chapter 6
Charles is a single person, age 35, with no dependents. In 2018, Charles has gross income of $75,000 from his sole proprietorship. Charles also incurs $80,000 of deductible business expenses in connection with his proprietorship. He has interest and dividend income of $22,000. Charles has $7,000 of itemized deductions. Charles's taxable income is A) $5,000. B) $10,000. C) $17,000. D) None of the above.
A) $5,000.
Abby owns a condominium in the Great Smokey Mountains. During the year, Abby uses the condo a total of 21 days. The condo is also rented to tourists for a total of 79 days and generates rental income of $12,500. Abby incurs the following expenses: Expense: Amount Mortgage interest $ 4,100 Property taxes 1,900 Utilities 2,200 Insurance 1,200 Depreciation 10,000 Using the IRS method of allocating expenses, the amount of depreciation that Abby may take with respect to the rental property will be A) $5,074. B) $8,515. C) $7,900. D) $10,000.
A) $5,074.
Generally, deductions for adjusted gross income on an individual's tax return include all the following types of expenses except those A) incurred in gambling activities. B) incurred in a trade or business. C) incurred in the production of rent income. D) incurred in the production of royalty income.
A) incurred in gambling activities.
Which of the following is not required for an expenditure to be deductible as a business or investment expense? A) recurring in nature B) ordinary and necessary C) reasonable in amount D) incurred by the taxpayer
A) recurring in nature
Maria pays the following legal and accounting fees during the year: Legal fees in connection with ongoing operations of a trade or business $4,000 Legal fees related to purchase of personal residence 2,600 Legal fees related to tax deficiency related to Schedule A itemized deductions 500 Tax return preparation fees: Allocable to preparation of Schedule C 2,000 Tax return preparation fees: Allocable to preparation of remainder of return 2,100 What is the total amount of her for AGI deduction for these fees? A) $4,000 B) $6,000 C) $8,100 D) $11,200
B) $6,000 Explanation: $4,000 business legal fees + 2,000 business accounting fees = $6,000
Taxpayers may deduct lobbying expenses incurred to influence legislation if the legislation is of direct interest to the taxpayer's trade or business.
FALSE
Accrual-basis taxpayers are allowed to deduct expenses when they meet either the economic performance test or the all-events test.
FALSE Explanation: Both criteria must be satisfied.
Brienne sells land to her brother, Abe, at a loss. A few years later, Abe sells the land to an unrelated party for a substantial gain. Brienne can recognize her realized loss on the land when Abe sells the land to an unrelated party.
FALSE Explanation: Brienne will never recognize the loss. Abe will be able to offset his gain by Brienne's loss.
wash sale occurs when a taxpayer realizes a loss on the sale of stock or securities and the taxpayer acquires substantially identical stock or securities within a 61-day period after the date of sale.
FALSE Explanation: The 61-day period of time extends from 30 days before the date of the sale to 30 days after the date of the sale.
Rachel, a self-employed business consultant, has significant expenses for travel business meals with clients in her work, but she has not kept receipts. She will be able to deduct a reasonable amount of these ordinary and necessary expenses under the Cohan rule.
FALSE Explanation: The Cohan rule does not apply to travel and entertainment. The Code does not allow any travel and entertainment deductions unless strict documentation requirements are met.
A sole proprietor paid legal fees in connection with the acquisition of a building that he uses in his business. The sole proprietor can deduct the legal fees for AGI.
FALSE Explanation: All costs related to acquiring the asset and placing it in service must be capitalized into the basis of the asset.
A sole proprietor contributes to the election campaign of a state governor. The candidate has promised to change a law that severely limits the growth of the sole proprietor's business. Given the direct benefit, the sole proprietor can deduct the contribution.
FALSE Explanation: Contributions to political candidates or political parties are never allowed as a deduction.
Expenses related to a hobby are deductible only to the extent of the gross income from the hobby.
FALSE Explanation: Expenses related to a hobby cannot be recognized.
Expenses relating to a hobby, limited to the receipts of the hobby, are deductible as "for AGI" deductions.
FALSE Explanation: Hobby-related expenses are not deductible.
In 2018 the IRS audits a company's 2016 tax return and determines that the president's salary was excessive and disallowed $100,000 of the salary deduction. Under the terms of the hedge (payback) agreement in the corporate bylaws, the president repays $100,000 of her salary to her employer in 2018. The president will amend her 2016 tax return to get a refund of the taxes paid on the excess salary.
FALSE Explanation: The president will take a deduction for AGI for the year of repayment.
If an activity produces a profit for at least two years during a consecutive five-year period, the burden of proof shifts to the IRS to show that the activity is not profit-motivated.
FALSE Explanation: The time period is three out of five years.
On July 1 of the current year, Marcia purchases a new home and borrows $320,000. Marcia is required to pay two points on the loan. The loan is secured by the residence and the charging of points is an established business practice in the area. The term of the loan is 20 years, beginning on July 1 of the current year. How much, if any, of the points may Marcia deduct in the current year? A) $0 B) $160 C) $3,200 D) $6,400
D) $6,400
An expense is considered necessary if it is "appropriate and helpful" in the taxpayer's business.
TRUE
Capital expenditures add to the value, substantially prolong the useful life, or restore the life of the property.
TRUE
In order for an expense to be ordinary, it must be reasonable in amount and it must bear a reasonable and proximate relationship to the income-producing activity or property.
TRUE
In which of the following situations are points paid on a home mortgage loan not deductible in the year of payment? A) purchase B) refinance C) construction D) improvement
B) refinance
Interest expense on debt incurred to purchase or carry tax-exempt securities is not tax deductible.
TRUE
Adjusted gross income (AGI) is the basis for a number of phase-outs of deductions.
True
For the years 2014 through 2018 (inclusive) Mary, a best-selling author, has been involved in operating an antique store. In 2014, 2015 and 2016 her revenue exceeded the expenses from the activity. In 2017 and 2018, the antique store generated a loss. Which statement is correct? A) The activity is a business. The IRS cannot prove it is a hobby. B) The activity is a hobby. Mary cannot prove it is a business. C) The activity is presumed to be a business. However, the IRS may prove it is a hobby. D) The activity is presumed to be a hobby. However, Mary may prove it is a business.
C) The activity is presumed to be a business. However, the IRS may prove it is a hobby.
Carole owns 75% of Pet Foods, Inc. As CEO, Carole must travel extensively and does so on the company jet. In addition, she also uses the jet to take several personal vacations. Carole reports the value of the personal use of the jet, $40,000, as additional compensation. Which of the following is true in terms of the corporation? A) The corporation includes $40,000 as miscellaneous income. B) The $40,000 has no impact on the corporation's income tax. C) The corporation takes a deduction of $40,000 for compensation expense. D) The corporation takes a deduction of $40,000 for dividend expense.
C) The corporation takes a deduction of $40,000 for compensation expense.
Sheila sells stock, which has a basis of $12,000, to her daughter for $7,000, the stock's fair market value. Subsequently, the daughter sells the stock to an unrelated party for $5,000. Which of the following is true for Sheila and her daughter?
A) Sheila - recognizes no loss Daughter - recognizes loss of $2,000
Pat, an insurance executive, contributed $1,000,000 to the reelection campaign of Governor Stephens, in hopes that Stephens will appoint her to a coveted position on the State Board of Insurance. How much of the contribution can Pat deduct? A) $0 B) $100,000 C) $500,000 D) $1,000,000
A) $0
Tory considered opening a cupcake store in Denver. Tory is currently a full-time dentist. After spending $8,600 on a market study, he decided against opening the store on August 1. What is the maximum amount of deduction for the current year attributable to this expenditure? A) $0 B) $5,000 C) $5,600 D) $6,800
A) $0
Donald sells stock with an adjusted basis of $38,000 to his son, Kiefer, for its fair market value of $30,000. Kiefer sells the stock three years later for $32,000. Kiefer will recognize a gain on the subsequent sale of A) $0. B) $2,000. C) ($6,000). D) ($8,000).
A) $0.
Jones, Inc., a calendar-year taxpayer, is in the air conditioner repair business. The business uses the cash method. In December of the current year, Jones charged $100 of supplies at Refrigeration, Inc., (he will pay the credit card bill in January) and also purchased $600 of supplies at XYZ on open account (he will make a payment on the open account in January). What is the amount that is deductible by Jones, Inc., in the current year? A) $100 B) $600 C) $700 D) The amounts must be capitalized and charged to expense as used.
A) $100 Explanation: Credit card charges are deductible in the year the charge is made regardless of the year in which the payment is made, but open account charges are not deducted until paid.
Jimmy owns a trucking business. During the current year he incurred the following: Gasoline and oil $100,000 Maintenance $15,000 Fines for speeding $8,000 Bribes to government inspection officials $21,000 The fines for speeding were a necessary cost because missing deadlines would cause lost business and are ordinary in the industry. What is the total amount of deductible expenses? A) $115,000 B) $123,000 C) $108,000 D) $144,000
A) $115,000
On December 1, Robert, a cash-method taxpayer, borrows $10,000 from the bank for use in his business. Under the terms of the loan, the bank discounts the loan by $300, paying Robert the $9,700 cash proceeds. If Robert repays the loan next year, he may deduct A) $300 next year. B) $300 this year. C) $25 this year and $275 next year. D) nothing since the note is "noninterest-bearing."
A) $300 next year. Explanation: A cash-basis taxpayer gets the deduction in the year in which interest is paid.
In 2018, Sean, who is single and age 44, received $55,000 of gross income and had $5,000 of deductions for AGI and $5,600 of itemized deductions. Sean's taxable income is A) $38,000. B) $43,000. C) $44,400. D) None of the above.
A) $38,000.
During the current year, the United States files criminal and civil actions against Joe, the CEO of Box Corporation, and Jane, the president of Cable Corporation, for price fixing. Both enter pleas of no contest and appropriate judgments are entered. Subsequent to this action, Square Corporation sues both Box and Cable for treble damages of $6,000,000. In settlement, Box and Cable each pay Square $1,200,000. What is the maximum amount that Box and Cable may each deduct? A) $400,000 B) $1,200,000 C) $2,000,000 D) $6,000,000
A) $400,000
Which of the following statements is false? A) A tax deduction is allowed to a taxpayer for estimated warranty expense. B) A tax deduction is allowed in association with a warranty only in the year in which warranty work is performed. C) A tax deduction is allowed for a contested amount if the amount is paid prior to final settlement. D) No tax deduction is allowed to an accrual-basis taxpayer for the amount of a down payment for a non-recurring expense when the work is to be performed in a subsequent period.
A) A tax deduction is allowed to a taxpayer for estimated warranty expense.
Business interest expense is limited for larger businesses. Which of the following statements is not correct with respect to this limitation? A) Businesses with current year gross receipts exceeding $10 million are subject to this limitation. B) Businesses will add back depreciation and amortization deductions to the taxable income in order to calculate the maximum interest deduction. C) The interest expense deduction is limited to business interest income plus 30% of adjusted taxable income. D) All of the above statements are accurate statements with respect to calculating the interest expense limitation.
A) Businesses with current year gross receipts exceeding $10 million are subject to this limitation. Explanation: The limitation applies to businesses with average annual gross receipts exceeding $25 million for the prior three year period.
Which of the following is not required for an accrual method taxpayer to currently deduct the cost of services received? A) The liability must be paid. B) The existence of a liability must be established. C) The amount of the liability is determined with reasonable accuracy. D) The services must actually be provided.
A) The liability must be paid.
Brent must substantiate his travel and entertainment expenses. Which of the following is not required for documentation? A) company expense report B) business relationship to the taxpayer of individuals entertained C) purpose of the expenditure D) time and place of the travel or entertainment
A) company expense report
All of the following deductible expenses are deductions for AGI except A) deductions reported on Schedule A. B) deductions reported on Schedule C. C) deductions reported on Schedule E. D) All of the above are deductions for AGI.
A) deductions reported on Schedule A. Explanation: Itemized deductions (deductions from AGI) are reported on Schedule A. Schedule C reports deductions for business-related expenses of sole proprietors. Schedule D reports deductions attributable to rent and royalty income.
RollerQueens Inc., a calendar-year accrual method taxpayer, enters into a contract each September with a cleaning service to clean the arena after each game during the team's October through March season. Under the criteria of the economic performance test, the RollerQueens Inc.'s deduction for cleaning expense A) is allowed in full in the year RollerQueens Inc. and the cleaning service enter into the contract. B) is not allowed until the cleaning service contract is fully satisfied in the following year. C) must be amortized over the contract period. D) is not allowed until payment is made.
A) is allowed in full in the year RollerQueens Inc. and the cleaning service enter into the contract. Explanation: Because the all-events test is satisfied (the liability is fixed), the expense recurs every year, economic performance occurs within the requisite period of time, and the item is not material, the taxpayer can take the deduction for the entire expense in the year in which the taxpayer and service provider enter into the contract.
Chana purchased 400 shares of Tronco Corporation stock for $40,000 in 2014. On December 27, 2018, Chana sells the 400 shares for $24,000. Chana purchases 300 shares of Tronco Corporation stock on January 16, 2019 for $8,000. Chana's recognized loss on sale of the 400 shares in 2018 and her basis in her 300 new shares are A) Recognized Loss Basis $0 $32,000. B) Recognized Loss Basis $4,000 $20,000. C) Recognized Loss Basis $12,000 $20,000. D) Recognized Loss Basis $16,000 $8,000.
B) Recognized Loss $4,000 Basis $20,000. The realized loss on the 400 shares is $16,000 ($24,000 - $40,000). $16,000 × 300/400 = $12,000 is disallowed due to the wash sale. $16,000 - $12,000 = $4,000 allowed loss in 2018. The basis of the new shares is the $8,000 cost plus the $12,000 unrecognized loss = $20,000 basis in new stock.
Rob sells stock with a cost of $3,000 to his daughter for $2,200, which is its fair market value. Later the daughter sells the stock for $3,200 to an unrelated party. Which of the following describes the tax treatment to Rob and Daughter? A)
B) Rob - Recognizes no loss Daughter- Recognizes gain of $200
On August 1 of this year, Sharon, a cash-method taxpayer, signs a lease for office space and begins business. The lease is for 3 years. At the time the lease is signed, Sharon pays the $12,600 rent for the entire 36-month lease term. How much can Sharon deduct this year? A) $350 B) $1,750 C) $5,950 D) $12,600
B) $1,750
On August 1 of the current year, Terry refinances her home and borrows $240,000. Terry is required to pay two points on the loan. The loan is secured by the residence and the charging of points is an established business practice in the area. The term of the loan is 20 years, beginning on August 1 of the current year. How much, if any, of the points may Terry deduct in the current year? A) $0 B) $100 C) $240 D) $4,800
B) $100
Leigh pays the following legal and accounting fees during the year: Legal fees in connection with a contract dispute in her trade or business $8,800 Legal fees related to resolving a tax deficiency related to business 4,000 Tax return preparation fees: Allocable to Schedules A and B 1,000 Tax return preparation fees: Allocable to Schedule C 1,200 Legal fees incident to a divorce 5,000 What is the total amount of her for AGI deduction for these fees? A) $10,800 B) $14,000 C) $15,000 D) $20,000
B) $14,000 Explanation: $8,800 + $4,000 + $1,200 = $14,000; the tax return fees allocable to Schedules A and B and legal fees incident to a divorce are not deductible.
On July 1 of the current year, Marcia purchases a small office building to use in her business and borrows $320,000. Marcia is required to pay two points on the loan. The loan is secured by the property and the charging of points is an established business practice in the area. The term of the loan is 20 years, beginning on July 1 of the current year. How much, if any, of the points may Marcia deduct in the current year? A) $0 B) $160 C) $3,200 D) $6,400
B) $160
Victor, a calendar-year taxpayer, owns 100 shares of AB Corporation stock, which was purchased three years ago for $5,000. Victor sells all 100 shares on December 27, of the current year, for $4,000 and on January 5, of the following year, purchases 60 shares of AB Corporation stock. Victor's recognized loss will be A) $0. B) $400. C) $600. D) $1,000.
B) $400. Explanation: (40/100) × ($5,000 - $4,000) = $400. The wash sale rules limit the loss recognition to the loss on the shares that are not repurchased.
Laura, the controlling shareholder and an employee of Southtown Corporation, receives an annual salary of $750,000. Based on several factors including the size of the corporation's operations and a comparison of salary received by officers of comparably sized corporations, the IRS contends that Laura's salary should be no higher than $600,000. The Court upheld the IRS's position. As a result, which of the following is true? A) $600,000 is deductible by the corporation; $600,000 is taxable to Laura. B) $600,000 is deductible by the corporation; $750,000 is taxable to Laura. C) $750,000 is deductible by the corporation; $750,000 is taxable to Laura. D) $750,000 is deductible by the corporation; $600,000 is taxable to Laura.
B) $600,000 is deductible by the corporation; $750,000 is taxable to Laura.
Bart owns 100% of the stock of Octo Corporation, which uses the accrual method. Bart's sister Samantha, a cash-method taxpayer, did some advertising work for Octo in November 2018. In December, Octo received a billing statement from Samantha for $5,000 and paid Samantha the $5,000 in January 2019. Samantha is a calendar-year taxpayer. When may Octo deduct the $5,000? A) 2018 B) 2019 C) Either 2018 or 2019 D) The expense is not deductible since Samantha is Bart's sister.
B) 2019
Erin, Sarah, and Timmy are equal partners in EST Partnership. Sarah also owns 40% of Elton Corporation. The remaining shareholders of Elton Corporation are: Erin (24%) and Sarah's uncle (36%). What percent ownership does Sarah directly or constructively own in Elton Corporation? A) 40% B) 64% C) 76% D) 100%
B) 64%
Mark and his brother, Rick, each own farms. Rick is experiencing severe financial difficulties and cannot afford to buy feed for his cattle. Mark purchases $2,000 of feed and gives Rick one-half of the feed. Mark tells Rick that there is no need to repay him and to consider the feed a gift. Which of the following statements is true? A) Mark can deduct $2,000 for the feed. B) Mark can deduct $1,000 for the feed. C) Rick must report $1,000 as income. D) None of the above is true.
B) Mark can deduct $1,000 for the feed. Explanation: Taxpayers cannot take a deduction for the expense of another person. Mark can only deduct the $1,000, the cost of the feed he used.
Three years ago, Myriah refinanced her home mortgage and was required to pay two points on the refinanced loan. The loan was secured by the property, and the charging of points was the established lending practice in the area. The term of the loan was 20 years. Myriah sold the house earlier this year and paid off the refinanced mortgage. In this year of the home sale, is Myriah allowed any deduction with respect to the points paid on the refinanced mortgage? A) Yes, she can deduct the full amount of the refinanced loan points in the year of sale because none of these points have been previously deducted. B) Yes, she can deduct the unamortized balance of the refinanced loan points in the year of sale. C) No, the full amount of the refinanced loan points were already deducted in the year the home mortgage was refinanced. D) No, points paid to refinance a home mortgage are never deductible.
B) Yes, she can deduct the unamortized balance of the refinanced loan points in the year of sale.
Kelsey enjoys making cupcakes as a hobby and occasionally sells them for parties. Kelsey receives $1,000 in revenues from cupcake sales this year and pays $1,300 for supplies. Kelsey takes the standard deduction each year. The net effect of the cupcake activity on Kelsey's taxable income is A) $0. B) an increase of $1,000. C) a decrease of $300. D) a decrease of $280.
B) an increase of $1,000. Explanation: Expenses related to activity classified as a hobby are not deductible so her taxable income will include the full $1,000 revenue.
Pamela was an officer in Green Restaurant which subsequently went bankrupt. Pamela started a new restaurant and, to establish goodwill, paid off the debts of $100,000 of Green Restaurant. She was under no obligation to do so. The $100,000 is A) deductible currently as an itemized deduction. B) capitalized because the expenses are not ordinary. C) deductible currently as a trade or business expense since the expenses are considered ordinary and necessary business expenses. D) None of the above.
B) capitalized because the expenses are not ordinary.
Assume Congress wishes to encourage healthy eating and is considering a deduction for broccoli purchases. In order to maximize the value of this tax deduction for taxpayers, Congress should provide for a(n) A) itemized deduction. B) deduction for AGI. C) deduction from AGI. D) All of the above would provide the same tax savings to taxpayers
B) deduction for AGI.
On Form 1040, deductions for adjusted gross income include the amounts paid for all of the following except A) one-half of self employment tax. B) home mortgage interest. C) student loan interest. D) contributions to a Health Savings Account.
B) home mortgage interest.
Gabby owns and operates a part-time art gallery, now in its fifth year. She views it as a business activity, but she is concerned that the IRS will challenge her classification and consider it a hobby. Her business results, using the cash method of accounting, were net losses in the first and fourth years and small profits in the second and third years. It is now almost year-end and based on projections, the business is showing a small profit of $6,000. Repairs to the security system and to the heating/cooling system were recently completed and these bills total $7,000. When should Gabby pay these bills? A) before year-end to get the current year deduction B) next year C) split into $6,000 this year and $1,000 next year D) It does not matter when she pays the bills. The work was performed this year, so the costs will be deducted this year.
B) next year
To be tax deductible by an accrual-basis taxpayer, an expense must be all of the following except A) ordinary and necessary. B) paid in cash. C) reasonable in amount. D) an expense of the taxpayer.
B) paid in cash.
Vanessa owns a houseboat on Lake Las Vegas that she personally uses for 25 days out of the year and rents for 280 days. For tax purposes, the houseboat is classified as A) neither a residence nor rental property. Because it is rented a nominal number of personal-use days, both revenue and expenses (other than those otherwise allowable) are ignored. B) rental property. Expenses in excess of income may be deducted although net income or loss is subject to the passive activity rules. C) property that is treated as a hobby, not allowing any deductions. D) a combination of the taxpayer's residence and rental property. The deduction for expenses is limited to the amount of income generated by the property.
B) rental property. Expenses in excess of income may be deducted although net income or loss is subject to the passive activity rules. Explanation: Since Vanessa's personal use of 25 days does not exceed 10% of the rental days (280 × .10 = 28 days), then the houseboat is not considered a residence under Section 280A. Neither is the use considered nominal since rental days exceed 14. Therefore, the houseboat is classified as rental property.
Various criteria will disqualify the deduction of a business or investment related expenditure. Which of the following criteria will not disqualify a business or investment expenditure? A) capital expenditure B) expenses related to tax-exempt income C) expenses are not incurred annually D) expenses are illegal or in violation of public policy
C) expenses are not incurred annually
Riva works at a full-time job, but also restores her antique doll collection and sells them on eBay. She received $10,000 of sales revenue and paid $12,000 of supplies expense. A number of factors must be weighed to determine the appropriate classification of the activity. Depending on that classification, the net effect on her taxable income will be
Business a reduction of $2,000. Hobby an increase of $10,000.
FIFO Corporation, a public-traded corporation, pays its CFO a basic salary of $900,000 and a $500,000 bonus awarded for exceptional service. Her compensation package is considered reasonable compensation when compared to other similar corporations and her level of responsibilities. FIFO can deduct A) $500,000. B) $900,000. C) $1,000,000. D) $1,400,000.
C) $1,000,000. Explanation: Compensation deductions are limited to $1,000,000 for public corporations paying "covered employees." A CFO is included in the category of covered employee.
Jason sells stock with an adjusted basis of $66,000 to JJ Inc., his 60% owned corporation, for its fair market value of $60,000. JJ Inc. sells the stock three years later for $67,000. JJ Inc.'s recognized gain or loss on the sale will be A) $0. B) ($3,000). C) $1,000. D) $4,000.
C) $1,000.
2020 Enterprises, owned by Xio who also manages the businesses, has generated more than $25 million of sales for each of the past five years. This year it is reporting the following income and deduction amounts: Sales $35,000,000 Cost of goods sold (22,000,000) Other operating expenses (8,000,000) Depreciation (2,000,000) Preliminary taxable income $ 3,000,000 Xio just received a statement from the bank reporting interest expense of $1,800,000 on a loan to 2020 Enterprises to fund operations and equipment purchases. How much of the interest expense can 2020 Enterprises deduct in computing this year's taxable income? A) $540,000 B) $900,000 C) $1,500,000 D) $1,800,000
C) $1,500,000 Explanation: Interest expense is limited to 30% of adjusted taxable income. .30($3,000,000 + 2,000,000 depreciation) = $1,500,000
Troy incurs the following expenses in his business, an illegal gambling establishment: Salaries to employees $200,000 Insurance expense 60,000 Utilities expense 70,000 Bribes to police 50,000 His deductible expenses are A) $0. B) $200,000. C) $330,000. D) $380,000.
C) $330,000.
In March of the current year, Marcus began investigating the possibility of opening a specialty clothing store. From March through June, he spent $2,300 on a market survey, $2,700 in consulting fees to find the best location and $3,600 in professional fees setting up an accounting and inventory system. Although he had never run his own business before, on August 1 he opened his doors for business. What is the maximum amount of deduction for the current year attributable to these expenditures? A) $0 B) $5,000 C) $5,100 D) $8,600
C) $5,100 Explanation: Marcus may elect to deduct lesser of the $8,600 expenses incurred or $5,000 currently. He can amortize the remaining $3,600 over 180 months, resulting in $20 per month. His current year amortization is $20 × 5 = $100, for a total deduction of $5,100. Page Ref.: I:6-15 and I:6-16; Figure I:6-1
Mackensie owns a condominium in the Rocky Mountains. During the year, Mackensie uses the condo a total of 23 days. The condo is also rented to tourists for a total of 77 days and generates rental income of $10,900. Mackensie incurs the following expenses in the condo: Expense Amount Mortgage interest $5,000 Property taxes 3,500 Utilities 2,500 Insurance 1,800 Depreciation 11,000 Using the court's method of allocating expenses, the amount of depreciation that Mackensie may take with respect to the rental property will be A) $0. B) $1,044. C) $5,796. D) $11,000
C) $5,796. Rental income $10,900 Minus: Tier 1-Mortgage interest (77/365 × $5,000) ( 1,055) Property taxes (77/365 × $3,500) ( 738) Minus: Tier 2- Utilities (77/100 × $2,500) (1,925) Insurance (77/100 × $1,800) ( 1,386) Minus: Tier 3- Depreciation (Remaining income) ( 5,796) Taxable rental income $ 0 The taxpayer's use exceeds 10% of the rental days so the property is limited by the vacation home rules. Note that the potential depreciation deduction is 77/100 × $11,000 = $8,470, but it is limited to the remaining income after taking all other deductions into account.
Liz, who is single in 2018, lives in a single family home and owns a second single family home that she rented for the entire year at a fair rental rate. Liz had the following items of income and expense during the current year. Income: Gross salary and commissions from Ace Corporation $50,000 Rent received from tenant in Liz's rental house 13,000 Dividends received on her portfolio of stocks 5,000 Expenses: Interest and property taxes on her own home 9,000 Taxes, interest and repair expenses on rental house 3,500 Depreciation expense on rental house 2,300 What is her adjusted gross income for the year? A) $64,300 B) $53,200 C) $62,200 D) $68,000
C) $62,200
Dana purchased an asset from her brother for $15,000. Her brother's basis was $20,000. If Dana sells the asset to an unrelated party for $12,000, she will recognize. A) $0. B) ($1,000) loss. C) ($3,000) loss. D) ($4,000) loss.
C) ($3,000) loss.
During the current year, Ivan begins construction of an office building and a hotel. He incurs $10,000 in property taxes during the construction of the office building and $15,000 for the hotel. Which of the following statements is true of the property taxes during the construction period? A) Ivan must capitalize the property taxes on both properties each year if an election is made. B) Ivan must deduct the property taxes on both properties each year. C) Ivan may elect to capitalize the property taxes on one of the properties while deducting the property taxes on the other for each year. D) Ivan may elect to capitalize the property taxes for the properties in one year and then deduct the property taxes on the properties the next year.
C) Ivan may elect to capitalize the property taxes on one of the properties while deducting the property taxes on the other for each year.
Juanita knits blankets as a hobby and sells them. In the current year, she earns $5,000 from her blanket sales and incurs expenses of $600. On her tax return, she should A) report $5,000 of hobby income and deduct $600 of hobby expenses from AGI. B) report $5,000 of hobby income and deduct $600 of hobby expenses for AGI. C) report $5,000 of hobby income, but she will not be able to take any deductions. D) report no hobby income and no hobby deductions.
C) report $5,000 of hobby income, but she will not be able to take any deductions.
Which of the following individuals is not considered a relative for purposes of the related parties loss disallowance rules under Sec. 267? A) brother B) husband C) sister-in-law D) grandfather
C) sister-in-law
Doug, a self-employed consultant, has been a firm believer in maintaining a paperless office. Unfortunately, he recently lost all of his business records in a ransomware attack, and his backup system was also compromised. Which of the following cases should Doug investigate to better understand substantiation requirements for business expenses? A) the tax benefit rule B) the Corn Products doctrine C) the Cohan rule D) the Arkansas Best doctrine
C) the Cohan rule Under the Cohan rule, the courts will allow a deduction that is not properly substantiated by the taxpayer if an expenditure clearly has been made. The Cohan rule will not apply to all categories of expenses such as travel and entertainment.
Under the accrual method, recurring liabilities may be deducted currently and paid in the next period if all of the following are present except for A) the all-events test is met. B) the expense is recurring. C) the expense is material. D) economic performance occurs within the shorter of 8 1/2 months after the close of the year or a reasonable period after the close of the year.
C) the expense is material.
Efrain owns 1,000 shares of RJ Inc. common stock which he purchased three years ago for $36,000. Efrain sells the 1,000 shares on October 15, 2018, for $10,000. On November 12, he purchases 400 shares of RJ Inc. preferred stock for $8,000. Efrain's recognized loss on the sale of the 1,000 shares will be A) $0. B) $10,400. C) $15,600. D) $26,000
D) $26,000 Explanation: Preferred stock is not considered substantially identical to common stock of the same corporation and wash sale rules will not apply. Therefore, the loss of $26,000 ($10,000 - $36,000) is allowed.
During the current year, Martin purchases undeveloped land as an investment. Martin intends to rent the land as pastureland and hopefully sell it later for a profit. In the current year, Martin receives no rent but he does pay taxes of $2,800, mortgage interest of $900 and liability insurance of $500. How much of these expenses can Martin deduct (before any limitations) on his current tax return? A) $0 B) $1,400 C) $3,700 D) $4,200
D) $4,200 Explanation: $2,800 + $900 + $500 = $4,200. These are ordinary and necessary expenses related to the income he hopes to produce.
Toby, owner of a cupcake shop in New York, had been considering opening a similar business (i.e., a cupcake shop) in Phoenix. After spending $6,800 investigating such possibilities in Phoenix, Toby decided against opening the store on July 1. What is the maximum amount of deduction for the current year attributable to these expenditures? A) $0 B) $5,000 C) $5,600 D) $6,800
D) $6,800
Emeril borrows $340,000 to finance taxable and tax-exempt investments. He incurs $18,000 investment interest expense, allocated equally between the taxable and tax-exempt investments. Ignore any possible investment interest expense limitation. How much of the interest expense is deductible, and where is it deductible? A) $18,000 for AGI B) $18,000 from AGI C) $9,000 for AGI D) $9,000 from AGI
D) $9,000 from AGI
Deductions for AGI may be located A) on the front page of Form 1040. B) on Schedule C as a deduction. C) on Schedule E as a deduction. D) All of the above are true.
D) All of the above are true.
Paul, a business consultant, regularly takes clients and potential clients out to dinner. In order to deduct these expenses, Paul must maintain records substantiating all of the following except A) the time and place of the dinners. B) the business relationship with the person invited. C) the business purpose of the dinners. D) All of the above information must be substantiated in order to deduct the entertainment costs.
D) All of the above information must be substantiated in order to deduct the entertainment costs.
Which of the following factors is important in distinguishing between capital and revenue expenditures? A) The expenditure improves the property, adding to the value of the property. B) The expenditure provides a betterment, adding to the value of the property. C) The expenditure restores the property. D) All of the above.
D) All of the above.
Toni owns a gourmet dog treat shop downtown. She spends $2,800 investigating opening another dog treat shop in Northtown and an additional $3,100 investigating a new location in Southtown. Toni does open the Northtown shop, but does not open the Southtown shop. A) Toni must capitalize and amortize the Northtown investigation costs, but can immediately deduct the Southtown investigation costs. B) Toni must capitalize and amortize the Northtown investigation costs, but the Southtown investigation costs are not deductible at all. C) Both the Northtown and the Southtown investigation costs must be capitalized and amortized. D) Both the Northtown and the Southtown investigation costs are currently deductible.
D) Both the Northtown and the Southtown investigation costs are currently deductible.
For the years 2014 through 2018 (inclusive) Max, a surgeon, has been involved in bowling competitions. Only in 2017 and 2018 did his revenue exceed the expenses from the activity. Which statement is correct? A) The activity is a business. The IRS cannot prove it is a hobby. B) The activity is a hobby. Max cannot prove it is a business. C) The activity is presumed to be a business. However, the IRS may prove it is a hobby. D) The activity is presumed to be a hobby. However, Max may prove it is a business.
D) The activity is presumed to be a hobby. However, Max may prove it is a business. Explanation: Under the presumption rule, if an activity results in a loss for 3 of 5 years, the burden of proof falls to the taxpayer to prove that the activity is a business rather than a hobby. Page Ref.: I:6-29
The Super Bowl is played in Tasha's home town. Tasha moves out of her house for 10 days and stays with her parents. She rents her house for a very high fee to a crew from ESPN. With respect to this rental activity, Tasha will A) report the rental income but be allowed a deduction for AGI for the related expenses (e.g., interest, taxes, utilities, depreciation). B) report the rental income but be allowed a deduction from AGI for the related expenses (e.g., interest, taxes, utilities, depreciation). C) report the rental income, but she will not be allowed any deductions other than the mortgage interest and property taxes. D) not be required to report the income, but she will not take any deductions other than her normal mortgage interest and property taxes.
D) not be required to report the income, but she will not take any deductions other than her normal mortgage interest and property taxes. Explanation: The 10 days of rental qualifies under the exception for rental for a nominal number of rental days (i.e., less than 15). She will not be required to report the income, but she will not take any deductions other than her normal mortgage interest and property taxes.
Self-employed individuals may claim, as a deduction for adjusted gross income, 50 percent of their A) traditional IRA contributions. B) disability insurance premiums. C) health insurance premiums. D) self-employment tax.
D) self-employment tax.
Which of the following factors is not used to determine whether an activity is a hobby or a business? A) the taxpayer's expertise in the activity B) the taxpayer's financial status C) the personal pleasure derived from the activity D) the success of the taxpayer in other dissimilar activities
D) the success of the taxpayer in other dissimilar activities
Deductions for adjusted gross income include all of the following except A) contributions to certain retirement plan arrangements. B) professional fees and supplies paid by elementary and high school teachers. C) expenses attributable to production of rental income. D) unreimbursed employee business expenses.
D) unreimbursed employee business expenses.
Fines and penalties are tax deductible if related to the taxpayer's trade or business.
FALSE
Kaitlyn owns a hotel in Phoenix, Arizona. The city of Phoenix has proposed legislation to increase the hotel room tax. Kaitlyn incurs $1,000 of lobbying expenses to discourage passage of the legislation. Kaitlyn can deduct the $1,000.
FALSE
Kickbacks and bribes paid to federal officials are deductible only if related to the taxpayer's trade or business.
FALSE
Generally, expenses incurred in an investment activity other than those incurred to produce rent and royalties are deductions from AGI.
FALSE Explanation: Effective in 2018, expenses incurred in an investment activity other than rental and royalty properties are not deductible.
Expenses paid with a credit card are deductible at the time a cash-basis taxpayer pays for the charge.
FALSE Explanation: The expenses are deductible at the time of the charge.
A small business uses the accrual method of accounting for its financial statements. It must also use the accrual method for computing taxable income
FALSE Explanation: The tax law does not require book-tax accounting conformity except in the case of using LIFO for inventory accounting.
Tess has started a new part-time business. She is concerned that the IRS will call it a hobby if her return is audited. This first year of business showed a small profit, and she expects it to continue to show modest profits. She would like to take advantage of the three out of five year profit rule to shift the burden of proof to the IRS. Because of the three-year statute of limitations, this will not be possible for the first year of business.
FALSE Explanation: Tess can file a special election to defer the determination until the fifth year of operation.
Points paid to refinance a mortgage on a principal residence are fully deductible in the year paid.
FALSE Explanation: They are treated as prepaid interest and amortized over the term of the loan.
A change to adjusted gross income cannot affect a taxpayer's itemized deductions.
False
A deduction will be allowed for an expenditure unless the Internal Revenue Code specifically disallows it.
False
A single taxpayer has adjusted gross income of $325,000 and has total itemized deductions in various categories totaling $20,000. The taxpayer discovers some additional deductions for AGI. The extra deductions can not affect his itemized deductions.
False
According to the tax formula, individuals can deduct the greater of for AGI deductions or from AGI deductions.
False
Itemized deductions are deductions for AGI.
False
Losses on the sale of property between a taxpayer and his/her more than 50-percent-owned corporation are disallowed.
TRUE Explanation: Losses on sales between related parties are not allowed. A shareholder and his more than 50-percent-owned corporation are related parties.
Points paid in connection with the purchase of a principal residence may be deducted in the year paid.
TRUE Explanation: Normally prepaid interest must be amortized over the life of the loan, but an exception allows immediate deduction in the case of the purchase of a principal residence.
An accrual-basis taxpayer may elect to accrue real property taxes ratably over the period to which the taxes relate.
TRUE Explanation: The economic performance test would normally require payment, but an election is allowed under Sec. 461 for a ratable deduction for accrual-basis taxpayers.
If a loss is disallowed under Section 267, a gain on a subsequent sale of the property by the related purchaser may be offset by the previously unrecognized loss.
TRUE Explanation: The original seller of the property in a related party sale will never recognize the loss, but if the purchaser later sells the property for a gain, the purchaser can offset the gain with the unrecognized loss.
Losses incurred on wash sales of stock or securities are generally disallowed in the year of sale.
TRUE Explanation: The wash sale limitations prevent the creation of artificial losses for tax purposes.
A taxpayer owns a cottage at the beach for family vacations, but also rents it out for one month of the summer. Expenses attributable to the rental use of a taxpayer's vacation home are limited to the gross income generated by the property. The residence is considered to fall into the mixed personal and rental dimension.
TRUE Explanation: A net loss cannot be recognized on a vacation home.
Generally, Section 267 requires that the deduction of unpaid (accrued) expenses be deferred until the year in which the related payee recognizes the amount as income.
TRUE Explanation: An accrual-basis taxpayer cannot deduct accrued expenses owed to a cash-basis related party.
Fees paid to prepare a taxpayer's Schedule C of the tax return (Profit or Loss from Business) are for AGI deductions.
TRUE Explanation: Legal and accounting fees related to self-employment activity are deductions for AGI.
Losses on sales of property between a taxpayer and his/her siblings are disallowed.
TRUE Explanation: Losses on sales between related parties are not allowed.
Under the wash sale rule, if all of the sold shares are not repurchased within the relevant time period, a portion of the loss on the sale is allowed.
TRUE Explanation: The portion of the loss relating to the shares not replaced will be allowed.
The vacation home limitations of Section 280A may also apply to boats and mobile homes.
TRUE Explanation: The term "dwelling unit" is very expansive and is based on whether the property provides shelter and accommodations for eating and sleeping.
The term "principal place of business" includes a home office used by a taxpayer for administrative or management activities of the business if no fixed location exists where the taxpayer conducts these activities.
TRUE Explanation: The term "principal place of business" includes a home office used by the taxpayer for administrative or management activities of the business if no other fixed location exists where these activities are performed.
A taxpayer opens a new business this year. Prior to opening, she incurred $45,000 of business investigation and preopening costs. The taxpayer can elect to currently deduct $5,000 and amortize the balance over 180 months.
TRUE Explanation: A taxpayer can elect to immediately deduct up to $5,000 of start-up expenditures, with the balance amortized over 180 months. Limitations apply when expenditures exceed $50,000.
Business investigation expenses incurred by a taxpayer who is already involved in a similar business and who enters the new business are deductible currently.
TRUE Explanation: For new business ventures, the key to current deduction of business investigation and pre-opening costs or capitalization and amortization of those costs rests on whether the taxpayer is already engaged in a similar business.
If property that qualifies as a taxpayer's residence is rented for less than 15 days per year, the taxpayer includes no rental income in gross income and similarly may claim no expenses related to the property other than interest and taxes.
TRUE Explanation: Rental of a personal residence for less than 15 days is considered nominal. Rental receipts are not recognized, nor are rental-related expenses deductible (other than the regular itemized deductions for mortgage interest and property taxes).
Expenses incurred in a trade or business generally are deductions for AGI.
True
Expenses incurred in connection with conducting a trade or business activity or in connection with production of income are generally deductible, but personal expenses are generally not deductible.
True
Individuals are generally allowed to deduct the greater of the standard deduction or itemized deductions.
True
