Prep for Final Flashcards

Prep for Final

1
Q

Accounting firm, during the heat of tax season, hired an
ordained minister to raise the tax staff’s emotional and
spiritual awareness level to help them better serve their
client’s needs. Does the expense constitute an ordinary and necessary business expense?

A

This problem addresses the general question of the meaning of “ordinary and necessary business expenses under § 162(a). Whether expenses are ordinary and necessary is a factual issue. To be deductible the expense must be both ordinary and necessary. They are necessary if they are appropriate and helpful, rather than absolutely essential. They are ordinary if “we know from experience” that these types of expenses are “common and accepted”
in this type of business. Welch v. Helvering. Therefore, what is ordinary and necessary varies by industry and changes over time. “The standard set up by the statute is not a rule of law, it is rather a way of life. Life in all its
fullness must supply the answer to the riddle.” Welch
The deductibility of a similar expenditure by a wood products broker was denied in Lionel Trebilcock, 64 T.C. 852 (1975), aff’d, 557 F.2d 1226 (6th Cir. 1977). However, there have been recent news stories of businesses
providing similar services to improve the work quality of its employees. Google workplace spirituality today and you get over 7 million hits and a very interesting discussion in Wikipedia detailing the development of the workplace spirituality movement since 1920. The answer to this question is uncertain.

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2
Q

Bill operates a printing business. On October 1, 20X1 he
incurred the following expenses:
· $50,000 to build an addition to the building housing the
business
· $2,000 to replace a section of roof on the building
· $1,000 to purchase 12 months worth of paper supplies
Which of these expenses are currently deductible as ordinary
and necessary business expenses and which are capital
expenditures?

A

Section 263 requires the capitalization of amounts paid to acquire, produce,
or improve tangible property. On the other hand, Sec. 162 allows the
deduction of all ordinary and necessary business expenses, including the
costs of certain supplies, repairs, and maintenance. This problem points out
the need to distinguish between capital expenditures and deductible supply,
repair and maintenance costs. The “repair regulations” provide important
guidance in this area. However, detailed examination of those regulations is
left for the Tax Timing class.
The cost of non-incidental materials and supplies are generally deducted in
the tax year first used or consumed. The regulations define “materials and
supplies” to mean tangible property used or consumed in the taxpayer’s
business operations that is not inventory and that is, among other things,
reasonably expected to be consumed in 12 months or less, beginning when
used in a taxpayer’s operations, has an acquisition or production cost of less
than $200, or it otherwise identified in published guidance. Under these
provisions, the paper would be deductible
The regulations also provide that the cost of certain routine maintenance
need not be capitalized. Under a routine maintenance safe harbor, an
amount paid is deductible if it is for recurring activities that a taxpayer
expects to perform to keep a unit of property in its ordinarily efficient
operating condition. The activities are routine only if, at the time the unit of
property is placed in service, the taxpayer reasonably expects to perform the
activities more than once during the class life of the unit of property. This
routine maintenance exception allows expensing for routine maintenance
activities on a building and its structural components (including building
“systems”). However, an activity is covered only if the taxpayer reasonably
expects to perform such maintenance more than once over a 10-year period.
This should allow for the expensing of the roof repairs.
The costs of the building addition must be capitalized.
Note that the regulations also provide important de minimis exceptions to
the capitalization requirements. One allows the deduction of amounts (up to
a specified ceiling) paid for the acquisition or production of a unit of tangible
property if the taxpayer had an applicable financial statement, had written
accounting procedures for expensing amounts paid for property that did not
exceed specified dollar amounts, and treated those amounts as expenses on
its applicable financial statement. The required written accounting
procedures in effect as of the beginning of the tax year may specify a per
item amount of less than $5,000. For taxpayers without an applicable
financial statement, they may elect the de minimis safe harbor and expense
up to $500 per invoice/item.
The regulations also provide a safe harbor for amounts paid for property
with an economic useful life of 12 months or less if the taxpayer’s accounting
procedures in place at the beginning of the tax year provide for the current
deduction of such amounts. The cost of each item of short- lived property
that is deductible under this de minimis rule may not exceed $5,000 ($500
for taxpayers without an applicable financial statement).

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3
Q

Christine is tired of practicing accounting and decides to open a
restaurant. In January, 20X1 she incurs the following
expenses: $15,000 in training employees, $11,900 in interior
decorating consulting, and $15,000 in advertising. In February,
20X1 Christine incurs the following additional expenses:
$5,000 employee compensation and $4,900 advertising. The
restaurant is ready for business on February 1, 20X1 but due to
road closures in the area does not receive its first customer
until March 1, 20X1. How much is Christine’s allowable 20X1
deduction for these expenditures?

A

Section 162 provides for a deduction for “ordinary and necessary expenses”
“in carrying on” a “trade or business.” Any expenses incurred by Christine
before her business began for purposes of § 162 will not meet this test.
Section 195 applies to expenses incurred before the trade or business has
begun (“start up expenses”). Start up expenditures are amounts paid for:
a) investigating the acquisition or creation of a trade or business; b) creating
a trade or business, and c) other expenses incurred before the first day of
for profit activities § 195(c)(1)(A) but only if the expense would have been
deductible if the trade or business was already in existence. § 195(c)(1)(B).
Thus, if the expenses are capitalizable under § 263, they will not fall within
§ 195.
In the problem the interior decorator fees a raise capitalization issue. Treas.
Reg. § 1.263(a)-2(d) requires capitalization of architect’s fees. We need
more facts here to see if the interior decorator fees were part of a major
remodel.
Another issue is the advertising expenses. In INDOPCO, Inc. v.
Commissioner the U.S. Supreme Court held that investment banking fees
and other fees paid by in connection with a friendly acquisition of had to be
capitalized because the acquisition provided long-term benefits to the
existing business from the acquisition synergies. The breadth of the
Supreme Court’s decision calls into question whether expenses previously
thought to be immediately deductible must now be capitalized. Since
advertising arguable creates an asset with a useful life of more than one
year, there was concern that INDOPCO would prevent the deduction of
advertising costs. However, in Rev. Rul. 92-80 the government stated that
advertising expenses will remain deductible despite INDOPCO until further
notice. But the Treasury reserves the right to require capitalization of
advertising expenses, on a prospective basis, if it changed its mind on the
proper treatment of advertising expenses.
For the rest of this problem we will assume that all the expenses qualify
under § 195.
Next we must determine when Christine’s trade or business commenced.
Section 195(c)(2) says to look to the regulations for rules relating to this
test. However, there are none. So we must look to case law. In Walsh v.
Commissioner, a restaurant was held to begin “carrying on” its business
when it opened its doors to customers. Applying Walsh, all of the January
and February expenses are start up expense. It should be noted that when a
business commences is a question of fact, and if the circumstances are
different, or the judge is different, a different conclusion is possible.
Next you must apply the § 195 rules. Section 195 allows you to elect to
deduct the start up expenses up to $5,000 § 195(b)(1)(A). Treas. Reg.
§ 1.195-1 has eliminated the need to make a proper election as it now
assumes a proper election to have been made whether or not any election
was actually made.
The maximum deduction is reduced dollar for dollar to the extent that the
start up expenses exceed $50,000 § 195(b)(1)(A)(ii). Christine incurred
total startup expenses of $51,800. The maximum deduction is reduced to
the extent the startup expenses exceed $50,000. Therefore the deduction is
limited to $3,200 ($5,000 – ($51,800 – 50,000)).
That leaves $48,600 which may not be immediately deducted but will be
amortized over 180 months starting with the month in which the active
trade or business began, or $270 a month. Since the business began on
March 1, 20X1, Christine is entitled to 10 months of amortization, or $2,700
in addition to the $3,200 deduction for a total 20X1 deduction of $5,900.
She will take annual deductions of $3,240 thereafter until the amount is fully
recovered.
Note that if Christine incurred these expenses but never opened her
business, she would not be entitled to any deduction under § 195. However,
when she abandons the business she will be entitled to deduct the expenses
under § 165(c)(2) for losses incurred in a transaction entered into for profit,
not connected with a trade or business. See Domenic, 34 T.C.M. 469 and
Rev. Rul. 77-254, 1977-2 C.B. 63. On the other hand, if she opened her
business and disposed of it prior to fully amortizing the start up costs, she
will deduct the remaining unamortized start up expenses under § 165(c)(1)
in the year of disposition. § 195(b)(2)

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4
Q

Christine’s business is a huge success. She pays her chef
$750,000 in salary plus a $250,000 year end bonus, and she
pays herself a salary of $3 million. Will the salaries and bonus
be deductible?

A

Section 162(a) allows a deduction for “reasonable” salary. You must meet
two tests: the payment must have compensatory “intent” and be reasonable
in “amount.” Treas. Reg. 1.162-7 Bonuses are treated as salary. Treas. Reg.
§ 1.162-9
Compensatory intent looks to whether the payment was really for services
rather than something else such as a disguised dividend. If Christine’s
business is run as a corporation, there is a motivation to pay out all the
profits as salary to her to avoid corporate double taxation.
As to reasonableness of the amount, the courts have developed a variety of
factors to examine. The principal factors are: a) the qualifications of the
employee; b) nature, extent and scope of employee’s work; c) size and
complexity of the business; d) the employee’s contribution to the success of
the business; e) how the employee’s salary compares to the salary scale of
employees generally; f) how the employee’s salary compares to the salary
scale of the industry; and g) prevailing economic conditions. Reasonableness
is thus a facts and circumstances determination and case law, as you might
expect, is highly inconsistent.
It is hard to apply these factors in a specific case. For example, Exacto
Spring Corporation dealt with a closely held company where the cofounder,
CEO and principal owner was paid $1,000,000 + a year. The court held that
the factor tests don’t provide any basis for a rational analysis. The court
noted that it could not function as a “super- HR” department. Instead it
applied a “rate of return” test. Since the rate of return earned by the
company exceeded expectations, higher than normal compensation was held
to be appropriate. The fact that the other shareholders did not complain was
an important factor in establishing “reasonableness.” Interestingly currently
there are more issues dealing with whether the salary paid to the owner was
unreasonably low, rather than unreasonably high as people attempt to avoid
paying social security taxes.
It should be noted that reasonableness of compensation is rarely an issue
when the employee is not also an owner of the business, or related to the
owner. If there is an arm’s length relationship between the business and the
employee, it is assumed that the employee has earned what the business
decides to pay.

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5
Q

Darryl lives in Connecticut and commutes by train to his office
in New York City each day. On one particular day, Darryl spent
$5 on a train ticket to New York, ate breakfast at the train
station for $10 and, after arriving at work, spent $20 in cab
fare to meet with a client. Which costs, if any, are deductible?

A

In additional to the capitalization rules, certain expenses are non-deductible
because they are personal in nature. Section 262 denies a deduction for
personal expenses. The issue often arises when looking at transportation
and commuting costs.
The costs of commuting to work are nondeductible personal expenses.
Treas. Reg. §§1.162-2(e), 1.212-1(f), 1.262-1(b)(5). Similarly, the cost of
breakfast is a non-deductible personal. § 262.
Only the $20 in cab fare to meet a client would be deductible under § 162
since it was incurred after Darryl had already arrived at work. The taxpayer’s
commute terminates after the taxpayer has arrived at the initial work
location, and any transportation costs incurred thereafter while on the job
(other than the commute home), are deductible costs incurred while in
“work” status.

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6
Q

Fred works and lives in San Francisco. One day, Fred flew from
San Francisco to Los Angeles on business. He ate lunch in Los
Angeles by himself and flew home that evening. Fred’s airfare
cost $200. The meal, with tip and tax included, cost $50. Which
costs, if any, are deductible?

A

Under section 162(a) all ordinary and necessary business expenses are
deductible. Section 162(a)(2) expands on this rule to provide that certain
expense (meals and lodging other than amount which are lavish or
extravagant under the circumstances) incurred while away from home in
pursuit of a trade or business are deductible where they would not have
been deductible if the taxpayer was not away from home.
The U.S. Supreme Court in Correl v. U.S. held that the requirement “away”
means that the taxpayer the travel must be sufficient far as to require a stop
for sleep or rest. The “from home” requirement refers to the location of his
principal place of business, not necessarily where he sleeps. Fred is not away
from home on business because he does not spend overnight in LA. The
airfare is deductible because it is work related travel expenses not involving
commuting. The meal eaten alone is not deductible because it is a personal
expenses and does not fall within § 162(a)(2) because he was not away
from home.
It is interesting to note that neither the Code nor the regulations define
“home.” The weight of authority is that, for purposes of this rule, “home” is
your work location. If Fred lived in New York but worked in San Francisco,
his “home” would be San Francisco and the money spent getting back and
forth between the two coasts would be non-deductible commuting expenses.
However, this view is not universally held. In Wallace v. Commissioner, 144
F.2d 407 (9th Cir. 1944) the Court held that home has its normal meaning -
where you live. This case is important because California courts lie in the 9th
Federal Circuit.

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7
Q

How would your answer to Problem 6 change if the business
meetings covered two days and Fred spent the night in Los
Angeles incurring $500 in hotel costs and $25 to have his suit
pressed, returning home late the next day?

A

Fred is now “away from home” since his business trip required an overnight
stay. His hotel costs are deductible (assuming $500 for one night in Los
Angeles is not lavish or extravagant under the circumstances). His meals are
now deductible, even if eaten alone, because he is traveling away from
home. The meals remain subject to the 50% limitation on deductibility under
§ 274(n)(1). The laundry can be considered an expense “incidental to travel”
under Treas. Reg. § 1.162-2(a) if necessitated by the travel.
The key benefit of meeting the away from home test is that all meals as well
as housing costs become deductible.

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8
Q

Steve is a tax partner who regularly takes key tax client
personnel to San Francisco Giant games in his firm’s luxury box
seats. Steve’s firm picks up the entire $500 bill consisting of: 2
tickets ($400) and hot dogs, garlic fries, snacks, and drinks
enjoyed at the game ($100). Steve always has bonafide
business discussions with his client during the ball game. How
much of the $500 can Steve’s firm deduct?

A

The 2017 Tax Cut and Jobs Act changed the rules on entertainment. §
274(a) specifically states that no deduction “shall be allowed for any item,
with respect to an activity which is of a type generally considered to
constitute entertainment.” § 1.274-2(b)(1) includes into the definition of
entertainment “nightclubs, cocktail lounges, theatres, country clubs, golf and
athletic clubs, sporting events”. The new law eliminated the exception if
there were bonafide business discussions. Thus, the fact that Steve had
business discussions with the client during the game is irrelevant and the
ticket price is not deductible at all.
In general, client meals are 50% allowed under Sec. 274(n) and 274(k).
However, § 1.274-2(b)(1) includes meals and beverages in the definition of
“entertainment” when incurred during the entertainment activity. Thus, the
food and beverages enjoyed at the game are also likely not deductible.

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9
Q

Tax Experts, Inc. (TE) incurred the following expenses for
meals for the year: $20,000 in client meals where TE
employees took out clients to discuss business, $5,000 in food
and beverage for annual employee-only Christmas party held at
TE’s office, $3,000 on food and beverage for the week-long
employee training on the new tax compliance software. How
much of the $28,000 would be deductible by TE?

A

Unlike meals eaten alone, meals eaten with a business client can be
deductible, whether at home or away from home. Any meal is a deductible
business expense if the meal is taken with a customer and significant
business occurs during or immediately before or after the meal.
§ 274(a)(1)(A); Treas. Reg. § 1.274-2(d)(3) The cost of the meal must not
be lavish of extravagant § 274(k)(1)(A). However, any deductible meal
expense is limited to 50% of the cost of the meal. § 274(n)(1)
§ 274(n)(2) allows specific exceptions to the 50% rule where taxpayers can
actually deduct 100% of meal costs. An annual Christmas party would fall
under recreational or social activities, primarily for benefit of employees [§
274(e)(4)]. Employee Training sessions would fall under business meetings
[§ 274(e)(5)]. However, since § 274(e)(5) is not listed under § 274(n)(2)
as one of the section that allows 100% expensing, it is subject to 50%.
Thus, the total amount deductible would be $16,500 [$20,000 * 50% +
$5,000 * 100% + $3,000 * 50%]

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10
Q

Joe is a partner at a local CPA firm. He is a member of the
Olympic Club located near his office. The Club has athletic and
eating facilities, the costs of both are included in his
membership dues. He spends 80% of his time at the club
meeting with clients for lunch and the remaining 20% for
personal purposes. He pays club dues of $500 per month. May
Joe deduct any of the dues?

A

Club dues are never deductible regardless of the amount of business use of
the club. § 274(a)(3). This was enacted to end the practice of professionals
attempting to deduct their golf course and similar dues as business
expenses, arguing that they conducted business while at the club.

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11
Q

On January 30, 20X1 Jim, a calendar year taxpayer, purchased
and immediately placed into service new depreciable
equipment for $700,000 for his business. The equipment has a
“class life” of 7 years but Jim hopes to use the machine for 10
years. At the end of the 10 years, Jim expects the salvage value
to be $10,000. Jim’s aggregate amount of taxable income from
his business is $550,000, before any deductions related to this
purchase. Compute each year of Jim’s deductions related to
this equipment. Assume §§ 168(k) and 179 do not to apply.

A

Under these assumptions, only the basic rules of § 168 will apply. Since this
is tangible personal property, depreciation is calculated using the double
declining balance method. § 168(b)(1)(A). Since the class life is seven
years, it is five-year property § 168(e)(1) which has a five-year applicable
recovery period. § 168(c). The applicable convention is the half-year
convention. § 168(d) The depreciable basis is $700,000 since the salvage
value is considered to be zero. § 168(b)(4).
20X1: He can claim first year regular depreciation of $140,000 ($700,000 ÷
5 years x 200% x 1⁄2 year convention = $140,000).
20X2 depreciation is $224,000 (560,000 ÷ 5 years x 200% = $224,000)
20X3 depreciation is $134,400 (336,000 ÷ 5 years x 200% = 134,400)
20X4 depreciation is $80,640 (201,600 ÷ 5 years x 200% = $80,640). (Note
that we do not switch to straight line here because straight line is exactly the
same as DDB and we only switch when straight line is greater. Straight line
would be computed by dividing the remaining basis ($201,600) by the
remaining useful life (2.5).)
20X5 we switch to straight line because the straight line depreciation
(120,960÷ 1.5 years = $80,640) is greater than the DDB depreciation 20X5
depreciation is therefore $80,640.
20X6 depreciation is $40,320

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12
Q

On November 1, 20X1, Sam, a calendar year taxpayer,
purchased a computer for business and personal purposes,
immediately placing it in service. The computer cost $4,800
and was his only business purchase in 20X1. The computer is
used 60% for business in each year. The computer has an
eight-year class life. Compute Sam’s allowable depreciation
deduction for 20X1 and 20X2. Assume § 168(k) and § 179 do
not apply.

A

First we calculate the full year depreciation amount. Since the purchases
were all in the last quarter of his tax year, and were his only purchases for
the year, it triggers the use of the mid-quarter. § 168(d)(3). Under the midquarter convention, goods purchased in January – March are deemed owed
for 10.5 months, in April – June deemed owned for 7.5 months, July –
September deemed owned for 4.5 months and October – December deemed
owned for 1.5 months (assuming a calendar year taxpayer). Therefore,
rather than getting 50% of the calculated full year depreciation, he gets only
12.5% (1.5 / 12).
20X1: He can claim first year regular depreciation of $144 ($4,800 ÷ 5 years
x 200% x (1⁄5/12) mid-qtr year conv = $240,* 60% business usage, equals
$144).
20X2: depreciation is $1,117.44 ([$4,800 – 144] ÷ 5 years x 200% =
$1,862.40, * 60% business usage, equals $1,117.44).

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13
Q

On January 30, 20X1, Tom bought a new building for $250,000
of which $200,000 is attributable to the building and the
balance to the land and immediately placed it in service. How
much depreciation is Tom allowed for 20X1 and 20X2?

A

Land is not an asset eligible for depreciation. We need to allocate the
purchase price between the value of the land and the value of the building,
and only depreciate the building value. Here was told that the building value
is $200,000.
Real estate is depreciated using the straight line method, no salvage value
and a mid-month convention. The analysis of this problem depends on
whether the building is residential rental property or other property.
Students need to identify that this is an issue in determining the correct
depreciable life.
If residential rental property under § 168(e)(2)(A), it has an applicable
recovery period of 27.5 years § 168(c). Under the mid-month convention,
any property purchased in a month is deemed purchased in the middle of
the month, regardless of the actual date of purchase. Since the building was
purchased in January, it is deemed placed in service January 15 and Tom
will be entitled to 11 1⁄2 months of depreciation in the first year.
For residential rental property his 20X1 depreciation = $200,000 ÷ 27.5
years x 11.5/12 month = $6,970. In 20X2 (and for the following 25 years)
his annual depreciation = 200,000 / 27.5 = $7,273. His final year
depreciation would be $3,932.
On the other hand, if this was not residential rental property the applicable
recovery period is 39 years § 168(c). His 20X1 depreciation = $200,000 ÷
39 years x 11.5/12 month = $4,915 In 20X2 (and for the following 37
years) his annual depreciation = 200,000 / 39 = $5,128 His final year
depreciation would be $221.

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14
Q

Jerry owns a dairy farm and decides to do small “patch-up” work to some damage done to the floors and walls due to water seepage. Jerry incurs $200 in repairing the damages. He can deduct this cost and is not required to capitalize it.

A

One can expect this type of occurrence in the normal life of such a building and this type of work does not enhance the useful life of the building nor increase the building’s value. It is a deductible repair.

The correct answer is ‘True’.

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15
Q

Alice and Jack spent $3,000 on investigating a location in the Philadelphia area in which they plan to build a new restaurant. They also spent $1,000 providing meals and entertainment to impress the area’s top chefs. At the time they incurred the costs, they had yet to open their restaurant to customers. They can treat the entire $4,000 as start up expenses which they can begin amortizing in the month they start their business.

A

Taxpayers are not allowed capitalize expenditures as start up cost that would not otherwise be deductible if incurred when they were engaged in an active trade or business. Since the meals and entertainment expenses would only be 50% deductible per §274(n), only $3,500 would be capitalized as a part of start up costs.
The correct answer is ‘False’.

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16
Q

CPA firm brings in a yoga instructor during the tax busy season to help relieve stress of the employees. Which is true about the CPA firm’s ability to take a deduction for the yoga instructor’s services?

Select one:

a. CPA firm can deduct as long as they can show the expense is appropriate and helpful to its business.
b. CPA firm can deduct as long as it can show the expense is common and accepted in their business.
c. CPA can only deduct if they can show BOTH from part a and b. Correct

A

In order to deduct the yoga instructor’s services, CPA Firm has to show that the expense is “ordinary and necessary”, which means that it must be appropriate and helpful AND a common and accepted expense.

The correct answer is: CPA can only deduct if they can show BOTH from part a and b.

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17
Q

Doug is a self-employed CPA. He belongs to a country club. He uses the club 100% for business purposes as he entertains important clients of his firm. He usually takes clients to his club immediately following bonafide business discussions. Under these facts, Doug can deduct his club membership dues.

A

The rule is clear. Sec. 274(a)(3) states that there is no deduction for amount paid or incurred for membership in any club, even if for business purpose.
The correct answer is ‘False’.

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18
Q

Millionaire Enterprises pays Jim Smith, its CEO and majority shareholder, a $3 million in salary and bonuses in 20X0. CEOs, in similar businesses with a similar educational backgrounds, were paid about $1.5 million in salary and bonuses in 20X0. Millionaire enterprises enjoyed a very profitable year in 20X0 and can trace its success directly to the actions of Jim Smith. Note Millionaire Enterprises is NOT a publicly held company. How much of Jim Smith’s 20X0 salary is likely deductible as reasonable compensation?

Select one:

a. $0
b. $1 million
c. $1.5 million
d. $3 million Correct

A

Per Exacto Springs Case, to determine reasonable compensation, we can look to rate of return. Since Millionaire Enterprises had a very profitable year that can be traced directly to Jim Smith’s actions, the $3 million will likely be deemed reasonable, even though it is more than other CEOs in similar businesses.

The correct answer is: $3 million

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19
Q

Paul gets on a round trip flight from San Francisco to Seattle for a business trip, coming back the same day. Cost $200 He has lunch by himself that day ($30) and takes the client out for dinner to discuss business ($80). He flies back that night. How much is his total deduction related to this trip?

Select one:

a. $200
b. $240 Correct
c. $260
d. $280

A

The flight is deductible under Sec. 162(a)(2). The Correl case required “sleep and rest” rule related to meals to be “away from home”. So, Paul’s lunch meal that he ate by himself is not deductible (just as if he would have been in SF), but the client meal is 50% allowed. So, the total deduction is 240, which is the flight of $200, plus 50% of the $80 client meal.

The correct answer is: $240

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20
Q

Sue is a sales representative for a corporation which sells computer systems. Sue and her customer were in a business meeting. In order to help improve her business relations with the customer she invites him to lunch with her immediately following the meeting and pays $100 for the meal. Later that evening, Sue takes another client to a SF Giants baseball game where they discussed business during the game. The two tickets cost $200. How much of the $300 paid by Sue is deductible?

Select one:

a. None
b. $50 Correct
c. $150
d. $250
e. $300

A

$50 is deductible. Since they were discussing business immediately before (or during or after) the meal, it is a deductible business meal. However, under § 274(a) only 50% of the cost is deductible. None of the entertainment (baseball game) is deductible, per § 274(a).

The correct answer is: $50

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21
Q

Fun Company had two events this year in which they provided food and beverages: their summer picnic (spending $6,000) and their Christmas party (spending $4,000). Only employees were allowed to attend the Christmas party, but spouses and children of employees were also invited to the summer picnic. How much of the $10,000 expenditure for this food and beverage is deductible by Fun Company?

Select one:

a. $0
b. $4,000
c. $5,000
d. $7,000
e. $10,000 Incorrect

A

Section 274(e)(4), referenced from Section 274(n)(2)(A), states that expenses for recreational and social activities are 100% allowed if primarily for the benefit of employees. In this problem, the Christmas party qualifies, but the picnic will include more non-employees so it would be limited to 50%. So, all $4,000, plus $3,000 (50% of $6,000), or a total of $7,000 would be deductible.

The correct answer is: $7,000

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22
Q

On July 4, 20X1, Tom bought a new residential rental real estate for $350,000 of which $275,000 is attributable to the building and the balance to the land and immediately placed it in service. How much depreciation is Tom allowed for 20X1?

Select one:

a. $3,232
b. $4,583 Correct
c. $5,417
d. $5,833
e. $10,000

A

Your answer is correct.

Land is not an asset eligible for depreciation. We need to allocate the purchase price between the value of the land and the value of the building, and only depreciate the building value. Here was told that the building value is $275,000.

Residential rental property under § 168(e)(2)(A) has an applicable recovery period of 27.5 years § 168(c). Under the mid-month convention, any property purchased in a month is deemed purchased in the middle of the month, regardless of the actual date of purchase. Since the building was purchased in July, it is deemed placed in service July 15 and Tom will be entitled to 5 1⁄2 months of depreciation in the first year.

His 20X1 depreciation = $275,000 ÷ 27.5 years x 5.5/12 month = $4,583.

The correct answer is: $4,583

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23
Q

On October 5, 20X1, Mom&Pop Corp, a calendar year taxpayer, purchased and immediately placed into service new depreciable equipment for $300,000 for his business. The equipment has a “class life” of 8 years and was the only asset purchased during the year. Compute Jim’s deductions related to this equipment in 20X1. Assume §§ 168(k) and 179 do not apply.

Select one:

a. $7,500
b. $9,375
c. $15,000 Correct
d. $45,000
e. $60,000

A

Your answer is correct.

Since the purchase was all in the last quarter of his tax year, and was his only purchase for the year, it triggers the use of the mid-quarter. § 168(d)(3). Under the mid-quarter convention, goods purchased in January – March are deemed owed for 10.5 months, in April – June deemed owned for 7.5 months, July – September deemed owned for 4.5 months and October – December deemed owned for 1.5 months (assuming a calendar year taxpayer). Therefore, rather than getting 50% of the calculated full year depreciation, he gets only 12.5% (1.5 / 12).

20X1: He can claim first year regular depreciation of $15,000 ($300,000 ÷ 5 years x 200% x (1⁄5/12) mid-qtr year conv = $15,000.

The correct answer is: $15,000

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24
Q

Skip owns 30% of the outstanding X Corporation stock. His shares are worth $1,000,000. He incurred $1,700 of expenses to attend the company’s annual shareholder meeting in which some important business decisions were to be made. The expenses consisted of $1,000 airfare, $500 hotel costs and $200 for meals. Which, if any, of these costs may he deduct?

A

Under § 212, individuals are allowed to deduct ordinary and necessary expenses paid or incurred during the taxable year for: (i) the production or collection of income, (ii) the management, conservation, or maintenance of property held for the production of income, or (iii) in connection with the determination, collection, or refund of any tax. In Higgins v. Commissioner, the US Supreme Court ruled that managing your own investments does not constitute a trade or business and therefore related expenses are not deductible under § 162. They are deductible, if at all, under § 212.

Harris v. Commissioner, dealt with an individual who traveled out to his property to clear the land and stack firewood. The court found that the costs of some of the trips were appropriate given the value of his investment in the land, but that the primary purpose of one of the trips was personal and was not to maintain the investment property. Thus whether there is another, personal motive is an important factor.

The Tax Court has generally looks at four factors to determine the deductibility of expenses for attending shareholder meetings under § 212: (1) were the costs incurred as part of a rationally planned, systematic investigation of business operations; (2) were the costs reasonable in relation to the magnitude of the investment and the value of the information reasonably expected to be derived from the trip; (3) do the circumstances negate a disguised personal motive for the travel; and (4) whether there is some showing of practical application, e.g., through investment decisions based on information gained from the trip. You can see these factors being weighed by the Court in Harris.

How those factors apply to our problem is a facts and circumstances analysis. In our problem, given the size of his investment, the dollars spent seem reasonable. It does not appear there was a hidden personal motive for taking the trip unrelated to his investment in the company. If so, the deduction for the meal expense of $200 will be limited by § 274(n) to 50% or $100.

It should be noted that in Rev. Rul. 56-511 the service ruled that attending a shareholder’s meeting is not deductible under § 212. However in LTR 8042071 and 8220084 deductions for attending shareholder meetings were allowed.

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25
Q

Tom likes to invest his personal money in a variety of types of investments. This year he spent $1,000 in travel costs and registration fees attending seminars discussing different types of investments. May he deduct the expenses under § 212?

A

This type of expense is specifically prohibited as a deduction by §274(h)(7). However, if Tom were in the trade or business of an investment advisor, the expense would be deductible under § 162 and § 274(h)(7) would have no application.

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26
Q

Sue paid her attorney $5,000 for his successful work in increasing the alimony payments she is entitled to receive from Tom. She also paid him $2,000 for his work in increasing child support payments due her. Her ex-husband Tom paid $6,000 to his lawyer. Are either Sue or Tom allowed to deduct any of these expenses?

A

Under § 262, no deduction is allowed for personal expenses. Attorney’s fees related to divorce are not deductible. Treas. Reg. § 1.262-1(b)(7). However, because alimony is taxable income to Sue, expenses incurred in the attempt (successful or not) to produce more alimony are deductible under §212(1). In Wild v. Commissioner the court extended this rule and held that attorney fees properly allocable to initially obtaining alimony were also deductible. Thus, Sue can deduct $5,000 in attorney’s fees relating to increasing her alimony.

No deduction is allowed to Sue with respect to the $2,000 of attorney fees to increase child support. Since child support is not income, the expenses do not relate to the production of income.

Tom is not entitled to deduct any of his attorney fee expenses since he is not producing income. Further, Treas. Reg. § 1.212-1(m) provides that an expense (not otherwise deductible) paid or incurred by an individual in determining or contesting a liability asserted against him does not become deductible by reason of the fact that property held by him for the production of income may be required to be used or sold for the purpose of satisfying such liability.

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27
Q

John is an executive of Bank W. The Bank reimbursed him $20,000 for the following legal and accounting fees he incurred:
Accountant fees for preparation of tax return $2,000
Accountant fees for tax advice 5,000
Legal fees for preparation of will 3,000
Legal fees for tax advice 10,000
What are the tax consequences to John?

A

John must report $20,000 of income unless an exclusion in § 132 applies. The only possible exclusion is working condition fringe which requires that, had John paid the expenses himself, they would have been deductible by him under § 162 or §167. The accountants fees for the tax return and for tax advice as well as the legal fees for tax advice would be deductible by John, but under § 212, not §162 or § 167 and thus the reimbursement does not qualify for exclusion. Generally fees for will preparation are not deductible unless they are related to tax planning. Rev. Rul. 72-545. Thus John will have $20,000 of income and may claim a miscellaneous itemized deduction of $17,000.

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28
Q

Jack and Jill, a married couple, run a sole proprietorship that is reported on Schedule C of their Form 1040. They paid $10,000 to have their tax return prepared, of which 75% of the cost relates to determining the income and expenses attributable to the business. What is the treatment of the $10,000 expense?

A

The entire $10,000 of tax return preparation fees would be deductible under §212(3) as a miscellaneous itemized deduction. However, we can treat the 75% allocable to the business as an above the line § 162 expense per Rev. Rul. 92-29. The remaining 25% will be deductible under § 212(3) as a miscellaneous itemized deduction.

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29
Q

Sue has always owned dogs. She began raising and training dogs for dog shows. In 20X1, her first year of raising and training dogs, she incurred a loss of $10,000. In 20X2, she had a smaller loss of only $1,000. Sue deducted these losses on her income tax return. On January 1 of 20X3, Sue received a notice that the IRS intends to disallow these losses under § 183. Sue believes she is engaging in these activities for profit and that the activities will show a profit starting in 20X3 and beyond. What are Sue’s options?

A

The starting point for the analysis is § 183 which applies if an activity is not engaged in for profit. The definition of “not engaged in for profit” is anything other than one for which deductions are allowable under §§ 162 or 212. §183(c). It is a facts and circumstances test with the relevant factors set forth in Treas. Reg. § 1.183-2(b). The key factors are: 1) Keeping complete and accurate books, having a separate bank account, abandoning unprofitable methods, 2) The time and effort expended by the taxpayer in carrying out the activity; 3) The success of the taxpayer in carrying out other similar or dissimilar activities and 4) The financial status of the taxpayer.

There is a presumption her activity is engaged in for profit if it makes money in three out of five consecutive years. § 183(d) While Sue’s business has yet to turn a profit, she is only two years into her operations. It is still possible for her to show a profit in three of the first five years of her business if she makes money in the current year and the following two years.

Sue has the ability to file an election under § 183(e). The impact of filing this election will be to bar the IRS from assessing a deficiency until the end of the 5th year of the business. This gives her the time to see if she is profitable for each of the next three years and therefore can benefit from the presumption that she had a profit motive for the activities from the start. To make the election Sue must file Form 5213 within 60 days after receipt of the I.R.S. notice. § 183(e)(3); Treas. Reg. §12.9(d)]

Alternatively, Sue could choose not to wait and to attempt to prove to the IRS that she entered into the business for profit. She would need to address the factors in the regulations and would bear the burden of proof.

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30
Q

John and Julia love cooking. They are both teachers and decided that because they have the summers off and enjoy it so much, they would start a small catering business. They are both very organized people and have kept detailed records of their expenses, appointments, and income. They have been doing this for three years and have a small but steadily building clientele. The business is not yet a profitable one but they hope, with a little bit of luck, it will turn around. Are their expenses subject to the §183 limitations?

A

Since John and Julia have lost money in each of the first three years, there is no way for them to have income in three of their first five years. Therefore they cannot file an election under § 183(e).

They will bear the burden of proof of showing that they entered into the catering business with the dominant intent of realizing a profit. They will need to rely on the factors set forth in the regulations. In their favor are the facts that they kept detailed records of expenses, appointments and income and had a growing clientele. Bad facts include the fact that they have other full time jobs and have yet to make a profit. The fact that they enjoy cooking is neither good nor bad. There is no rule that says you cannot enjoy your work.

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31
Q

Ron has the following income and expenses from an activity he conducts from which is not engaged in for profit. His income and expenses properly allocated to this activity were as follows:
Income $2,000
Property Taxes 800
Utilities & Maintenance 500
Depreciation 1,000
Ron’s adjusted gross income for the year is $68,000 without considering the above items. How much of these expenses may Ron deduct?

A

Since the facts tell us that Ron does not engage in this activity for profit, we are subject to § 183. Ron will report the $2,000 of income. Under § 183 he will be allowed his full deduction for property taxes and his deduction related of the remaining expenses will be limited to the excess of his income from the activity over the property tax deduction. All excess deductions will be lost permanently.

In determining which expenses are deductible, that are divided into three groups or “tiers.” Tier 1 are deductions which are allowable under other provisions of the code even if he had no earned any income from the hobby. § 183(b)(1). This includes his property taxes, qualified residence interest, and casualty losses. These expenses are deductible in full even if Ron had no income. However, the income from the hobby is first reduced by these Tier 1 expenses, before we can determine whether any of the remaining expenses are deductible.

The remaining expenses are further categorized into Tier 2 and Tier 3 expenses. Tier 2 deductions are all deductions which are not in Tier 1 or Tier 3. They are deductions other than those that affect basis. § 183(b)(2), Treas. Reg. §1.183-1(b)(1)(i). Tier 3 deductions are those that affect basis (e.g. depreciation). § 183(b)(2), Treas. Reg. § 1.183-1(b)(1)(i).

Here the property taxes of $800 are Tier 1 deductions, the utilities and maintenance are Tier 2 deductions and the depreciation is a Tier 3 deduction. After reducing the $2,000 of income for the Tier 1 property taxes, we are left with $1,200 of allowable deductions at Tier 2. Since our Tier 2 deductions are $500, they will be allowed in full and we are left with $700 of allowable Tier 3 deductions. We can take $700 of the $1,000 of depreciation and the remaining $300 of other expenses will never be deductible. There is no carryover of the disallowed expense.

Ron will report the $2,000 as gross income. He will take the property taxes as a regular itemized deduction. The $1,200 of other expenses allowed will be treated as miscellaneous itemized deduction under § 67 subject to the 2% AGI floor. Temp. Treas. Reg. § 1.67-1T(a)(1)(iv), Purdey v. U.S. 92-2 USTC ¶50,894 (Fed. Cl. 1997).

Ron’s AGI is $70,000 ($68,000 + 2,000) and 2% of AGI = $1,400. Assuming he has no other miscellaneous itemized deductions, none of the $1,200 Tier 2 and Tier 3 deductions may be taken. He will still have to report the $2,000 of income but will actually get only the $800 of property taxes as an allowable deduction.

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32
Q

Sue and Dan own a mountain home that they used in the current year for 45 days. They rented out the home for 15 days. Their rental income and the annual expenses for the home were as follows:
Rental Income $2,000
Qualified Residence Interest 2,000
Property Taxes 1,000
Utilities & Maintenance 3,000
Depreciation 6,000
Determine the tax consequences to Sue and Dan.

A

Section 280A deals with the allowance of deductions related to personal residences which are rented out part of the year as well as home office expenses. Section 280A(a) provides the general rule that no deductions relating to a dwelling unit used as a residence are allowed, except as provided elsewhere in § 280A. Much like § 183, we divide our expenses into three tiers and apply similar ordering rules. A key difference from § 183, however, is that disallowance expenses carry over to future years and can be taken if there is sufficient income.

First we must determine the meaning of “residence.” Under § 280A(d), a taxpayer uses a dwelling as a residence if the number of days of personal use exceeds the greater of: a) 14 days or b) 10% of the rental days. Since their 45 days of personal use exceeds the greater of these amounts, the house is considered to be used as a residence by Sue and Dan and deductions are subject to limitation.

To compute their allowable rental property deductions, we first divide the expenses into three tiers, allocate the deduction in each of those tiers between business use and personal use, and finally apply the income limitation to the Tier 2 and Tier 3 business use expenses. Prop. Treas. Reg. §1.280A-2(i)(5).

Tier 1 expenses are those deductible without regard to business use identified in §280A(b): Taxes, qualified residence interest, and casualty losses. Prop. Treas. Reg. §1.280A-2(i)(5)(i). Tier 2 are all other expenses which would be deducted in a profit-motivated activity such as utilities and maintenance expenses but which don’t reduce basis. Prop. Treas. Reg. §1.280A-2(i)(5)(i). Tier 3 expenses are those expenses which would be deducted in a profit-motivated activity which reduce the basis of assets such as depreciation. Prop. Treas. Reg. § 1.280A- 2(i)(5)(i).

Next we must allocate the expenses between personal use and business use. While Tier 1 expenses remain fully deductible, only the allocated Tier 1 business use expenses will reduce available income as we determine Tier 2 and Tier 3 allowable expenses. On the other hand, any Tier 2 or Tier 3 expenses allocated to personal use will never be deductible, and those allocated to business use are deductible only to the extent of remaining income.

Tier 1 expenses are allocated between rental use and personal use based on the number of rental days to number of days in the year. Bolton v. Commissioner. Here the rental use was 15 days and there are 365 days (366 in leap year). Therefore only $82 of mortgage interest and $41 of taxes are allocable to the rental use. The balance of the taxes and mortgage interest remains fully deductible, but are ignored in applying the income limitation to the Tier 2 and Tier 3 expenses.

Since the taxpayers had $2,000 of rental income and $123 of Tier 1 expenses were allocated to business use, the income limitation of §280A(c)(5) will allow a maximum deduction of $1,877 of the remaining expenses. We must allocate the expenses between Tier 2 (everything except depreciation) and Tier 3 (depreciation) expenses and further allocated those expenses between rental use and personal use.

Tier 2 and Tier 3 the expenses are allocated between rental use and personal use based on a different formula - the number of rental days to total days of use (not days in the year as was used to allocate Tier 1 expenses). §280A(e)(1). Rental use was 15 days; total use was 60 days (15 days rental + 45 days personal use). Therefore 1⁄4 of each Tier 2 and Tier 3 expense will be allocated to the rental activity and the remaining 3⁄4 are nondeductible personal use. As a result, $750 utilities and maintenance (Tier 2 Expense) and $1,500 depreciation (Tier 3 Expense) are allocated to the rental use.

Applying the § 280A(c)(5) limitation

Gross Receipts from Business 2,000
(Business Expenses not connected with the use of the home) (0)
Gross Income (Prop. Treas. Reg. § 1.280A-3(d)(2)) 2,000
Allocated Tier 1 expenses (123)
Limit on Tier 2 Expenses 1,877
Allocated Tier 2 Expenses subject to limit (750)
Limit on Tier 3 Expenses 1,127
Tier 3 Expense subject to limit 1,500

In conclusion, all of the interest and property taxes will be deductible. Of the utilities and maintenance cost, the $750 of allocated to the rental activity will be deductible. Only $1,127 of the $1,500 depreciation expense allocated to the rental activity will be currently deductible. However, the $373 of depreciation disallowed may be carried over to subsequent year as a Tier 3 expense per the flush language in § 280A(c)(5).

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33
Q

How would your answer to Problem 9 change if Sue and Dan rented out the residence for only 14 days?

A

Section 280A(e) limits the allowable deductions to the rental income. However, a special rule applies if the property is rented for less than 15 days, which it was here. Under §280A(g) Sue and Dan are denied all deductions other than deduction not tied to income (Tier 1 deductions), but can exclude the income. Thus, while they need not report the rent received, they are not entitled to claim any deduction for the $3,000 of utilities expenses or the $3,000 of depreciation. On the other hand, they still get their deduction for the $2,000 qualified residence interest under § 163(h)(3) (assuming the requirement of that statute are met) and the $1,000 in property taxes (under § 164) because these deductions are allowable whether or not the dwelling is rented. § 280A(b).

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34
Q

Chris is a professional saxaphone player, hiring himself out to do gigs at various pubs and entertainment halls. He has set up a special room in his house which is soundproofed in which he practices, has a telephone and answering machine used for business calls, and where he keeps his books and records. He does not use the room for anything other than his music business. His records show the following items of income and expense for the current year:
Business Income and Expense, unrelated to the home
Performance Fee Income 20,250
Business Expenses 12,000

Allocated expenses related to business use of the home
Real estate taxes 3,000
Qualified residence interest 1,000
Utilities 3,000
Depreciation 2,000

In each of the past five years, Chris’s business has been profitable. What are the tax consequences to Chris?

A

The prior problems dealt with the issue of the deductibility of the expense of a dwelling being used in a rental business. This question raises the deductibility of the expense of the “home office” - a portion of a dwelling used in a trade or business. Section 280A(c)(1) says deductions are allowed with respect to a portion of a dwelling unit exclusively used on a regular basis as 1) the principal place of business of any trade or business of the taxpayer, 2) a place where patients, clients or customers are met, or 3) a separate structure, used in a trade or business.

Under Prop. Treas. Reg. §1.280A-2(b)(2) there is a three part test to determine what is the “principal place of business.” You look to: 1) the portion of total income attributable to each location; 2) the amount of time spent at each location; and 3) the facilities available at each location.

Chris’ home wouldn’t appear to by his principal place of business since he earns his living in nightclubs and not at home. However, the flush language of § 280A(c)(1) states that a home office will meet the principal use test if the home is used for the administrative or management activities of Chris’ trade or business and Chris has no other fixed location where he conducts substantial administrative or management activities. Chris will meet this test and be allowed a deduction for the home expenses properly allocable to his office.

Since Chris is using only a portion of the house, there must be an allocation of his home expenses between business use and personal use, and among the same three tiers discussed in the previous problem. The allocations can be made on any reasonable basis. Usually it is based on the square footage of the work area divided by the total square footage of the home. In our problem, however, we are provided with the expenses already allocated.

The deductibility of these allocated expenses is subject to the income limitation as follows:

Gross Receipts from Business 20,250
(Business Expenses not connected with the use of the home) (12,000)
Gross Income (Prop. Treas. Reg. § 1.280A-3(d)(2)) 8,250
Allocated Tier 1 expenses (4,000)
Limit on Tier 2 Expenses 4,250
Allocated Tier 2 Expenses (3,000)
Limit on Tier 3 Expenses 1,250
Tier 3 Expense subject to limit 1,250

Therefore, the 4,000 interest and taxes, the $3,000 utilities expense and $1,250 of the depreciation will be currently deductible. The remaining $750 Tier 3 depreciation expense is not currently deductible because of the income limitation but will be carried into future years.

Note that under Rev. Proc. 2013-13 the is a safe harbor allowance for home office deductions. Under this safe harbor, Chris would take his Tier 1 expenses plus $5 times the square footage of his office up to 300 square feet ($1,500) which is significantly below the actual deduction Chris is allowed. There are some benefits to the safe harbor, however. First, it reduces the paperwork required since no allocation of Tier 2 or Tier 3 expenses is required. Second, none of the safe harbor deduction is treated as depreciation so that Chris will not need to reduce the basis in his home.

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35
Q

How would your answer to Problem 11 change if the business expenses were $30,000?

A

If the business expenses were $30,000 there would be no gross income from the business under § 280A. It would show $9,750 negative gross income. Therefore only the $4,000 of Tier 1 expenses would be allowable. The remaining $3,000 of utilities and $2,000 of depreciation would carry over, retaining their character as Tier 2 or Tier 3 expenses. Overall Chris would show a $13,750 loss from the business - the $20,250 of gross receipts less the $30,000 of business expenses and $4,000 of Tier 1 expenses. The non home related expenses are not limited by § 280A(a).

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36
Q

How would your answer to Problem 12 change if Chris’s activities had never been profitable and were subject to § 183?

A

A home office deduction is available only if a portion of a dwelling unit is used for the taxpayer in the course of his trade or business. If Chris was conducting his hobby from his home, there would be no home office deduction available.
What about § 280A(f)(3) which provides that § 183 does not apply to dwelling units? That would not help us here since we don’t qualify for the home office deduction under § 280A(c)(1).
Here is where § 280A(f)(3) might apply. Assume that taxpayer rents out his house for a few weeks during the year and otherwise uses it as his residence and that his rental activities do not meet the profit motive requirement of § 162. Thus his expenses are potentially subject to denial under § 183. In this circumstance §280A(f)(3) will allow a § 280A deduction of the home expenses allocable to the rental activity and § 183 does not apply to prevent the deductions. Guido Ruggiero TC Memo 1997-423 (1997). However, if the taxpayer’s personal use of the home was insufficient for the home to be treated as his residence, § 280A would not apply. In that circumstance §183 would apply to deny the deductions in excess of income (other than Tier 1 deductions). Senate Report No. 94-938 (PL 94-455) p.153

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37
Q

How would your answer to Problem 11 change if, instead of running his own business, Chris were an employee of the San Francisco Symphony, which provides practice rooms for its musicians?

A

Under § 280A(c)(1) flush language, if an employee wants to claim a deduction for a home office, there is an additional test that must be met. The home studio will qualify as a principal place of business only if it is maintained “for the convenience of the employer.” Since the Symphony provides practice rooms, it would be difficult to argue that Chris’ home office is maintained for the convenience of the Symphony. Chris would not be entitled to any deduction for his home office.

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38
Q

Robert, who has always loved dogs, trains dogs in his free time. Which is the least relevant factor in determining whether the dog training is an activity engaged in for profit?

Select one:

a. Whether Robert had net income or a net loss in the first year of activity
b. Amount of hours Robert spent each week in the activity
c. The level of his expertise and experience in training dogs
d. Robert’s financial status Incorrect

e. Robert’s use of detailed books that record all transactions in the activity

A

All of these are important factors to determining whether a taxpayer is engaged in an activity for profit:

Amount of hours Robert spent each week in the activity
The level of his expertise and experience in training dogs
Robert’s financial status
Robert’s use of detailed books that record all transactions in the activity
Whether Robert had net income or a net loss in the first year of the activity is likely the least important factor, as many business may start off losing money in the first year. The trend after year 1 would likely be more important.

The correct answer is: Whether Robert had net income or a net loss in the first year of activity

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39
Q

David has been audited by the IRS. The IRS asserts that David’s dog training is not an activity engaged in for profit. David had a net loss of $22,000 and $16,000 in the first two years. David believes that the first two years of losses related to start up costs to get the business “rolling”. He expects to break even in year 3 and be very profitable in year 4 and 5. He also anticipates by year 4 that he will quit his job and work full time in the dog training business. Under these facts, David should file a §183(e) election.

Select one:
True
False Incorrect

A

A §183(e) election postpones any assessment of tax where the IRS is alleging that the activity is not for profit. David should make the election because he believes that his factors are stronger after year 5, including devoting more time to the activity and having a better history of income in the activity. As an added bonus, he might even earn the presumption of being for profit if he can turn a profit in year 3, 4, and 5.

The correct answer is ‘True’.

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40
Q

Which of the following statements is TRUE?

Select one:

a. Section 183 will never limit deductions with respect to an activity if the taxpayer shows a profit in the activity in at least 3 of the preceding 5 taxable years
b. Section 183 will always limit deductions with respect to an activity if the taxpayer shows a loss in the activity in at least 3 of the preceding 5 taxable years
c. If §183 applies to an activity for a taxable year, the taxpayer must include the hobby income, but all hobby expenses have been suspended. Correct
d. Losses disallowed under § 183 are carried forward to succeeding taxable years

A

Earning income in 3 out of 5 years (or not earning income in 3 out of 5 years) merely raises a presumption. That presumption can be overcome with facts to the contrary. Section 183 requires taxpayers determined to be engged in activity not for profit to include the hobby income, but all hobby expenses have been suspended. The excess losses, as well as any disallowed deductions, cannot be carried over.

The correct answer is: If §183 applies to an activity for a taxable year, the taxpayer must include the hobby income, but all hobby expenses have been suspended.

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41
Q

T pays a CPA $10,000 to prepare his income tax return. His CPA estimates that 60% of the $10,000 fees relate to preparing T’s sole proprietorship business (Sch C), a portion of his tax return. How should T handle the $10,000 tax preparation fee on his return?

Select one:

a. Deduct $6,000 as a business expense “above the line” and $4,000 is a nondeductible misc. itemized expenditure. Correct
b. Deduct $4,000 as a business expense “above the line” and $6,000 is a nondeductible misc. itemized expenditure.
c. Deduct all $10,000 as a business expense “above the line”
d. The $10,000 is a nondeductible misc. itemized expenditure.

A
Feedback
Under 212(3), the tax preparation fee is a misc. itemized deduction, currently suspended by 2017 Tax Cuts and Jobs Act.  However, Rev Rul 92-29 allows the portion that relates to preparing Sch C to be deducted "above the line" on Sch C to offset business income.  Thus, 60% of the $10,000 ($6,000) is deducted on Sch C and $4,000 is a nondeductible misc. itemized deduction (because it is suspended). 

The correct answer is: Deduct $6,000 as a business expense “above the line” and $4,000 is a nondeductible misc. itemized expenditure.

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42
Q

Becky sells home-made jewelry out of her home. A room in her home qualifies as a home office. The room’s square footage makes up 10% of the overall square footage of the house. Considering expenses unrelated to the home, the jewelry business has net income of $2,000. She has property taxes and mortgage interest on her entire home of $10,000. How much mortgage interest and property taxes can she deduct anywhere on her return in the current year?

Select one:

a. $0
b. $1,000
c. $2,000
d. $10,000 Correct

A

Of the $10,000 of property taxes and mortgage interest, $9,000 is deemed personal and deductible on Sch A and $1,000 is business and deductible on Sch C to reduce business income. So, the full $10,000 is deducted somewhere on the return.

The correct answer is: $10,000

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43
Q

Becky sells home-made jewelry out of her home. A room in her home qualifies as a home office. The room’s square footage makes up 10% of the overall square footage of the house. Considering expenses unrelated to the home, the jewelry business has net income of $2,000. She has property taxes and mortgage interest on her entire home of $10,000. Also, she has utilities on her entire home of $8,000. How much utilites can she deduct anywhere on her return in the current year?

Select one:

a. $0
b. $800 Correct
c. $2,000
d. $8,000
e. None of the above

A

Of the $10,000 of property taxes and mortgage interest, $9,000 is deemed personal and deductible on Sch A and $1,000 is business and deductible on Sch C to reduce business income. This reduces the net business income to $1,000. Of the $8,000 utilities, 10% ($800) is related to business. The other $7,000 is personal and nondeductible. Since $800 is less than the $1,000 net business income, all $800 is deductible on Sch C, reducing net business income.

The correct answers are: $800, None of the above

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44
Q

Becky sells home-made jewelry out of her home. A room in her home qualifies as a home office. The room’s square footage makes up 10% of the overall square footage of the house. Considering expenses unrelated to the home, the jewelry business has net income of $2,000. She has property taxes and mortgage interest on her entire home of $10,000. Also, she has utilities on her entire home of $8,000. Also, she has depreciation on her entire home of $6,000. How much depreciation can she deduct anywhere on her return in the current year?

Select one:

a. $0
b. $200 Correct
c. $600
d. $2,000
e. $6,000

A

Of the $10,000 of property taxes and mortgage interest, $9,000 is deemed personal and deductible on Sch A and $1,000 is business and deductible on Sch C to reduce business income. This reduces the net business income to $1,000. Of the $8,000 utilities, 10% ($800) is related to business. The other $7,000 is personal and nondeductible. Since $800 is less than the $1,000 net business income, all $800 is deductible on Sch C, reducing net business income to $200. Of the $6,000 of depreciation, only $600 is related to business and thus deductible. However, home related expenses are limited to net business income, which is $200. Thus, only $200 is deductible in the current year and $400 would be carried forward.

The correct answer is: $200

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45
Q

Sue and Dan own a mountain home which they personally used for in the current year for 146 days and rented out for 146 days. It was left unoccupied for 73 days. What percent of property taxes are deducted “above the line” directly against rental income?Twenty percent (73 / 365) of the depreciation expense for the year must be allocated to the rental income.

Select one:

a. 20%
b. 40% Correct
c. 50%
d. 60%

A

The allocation formula stated (146 days rented / 365 days in the year), or 40% in this problem, applies to the apportionment of taxes as well as mortgage interest.

The correct answer is: 40%

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46
Q

Sue and Dan own a mountain home which they personally used for in the current year for 73 days and rented out for 73 days. Twenty percent (73 / 365) of the depreciation expense for the year must be allocated to the rental income.
Select one:
True Incorrect
False

A

The allocation formula stated (73 days rented / 365 days in the year) applies to the apportionment of mortgage interest and taxes only. All other expenses would be allocated based on a formula of days rented (73) to total days used (144) or 50%
The correct answer is ‘False’.

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47
Q

Sue and Dan own a home in Indianapolis, Indiana, the site of the 2016 National Football League Super Bowl. Their home is close to the stadium. A travel agent offered them $20,000 a week if they would rent their house for the 16 days leading up to the game. They come to you for advise. You tell them that if they only rent their home for two weeks (2 days less than the 16 days they stated) they would not have to report any of the income and could still deduct their expenses for cleaning the house before and after the rental. Your advice is not completely accurate.

Select one:
True Correct
False

A

While you were correct that if the rental was limited to 14 days, they will not be taxed on the income. However, they are not allowed any deductions, other than those items which are deductible regardless of income (mortgage interest and property taxes). So you were incorrect when you told them they could deduct the house cleaning costs.

The correct answer is ‘True’.

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48
Q

Tom, single and runs his own tax preparer business. He has Net Schedule C income of $150,000. His only other income is interest income unrelated to his business of $12,500. Assume he takes the $12,000 standard deduction on his current tax return. He runs the business by himself out of his home so he does not pay any W-2 wages nor has he purchased any tangible property.

Ignoring the self-employment tax deduction, how much Section 199A deduction is available to Tom on his current year return?

A

Per § 199A(b)(2), Tom can take a deduction for 20% of Qualified Business Income (QBI). § 199A(c)(1) defines QBI as coming from a “qualified trade or business”. § 199A(d) identifies a qualified trade or business as any trade or business other than a “specified trade or business”. Unfortunately for Tom, per § 199A(d)(2), his tax preparer business is a specified service trade or business” since it is in the field of accounting.

However, per § 199A(d)(3) taxable income exception (below the threshold amount), Tom can treat his Specified Service Income of $150,000 as QBI.

Tom’s taxable income is calculated as follows:
Sch C Income 		 $150,000
Interest Income		 $  12,500
Standard deduction	($  12,000)
Taxable Income		 $150,500  

NOTE: For simplicity, we are ignoring the self-employment deduction.

Since Tom’s taxable income is less than $157,500, he can take the full 20% of $150,000, i.e. $30,000, as a § 199A deduction.

Taxable Income Limit: He still must apply the taxable income rule at § 199A(a)(1)(B): the deduction cannot exceed 20% of taxable income less any net long term capital gain. 20% of the taxable income ($150,500) would be 30,100. Since the limit is higher, he is eligible for a deduction of $30,000.

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49
Q

How would your answer to Problem 1 change if Tom received $100,000 of interest income rather than $12,500?

A

Tom’s tax preparer business is still a specified service trade or business since it is in the field of accounting. Since his taxable income exceeds $217,500, he is not eligible for the § 199A(d)(3) taxable income exception and thus will get zero § 199A deduction.

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50
Q

Tom grows tired of tax preparation. Instead, he starts a new business, opening up a restaurant as a sole proprietorship. He has Net Schedule C income of $150,000. His only other income is interest income unrelated to his business of $12,500. Assume he takes the $12,000 standard deduction on his current tax return. He purchases a building and a lot of tangible personal property for the restaurant. He also hires one employee. He pays W-2 wages of $40,000 and has tangible property of $600,000.

Ignoring the self-employment tax deduction, how much Section 199A deduction is available to Tom on his current year return?

A

Per § 199A(b)(2), Tom can take a deduction for 20% of Qualified Business Income (QBI). § 199A(c)(1) defines QBI as coming from a “qualified trade or business”. § 199A(d) identifies a qualified trade or business as any trade or business other than a “specified trade or business”. Tom’s restaurant business is not one of the specified trade or business. Thus, the $150,000 of net Schedule C income is QBI.

Tom’s taxable income is calculated as follows:
Sch C Income 		 $150,000
Interest Income		 $  12,500
Standard deduction	($  12,000)
Taxable Income		 $150,500

Tom § 199A expense would normally be subject to the wage and property limitations of § 199A(b)(2)(B). However, since his taxable income is less than $157,500, Tom qualifies for the exception under § 199A(b)(3)(B).

Therefore, he can take the full 20% of $150,000, i.e. $30,000, as a § 199A deduction.

Taxable Income Limit: He still must apply the taxable income rule at § 199A(a)(1)(B): the deduction cannot exceed 20% of taxable income less any net long term capital gain. 20% of the taxable income ($150,500) would be 30,100. Since the limit is higher, he is eligible for a deduction of $30,000.

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51
Q

How would your answer to Problem 3 change if Tom received $100,000 of interest income rather than $12,500?

A

Sch C Income $150,000
Interest Income $100,000
Standard deduction ($ 12,000)
Taxable Income $238,000

Now we have QBI with taxable income above the range or more than the threshold + 50K ($207,500). The computation at 199A(b)(3)(B) applies.

The lesser of:
• 20% of QBI $30,000 ($150,000 * 20%)
-OR-
The greater of
• 50% of W-2 wages $20,000 ($150,000 * $20,000)
Or
25 % of W-2 wages $10,000 (40,000 * 25%) + $15,000 [(2.5% of unadjusted basis ($600,000)]= $15,000 TOTAL $25,000

Tom’s § 199A deduction would be limited to $25,000.

Taxable Income Limit: He still must apply the taxable income rule at § 199A(a)(1)(B): the deduction cannot exceed 20% of taxable income less any net long term capital gain. 20% of the taxable income ($238,000) would be $47,600. Since the limit is higher, he is eligible for a deduction of $25,000.

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52
Q

How would your answer to Problem 3 change if Tom received $39,500 of interest income rather than $12,500?

A

Tom needs to figure out his excess amount, per of § 199A(b)(3)(B)(iii):
QBI deduction without the W-2 & Basis limit
LESS: QBI deduction if limit applied in full

20% * $150,000 LESS [25% * $40,000 + 2.5% * $600,000]
$30,000 LESS $25,000 = $5,000

Phase-in of the Limit:
$5,000 * 40% = $2,000
40% comes from (177,500 – 157,500) / 50,000

Full Deduction less Limit:
(20% * $150,000) Less $2,000 = $28,000

Tom has qualified business income (QBI) and his taxable income is “in the range”:

Sch C Income $150,000
Interest Income $ 39,500
Standard deduction ($ 12,000)
Taxable Income $177,500 * ignoring self employment tax deduction for this problem.

Tom needs to figure out his excess amount, per of § 199A(b)(3)(B)(iii):
QBI deduction per (2)(A) over the amount determined under 2(B).

Recall from Problem #4
The lesser of: 
	•	20% of QBI $30,000 ($150,000 * 20%) 
       -OR-
The greater of 
	•	50%  of W-2 wages $20,000 ($150,000 * $20,000) 
Or 
25 % of W-2 wages $10,000 (40,000 * 25%) + $15,000 [(2.5% of unadjusted basis ($600,000)]= $15,000 TOTAL $25,000

Tom’s § 199A deduction would be limited to $25,000.

Thus, the limit (“excess amount”) is $5,000

Phase-in of the Limit: 199A(b)(3)(B)(ii)
$5,000 * 40% [(177,500-1557,500)/50,000]= $2,000

Full Deduction less Limit:
(20% * $150,000) Less $2,000 = $28,000

Taxable Income Limit: He still must apply the taxable income rule at § 199A(a)(1)(B): the deduction cannot exceed 20% of taxable income less any net long term capital gain. 20% of the taxable income ($177,500) would be $35,500. Since the limit is higher, he is eligible for a deduction of $28,000.

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53
Q

How would your answer to Problem 1 change where Tom was a tax preparer assuming Tom received $39,500 of interest income rather than $12,500?

A
Tom’s taxable income is calculated as follows:
Sch C Income 		$150,000
Interest Income		$  39,500
Standard deduction	($ 12,000)
Taxable Income		$177,500

Recall that Tom’s business is a specified service business per 199A(d)(2). 199A(d)(3) provides that if a specified service business generates income greater than the threshold (199A(e )(2), 157,500 (for Tom as single) but not in excess of the top or the range (+50k or +100K mfj), “then that income will not fail to be as qualified business income but only the” applicable percentage.

199A(d)(3)(B) provides the computation to arrive at applicable percentage: 100%- percentage equal to the ratio of excess of taxable income in excess of threshold bears to the range ($50K, $100K mfj).

Tom’s applicable percentage is: 60% [1- [(177,500-157,500)/50,000)]]

* SSI $150,000
* Applicable percentage 90,000 (150,000 * applicable % 60%)
* Line 2 now becomes the “new QBI” and 199A(b) applies
* 199A(b)(2) initial deduction $18,000 (90,000 * 20%)
* 199A(b)(3)(B)(ii) provides for an additional limit when the taxable income is in “the range”:  the reduction is “the amount which bears the same ratio to “the excess amount” as the excess of taxable income over the threshold bears to the range.  
* 199A(b)(3)(B)(iii) the excess is the amount determined under 2(A) [SSI * 20%] over the 2(B) computation- wages computation.  
* We don’t have any wages in this fact pattern so the computation is as follows:  excess of $18,000 (20% * 90,000) and no wages 

* (ii) computation [(177,500-157,500]/50,000]= 40%
* 18,000 *40% = $7,200 (this is the reduction)
* 18,000- 7,200 = 10,800 this is your 199A deduction.  

The key to this is that 199A(d) takes the initial 20% of SSI income and reduces it by the percentage computation at 199A(d)(3)(B) converting it to “applicable percentage” which then essentially becomes the “new” QBI and the limitation at 199A(b)(3)(B) applies.

Taxable Income Limit: He still must apply the taxable income rule at § 199A(a)(1)(B): the deduction cannot exceed 20% of taxable income less any net long term capital gain. 20% of the taxable income ($177,500) would be $35,500. Since the limit is higher, he is eligible for a deduction of $10,800.

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54
Q

Sam, who is single, runs his own accounting firm as a sole proprietorship. His schedule C income is $140,000. He has no capital gains or losses and his total taxable income after all deductions is $100,000. How much is his Sec. 199A deduction?

Select one:

a. zero
b. $8,000
c. $20,000 Correct
d. $28,000
e. $100,000

A

Your answer is correct.

Sam is in the green bucket. So, even though he has a specified service income, all the income from the business is treated as QBI, per §199A(d)(3)(A). Thus, the Sec. 199A deduction is 20% * $140,000 = $28,000. However, he is still subject to the taxable income limit of 20% * $100,000 = $20,000.

The correct answer is: $20,000

55
Q

Mark, who is single, runs his own book store as a sole proprietorship. His schedule C income is $140,000. He has net long term capital gains of capital gains of $10,000 and his total taxable income after all deductions is $100,000. How much is his Sec. 199A deduction?

Select one:

a. zero
b. $18,000 Correct
c. $20,000
d. $28,000
e. $90,000

A

Mark is in the green bucket. So, he has a qualified business, so his $140,000 is all QBI. Thus, the Sec. 199A deduction is 20% * $140,000 = $28,000. However, he is still subject to the taxable income limit of 20% * ($100,000 - $10,000) = $18,000.

The correct answer is: $18,000

56
Q

Alice and Bob are a married couple. Alice runs her own toy store as a sole proprietorship. Her schedule C income is $200,000. Assume the sole propreitorship pays no wages, but has original cost of qualified property of $400,000.

Alice and Bob have no capital gains or losses and their total taxable income after all deductions is $250,000. How much is their Sec. 199A deduction?

Select one:

a. zero
b. $10,000
c. $30,000
d. $40,000 Correct
e. $50,000

A

Alice and Bob are in the green bucket. They have a qualified business, so their $200,000 Sch C income is all QBI. Thus, the Sec. 199A deduction is 20% * $200,000 = $40,000. The taxable income limit of 20% * $300,000 = $60,000 will not change the answer. Their Sec. 199A deduction is $40,000. Remember, since we are in the green bucket, we do not have the wage or basis limitation.

The correct answer is: $40,000

57
Q

Jack Box, a single taxpayer, owns 100% of a S Corporation, which runs a successful burger restaurant. Jack has taxable income of $450,000. The S Corp has the following activity:

Ordinary Income of $500,000
W-2 Wages paid of $100,000
Original cost of qualified property of $400,000
How much is their Section 199A deduction?

Select one:

a. zero
b. $35,000
c. $50,000 Correct
d. $90,000
e. $100,000

A

Jack is in the red bucket. He can get some QBI because he is in a qualified business. Before looking at limitations, his Sec. 199A deduction appears to be 20% * $500,000 = 100,000

However, he is subject to the W-2 Wage and Basis limit, which is the higher of

50% of wages (100,000) = $50,000, or
25% of wages (100,000), plus 2.5% of basis (400,000) = $35,000
The taxable income limit of 20% * $450,000 = $90,000 will not be a factor.

FInal answer for Sec. 199A deduction is $50,000.

The correct answer is: $50,000

58
Q

Sally Fields, single taxpayer, owns 100% of a S Corporation, which runs a successful cookie shop. Sally has taxable income of $250,000. The S Corp has the following activity:

Ordinary Income of $200,000
W-2 Wages paid of $60,000
Original cost of qualified property of $800,000
How much is her Section 199A deduction?

Select one:

a. zero
b. $5,000
c. $30,000
d. $35,000 Correct
e. $40,000

A

Sally is in the red bucket. She can get some QBI because she is in a qualified business. Before looking at limitations, her Sec. 199A deduction appears to be 20% * $200,000 = 40,000

However, he is subject to the W-2 Wage and Basis limit, which is the higher of

50% of wages (60,000) = $30,000, or
25% of wages (60,000), plus 2.5% of basis (800,000) = $35,000
The taxable income limit of 20% * $250,000 = $50,000 will not be a factor.

Final answer for Sec. 199A deduction is $35,000.

The correct answer is: $35,000

59
Q

Ben Matlock, single taxpayer, owns 100% of a S Corporation, which is a successful law firm. Matlock has taxable income of $550,000. The S Corp has the following activity:

Ordinary Income of $400,000
W-2 Wages paid of $200,000
Original cost of qualified property of $100,000
Select one:
a. zero Correct
b. $52,500
c. $80,000
d. $100,000
e. $110,000
A

Matlock is in the red bucket. Per §199A(c), none of the specified service income is teated as QBI so he will get zero Sec. 199A deduction.

The correct answer is: zero

60
Q

Jack and Jill, married couple, have taxable income of $395,000. Jack owns 100% of a S Corporation, which runs a successful burger restaurant. The S Corp has the following activity:

Ordinary Income of $500,000
W-2 Wages paid of $120,000
Original cost of qualified property of $400,000
How much is their 199A deduction?

Select one:

a. $32,000
b. $60,000
c. $68,000 Correct
d. $79,000

A

Jack and Jill are in the yellow bucket. There is QBI because he is in a qualified business. Before looking at limitations, his Sec. 199A deduction appears to be 20% * $500,000 = 100,000

However, he is subject to the W-2 Wage and Basis limit, which is the higher of

50% of wages (120,000) = $60,000, or
25% of wages (120,000), plus 2.5% of basis (400,000) = $40,000
It would appear our answer is $60,000, since we are limited by $40,000. However, we need to be rewarded for being within the phase-in range.

Applicable % = (395,000 - 315,000) / 100,000 = 80%

Limit reduced to Applicable %= 40,000 * 80%= 32,000

QBI deduction= 100,000 - 32,000 = $68,000

The taxable income limit of 20% * $395,000 = $79,000 will not be a factor.

The correct answer is: $68,000

61
Q

Carl and Carla, married couple, have taxable income of $395,000. Carl owns 100% of a S Corporation, which runs a successful burger restaurant. The S Corp has the following activity:

Ordinary Income of $500,000
No W-2 Wages paid
No Original cost of qualified property
How much is their 199A deduction?

Select one:

a. zero
b. $20,000 Correct
c. $79,000
d. $100,000

A

Carl and Carla are in the yellow bucket. There is QBI because he is in a qualified business. Before looking at limitations, his Sec. 199A deduction appears to be 20% * $500,000 = 100,000

However, he is subject to the W-2 Wage and Basis limit, which is the higher of

50% of wages (0) = $0, or
25% of wages (0), plus 2.5% of basis (0) = $0
It would appear our answer is $0, since we are limited by $100,000. However, we need to be rewarded for being within the phase-in range.

Applicable % = (395,000 - 315,000) / 100,000 = 80%

Limit reduced to Applicable %= 100,000 * 80%= 80,000

QBI deduction= 100,000 - 80,000 = $20,000

The taxable income limit of 20% * $395,000 = $79,000 will not be a factor.

The correct answer is: $20,000

62
Q

A and B, married couple, have taxable income of $325,000. A owns 100% of a S Corporation, which runs a successful accounting firm. The S Corp has the following activity:

Ordinary Income of $300,000
W-2 Wages paid of $100,000
Original cost of qualified property of $200,000
How much is their 199A Deduction?

Select one:

a. $45,000
b. $53,100 Correct
c. $54,000
d. $60,000
e. $65,000

A

A and B are in the yellow bucket. This is a specified business. Let’s go through the steps:

Step 1: Applic %= (325,000 - 315,000) / 100,000 = 10%

QBI= $300,000 * (100% - 10%) = $270,000

W-2 wages= $100,000 * (100% - 10%) = $90,000

Basis= $200,000 * (100% - 10%) = $180,000

Step 2: 20% of $270,000 = $54,000, reduced by greater of

§50% of Wages ($90,000) = $45,000, or
§25% of Wages ($90,000), plus 2.5% ($360,000) = $31,500
Thus, the limit (54,000-45,000) is 9,000. Multiply by Applic %, which is 10%= 900

Step 3: 54,000 - 900 = 53,100.

The taxable income limit of 20% * $325,000 = $65,000 will not be a factor.

The correct answer is: $53,100

63
Q

Taxpayer borrowed $100,000 from Bank A on January 1 and deposited the funds into to a new non-interest bearing checking account. The activity in this checking account was as follows:

2/1 Paid $20,000 to buy a personal car
4/1 Paid $40,000 to buy office equipment for his business (non-passive)
6/1 Paid $30,000 for investment expenditure (non-passive)
8/1 Paid remaining $10,000 to invest in a passive activity

How is the interest paid on this $100,000 loan categorized for purposes of determining the deductibility of the interest expense?

A

The classification of the loan interest expense depends upon the use to which the loan proceeds are put. When the funds are first deposited into the checking account, the funds are viewed as being used for investment (even if in an noninterest bearing account). Therefore, initially all the interest expense on the debt is classified as investment interest. Temp. Treas. Reg. §1.163-8T(c)(4)(i).

Thereafter, the loan is reclassified depending on how the proceeds are spent and the interest on the loan is similarly reclassified. Once the $100,000 is fully spent, the character of the interest is generally fixed, until the loan is paid off.

Transactions
Personal
Investment
Trade or Business
Passive
1/1 Deposit

100,000

2/1 Buy Car
20,0000
80,000

4/1 Office
20,000
40,000
40,000

6/1 Investment
20,000
40,000
40,000

8/1 Passive
20,000
30,000
40,000
10,000

This classification is important because trade or business interest is fully deductible §162; investment interest is deductible only to the extent of net investment income §§163(d); 163(h)(2)(B); passive interest is subject to the passive loss rules and personal interest is not deductible at all §163(h)(1).

64
Q

How would your answer to Problem 1 change had the $10,000 investment made on 8/1 been for the purchase of tax exempt municipal bonds?

A

The interest on the $10,000 loan used to purchase tax exempt municipal bonds still be investment interest expense but it would not be deductible. Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from federal income taxation is not deductible. §265(a)(2). See Treas. Reg. §1.163-8T(m)(2)(i).

65
Q

Taxpayer borrowed $5,000 on January 1, 20X1 and deposited the proceeds in his regular checking account that already had a balance of $4,000 consisting of earned funds. He borrowed an additional $5,000 on February 11 and deposited them into the same account. All of his expenditures before January 1, 20X1 were for personal expenses. The activity in the account for January, February and March, 20X1 was as follows:

1/1 $4,000 Opening Balance
1/1 $5,000 Deposit of Borrowed Funds (balance $9,000)
1/13 $3,000 Personal expenditure (balance $6,000)
1/14 $6,000 Trade or business expense (balance $0)
2/11 $5,000 Deposit of Borrowed Funds (balance $5,000)
2/12 $3,000 Deposit of Salary (balance $8,000)
3/1 $4,000 Personal expenditure (balance $4,000)
3/2 $4,000 Trade or business expense (balance $0)

How are the two loans characterized for purposes of determining the deductibility of the interest expense?

A

Under Temp. Treas. Reg. § 1.163-8T(c)(4)(ii), amounts expended from an account containing both borrowed and personal funds are first treated as coming from borrowed funds. That is true whether there was money in the account before the borrowing or if money was added to the account after the borrowing but before the expenditure.

Looking at the 1/1 loan, it would appear that the first $3,000 of borrowed funds would be allocated to the personal expenditure and only $2,000 allocated to the trade or business expense. However, Temp. Treas. Reg. §1.163-8T(c)(4)(iii)(B) provides that if an expenditure is made within 15 days after debt proceeds are deposited, taxpayer may elect how to allocate the expenditure among those 15 days of expenditures regardless of the general ordering rules. Thus Taxpayer may allocate all $5,000 of 1/1 borrowing to the 1/14 trade or business expense even though it came after the personal expenditure.

With respect to the 2/11 loan, under the ordering rule $4,000 of the borrowing would convert to a personal loan on 3/1 leaving only $1,000 to convert to a trade or business loan on 4/12. Temp. Treas. Reg. §1.163-8T(c)(4)(iii)(B) is of no help because the expenditures were made more than 15 days after the borrowing.

However, the rule of Temp. Treas. Reg. §1.163-8T(c)(4)(iii)(B) is expanded by Notice 89-35, 1989-1 CB 675 to include expenditures made within 30 days after or before the loan, including any expenditure made from any account or paid by cash. Thus taxpayer can elect to treat the remaining $1,000 of the 1/14 trade or business expenditure (within 30 days before the borrowing) and $4,000 of the 3/2 trade or business expenditures (within 30 days after the borrowing) as coming out of borrowed funds thereby characterizing the entire second debt as trade or business debt.

Intermingling borrowed money with other funds is best avoided. If the funds had been kept in separate accounts, the taxpayer could have paid for the personal expenses from the personal account to the extent possible, without having to rely on the timing rules and their exceptions.

Note also that for purposes of determining the effective date of the allocation of a deb to an expenditure, solely for purposes of classifying the interest Temp. Treas. Reg. §1.163-8T(c)(4)(iv) provides that the taxpayer may treat all expenditures made during any calendar month from debt proceeds in the account as occurring on the later of the first day of such month or the date on which such debt proceeds are deposited in the account. Thus, for example, the 1/14 trade or business expenditure could be treated as occurring on the same day as the receipt of the loan proceeds, eliminating the need to allocate part of the January interest expense to investment income expense.

66
Q

A borrowed $100,000, $60,000 of which was properly allocated to business expenditures (non-passive), $20,000 allocated to personal expenditures and the remaining $20,000 allocated to investment (non-passive) expenditures. If A pays back $40,000 of the loan, how is the remaining $60,000 of the loan categorized for purposes of determining the deductibility of the interest expense?

A

Temp. Treas. Reg. § 1.163-8T(d)(1) provides that repayments of debt are allocated in the manner most beneficial to the taxpayer. Thus the repayment is first allocated to the $20,000 of personal debt (whose interest is nondeductible) and then $20,000 to investment debt (whose is deductible subject to limitations) and none to the business debt (whose interest is fully deductible).

67
Q

In 20X1, Tom borrowed $100,000 and immediately used the proceeds to purchase stocks and bonds. Tom earned $3,000 of qualified dividends and $1,000 of investment interest from his investments. He paid $10,000 of interest on the debt. He has no other investment interest expense, received no other investment income and incurred no investment related expenses during the year. What is the amount of his 20X1 investment interest expense deduction?

A

A taxpayer is allowed to deduct investment interest expense to the extent of his net investment income per § 163(d)(1). Tom’s net investment income potentially includes the $3,000 of qualified dividend income and the $1,000 of investment interest (§163(d)(4)). However, under current law, qualified dividends are a tax favored item, taxed at capital gains rates. Under the flush language of § 163(d)(4)(B) qualified dividends are not included as investment income unless the taxpayer elects to include them because including them in the §163 calculation results in their being taxed at ordinary income rates. His investment income is only $1,000 unless he affirmatively chooses to include the dividends in the calculation.

Without an election, Tom is only allowed to deduct $1,000 of investment interest in the current year. The $9,000 of additional investment interest, however, carries over and may be deducted in future years if he has sufficient investment income in those later years. § 163(d)(2). If he makes the election, Tom is allowed to deduction $4,000 with a $6,000 carryover.

68
Q

Assuming the facts of Problem 5, in 20X2 Tom paid $10,000 of interest on the debt and earned $12,000 of investment interest. Additionally, $2,000 of the $100,000 borrowed amount was forgiven by the lender and was not excludable from Tom’s income. What is the amount of his 20X2 investment interest expense deduction?

A

In 20X2 Tom has $10,000 of the current investment interest expense and at least $12,000 of investment income. Thus he may deduct the full amount of the 20X2 investment interest expense. Since his investment income for the year exceeds his investment interest expense, he can deduct some of the 20X1 disallowed investment interest expense which carried over.

What about the cancellation of indebtedness? Section 163(d)(4)(B) defines “investment income” as including the income from property held for investment and the gain from the disposition of such property. Section 163(d)(5)(A) defines “property held for investment.” In PLR 200952018, the Service ruled that taxable income from the cancellation of an “investment loan” gives rise to investment income. Thus there is $4,000 of excess investment income in 20X2.

69
Q

Chris is married and files a joint return with his wife. Their adjusted gross income for the year was $100,000 all of which was from their $94,000 combined salary and $6,000 of investment interest income. They had the following items of which affect the computation of their investment interest expense deduction:

Investment Income $6,000
Investment Interest Expense 15,000
Broker stock management Fees 2,100
Tax return preparation fees 1,800

What is the amount of their investment interest expense deduction?

A

Per §163(d)(1), a taxpayer can deduct investment interest expense up to net investment income. Net investment income is defined as the excess of “investment income” over “investment expenses.” Investment expenses are only those deductions “allowed” which are directly connected with the production of the investment income. §163(d)(4)(C).

However, after the JCTA suspended misc. itemized deductions under §67(g), no investment expenses are actually “allowed”. Therefore, as a practical matter, net investment income = investment income.

Thus, the $15,000 of investment interest expense is limited to $6,000, the amount of investment income. The remaining $9,000 carries forward indefinitely.

70
Q

Taxpayer borrowed $20,000,000 (Debt A) and invested all of the loan proceeds in his business. His business has had greater than $25 million in gross receipts in each of the last 4 years. In the current year, taxpayer’s business has the following activity:

Gross Sales $30,000,000
Cost of sales $25,000,000
Interest income $ 100,000
Interest expense on Debt A $ 2,000,000
Depreciation expense $ 2,600,000

How much of the $2,000,000 of interest on Debt A is deductible?

A

The first step is to calculate taxable income:

Gross Sales				 30,000,000
Cost of sales 			(25,000,000)
Interest income			      100,000 
Interest expense			  (2,000,000)
Depreciation expense		  (2,600,000)

Net taxable income 500,000

Now that we have taxable income, the second step is to post the specific adjustments to get to our adjusted taxable income:

Net taxable income 500,000
Subtract: Interest income (100,000)
Addback: Interest expense 2,000,000
Addback: Depreciation 2,600,000

Adjusted taxable income 5,000,000
Plus: Bus. Interest income 100,000

Base 5,100,000

Rate 30%

Interest expense “ceiling” 1,530,000

Thus, of the $2,000,000 of interest expense, only 1,530,000 would be currently deductible per Sec. 163(j). The remaining 470,000 gets carried forward to next year.

71
Q

Taxpayer paid the following interest.

Interest on student loans $500
Credit card interest 300
Interest on loan to purchase a car 1,000

Which interest might be deductible?

A

The short answer is that, depending on the fact, all “might” be deductible. The interest on the loan to purchase a car is a nondeductible personal expense unless it is structured as a home equity loan or the car is used in business. The interest on the credit card is a nondeductible personal expense unless the credit card was used to pay for investment or trade or business expenses, in which case all or part of the credit card interest may be deductible. The student loan interest may be deductible under §221 in the requirements of that section are met.

72
Q

Tom paid $3,000 of interest on loans incurred to pay for college tuition. Tom attended classes on a full-time basis during the day and worked part-time in the evenings. His “modified AGI” was $53,000. How much of the $3,000 student loan interest expense will Tom be able to deduct?

A

Section 221 allows for the deduction of a limited amount of interest on qualified education loans. This is an exception to the general rule that personal interest is nondeductible. Interest on a qualified education loan is deductible up to a maximum of $2,500 a year.

However, this maximum is reduced once the taxpayer’s modified AGI exceeds $50,000 ($100,000 for a joint return) and goes to $0 when modified AGI exceeds $65,000 ($130,000 for a joint return). Since Tom’s modified AGI is $53,000, there will be reduction in the maximum deduction. The $2,500 maximum interest deduction is reduced under §221(b)(2)(B) in the amount that bears the same ratio to the amount taken into account as the excess of the taxpayer’s modified AGI over $50,000 ($100,00 joint return) bears to $15,000 ($30,000 joint). Here, his modified AGI exceeds $50,000 by $3,000. The ratio of 3,000 to 15,000 is 20%. Therefore, his maximum deduction of $2,500 is reduced by 20%. Tom’s deduction is limited to $2,000.

73
Q

Would your answer to Problem 10 change if Tom worked full-time during the day and attended classes on a part-time basis in the evenings?

A

One of the requirements of § 221 is that an education loan must be made to an “eligible student.” § 221(d)(1)(C) Section 221(d)(3) defines “eligible student” by reference to §25A(b)(3). That section requires, among other things, that the student take at least one-half of a full time load. We need to determine whether Tom’s part time class total enough to meet the at least one half of a full time load test. What constitutes a full time load varies from college to college and sometimes from department to department within a single college.

74
Q

On January 1, 20X1 Ron purchased his principal residence for $600,000, borrowing $450,000 (Debt A), secured by the home. In addition, Ron opened a line of credit secured by the home. During 20X1 he borrowed $50,000 (Debt B) from the credit line and used the $50,000 for personal expenditures unrelated to the residence. He paid interest of $60,000 on Debt A and $5,000 on Debt B. How much interest expense is he entitled to deduct in 20X1?

A

Qualified residential interest is deductible as another exception to the nondeductibility of personal interest. There are a number of requirements which must be met. First, the loan must be secured by a “qualified residence.” Qualified residence is defined in §163(h)(4)(A) to include a principal residence plus one additional residence designated by the taxpayer, which can be changed annually. Second, the loan must qualify as either acquisition indebtedness §163(h)(3)(A)(i) or home equity indebtedness §163(h)(3)(A)(ii).

Under § 163(h)(3)(B) whether a loan constitutes acquisition indebtedness generally depends on how the loan proceeds were used. To be acquisition indebtedness the loan proceeds must have been used to acquire or substantially improve a qualified residence or used to refinance an existing acquisition debt. Acquisition indebtedness limited to a loan principal amount of $1,000,000 § 163(h)(3)(B)(ii) if incurred before December 31, 2017, or $750,000 if incurred after that. § 163(h)(3)(F)(i)(II)

Per § 163(h)(3)(F)(i)(I), the TCJA suspended all home equity indebtedness in tax years 2018 thru 2025. Thus, the $5,000 interest on Debt B is not deductible.

75
Q

Would your answer to Problem 12 change if Debt A totaled $1,500,000 and Debt B totaled $200,000 and the home was purchased for $2,000,000?

A

Acquisition indebtedness is limited to a principal amount of $1,000,000 if incurred before December 31, 2017, or $750,000 if incurred after that.

If incurred before December 31, 2017, then 1,000/1,500 or 2/3 of the Debt A interest of $60,000 would be deductible. The amount would be $40,000

If incurred after December 31, 2017, then 750/1,500 or 1/2 of the Debt A interest of $60,000 would be deductible. The amount would be $20,000

Regardless of when Debt B was incurred, none of the $5,000 of home equity interest would be deductible for any year from 2018 thru 2025.

76
Q

In 20X1, Susan purchased her principal residence for $200,000, paying $50,000 in cash and taking out a 30-year interest only loan of $150,000, secured by the property (the “First Loan”). She paid two points ($3,000) to the lender. On January 1, 20X4, she took out a new 30-year $150,000 interest only loan at a new lower interest rate (the “Second Loan”). She used the proceeds to pay off the $150,000 balance of the First Loan. She paid two points ($3,000) to the lender for the Second Loan. On January 1, 20X6, she again refinanced her $150,000 interest only loan at a still lower interest rate (the “Third Loan”). The Third Loan was a 10-year loan secured by the property and she paid three points ($4,500) to the lender. In each instance she paid the points from separate funds and the amount of the points paid were commercially reasonable. What are the tax consequences of the points paid on the First Loan, the Second Loan and the Third Loan?

A

In general, points are prepaid interest. It must first be determined that the points are intended as interest, not something else like title report, escrow fee, deed preparation, or insurance. Rev. Rul. 94-27 provides guidance on when points will be treated as interest. In order to be treated as points, they must be computed as a percentage of the amount borrowed, conform to established business practices in the area and be paid with with money the borrower deposited and not merely deducted from the loan proceeds (“new money”).

Under §461 the points must be deducted over the life of the loan. However, under certain circumstances points are immediately deductible. Points on acquisition indebtedness – debt incurred for the purchase or improvement of a home - are immediately deductible. §461(g)(2). Therefore, the $3,000 in points paid on the First Loan in 20X1 are deductible in 20X1.

The Second Loan was used to refinance and pay off the First Loan. The Second Loan is treated as home acquisition debt for purposes of the deductibility of qualified residential interest. §163(h)(3)(B) flush language. However, the Second Loan is not treated as home acquisition debt for purposes of deductibility of points. But see, Huntsman v. Commissioner, 905 F.2d 1182 (8th Cir. 1990) allowing points to be deducted on a permanent home loan replacing interim short term financing. The $3,000 in points paid on the Second Loan loan must be amortized and deducted at a rate of $100 per year over the 30 year life of the loan. Rev. Rul. 87-22.

Similarly, the $4,500 points paid on the Third Loan must be amortized and deducted at a rate of $450 a year over the 10 year life of that loan. However, the proceeds of the Third Loan have paid off the balance owing on the Second Loan when there was still $2,800 of remaining unamortized points. These $2,800 of unamortized points on the Second Loan become immediately deductible when the Second Loan is paid off. Thus the 20X6 interest deduction is $3,250.

77
Q

George invested in XYZ Corporation by purchasing $100,000 of common stock at its then fair market value. George sold the stock for its current fair market value of $40,000. Is there any difference in result to George if he sold the stock to an unrelated buyer or to his son?

A

Section 165(a) permits the deduction of losses “sustained during the taxable year and not compensated for by insurance or otherwise.” Treas. Reg. §1.165-1(b) provides that, to be deductible, a loss generally must be: (i) evidenced by a closed and completed transaction; (ii) fixed by an identifiable event; and (iii) sustained in the year claimed.

If the loss is incurred by an individual it must fall into at least one of the following categories in order for it to be deductible: (i) incurred in a trade or business; (ii) incurred in a transaction entered into for profit; or (iii) arising from fire, storm, shipwreck, or other casualty or from theft. The amount of the loss will (in general) be the taxpayer’s basis in the property, less any amount realized on its disposition §§165(b), 1001(a); Treas. Reg. § 1.165-1(c).

If Sam sold the stock to an unrelated party, he would be entitled to a $60,000 deduction for a loss incurred in a transaction entered into for profit. An investment loss resulting from the sale or exchange of property is deductible above the line. Treas. Reg. §1.62-1T(c)(4). However, § 1211 limits the deductibility of capital losses to the taxpayer’s capital gains plus, in the case of an individual, $3,000. §165(f).

The answer would be different if Sam sold the stock to his son. Under § 267(a)(1), no deduction otherwise allowable is allowed with respect to any loss from the sale or exchange of property, directly or indirectly, between related persons. Related persons are defined in § 267(b) and includes fathers and sons. §§267(b)(1), 267(c)(4). Sam would be denied his $60,000 loss if he sold it to his son.

78
Q

George invested in XYZ Corporation by purchasing $100,000 of common stock at its then fair market value. George sold the stock to his son for its then current fair market value of $40,000. What are the tax consequences to Son if two years later Son resold the stock for $90,000 to an unrelated buyer?

A

When Son resells the stock, he will recognize a $50,000 gain since his cost basis was $40,000. Even though the stock is now outside the related party group, his father does not get to recognize the $60,000 loss previously denied by § 267(a)(1). Section §267(d) provides some relief, but it is the Son, not Sam, who benefits. The flush language provides that gain on the subsequent sale by Son is recognized by him only to the extent it exceeds the previously disallowed loss. Son’s gain of $50,000 is reduced by the $60,000 loss previously disallowed to Sam. Treas. Reg. §§1.267(d)-1(a)(1); 1.267(d)-1(a)(4), Ex. (1). Son will recognize no gain. The remaining $10,000 of disallowed loss will provide no benefit to either Sam or his son.

79
Q

The taxpayer and his spouse have the following activity for 20X1 year:

Dividends $400,000
Capital Gains $600,000
Net Business loss ($800,000)
Standard deduction $ 24,000

Assume the large business loss was from the disposal of a business activity that freed up years of passive losses. What is the couple’s taxable income for 20X1 year?

A

Section 461(l) limits nonpassive business losses to business income, plus $500,000 for MFJ ($250,000 for single taxpayers). Thus, in this problem the $800,000 business loss is limited to $500,000. The excess ($300,000) is called an “excess business loss” is carried forward to the 20X2 year as a net operating loss.

The couple has $1,000,000 of nonbusiness income, which can be offset by $500,000 of business loss. After deducting the standard deduction, the couple’s taxable income is $476,000.

80
Q

Assume the same facts as Problem 3. Now, we are in the 20X2 year. Assume in 20X2, the couple has taxable income before considering any NOL carryforward of $200,000. What is the couple’s taxable income?

A

Remember that the couple has a $300,000 NOL carryforward into the 20X2 year. However, it can only offset 80% of taxable income. Thus, we can utilize 80% of 200,000, or $160,000 in the current year. That means that taxable income for 20X2 would be $40,000 and we would still have a $140,000 NOL carryforward to 20X3.

81
Q

Sam experienced a difficult year in his shoe business. Sam is single and reported the following income and allowable deductions for the year:

Income
Business Income $30,000
Gain on Sale of Business Asset 5,000
Gain on Sale of Personal Asset 2,000
Personal Interest Income 1,000

Expenses
Business Expenses 42,000
Mortgage interest expense 15,000

How much is Sam’s net operating loss for the year and what are the tax consequences of the loss?

A

Sam has a current year loss of $19,000 ($38,000 of income less $57,000 of deductible expenses). His taxable income for the year is $0. The question is whether he can get any tax benefit from the $19,000 excess loss.

A net operating loss (“NOL”) can be used to offset taxable income in other years. However, his NOL may be less than the $19,000 excess loss. Individual NOLs come from deductions and losses from a trade or business, deductible employee business expenses, or deductions for casualty or theft losses §§ 172(c), 172(d)(1), 172(d)(4). An individual’s NOL is generally the lesser of: 1) the taxpayer’s overall loss for the year or 2) the net operating loss.

To calculate his net operating loss under § 172: (i) nonbusiness capital losses are deductible only to the extent of nonbusiness capital gains. §172(d)(2)(B), and (ii) other nonbusiness deduction (other than casualty losses) are limited to nonbusiness income. §§ 172(d)(2)(A); 172(d)(4).

Sam’s gross income is $38,000. For purposes of calculation of Sam’s NOL, the deductions allowed are the business expense of $42,000 and the personal expense of $15,000 but limited to the nonbusiness income of 3,000. Thus the total expenses allowed are $45,000 resulting in a $7,000 NOL. Of Sam’s actual loss of $19,000 for the year, only $7,000 is treated as a net operating loss.

Under the general rule, an NOL can be carried back for two years and carried forward for up to 20 years. Under certain circumstances an alternative carryback rules are available, extending the carryback beyond two years depending on the nature of the loss and the year in which it was sustained.

A taxpayer may elect to waive of the carryback and just use the NOL as a carry forward. You must determine whether the NOL is more valuable as a carryback (with an immediate “quickie” refund) or as a carryforward. This is done by comparing the refund which would be generated the carryback years to the anticipated tax benefits for deducting the NOL against future income. You must also factor in time value of money since you get an immediate refund if you carry back the NOL, but have to wait if you carry it forward. Finally, the amount of the refund in the carryback year can be calculated with reasonable certainty which the value of the NOL carryforward is dependent on the taxpayer’s income in future years and the applicable tax rates in those years.

82
Q

Jim owns and runs a successful dry cleaning business as a sole proprietorship. He buys a van to use to make pickups and deliveries. Bob, one of his employee sales representatives, decides to buy a car in order to commute to work and use for personal purposes on the weekend. Each finances the purchase of their car through the car dealership. Which of the following statements are true?

Select one:

a. The interest payments Jim makes on the car loan are deductible Correct
b. The interest payments Bob makes on the car loan are deductible
c. The interest payments both Jim and Bob makes on the car loans are deductible
d. Interest paid by neither of them is deductible

A

Only the interest paid by Jim is deductible. Tracing rule #1 states that deductibility is determined by the use of funds. Jim’s interest is deductible because interest paid or accrued on indebtedness incurred in connection with the conduct of a trade or business is deductible. §§ 163(a), (h)(2)(A). However Bob’s interest is not deductible since interest paid or accrued on indebtedness incurred in the trade or business of performing services as an employee is personal interest and thus not deductible. §163(h)(2)(A).

The correct answer is: The interest payments Jim makes on the car loan are deductible

83
Q

On January 1, Lisa borrowed $10,000 and deposited it in an account that already contained $30,000 of earned funds.

On January 7, Lisa pays $20,000 out of the account for a personal expenditure.
On January 10, Lisa pays $5,000 out of the account for a business expenditure.
On January 20, Lisa pays $15,000 out of the account for an investment expenditure.
Ignoring the few days that the expenditure sat in the bank account, what is the character of the interest on the borrowed funds?

Select one:

a. all personal interest
b. 50% businerss interest; 50% personal interest;
c. 50% business interest; 50% investment interrest Incorrect
d. 1/3 personal interest; 1/3 business interest; 1/3 investment interest
e. all business interest

A

Under Reg. 1.163-8T(c)(4)(ii) [Tracing Rule #3], expenditures first come from borrowed funds. However, Reg. 1.163-8T(c)(4)(iii)(B) [Tracing Rule #4], provides a 15 day rule where the taxpayer can earmark any expenditure occuring within 15 days of th deposit of borrowed funds directly to the borrowed funds.

Therefore, Lisa can earmark the $5,000 business expenditure (on Jan. 10) directly against borrowed funds , deposited on Jan. 1. Lisa can not earmark the Jan. 20 investment expediture to borrowed funds because that is more than 15 days after the deposit of borrowed funds. Therefore, the first $5,000 of business expendiutre goes to borrowed funds. We then go back to Tracing Rule #3 and go through the expenditures in chronological order, so the next expenditure against borrowed funds is the $20,000 of personal expenditure. Thus, in determining the character of the interest on the $10,000 of borrowed funds, the first $5,000 is business and the other $5,000 is personal.

The correct answer is: 50% businerss interest; 50% personal interest;

84
Q

This year Sue, who is single and whose adjusted gross income is $53,000, paid interest of $3,500 on a student loan in its third year of repayment, $1,500 on credit cards used to pay for a vacation trip, and $3000 on a personal automobile loan. How much interest is deductible by Sue?

Select one:

a. $8,000
b. $3,500
c. $2,500
d. $2,000 Correct
e. $500

A

All of these loans give rise to personal, nondeductible interest except the education loan. Educational loan interest is deductible but only to the extent of the specified limitation, which is $2,500 reduced by $1/15 for every dollar AGI exceeds $50,000. Since her AGI of $53,000 exceeds $50,000 by $3,000, the maximum deduction is reduced by $500 to $2,000.

The correct answer is: $2,000

85
Q

Bill owns a condominium worth $1,500,000, which secures a $970,000 mortgage he took to acquire the condominium. Bill uses the condominium as his principal residence. In 2016, Bill purchases a new boat for recreational purposes and borrows an additional $150,000 to pay for the boat, secured by a second mortgage on the condo. How much of the interest paid on the second mortgage is deductible?

Select one:

a. The interest on $150,000
b. The interest on $100,000
c. The interest on 30,000
d. No interest is deductible on the second mortgage Correct

A

The interest on the second mortgage is home equity interest. After the 2017 Tax Cuts and Jobs Act, per § 163(h)(3)(F)(i)(I), interest on all home equity interest is nondeductible, even if the loan was taken out before 2018.

The correct answer is: No interest is deductible on the second mortgage

86
Q

In Jan. 1, 2019, Donna purchased a house used as her principal residence for $2 million. She paid $500,000 in cash and used $1.5 million proceeds from a loan, which was secured by the residence. The interest rate on her $1.5 million loan was 6%. How much interest is deductible by Donna in 2019?

Select one:

a. zero
b. $6,000
c. $45,000 Correct
d. $60,000
e. $90,000

A

This is acquitiion indebtedness incurred in 2019. Per 2017 Tax Cuts and Jobs Act and § 163(h)(3)(F)(i)(II), the limit was acquisition indebtedness incurred during tax years 2018 thru 2025 is $750,000. Since the debt is $1.5 million, only 50% is deductible. The interest rate is 6%, so total interest is 6% * 1.5 million, or $90,000. Deductible interest is 50% of $90,000, or $45,000.

The correct answer is: $45,000

87
Q

Fred and Ginger purchased their principal residence a few years ago, borrowing $100,000 which is secured by a mortgage on the property. On January 1 of this year, when the residence is worth $200,000 and the mortgage balance is still $100,000, they refinance, borrowing $200,000 for at 5% per year for 10 years and paying 2 points. How much of the $4,000 points on the new mortgage is deductible this year?

Select one:

a. $200
b. $400 Correct
c. $2,200
d. $4,000
e. Actually, interest represented by points are never deductible.

A

$400 of the points is deductible this year. Fred and Ginger paid a total of $4,000 in points ($200,000 x 2%). However, since the loan proceeds were not used to acquire or improve the property, the points must be amortized over the 10 year life of the loan. They will deduct $400 a year for 10 years.

The correct answers are: $200, $400

88
Q

On January 1, 20X1, Eddie borrowed $100,000. He took the funds and deposited it into his business bank account where it sat for six months. On July 1, 20X1, Ed used all of the $100,000 to purchase assets used in his business. The interest on the $100,000 of borrowed funds in the 20X1 year will all be characterized as trade or business interest.

Select one:
True
False Correct

A

Under Treas. Reg. §1.163-8T(c)(4)(i), funds that sit in an account are characterized as investment interest. Since the the funds sat in an account for six months, half of the annual interest will be investment interest and half will be trade or business interest, due to the expenditure on July 1st.

The correct answer is ‘False’.

89
Q

Company X has had gross receipts in excess of $25 million in each of the last 4 years. In 2018, Company X had the following activity:

Gross Receipts $40,000,000
Interest Income $1,000,000
Salaries expense $5,000,000
Interest expense $15,000,000
How much of the 15 million of interest expense is deductible? 

Select one:

a. zero
b. $9 million
c. $10 million Correct
d. $15 million

A

First, we calculate Taxable Income

Gross Receipts $35,000,000
Interest Income $1,000,000
Salaries expense ($5,000,000)
Interest expense ($15,000,000)
Taxable Income  $16,000,000
Adjusted Taxable Income is 
Taxable Income  $16,000,000
Subtract Int. Inc. ($1,000,000)
Add back Int. Exp $15,000,000
Adj. Taxable Income $30,000,000
Per § 163(j), Interrest is limited to 30% taxable income + Business Interest income, which is 30% (30 million) + 1 million= 10 million

The correct answer is: $10 million

90
Q

On Jan. 1, X1, Henry took out a $10,000 loan. He immediately used $5,000 of the proceeds to buy business assets and used $5,000 of the proceeds to purchase stock in the stock market. On Jan. 1, X2, Henry paid back $5,000 of the $10,000 bank loan. What is the character of the interest on the remaining $5,000 loan?

Select one:

a. All business Correct
b. All investment
c. 50% business; 50% investment
d. 50% business; 50% personal
e. all personal

A

Per § 1.163-8T(d)(1) [Tracing Rule #5], repayments are deemed made in the following order: personal, investment, passive and then business. Thus, in this problem, the $5,000 repayment all went to wipe out the investment portion of the debt. So, the remaining debt is all business.

The correct answer is: All business

91
Q

Al invested in XYZ Corporation by purchasing $100,000 of common stock. Subsequently, Al sold the stock to his son Sam for $40,000. A year later, Sam sold the stock for $50,000 to an unrelated taxpayer. What are the tax consequences to Al and Sam from these transactions?

Select one:

a. Al can not deduct the loss of $60,000 upon sale to Sam. Sam must report a taxable gain of $10,000 upon the sale to the unrelated taxpayer
b. Al can not deduct the loss of $60,000 upon sale to Sam. Sam will report neither gain nor loss upon the sale to the unrelated taxpayer Correct
c. Al can not deduct the loss of $60,000 upon the sale to Sam. Sam has a deductible $50,000 loss upon his sale to the unrelated taxpayer.
d. Al can not deduct the loss of $60,000 upon the sale to Sam but can claim the loss when Sam sells to the unrelated party. Sam has a taxable gain of $10,000 upon his sale to the unrelated taxpayer.

A

Al’s $60,000 loss is disallowed because his sale was to a related party. Sam can use Al’s disallowed loss to offset the amount of his subsequent gain. Sam will realize a $10,000 gain on his sale to an unrelated party but the gain will not be taxable to him. The remaining disallowed loss will never benefit anyone.

The correct answer is: Al can not deduct the loss of $60,000 upon sale to Sam. Sam will report neither gain nor loss upon the sale to the unrelated taxpayer

92
Q

Barbara gave $100 to a homeless family living on the street. May she take a charitable deduction for the $100?

A

Section 170 allows for the deduction of a charitable contribution as defined in § 170(c). Section 170(c) defines a charitable contribution as a gift to certain charitable institutions. Individuals are not qualified recipients under §170(c). Therefore, regardless of circumstances or intent, gifts made directly to needy individuals, or funds set up to aid a specific individual, are not deductible as charitable donations.

93
Q

Joe donated 200 shares of Xerox stock to Shining Door University. He had purchased the stock four years earlier for $38,000. On the date of the contribution, the stock had a fair market value of $40,000. His adjusted gross income for the current year was $100,000. This was Joe’s only charitable contribution. How much is Joe’s charitable contribution deduction with and without all available elections?

A

Shining Door University is a permissible recipient assuming that it is a corporation created in the United States, organized and operated exclusively for educational purposes. §170(c)(2)(B). We must determine the amount of the donation for purposes of the charitable deduction and apply the appropriate deduction percentage limitation rule.

When property is donated, the amount of the donation is generally the fair market value of the property. Treas. Reg. § 1.170A-1(c)(1). There are certain exceptions to the fair market value rules when appreciated property is donated. However, none of those exceptions apply here. Thus, the full $40,000 is allowed.

Note that the $2,000 inherent gain is not triggered by virtue of the donation. The charitable deduction for the fair market value is allowed without the tax on inherent gain ever having to be paid. This results in the donation of appreciated property often having a significantly lower after tax cost to the donor than the donation of the same amount of cash.

There is, however, a downside to the donation of appreciated property with long term capital gains. While under §170(b)(1)(A)(ii), an individual’s charitable deduction is generally limited to 50% of his “contribution base” (for our purposes AGI), if the property has long term capital gains, the deduction is limited to 30% of the contribution base. §170(b)(1)(C)(iv). Since his contribution base in $100,000, he will only be able to deduct $30,000 of his $40,000 charitable contribution, with the balance carrying forward for up to five years. §§170(b)(1)(C)(ii), 170(d)(1)(A)(ii).
If Joe made an election under § 170(b)(1)(C)(iii), his limitation goes back to 50% of his contribution base. However, by making this election, the amount of his donation is reduced the long term capital gains, from $40,000 to $38,00.

Without the election, he has a $30,000 current deduction and a $10,000 deduction carryover. With the election he has a $38,000 current deduction and no carryover. Which one is better depends whether (and when) he will be able to make use of the carryover.

Joe has a third alternative. If he sold the stock first, recognized the $2,000 long term capital gain he would pay $300 in capital gains tax. That would leave him $39,700 in cash to donate, which would be fully deductible since cash donations remain subject to the 50% limitation.

The after tax cost of the three alternatives must be analyzed to see which is the best for Joe.

94
Q

How would your answer to Problem 2 change if Joe bought the stock in the same year as his contribution?

A

The gain in the stock would be short term. Under § 170(e)(1)(A) the amount of the donation is automatically reduced for the short term capital gains in the donated property. Joe’s deduction would be limited to $38,000 (40,000 - 2,000 short term capital gains) subject to the 50% of AGI limit. Note that the 30% deduction limitation rule of §170(b)(1)(C)(i) does not apply here since it only applies to “capital gain property” which is defined in § 170(b)(1)(C)(iv) as property the sale of which would give rise to long term capital gain.

95
Q

Sue is the leader of a Girl Scout troop. During the year she incurred the following expenses in providing her volunteer services to the organization:

Cost of her uniform $ 30
Airfare costs for field trip to Disneyland 150
Hotel & food costs incurred on trip to Disneyland 150
Value of her donated time 500

To what extent, if any, is Sue entitled to a charitable deduction for these amounts?

A

Sue gets no deduction for the value of her donated time. Treas. Reg. §1.170A-1(g) Sue will be entitled to deduct the cost of her uniform only to the extent that the uniform worn while performing donated services is without general utility. According to the Girl Scout website: “The official uniform for adults is navy blue business attire worn with a Girl Scout scarf (either Legacy or Promise) and membership pins for women and the Girl Scout Service Mark tie for men.” The cost of the navy blue business attire would not be deductible. The cost of the scarf and pins would meet the test.

Sue may be able to deduct transportation, meals and lodging expenses while away from home in Disneyland, so long as no significant personal pleasure involved. §170(j) Mileage related to charitable activities is allowed at 14 cents per mile. This does not mean that Sue gets no deduction if she enjoys herself. It is certainly debatable whether there is “personal pleasure” in taking a group of girl scouts to Disneyland in any event. The focus of this rule is really on whether there was another personal pleasure motive, unrelated to the charitable activity, that was a “significant” reason for making the trip.

96
Q

Jean contributed a microscope to Stanford University for student use in the classroom. She bought the microscope for $2,000 more than one year ago. Its fair market value was $3,000 at the time of the contribution. How much is Jean’s charitable deduction?

A

Under the general rule, Jean is entitled to a charitable donation of $3,000, the fair market value of the donated microscope. However, § 170(e)(1)(B) reduces the amount of the deduction for donated tangible personal property by the long term capital gains inherent in the property unless the requirements of §170(e)(1)(B) are met. Whether §170(e)(1)(B) applies depends upon the use to which the property is put by the charity and the type of charity to which you make the donation. In this problem, the §170(e)(1)(B) limitation will apply only if Stanford University’s use of the donated microscope is unrelated to its educational purpose or function or if it sells the microscope. If §170(e)(1)(B) applies, Jean’s donation will be only $2,000.

The donor is responsible for proving the charity’s actual use of the property. Treas. Reg. § 1.170A-4(b)(3)(ii). She can either prove the actual use to which the property was put or argue that it is reasonable to anticipate that the property will not be put to an unrelated use. Treas. Reg. §1.170A-4(b)(3)(ii). Since she donated the microscope specifically for student use in the classroom, she can certainly argue that it is reasonable to anticipate that Stanford will be using the microscope for educational purposes. Jean would be better served, however, with a letter from Stanford indicating the actual use to which the microscope was put, and a photograph or video of her donated property being used in the classroom. Note that a letter thanking her for the donation is not enough here. We must prove actual use after receipt, not just the fact of receipt.

97
Q

James purchased $5,000 of stock in X Corporation four years ago. It is currently worth only $1,000. He would like to make a contribution to his church and has asked whether it’s a good idea for him to contribute the stock to the church. What is your advice?

A

James’ charitable contribution would be limited to the $1,000 fair market value of the donated property. The donation will not trigger recognition of the loss. Treas. Reg. §1.170A-1(c)(1). He would be better off selling the stock, recognizing the loss and then donating the $1,000 in cash. If he were in a charitable mood he could increase his donation by the taxes he saves from deducting the $4,000 long term capital loss.

98
Q

Eric is single and itemizes on his current year tax return. He makes a $300 cash donation, in addition to noncash donations of miscellaneous clothes with a total FMV of $400, and a painting worth $6,000 to a qualified charity. What are the documentation requirements of these donations?

A

Eric’s $300 cash donation exceeds $250 threshold. Therefore, bank records or cancelled checks are not sufficient documentation. Per § 170(f)(8), Eric must have written acknowledgement from the charity. That written acknowledgement should include the charity’s name, address, and the amount of cash donated. It should also include whether the done organization provided any goods or services in consideration for the donation. Finally, Eric should have this documentation at the time he files his timely tax return, per § 170(f)(8)(C).

Eric’s $400 donation of clothes also needs written acknowledgement similar to what was described in the previous paragraph. In addition, per Ohde v. Commissioner Case, there needs to be a specific description of each piece of clothing donated. For example, instead of “clothes”, “large, long sleeve Ralph Lauren shirt”. Per Per § 170(f)(16), all clothing donated must be in good used condition or better.

Eric’s $6,000 donation of artwork will have the most stringent of documentation requirements. It is still subject to the written acknowledgement requirement. Because it is a noncash donation greater than $500, it will have also have to meet the written records described in the § 170(f)(11)(B) & Reg. 1.170-13(b)(3), which is (1) Date and manner acquired, (2) detailed description, (3) cost basis, (4) FMV at time contrib., (5) method to determine FMV. Because the noncash donation’s value exceeds $5,000, the method to determine FMV must be from a qualified appraisal. Note that this appraisal must be received before Eric files a timely tax return for the year of donation.

99
Q

Which of the following taxes are deductible: i) State sales tax, ii)Social Security taxes paid by an employee, iii) Social Security taxes paid by someone who is self-employed, iv) State Unemployment Insurance contributions (or State Disability Insurance payments) or v) Federal Income tax?

A

State sales tax

This deduction is a revolving door. State sales tax use to be fully deductible, then nondeductible, and then deductible once again, but only in lieu of the state income tax deduction, then nondeductible again. Currently state sales tax is deducible only if no deduction is claimed for state income taxes. You deduct the larger of the two amounts. Then, you add that to personal property taxes and the total amount is limited to $10,000 for tax years 2018 thru 2015, per § 164(b)(6).

Social Security taxes paid by an employee

Social security taxes for employees are paid one-half by the employer and one-half by the employee. The employer gets to deduct the one-half it pays as a business expense. However, the social security taxes paid by the employee are not deductible. It does not fall into any of the types of taxes listed as deductible in § 164 and it is excluded as a deduction by §275(a)(1)(A).

Social Security taxes paid by someone who is self-employed

Section 164(f)(1) provides that a self-employed individual may deduct one-half of the Self Employed Contributions Act taxes. This deduction is designed to put the self employed individual on parity with an employer who can deduct the social security taxes its pays on behalf of an employee as a business expense. Under §164(f)(2), the deduction allowed to the self employed is an above the line deduction.

State Unemployment Insurance contributions (or State Disability Insurance payments)

State unemployment insurance or disability insurance payments are deductible as state income taxes per Rev. Rul. 81-192, 1981-2 C.B. 50. even though they look more like insurance payments than taxes.

Federal Income tax

These taxes are not deductible. They are not listed as deductible taxes under § 164 and their deduction is specifically prohibited by § 275(a)(1). See also Treas. Reg. § 1.164-2(a).

100
Q

Son owns his own home but is having financial difficulties. Son’s father decides to pay Son’s $10,000 property taxes directly to the county. Who, if anyone, is allowed a deduction for the property taxes?

A

Taxes are deductible by the person liable for the obligation. Since the son owns the property, the father is not entitled to a deduction. Treas. Reg. §1.164-1(a). Since the son did not pay the taxes, the Son not entitled to a deduction either them. You may be successful arguing that the payment by the father is a deemed gift to son of the funds followed by the deemed payment of the taxes by son. It would have been better to have the father actually transfer money to the son as a gift or a loan and have the son write the check for the taxes.

101
Q

Jack suffers from a chronic back ailment. His doctor has prescribed the installation of a hot tub in his home and for him to spent one day a week lying on the sand at the beach. Pursuant to his doctor prescription, Jack incurs the following costs:

· $10,000 for purchase and installation of a hot tub which according to a real estate appraiser adds $2,000 to the value of the house
· $50 per month in maintenance of the hot tub
· $10 per month in utilities costs related to the hot tub
· Driving expenses for the 120 mile drive, each way, one day per week, so that he can lie down on a sandy beach
· $55 each time he drives to the beach to pay for a room at the Beach Motel the evening before his “warm sand” treatment because his back condition will not allow him to drive in both direction on the same day

How much are Jack’s deductible medical expenses assuming that his adjusted gross income is $20,000 and none of these expenses are covered by his medical insurance?

A

Medical care is defined in § 213(d). The hot tub would be deductible to the extent that it is directly related to a specific medical condition and not merely to improve a patient’s general health. See Gerard where the cost of a home air conditioner was treated as a medical expense for a cystic fibrosis patient. Treas. Reg. § 1.213-1(e)(1)(iii). However, §263(a)(1) says no deduction shall be allowed for permanent improvements which increase the value of property. The tension between these two provisions is resolved by Treas. Reg. § 1.213-1(e)(1)(iii) which provides that the cost of the improvement, reduced by the increase in value of the property, is a medical expense. Thus, $8,000 of the $10,000 paid for the purchase and installation of the hot tub is a deductible medical expense. See Rev. Rul. 87-106 in the materials discussing what types of home improvements are eligible for a full medical expense deduction v. capitalizable and deductible only to the extent the cost exceeds the increase value of the home.

The maintenance and utility expense attributable to the hot tub is deductible in full. Pursuant to Treas. Reg. § 1.213-1(e)(1)(iii), no proration is required.

One day per week lying on a sandy beach is an unusual medical treatment but not unheard of. Commissioner. v. Bilder, 369 U.S. 499 (1962) the Court held that the costs of moving heart patient to Florida for health reasons were deductible. However, even if the sandy beach prescription meets the test of being medically related, only the transportation cost would be deductible. The cost of lodging “primarily for and essential to medical care” is deductible only if travel is primarily to receive medical care from a physician in a licensed hospital or in a medical care facility and so long as there is no “significant element of personal pleasure, recreation or vacation.” § 213(d)(2). Since Jack is not receiving care at a hospital, the lodging expense would not qualify as a medical expense. See Treas. Reg. §1.213-1(e)(1)(iv) which provides that if a doctor prescribes going to a warm climate for a specific ailment, the cost of transportation, but not meals and lodging, would be deductible. If going to the beach was just for general improvement of health, nothing would be deductible.

Assuming the prescription of a day at the beach was medically related, Jack should be able to cost of driving, either by allocation of his actual automobile expenses or taking the standard rate for the 120 miles. For 2016, the standard rate for medical mileage is $0.19 per mile.

A deduction of medical expenses is allowed only to the extent such expenses exceed 7.5% of the taxpayer’s adjusted gross income for tax years 2018 and 2019, per § 213(f). The floor is scheduled to increase to 10% of the taxpayer’s adjusted gross income in tax years 2020 thru 2025.

Therefore, Jack’s deduction is limited to the extent his expenses for medical care exceed $1,500 ($20,000 x 7.5%) for tax years 2018 and 2019, or $2,000 ($20,000 x 10%) for tax years 2020 thru 2025.

102
Q

John has cancer that requires special hospital treatments once a week. John stays in a hotel near the hospital after he receives his treatment because he is physically unable to return home until the day after the treatment. He pays $100 a night for his room. Assuming the hotel expense is not covered by medical insurance, he has no other out of pocket medical expenses and that his adjusted gross income is $20,000, what are John’s deductible medical expenses?

A

The cost of lodging will qualify as a medical expense under § 213(d)(2) so long as the lodging is away from home and primarily for and essential to medical care provided by a physician in a licensed hospital or medical care facility. The deduction may be denied, however, if the expenses are lavish or extravagant under the circumstances or if there is a significant element of personal pleasure.

John would appear to meet all these requirements. However, under §213(d)(2) last sentence, the deduction for lodging is limited to $50 a night. (Why, then, do we need the “lavish or extravagant limitation?”). Assuming the tax year is 2018 or 2019, his total allowable deduction of $2,600 ($50 x 52 weeks) must be reduced by $1,500 (7.5% of his AGI). Therefore, if the lodging is his only medical expense, his deduction is limited to $1,100.

103
Q

Kelly is a 6-year-old with cancer. Her mother drives her each week to receive chemotherapy in the hospital. Kelly is required to stay the night in the hospital following each treatment. Kelly’s mom spends each of those nights in a nearby hotel so that she can maximize her time with Kelly and take her home at checkout time in the morning. Mom paid $3,640 in hotel costs (52 nights at $70 per night) and drove a total of 4,000 miles. Assuming the expense is not covered by medical insurance, she has no other out of pocket medical expenses and that her adjusted gross income is $20,000, what are Mom’s deductible medical expenses?

A

Section 213(d)(2) does not specifically address lodging expenses incurred by someone other than the person receiving the medical treatment. However, courts have held (and IRS has ruled) that costs incurred by a companion whose presence is medically necessary are deductible up to the $50 per person per night limit.

Mom’s deductible medical expenses are $2,600 of hotel (52 nights at $50 a night limit) plus $760 mileage (4,000 miles x 19 cents per mile). These expenses will be reduced by $1,500 (7.5% of Mom’s $20,000 AGI) for tax years 2018 and 2019.

104
Q

Joe is a self-employed accountant who pays for his personal medical insurance. The premiums were $1,000. Joe’s adjusted gross income is $20,000. May he deduct any of these premiums?

A

The cost of insurance is included in the definition of medical expenses. §213(d)(1)(D); Treas. Reg. § 1.213-1(e)(4). It will therefore be deductible, subject to the 7.5% of AGI limitation. Since 7.5% of his AGI is $1,500, none of the insurance premiums would result in a deduction under § 213.

However, there is another deduction available under §162(l). That section allows self-employed individuals to deduct the cost of insurance premiums paid for insurance which constitutes medical care for the taxpayer, the taxpayer’s spouse and the taxpayer’s dependents. It is an above the line deduction and is therefore not subject to the § 213 AGI limitation. Any amount taken into account in computing the §162(l) deduction is not deductible under §213 (§ 162(l)(3). Therefore, Joe will be entitled to an above the line deduction of the entire amount paid for health insurance assuming that at least $1,000 of his $20,000 adjusted gross income is from his accounting practice. §162(l)(2).

105
Q

Physician diagnosed taxpayer as obese. Because the doctor is fearful for the taxpayer’s physical well being, he prescribed a special weight loss program that includes reduced calorie food products, support meetings, and weight-loss counseling. The expenses incurred are not covered by taxpayer’s insurance. Which, if any, of these expenses constitute medical expenses?

A

Section 213(d)(1) provides, in part, that medical care means amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. Obesity has been held to be a disease by governmental health officials. However, no deduction is allowed for weight-loss programs which weren’t intended to address taxpayer’s medical situation but rather are used just to improve the taxpayer’s general health or physical appearance. See Treas. Reg. §1.213-1(e)(1)(ii)

In Rev. Rul. 2002-19 the IRS ruled that amounts paid by taxpayers for medically necessary weight-loss programs to treat hypertension qualified as amounts paid for medical care under § 213(d)(1). However, the deduction for the food was denied. Section213(b) provides that medicine or a drug comes within the definition of § 213(a) only if it is a “prescribed drug” and § 213(d)(3) provides that the term “prescribed drug” means a drug or biological which requires a prescription of a physician for its use by an individual. Amounts paid for reduced-calorie foods are not deductible because they were merely substitutes for foods normally eaten, intended to meet nutritional requirements and were not drugs requiring the prescription of a doctor.

106
Q

Tim suffers from glaucoma. Dr. Leary, a physician at San Francisco General Hospital prescribed medicinal marijuana to treat Tim’s medical condition, the purchase of which is legal under California law. May Tim deduct the cost of purchasing his doctor prescribed medicinal marijuana as a medical expense?

A

Section 213(b) provides that medicines are medical expenses only if they are a prescribed drug. Medicinal marijuana would seem to meet this test in California since it is legally available only with a doctor’s prescription. However, the Federal Controlled Substances Act prohibits the possession of marijuana even with a physician’s prescription authorized by state law. Treas. Reg. § 1.213-1(e)(2) states that medicine and drugs only include items which are “legally procured.” In Rev. Rul. 97-9, 1997-1 CB 77, the Service held that, notwithstanding state law, medicinal marijuana is not “legally procured” under Federal law and the cost is not deductible as a medical expense.

There is some important background on Rev. Rul. 97-9. Back in the ’60s there was a drug called Laetrile which was supposed to cure cancer. It had not been approved for medical sale by the federal Food and Drug Administration (“FDA”), but some states legalized it. The IRS had ruled that so long the drug was legally procurable under state law, it was a deductible medical expense.

A few years later it was determined that Laetrile had no medical properties. The FDA could not ban it because it wasn’t a drug. So the federal government banned the interstate transportation of Laetrile. This stopped all sales because Laetrile was made in Mexico so there was no way to legally get it into the country. However, the ruling saying a drug authorized under state law qualified as a medical expense was never revoked.

Along comes medicinal marijuana which, under the Laetrile ruling, should give rise to a deductible medical expense in a state which has legalized it with a doctor’s prescription. In Rev. Rul. 97-9, 1997-1 CB 77, the Service revoked the Laetrile ruling and held that a drug cannot be “legally procured” if banned under Federal law, regardless of state action.

107
Q

The Coalition for the Cleansing of America is a qualified § 501(c)(3) charity. Desiring to raise money, it arranges a special performance by a local circus. Tickets are normally sold for $20 each but for this event tickets are $50 with the entire sale proceeds going to the Coalition. Sandy purchases 5 $50 tickets for her family. She is allowed to deduct $250 as a charitable contribution deduction.

Select one:
True
False Correct

A

Feedback
Only part of the amount Sandy paid is a charitable contribution. The $50 a ticket must be reduced by the $20 per ticket value she gets in exchange. Her charitable contribution is only $30 a ticket. The fact that the Coalition receives the entire $50 a ticket from the sale does not change the fact that Sandy is receiving something of value in return for her “donation.”

The correct answer is ‘False’.

108
Q

Ron and Barbara are married and file a joint return. Their adjusted gross income for 2018 without net operating losses taken into account is $100,000. They contributed $70,000 cash to various churches, schools, and similar “public” charities described in § 170(b)(1)(A). How much are Ron and Barbara allowed to claim as a charitable itemized deduction for this year?

Select one:

a. $0
b. $36,000
c. $60,000 Correct
d. $70,000

A

While their contribution is $70,000 their deduction will be limited to $60,000 since under §170(b)(1)(A) and (B), Ron and Barbara are not permitted to deduct more than 60% of their contribution base, defined in §170(b)(1)(F) as adjusted gross income without net operating losses taken into account.

The correct answer is: $60,000

109
Q

George donated stock worth $100,000 to Golden Bear University. It was his only charitable contribution for the year. His basis in the stock was $1. His adjusted gross income was $1,000,000. Which of the following is relevant concern of George?

Select one:

a. Whether Golden Gate University will keep the stock or sell it
b. How long ago George bought the stock Correct
c. The availability of the § 170(b)(1)(C)(iii) election

A

George’s only concern is whether he has a long term or short term holding period. If it is long term, his donation is $100,000. If it is short term his donation is $1. What GGU does with the stock is relevant for donations of tangible property but not intangibles like stock. The § 170(b)(1)(C)(iii) election is not relevant because: 1) he has enough AGI so that the 30% limitation would still allow a full deduction and 2) if elected his charitable contribution would be reduced to $1.

The correct answer is: How long ago George bought the stock

110
Q

In the current year, Jane Nice donated stock worth $12,000 in which she had a basis of $10,000. Jane purchased the stock two years ago. Jane’s AGI is $30,000 in the current year. Assuming that Jane does not make a Sec. 170(b)(1)(C)(iii) election, what are the tax consequences related to the contribution?

Select one:

a. $0 with no carryforward
b. $0 with a $12,000 carryforward
c. $9,000 with no carryforward
d. $9,000 with a $3,000 carryforward Correct
e. $10,000 with no carryforward
f. $12,000 with no carryforward

A

Because it is long term property, Jane would get to take the FMV of the property, $12,000. However, as capital gain property, Jane’s stock is subject to the 30% limitation on AGI, i.e. 30% of $30,000, or $9,000. Thus, Jane would get $9,000 deduction and a $3,000 carryforward

The correct answer is: $9,000 with a $3,000 carryforward

111
Q

Maria has AGI of $100,000. She donated stock to GGU worth $50,000, which she had a basis of $40,000. She held the stock for three months before making the donation. What are the tax consequences related to the contribution?

Select one:

a. $10,000
b. $30,000
c. $30,000 with a $10,000 carryforward
d. $40,000 Correct

A

Maria’s donation is short term capital gain property, so the deuction is the FMV, reduced by the short term gain. Thyat is $50,000, reduced by $10,000, which equals $40,000. The ceiling is 50%, so 50% of $100,000 is $50,000, so there is no limit.

The allowable deduction in the current year is $40,000 with no carryforward.

The correct answer is: $40,000

112
Q

Bob recently sufferred a stroke. Because of the difficulty in climbing stairs, a doctor ordered that an elevator be built in his home. Bob spent $20,000 to build the elevator in his home and it increased the value of his home by $12,000.

Without considering any floor, Bob would be able to deduct $8,000 with respect to the elevator.

Select one:
True Correct
False

A

Per § 1.213-1(e)(1)(iii), Bob is entitled to deduct the cost paid for the elevator ($20,000), less the increase in the value of the home ($12,000) by installing the elevator. That total is $8,000

The correct answer is ‘True’.

113
Q

Karen Baker, a cash basis calendar year taxpayer, paid the following during the year:

Social security taxes withheld from her salary $6,000
Personal property taxes $500
State income tax withheld $5,000
Real Property taxes $8,000
Sales tax $1,000
What is the total itemized deductions may Karen claim for taxes on her return?

Select one:

a. $5,000
b. $10,000 Correct

c. $13,000
d. $13,500
e. $19,500

A

Per § 164, Karen may deduct

personal property taxes $500
real property taxes $8,000
higher of state income taxes ($5,000) or sales taxes ($1,000), which is $5,000

The total taxes is $13,500, but per § 164(b)(6) total taxes is limited to $10,000.

The correct answer is: $10,000

114
Q

Henry and Isabel Wittington have adjusted gross income of $20,000 for this year, when they pay the $2,100 of expenses which meet the definition of “medical care.” How much is the Wittingtons’ medical expense deduction for this year?

Select one:

a. $100
b. $400
c. $600 Correct
d. $1,500
e. $1,700

A

Their medical expenses of $2,100 is reduced by 7.5% of their $20,000 AGI ($20,000 x 7.5%= $1,500). The difference is $600($2,100 minus $1,500). See §213(a).

The correct answer is: $600

115
Q

In order to rehab her injured back, Sally’s doctor ordered her to travel to a special gym in a nearby state with “state-of-the-art” equipment to work out for one week. She spent $600 on a roundtrip flight and stayed alone in a hotel for $60 for six nights, totaling $360. Without considering any floor, how much deductible medical expense would Sally have?

Select one:

a. $0
b. $600 Correct
c. $900
d. $960

A

Your answer is correct.

Sally can deduct the $600 roundtrip flight. However, since the medical care is at a gym and not at a licensed hospital, no hotel costs are deductible. Thus, only the $600 is deductible.

The correct answer is: $600

116
Q

Eleven year old Billy has leukemia. Pursuant to doctor’s orders, Billy needs to travel across the country to receive medical treatment for eleven days by a doctor in a licensed hospital, considered the best in the country. Because of Billy’s age, his father is required to accompany him. Billy’s flight costs $500 and his father’s flight also costs $500. The treatment occurs during the day in the hospital, but Billy and his father stay together at a nearby hotel for ten nights on the trip, paying $120 per night, totaling $1,200.

Before considering any floor, how much medical expense is deductible?

Select one:

a. $1,000
b. $1,200
c. $1,700
d. $2,000 Correct
e. $2,200

A

Your answer is correct.

Both Billy and his father plane ticket are deductible, totaling $1,000. Because treatment is being provided by a doctor in a licensed hospital, Billy’s lodging is deductible and so is his father’s, since he is required to accompany Billy. The amount is limited to $100 per night. Thus, another $1,000 is deductible for lodging.

Total medical expense deduction before considering any floor is $2,000.

The correct answer is: $2,000

117
Q
John and his wife file a joint return. Their gross income before adjustments is $100,000. Their earned income is from their salaries as employees and they have no children or other dependents. They have the following items which they would like to claim as deductions:
Alimony paid to John’s ex-wife	9,000
Real Property Taxes	2,000
State income taxes	9,000
Qualified residence interest	10,000
Student Loan interest	1,000
Work related seminar	5,000
Donation of cash to charity	3,000
Tax Return Preparation fee	1,000
State sales tax	2,750

What is their adjusted gross income and taxable income?

A

The first step in analyzing this problem is to examine each one of the items and determine whether the deductions are: 1) above the line; 2)regular itemized; 3) miscellaneous itemized; or 4) not deductible.
• Alimony - deductible § 215; Above the line §62(a)(10)
• Real Property Taxes - Regular itemized deduction § 67(b)(2)
• State income taxes - Regular itemized deduction § 67(b)(2)
• Qualified residence interest - Regular itemized deduction § 67(b)(1)
• Student loan interest - Above-the-line § 62(a)(17)
• Work related seminars - Miscellaneous itemized deduction because not listed in § 67(b) [NOT deductible for tax years 2018 thru 2025 under TCJA]
• Donation of cash to charity - Regular itemized deductions § 67(b)(4)
• Tax Return Preparation fee - Miscellaneous itemized deduction because not listed in § 67(b) [NOT deductible for tax years 2018 thru 2025 under TCJA]
• State sales tax - deductible in lieu of state income taxes but since state income tax amount higher, not deductible

Adjusted Gross Income

Their adjusted gross income is $90,000: the $100,000 before adjustments less the $9,000 alimony paid and the $1,000 student loan interest.

Regular Itemized Deductions

Their regular itemized deductions total $24,000:

Real Property Taxes	2,000
State income taxes	9,000
Total Taxes limited to 10K    (1,000)
Qualified residence interest	10,000
Charitable Contribution	  3,000
Regular Itemized Allowable	23,000

Miscellaneous Itemized Deductions

Not deductible. Suspended for tax year 2018 thru 2025 by TCJA- §67(g)

Personal Exemptions

Not deductible. Suspended for tax year 2018 thru 2025 by TCJA- §151(d)(5)

Their taxable income is

AGI 90,000
(Standard Deduction) 24,000 (Exceeds itemized deductions)
Taxable income = $66,000

118
Q

Marjorie is single and has taxable income of $600,000, all from salary. Ignoring inflation adjustments, which income tax brackets will apply to her and what is her marginal and effective tax rate?

A

In talking about tax rates, it is important to remember that as income goes up, the marginal tax rate goes up. However, the higher marginal tax rate applies only to the income which falls into that higher bracket. You maintain the benefit of the lower tax rates on the lower brackets of income.

For a single taxpayer (ignoring inflation adjustments), the brackets are as follows:

For 2018, after TCJA and per § 1(j)(2)(C) the adjusted brackets for a single taxpayer are as follows:

Bracket Rate Tax
over 500,000 150,689.5
extra 100,000 37% 37,000_
TOTAL 187,689.5

Marjorie’s marginal tax rate is 37%. Marjorie’s effective tax rate - calculated by dividing her total tax paid by her taxable income - is only 31.3%. That is because even though her top marginal rate is 37%, most of her income was taxed at lower marginal rates.

119
Q

Joan is single and has an AGI of $150,000. She has one child, Sam, who is 20. Joan provides for all of Sam’s expenses. Sam is single and a full-time student. He earned $2,000 during the year from a part-time job and has no other deductible expenses. May Joan take a child tax credit with respect to Sam on her return? If so, how much?

A

§ 24(c) requires that the child does not reach the age of 17 by year end to be eligible for the child tax credit. Thus, Joan will not be able to take the full $2,000 credit.

However, Joan would be eligible to take a $500 credit under § 24(h)(4) if he meets the definition as a qualifying relative in § 152(d).

We need more facts to determine whether Sam’s principal place of abode is the same as Joan’s. We need to know if Sam lives at home while going to school or, if he lives at school, does he return home during breaks or continues to live somewhere else. Note that temporary absences because of education are ignored. Treas. Reg. § 1.152-1(b).

Editor’s note: Eligibility for the reduced credit for college students has one major “hurdle”. § 151(d)(1)(B) has a gross income of the student requirement to be less than the exemption amount. The income of the student was very low in this example so that it is not an issue.

120
Q

Would your answer to Problem 3 change if Sam is 16 years old, in high school, and living at Joan’s residence?

A

Sam meets the age requirement in § 24(c), which requires that the child does not reach the age of 17 by year end to be eligible for the child tax credit. In addition to the age requirement, § 24(c) requires Sam meet the “qualifying child requirement in § 152(c).

Qualifying child is defined in § 152(c)(1) as one who: 1) bears a relationship to the taxpayer set forth in §152(c)(2); 2)has the same principal abode as taxpayer for more than half the year; and 3) who has not provided over one-half of his own support.

Since AGI is not greater than $200,000, Joan can take the full $2,000 child tax credit with respect to Sam.

121
Q

Joanne is 16 years old, single and lives at home with her parents. She earned $10,000 during the year from a part-time job and has no deductible expenses. Calculate Joanne regular tax liability.

A

Joanne’s $10,000 of earned income is taxed on the single rate.

Editor’s note: I am unclear on how much standard deduction Joanne would get. The increased general standard deduction under §63(c)(7) for singles taxpayers of $12,000 would wipe out all of her income. However, § 63(c)(5) states “in the case of an individual with respect to whom a deduction is allowable to another taxpayer”. Technically, under the new tax law, there is no deduction allowable for dependents, but there is a credit. And in this case, Joanne’s parent are allowed to take a child tax credit for her.

We still get to the same place in this example because she is allowed a standard deduction under §63(b) in computing taxable income. The basic standard deduction for a single taxpayer is $12,000. However, if you can be claimed as a dependent, your standard deduction of $12,000 may be reduced by § 63(c)(5) which provides that the standard deduction is the lesser of $12,000 or the greater of: (i)$500 (subject to adjustments for inflation) or (ii)earned income + $250. (For 2016 the inflation adjusted amount is $1,050 rather than $500.)

Joanne has $10,000 of earned income. The § 63(c)(5) limit is the greater of $500 or $10,250 (earned income + $250). Thus, her $12,000 standard deduction would be limited to $10,250. Joanne’s taxable income is $0. Thus, she has zero tax liability.

122
Q

How would your answer to Problem 5 change if Joanne’s $10,000 of income was from interest rather than wages?

A

Joanne’s unearned income is taxed at the trust and estates tax rates.

Joanne’s inflation adjusted standard deduction per § 63(c)(5)(A) is $2,100. Thus, her taxable income would be $7,900

Using the trust and estate tax rates, her tax liability would be

10%
$0 - $2,550

24%
$2,551 - $9,150
$    255
35%
$9,151 - $12,500
$ 1,839
37%
Over $12,500
$ 3,011.5

($7,900 – $2,551) * .24 + $255 = $1,539

123
Q

Al is single. He is a tax partner in a small accounting firm where he receives only ordinary income on his Sch K-1 of $290,000. His other items of income and expense (unrelated to his Sch K-1) for the year were as follows:
Interest income of $10,000
State income taxes paid of $30,000
Real Estate taxes paid of $10,000
Qualified residential interest expense (acquisition debt) of $20,000
Qualified residential interest expense (home equity debt) of $10,000
Interest expense of $1,000 on auto loan for a car used solely to commute back and forth to work
Gift of stock to Golden Gate University with a fair market value of $20,000 and an adjusted basis of $5,000 which he has owned for five years

Assume that there are AMT depreciation differences in the partnership that flows through to Al (his prorata share) of $100,000, representing less depreciation for AMT relative to regular tax.

Ignoring inflation adjustments, calculate Al’s regular and alternative minimum tax liability.

A

The AMT is a second set of calculations you must do. To the extent that your AMT is greater than your regular tax, the difference is an “additional tax” you must pay. The 2017 Tax Cuts and Jobs Act suspended a lot of deductions for regular purposes, which matched the treatment for AMT. Having less AMT adjustments, as well as increasing the exemption, has resulted in substantially less taxpayers to be in AMT.

The following highlights the primary differences in how deductions are treated in calculating the regular tax and the AMT:

REGULAR TREATMENT AMT TREATMENT
§164 taxes- lim to $10K Disallowed if item ded
§168 depreciation Allowed but only using alternative
method using class lives and
applying 150% declining balance.
§ 56(a)(1)

Since the AMT tax is the excess of the AMT tax over the regular tax, you must first compute the regular tax, compare it to the tax calculated under the AMT rules and, if the AMT tax is higher, add the difference to your liability as an additional tax:

AGI $300,000 = Sch K Partnship income 290,000 + 10,000 interest

Regular Itemized Deductions

State income tax 30,000
Real estate tax 10,000
Total state taxes limited to 10,000 (30,000)
Acquisition debt 20,000
Home equity debt (Not deductible)* 0
Auto loan debt (Not deductible)** 0
Charitable contributions 20,000
Total 50,000

Taxable income (500,000 – 50,000) = 250,000

  • Home equity interest was suspended by 2017 Tax Cuts and Jobs Act, per § 163(h)(3)(F)(i)(I). Thus, $10,000 is not deductible.
  • *Auto loan proceeds was used to purchase a car solely for commute purposes. The $1,000 interest on this debt is traced to personal purposes and is therefore not deductible.

For a single taxpayer (ignoring inflation adjustments), the brackets are as follows:

Bracket Rate Tax
Up to 200,000 45,689.5
Over 200,000 34% 17,000_
TOTAL 62,689.5

Note that Al would also be subject to the additional 0.9% Medicare tax. §1401(b)(2)(A) which applies to modified adjusted gross income in excess of $200,000 for a single individual, $250,000 for married filing jointly and $125,000 for married filing separately.

Now we compute the Alternative Minimum Tax and compare it to the regular tax calculated.

You can begin the calculation in one of two ways: 1) start with AGI and deduct just the allowable deductions or 2) start with taxable income and add back all the adjustments which are not allowed for AMT calculations, The Form 1040 uses Method #2; however, Method #1 is easier and a good way of checking your calculations:

Method #1:
AGI	300,000
Mortgage interest    	    (20,000)
Charity	(20,000)
Depreciation Difference             100,000

AMTI 360,000

None of the other deductions are allowable for AMT.

Method #2
If you start with taxable income, you must reverse adjustments that don’t apply to AMTI. That means adding back deduction which are not allowed for AMT and reversing the effect of Pease and PEP:

Taxable income 250,000
Plus state income tax deduction 10,000
plus depreciation difference 100,000
AMTI 360,000
Less: Exemption Amount * (70,300)
AMTI after Exemption 289,700

*The exemption is $70,300 (without inflation adjustment) for a single person §55(d)(4)(A)(i)(II). No phaseout of this exemption because AMTI does not exceed $500,000 (AMTI level for single individual).

Tentative minimum tax on $289,700 calculated as follows:

AMTI after Exemption
Tax Rate
0 - $191,500
26%
Above $191,500
28%

(191,500 * 26%) + (289,700 – 191,500) * 28% = 49,790 + 27,496= 77,286

Tentative Minimum tax liability 77,286
Regular tax liability 62,690
AMT tax 14,596

124
Q

Larry is a single individual and has the following items of income:

Regular interest	5,000
Tax exempt interest	5,000
Rent from triple net lease         	40,000
Salary	190,000
Gain from sale of home	275,000

Larry has lived in the home as his primary personal residence for the last five years. Larry has no expenses related to any of this income. Calculate Larry’s net investment income tax.

A

There is a net investment income tax (“NIIT”) under § 1411 which began in 2013. The rate is 3.8% of the lower of net investment income or the amount of modified adjusted gross income (MAGI) over specific thresholds.
For an individual, the NIIT applies once MAGI exceeds $200,000. His modified adjusted gross income includes the regular interest, the rent from the triple net lease, his salary and $25,000 of the gain from the sale of his home which exceeds the $250,000 exclusion under § 121. Larry’s MAGI is $260,000 exceeding the threshold by $60,000. He will subject to tax on his net investment income, but not in excess of $60,000.
Larry’s net investment income actually exceeds $60,000. His net investment income includes his $5,000 regular interest, the $40,000 rent from the triple net lease and the $25,000 taxable gain on the sale of his residence for a total of $70,000. However, since his MAGI only exceeded the threshold by $60,000, the tax will only be imposed on $60,000.
Larry will have to pay a tax of 3.8% on $60,000 or $2,280.

125
Q

Which of the following is NOT an above the line deduction?

Select one or more:

a. Alimony paid
b. Section 199A deduction Correct
c. Student loan interest
d. CPA dues paid by an employed CPA Incorrect

A

CPA dues paid by an employed CPA would be a misc. itemized deduction and not an “above the line” deduction. Due to the 2017 Tax Cuts and Jobs Act, misc. itemized deductions have been suspended. CPA dues would only be an above the line deduction for a self-employed CPA as a Sch C business expense. The following are also above the line deductions: alimony paid, per § 62(a)(10) and student loan interest, per § 62(a)(17).

Section 199A deductions is NOT an above the line deduction, instead deducted after AGI.

The correct answer is: Section 199A deduction

126
Q

Which is a regular itemized deduction (i.e., itemized deduction, but not a misc. itemized deduction)?

Select one:

a. Business expenses
b. Rental expenses
c. Charitable contributions Correct
d. Hobby losses

A

Only charitable contributions on this list is a regular itemized deduction, per § 67(b)(4). Business and rental expenses are an “above the line” deduction, taken on Sch C and Sch E respectively. Hobby losses are a misc. itemized deduction, subject to the 2% of AGI floor.

The correct answer is: Charitable contributions

127
Q

Married couple Fred and Wilma Flintstone file a joint tax return in 2019. They have no children. Standard deduction for a joint return is $24,000. They have the following activity

Fred's salary of $120,000
Wilma's salary of $50,000
Interest income of $20,000
Alimony paid by Fred to a former spouse of $10,000
Cash Contributions of $5,000
Real Estate Taxes of $15,000
State income taxes of $12,000
Medical Expenses of $6,000
What is their taxable income?

Select one:

a. $148,000
b. $156,000 Correct
c. $159,000
d. $165,000

A

Your answer is correct.

Total Gross Income is

Fred Salary     120,000
Wilma's Salary  50,000
Interest income 20,000
Total Gross Income= $190,000
Total AGI is 

Gross Income 190,000
Alimony paid 10,000
AGI = 180,000
Itemized deductions are

Medical expenses = 0 (5,000 less ceiling 10% * 180,000)
Taxes = 10,000 (limited to $10,000)
Cash Contribution = 5,000
Standard deduction of $24,000 is higher than $15,000

Taxable income = 180,000 less 24,000 = 156,000

The correct answer is: $156,000

128
Q

Ricky and Lucy Ricardo have taxable income of $550,000, all from salary. They have no children. What is the couple’s federal income tax liability?

Select one:

a. $91,379
b. $126,718
c. $142,379 Correct
d. $169,190

A

Your answer is correct.

Taxable income of $550,000

Bracket Rate Tax

up to 400,000 91,379

extra 150,000 37% 51,000_

TOTAL 142,379

The correct answer is: $142,379

129
Q

Barney and Betty Rubble is a married couple that files jointly. They have AGI of $410,000 and take the standard deduction on their tax return. They have a 15 year old son Bam Bam, who lives with them. They provide 90% of the support for Bam Bam. How much child tax credit is Barney and Betty entitled to for 2019?

Select one:

a. None
b. $1,500 Correct
c. $1,800
d. $2,000

A

Your answer is correct.

Since they provide greater than 1/2 of the support for Bam Bam, Barney and Betty qualify for a child care credit, normally $2,000. However, since their AGI exceeds $400,000, $50 phases out for $1,000 over $400,000. Since their AGI is 10,000 over, 10 times $50, or $500 of the $2,000 credit is phased out. This leaves $1,500 child tax credit to take on their tax return.

The correct answer is: $1,500

130
Q

Mary, a single taxpayer, has net self-employment income of $200,000 from a sole proprietorship, providing legal services. She has no other income or expenses.

Calculate Mary’s self-employment tax, assuming the year is 2018.

Select one:

a. $21,277
b. $21,721 Incorrect
c. $28,259
d. $30,600

A

Net self-employment income $200,000

Percentage .9235*

                                            $184,700  This is > the $128,400 threshold for 2018

            Soc Sec tax only to the threshold

*The .9235 is to factor in the fact that 50% of the self-employment tax is a deduction. The total of the tax percentage is 15.3% (12.4 + 2.9) and 50% of 15.3 is 7.65. 100% is reduced by .0765 to get to the .9235 amount.

Total Self Employment tax is the Social Security Tax + Medicare Tax.

Social Security Tax: Medicare Tax

$128,400 (Limit for 2018) $184,700

x 12.4% x 2.9%

15,921 + 5,356 = 21,277

The correct answer is: $21,277

131
Q

Which of the following is a miscellaneous itemized deduction and thus currently suspended as a deduction for years 2018 thru 2025?

Select one:

a. Medical expenses
b. Home acquisition mortgage interest
c. CPA dues paid by self-employed CPA Incorrect
d. None of the above

A

None are miscellaneous itemized deductions. CPA dues by a self employed person and alimony are all above-the-line §§ 62(a)(1). Medical expenses and home acquisition mortgage interest are regular itemized deductions. § 67(b)(5), § 67(b)(1)

The correct answer is: None of the above

132
Q
Wesley, who is single, has adjusted gross income of $200,000 for the tax year 2019. He has the following deductions in computing his regular tax liability:
State income tax $10,000
Home equity debt interest $10,000
Real property taxes $10,000
Cash charitable contribution $10,000

His total itemized deduction are $20,000.

Select one:
True Correct
False

A

State income taxes and property taxes have a ceiling of $10,000. Home equity interest is not deductible. Cash contributions of $10,000 are deductible in full (in this example) for a total of $20,000.

The correct answer is ‘True’.

133
Q

Once the taxpayer calculates their AMTI and then its tentative minimum tax, they compare it to their regular tax. Assuming they do not have credit carryforward, they would be required to pay regular tax or the tentative minimum tax, whichever is higher.

Select one:
True Correct
False

A

This is a correct statement. However, if they did have a AMT credit carryforward, they can reduce their regular tax, but never below their tentaive minimum tax

The correct answer is ‘True’.

134
Q

Wesley has adjusted gross income of $200,000. He has the following allowable deductions in computing his regular tax liability:

State income tax $10,000
Home equity debt interest $10,000
Real property taxes $10,000
Charitable contribution $10,000

His alternative minimum tax income before credits is $180,000

Select one:
True
False Correct

A

The only deduction allowed for purposes of AMT is the charitable contribution. His AMTI is $190,000.

The correct answer is ‘False’.