government as a disaster
IV. Medical expenses in excess of 7.5% of AGI and insurance reimbursement

III only

Only the interest on the first $780,000 of debt will continue to be treated as acquisition debt. Because they still fall under the old debt rules, the interest on the full $780,000 is deductible, but the remaining loan principal amount of $70,000 (the amount above the refinanced principal) is not treated as acquisition debt and is not deductible.


During the current year, Dominic paid the following interest charges:

-On a loan to purchase home furniture: $800
-On a home mortgage loan (original amount $130,000, FMV of home $200,000): $9,000
-On a home equity loan acquired this year to purchase a boat and secured by his personal residence ($10,000): $750

How much is Dominic’s deductible interest amount if he chooses to itemize for the current year?

A. $9,000
B. $9,750
C. $9,800
D. $10,550


The interest on the loan to purchase the home furniture is consumer interest and is not deductible. The interest on the home mortgage loan is qualified residence interest and is deductible because the original acquisition indebtedness is well under the limit. Interest on a home equity loan that is not used to either purchase or substantially improve the residence that is used as its security is not deductible.


Sasha is a broker and a CFP® professional. She has a client, Martin, who is a single filer and has made several loan transactions during the current year. Martin wants to know if he has enough interest expense to itemize the deduction on his income tax return when he completes it on his tax preparation software for the current year. He brought all of the documentation to Sasha’s office for review. Sasha thinks she can help Martin, but income taxes are not her specialty. What should Sasha do next to help her client?

A. Sasha is fine in advising Martin. A CFP® professional knows enough about tax topics to advise a client in this area.
B. Martin uses tax preparation software, so Sasha tells him the deduction will be handled appropriately by the tax preparation program.
C. Sasha should ask for assistance from a tax preparer or CPA to ensure Martin receives the right advice.
D. Sasha tells Martin that all interest is deductible, so he should be fine itemizing his deductions as long as the total of the deductions exceeds the standard deduction amount.


She should always strive to give her client the best and most technically accurate advice possible. Because she is not a tax specialist, Sasha should get assistance when dealing in areas outside of her competency. Telling a client that a software program is a substitute for advice concerning tax planning is not in the best interest of the client. All interest paid by a taxpayer may not be tax-deductible interest.


Your client, Angela, is a single filer. As agreed upon in the engagement letter, Angela has informed you of a promotion and a raise in salary at her current employment. After her raise, Angela will have $160,000 of taxable income, placing her in the 24% tax bracket. As a CFP® professional, what steps should you take to assist Angela?

A. Continue to monitor Angela’s taxable income levels, and make recommendations for changes to stay below the 24% tax bracket.
B. Prepare Angela to budget for her increased tax liability, especially for the next year, so the tax increase is not a surprise.
C. As long as Angela’s taxable income stays within the 24% tax bracket, the CFP® professional does not need to make any other recommendations.
D. Because her circumstances have changed significantly since the initial engagement, the CFP® professional should obtain a new engagement letter.


Angela is currently in the 24% marginal income tax bracket. As a CFP® professional, you should monitor and evaluate her current and future tax situations and undertake tax management and planning techniques to keep her from slipping into the 32% bracket.


Clinton is self-employed and has the following items that will affect his calculated tax liability of $12,100 owed for the current tax year:

-Estimated taxes paid during the tax year: $11,300
-Unreimbursed child care expenses (one child): $4,000
-Qualifying child younger than age 13 (son, age 7): $2,000

How much will Clinton have to submit with his income tax return this year?

A. $0 with no refund
B. $0 and receive a $1,800 refund
C. $3,200
D. $4,200


Clinton will not need to pay anything when he submits the return. After applying his nonrefundable tax credits of $2,600 ($2,000 child tax credit and $600 child and dependent care credit), he has a remaining tax liability of $9,500. After applying his estimated taxes paid, a $1,800 overpayment refund is due to Clinton.


Steve, an unmarried individual, pays Karen, a housekeeper, $7,000 this year to care for his physically incapacitated mother so he can remain gainfully employed. Steve has an AGI of $58,000 and claims his mother as a dependent on his tax return. Steve does not participate in an FSA at work. Steve’s credit for dependent care expenses, if any, for 2021 is which of the following?

A. $0
B. $600
C. $1,200
D. $3,000


The maximum amount of Steve’s unreimbursed dependent care expenses eligible for the credit is $3,000. Because Steve has an AGI in excess of $43,000, he can claim a 20% credit or an amount of $600 ($3,000 × 0.20).


Alfonzo and Shanice both work and have two children, ages 3 and 4. Between them, Alfonzo and Shanice’s AGI for the current year is $75,000 (they file married filing jointly), and they have paid $13,000 in dependent child care expenses for this year. What is the amount of their child tax credit for 2021?

A. $1,200
B. $2,000
C. $4,000
D. $5,200


Their child tax credit is $4,000 ($2,000 × 2). They are also eligible for a dependent child care tax credit of $1,200.