Reg Chapter 1

In a divorce settlement, the ex-husband was required by court order to pay his ex-wife $36,000 in alimony. She received $25,000 in cash, a painting valued at $10,000, and the use of his beach house, valued at $3,000. What amount of gross income should she report as alimony? a. $25,000 b. $38,000 c. $35,000 d. $36,000

Choice "a" is correct. Alimony includes only payments received in cash or its equivalent (e.g., the payment of bills on behalf of the ex-spouse). Choice "c" is incorrect. The painting would not be included in alimony because it is not a payment in cash or its equivalent. Choice "d" is incorrect. The amount of alimony ordered by the court does not determine the amount of alimony that is considered gross income for tax purposes. Choice "b" is incorrect. Neither the painting nor the use of the beach house would count as alimony because they are not payments in cash or its equivalent.

Baker, a sole proprietor CPA, has several clients that do business in Spain. While on a four-week vacation in Spain, Baker took a five-day seminar on Spanish business practices that cost $700. Baker's round-trip airfare to Spain was $600. While in Spain, Baker spent an average of $100 per day on accommodations, local travel, and other incidental expenses, for total expenses of $2,800. What amount of total expense can Baker deduct on Form 1040 Schedule C, "Profit or Loss From Business," related to this situation? a. $1,200 b. $1,800 c. $700 d. $4,100

Choice "a" is correct. Baker can deduct $1,200 in total expense on Form 1040 Schedule C, calculated as follows: Direct educational expenses $ 700 [cost of the course] Daily expenses for 5-day seminar 500 [$100 per day × 5] Total educational expenses $ 1,200 Rule: If foreign travel is primarily for personal in nature (e.g., a vacation), none of the travel expenses (e.g., round trip airfare) incurred will be allowable business deductions, even if the taxpayer was involved in business activities while in the foreign country. Note: It does not appear that the examiners are attempting to trick candidates on the classification of the business expenses as travel or educational. It appears that the purpose of the question is to test the candidate's ability to recognize when expenses are deductible and when they are not deductible business expenses. Choice "c" is incorrect, as the expenses for the 5-day period Baker attended the seminar were directly related to being in Spain for the additional period of time and are allowable business deductions. Choices "b" and "d" are incorrect, per the above rule.

Baum, an unmarried optometrist and sole proprietor of Optics, buys and maintains a supply of eyeglasses and frames to sell in the ordinary course of business. In the current year, Optics had $350,000 in gross business receipts and its year-end inventory was not subject to the uniform capitalization rules. Baum's current year adjusted gross income was $90,000 and Baum qualified to itemize deductions. During the year, Baum recorded the following information: Business expenses: Optics cost of goods sold $ 35,000 Optics rent expense 28,000 Liability insurance premium on Optics 5,250 Other expenditures: Baum's self-employment tax $ 29,750 Baum's self-employment health insurance 8,750 Insurance premium on personal residence. In the current year, Baum's home was totally destroyed by fire. The furniture had an adjusted basis of $14,000 and a fair market value of $11,000. During the year, Baum collected $3,000 in insurance reimbursement and had no casualty gains during the year. 2,625 Qualified mortgage interest on a loan to acquire a personal residence 52,500 Annual interest on a $70,000, 5-year home equity loan. The loan was secured by Baum's home, obtained January 2 of the current year. The fair market value of the home exceeded the mortgage and the home equity loan by a substantial amount. The proceeds were used to purchase a car for personal use. 3,500 Points prepaid on January 2 of the current year to acquire the home equity loan 1,400 Real estate taxes on personal residence 2,200 Estimated payments of current year federal income taxes 13,500 Local property taxes on the car value, used exclusively for personal use 300 What amount should Baum report as current year net earnings from self-employment?

Choice "a" is correct. Baum should report $281,750 as current year net earnings from self-employment (line 12 of the Form 1040), calculated as follows: Gross business receipts $ 350,000 Cost of goods sold (35,000) Rent expense (28,000) Liability insurance premium (5,250) Net earnings on Schedule C $ 281,750 Choices "d", "b", and "c" are incorrect. Self-employment tax and self-employment health insurance expenses are adjustments from total gross income. They are not deducted from self-employment earnings (i.e., not reported net on line 12 of the Form 1040). Note: There are many distracters in this question, all relating to items that are either deductible as part of itemized deductions or not deductible. Be careful to read the requirement of the question before spending unnecessary time on the question. The statement that Baum's year-end inventory was not subject to the uniform capitalization rules is a distracter as well. There is not enough information given in the facts to apply the rules if he had been subject to them.

Adams owns a second residence that is used for both personal and rental purposes. During the current year, Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct? a. Utilities and maintenance on the property must be divided between personal and rental use. b. All mortgage interest and taxes on the property will be deducted to determine the property's net income or loss. c. A rental loss may be deducted if rental-related expenses exceed rental income. d. Depreciation may not be deducted on the property under any circumstances.

Choice "a" is correct. Because the second property was personally used more than 14 days, any net loss from the rental of the property will be disallowed. All related expenses must be prorated between the personal use portion and the rental activity portion. Prorated depreciation is permitted for the rental activity.

A cash basis taxpayer should report gross income: a. Only for the year in which income is actually received whether in cash or in property. b. For the year in which income is either actually or constructively received, whether in cash or in property. c. Only for the year in which income is actually received in cash. d. For the year in which income is either actually or constructively received in cash only.

Choice "b" is correct. A cash basis taxpayer should report gross income for the year in which income is either actually or constructively received, whether in cash or in property. Choice "c" is incorrect. Income also can be constructively received in property, not only actually in cash. Choice "a" is incorrect. Income also can be constructively received, not only actually. Choice "d" is incorrect. Income also can be received in property, not only cash.

On December 1 of the current taxable year, Krest, a self-employed cash basis taxpayer, borrowed $200,000 to use in her business. The loan was to be repaid on November 30 of the following year. Krest paid the entire interest amount of $24,000 on December 1 of the current year. What amount of interest was deductible on Krest's current year income tax return? a. $2,000 b. $0 c. $24,000 d. $22,000

Choice "a" is correct. Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on December 1, of the current year, only the interest relating to December of the current year can be deducted in the current year. The question does not give an interest rate, but because the loan is to be repaid in a lump sum at maturity, 1/12 of the interest, or $2,000 applies to each month. Choice "b" is incorrect. Because $2,000 of the interest relates to the current year, this amount is deductible in the current year. Choice "d" is incorrect. This is the amount that cannot be deducted until the following year, the year to which the interest relates. Be sure to read questions like this very carefully, because if you had simply misread the question as seeking the amount deductible in the following year, you would get the question wrong despite understanding the rule. Choice "c" is incorrect. Cash basis taxpayers can deduct interest in the year paid or the year to which the interest relates, whichever is later, thus 11 months of the interest will not be deductible until next year.

Dietz is a passive investor in three activities which have been profitable in previous years. The profit and losses for the current year are as follows: Gain/(Loss) Activity X $ (30,000) Activity Y (50,000) Activity Z 20,000 Total $ (60,000) What amount of suspended loss should Dietz allocate to Activity X? a. $22,500 b. $20,000 c. $18,000 d. $30,000

Choice "a" is correct. For the current year, there is a net passive loss of $60,000. This should be allocated to the two activities with passive losses in the ratio of their losses to total losses. Activity X will receive an allocation of $22,500 of the net loss [$60,000 × ($30,000 / $80,000)].

James Corp. issue stock options to employees under an Employee Stock Purchase Plan. Which of the following statements is correct? I. The option exercise price may not be less than the lesser of 95% of the FMV of the stock when granted or exercised. II. The option cannot be exercised more than 27 months after the grant date. a. II only. b. Neither. c. Both. d. I only.

Choice "a" is correct. I is not correct because the rule states 85%, not 95%. II is a correct statement. This is a requirement of an ESPP. Choices "d", "c", and "b" are incorrect per the above explanation.

The uniform capitalization method must be used by: I. Manufacturers of tangible personal property. II. Retailers of personal property with $2 million in average annual gross receipts for the three preceding years. a. I only. b. II only. c. Neither I nor II. d. Both I and II.

Choice "a" is correct. I only. Rule: The uniform capitalization rules apply to the following: 1.Real or tangible personal property produced by the taxpayer for use in a trade or business. 2.Real or tangible personal property produced by the taxpayer for sale to customers. 3.Real or personal property acquired by the taxpayer for resale. 4.However, the uniform capitalization rules do not apply to property acquired for resale if the taxpayer's annual gross receipts for the preceding three tax years do not exceed $10,000,000 (not $2 million). Choices "b", "d", and "c" are incorrect, per the above.

Mort and Mindy met at a New Year's Eve party held December 31, Year 1. They instantly bonded, fell madly in love, and were married at 11:38 p.m. that night. Sadly, Mort passed away November 15, Year 2. In January, Year 3, Mindy gave birth to triplets Mark, Mandy, and Maureen. Assuming Mindy has not remarried, what filing status should she use for Year 5? a. Head of household. b. Surviving spouse. c. Married filing jointly. d. Single.

Choice "a" is correct. Mindy should file using the head of household status. She has dependent children living with her, and no longer qualifies as married or as a surviving spouse. Head of household is the most favorable filing status for which she qualifies. Choice "d" is incorrect. Mindy qualifies for a more favorable filing status than single. Choice "c" is incorrect. Mindy is no longer married and Mort did not die in Year 5, so she is not eligible for the married filing jointly status. Choice "b" is incorrect. At Year 5, more than two years have passed since Mort's death so Mindy no longer qualifies for surviving spouse (qualifying widow) status.

On December 1, Year 1, Michaels, a self-employed cash basis taxpayer, borrowed $100,000 to use in her business. The loan was to be repaid on November 30, Year 2. Michaels paid the entire interest of $12,000 on December 1, Year 1. What amount of interest was deductible on Michaels' Year 2 income tax return? a. $11,000 b. $12,000 c. $1,000 d. $0

Choice "a" is correct. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers. The loan is for 1 month in Year 1 and 11 months in Year 2. Therefore, 1/12 of the interest is deductible in Year 1 and 11/12, or $11,000 is deductible in Year 2. Choices "b", "c", and "d" are incorrect. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers.

Nare, an accrual-basis taxpayer, owns a building which was rented to Mott under a ten-year lease expiring August 31, Year 8. On January 2, Year 2, Mott paid $30,000 as consideration for cancelling the lease. On November 1, Year 2, Nare leased the building to Pine under a five-year lease. Pine paid Nare $10,000 rent for the two months of November and December, and an additional $5,000 for the last month's rent. What amount of rental income should Nare report in its Year 2 income tax return? a. $45,000 b. $10,000 c. $15,000 d. $40,000

Choice "a" is correct. Prepaid rent is income when received even for an accrual-basis taxpayer. The $30,000 received as consideration for cancelling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month's rent is also rental income. Choice "b" is incorrect. The $30,000 received as consideration for cancelling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month's rent is also rental income. Choice "c" is incorrect. The $30,000 is in substitution of rental payments and is thus rental income. Choice "d" is incorrect. The $5,000 prepaid for the last month's rent would also be rental income.

Klein, a master's degree candidate at Blair University, was awarded a $12,000 scholarship from Blair in Year 8. The scholarship was used to pay Klein's Year 8 university tuition and fees. Also in Year 8, Klein received $5,000 for teaching two courses at a nearby college. What amount is includable in Klein's Year 8 gross income? a. $5,000 b. $12,000 c. $17,000 d. $0

Choice "a" is correct. Scholarships are nontaxable for degree seeking students to the extent that the proceeds are spent on tuition, fees, books and supplies. The $5,000 for teaching courses is taxable compensation for services delivered. Choice "d" is incorrect. The $5,000 for teaching courses is taxable compensation for services delivered. Choice "b" is incorrect. The scholarship is not taxable because Klein is a degree seeking student and used the proceeds for tuition and fees. Furthermore, the $5,000 for teaching courses is taxable compensation for services delivered. Choice "c" is incorrect. The scholarship is not taxable because Klein is a degree seeking student and used the proceeds for tuition and fees.

Which of the following statements regarding an individual's suspended passive activity losses is correct? a. Suspended losses can be carried forward, but not back, until utilized. b. $3,000 of suspended losses can be utilized each year against portfolio income. c. A maximum of 50% of the suspended losses can be used each year when an election is made to forgo the carry-back period. d. Suspended losses must be carried back three years and forward seven years.

Choice "a" is correct. Tax rules allow suspended passive losses to be carried forward, but not back, until utilized. Choice "b" is incorrect. This is the rule for capital losses. It does not apply to passive losses. Choice "d" is incorrect. This rule is not correct. There is no carryback allowed for suspended passive losses. Choice "c" is incorrect. This rule is not correct. There is no carryback allowed for suspended passive losses.

Dale received $1,000 in the current year for jury duty. In exchange for regular compensation from her employer during the period of jury service, Dale was required to remit the entire $1,000 to her employer in this year. In Dale's current year income tax return, the $1,000 jury duty fee should be: a. Deducted from gross income in arriving at adjusted gross income. b. Included in taxable income without a corresponding offset against other income. c. Claimed as an itemized deduction to the extent exceeding 2% of adjusted gross income. d. Claimed in full as an itemized deduction.

Choice "a" is correct. The $1,000 jury duty fee that was required to be remitted to the employer may be deducted from gross income in arriving at adjusted gross income. This, in effect, washes out the $1,000 income she will have to report as part of gross income for the jury duty fees paid to her. Choices "d" and "c" are incorrect. The amount remitted is allowed as an adjustment in arriving at AGI, not as an itemized deduction. Choice "b" is incorrect. A corresponding offset is allowed against other income as an adjustment in arriving at AGI.

Perle, a dentist, billed Wood $600 for dental services. Wood paid Perle $200 cash and built a bookcase for Perle's office in full settlement of the bill. Wood sells comparable bookcases for $350. What amount should Perle include in taxable income as a result of this transaction? a. $550 b. $0 c. $200 d. $600

Choice "a" is correct. The $200 cash received plus the $350 fair value of the bookcase received must be included in income by Perle, for a total of $550. The income is based on the value in money or fair value of property received by Perle, not the $600 billed. Choice "b" is incorrect. Perle must report taxable income as a result of this transaction. Choice "c" is incorrect. The $350 fair value of the bookcase received is also income for Perle. Choice "d" is incorrect. The income is based on the total value received by Perle, not the $600 billed.

Which of the following types of costs are required to be capitalized under the Uniform Capitalization Rules of Code Sec. 263A? a. Warehousing. b. Distribution. c. Marketing. d. Office maintenance.

Choice "a" is correct. The Uniform Capitalization Rules require the capitalization of certain costs related to inventory. They include direct materials, direct labor, and indirect overhead costs including warehousing. Choice "c" is incorrect. Marketing is a selling expense, which is not required to be capitalized under the Uniform Capitalization Rules. Choice "b" is incorrect. Distribution is a selling expense, which is not required to be capitalized under the Uniform Capitalization Rules. Choice "d" is incorrect. Office maintenance is a general and administrative expense, which is not required to be capitalized under the Uniform Capitalization Rules.

Which one of the following statements is correct with regard to an individual taxpayer who has elected to amortize the premium on a bond that yields taxable interest? a. The bond's basis is reduced by the amortization. b. The amortization is treated as an itemized deduction. c. The amortization is not treated as a reduction of taxable income. d. The bond's basis is increased by the amortization.

Choice "a" is correct. The bond's basis is reduced by the amortization of the premium. Choice "b" is incorrect. For bonds acquired after 12/31/87, the amortization of the premium is an offset to interest income on the bond rather than a separate interest deduction. Choice "c" is incorrect. The amortization of the premium will reduce taxable income. Choice "d" is incorrect. The bond's basis will be decreased by the amortization.

IRC Section 263A requires the capitalization of certain indirect costs related to inventory when a qualifying business is manufacturing tangible personal property. Which of the following costs is not required to be capitalized as part of this adjustment? a. Marketing. b. Securities services. c. Recruiting. d. Payroll.

Choice "a" is correct. The general rule is that product costs are capitalized, such as direct materials, indirect materials, and factory overhead. Period expenses are not capitalized, including G&A, selling, and R&D. Marketing is a period expense that is not capitalized.

Which of the following conditions must be present in a post-1984 divorce agreement for a payment to qualify as deductible alimony? I. Payments must be in cash or its equivalent. II. The payments must end at the recipient's death. a. I only. b. Both I and II. c. Neither I nor II. d. II only.

Choice "b" is correct. Among the requirements for payments to be classified as alimony are the following: 1.Payment must be in cash or its equivalent. 2.Payments cannot extend beyond the death of the payee-spouse. 3.Payments must be legally required pursuant to a written divorce (or separation) agreement. 4.Payments cannot be made to members of the same household. 5.Payments must not be designated as anything other than alimony. 6.The spouses may not file a joint tax return. Note: The requirements for payments to be considered alimony (income) are the same as for payments to be alimony (deductions).

Flowers, a married taxpayer, purchased an annuity for $64,400 that will pay $700 per month over the life of Flowers and Flowers' spouse. At the time of purchase, the couple's joint life expectancy was 23 years. Flowers received payment beginning April 1, Year 1, amounting to $6,300 in the first year of the annuity contract. How much is includable in Flowers' gross income in the first year? a. $4,200 b. $0 c. $6,300 d. $2,100

Choice "a" is correct. The investment amount is divided over the number of months of expected recovery. $64,400 / 276 = $233.33 (23 years × 12 months = 276 months). This is the amount of each payment that is a cost recovery and not taxable. Payments began in April of this year, resulting in 9 payments this year ($233.33 × 9 = $2,100). This is the portion of the $6,300 that is not taxable. So the taxable amount is $4,200 ($6,300 - $2,100 = $4,200). Choice "b" is incorrect. Zero indicates that all of the payments are not taxable. But only the prorated amount of the cost recovery is not taxable. Choice "d" is incorrect. $2,100 is the nontaxable portion of the payment based on the above computation. Choice "c" is incorrect. $6,300 is the total amount received. But the prorated portion of the cost recovery is not taxable.

Which of the following is (are) among the requirements to enable a taxpayer to be classified as a "qualifying widow(er)"? I. A dependent has lived with the taxpayer for six months. II. The taxpayer has maintained the cost of the principal residence for six months. a. Neither I nor II. b. I only. c. Both I and II. d. II only.

Choice "a" is correct. The requirements that enable a taxpayer to be classified as a "qualifying widow(er)" are: 1.The taxpayer's spouse died in one of the two previous years and the taxpayer did not remarry in the current tax year, 2.The taxpayer has a child who can be claimed as a dependent, 3.This child lived in the taxpayer's home for all of the current tax year, 4.The taxpayer paid over half the cost of keeping up a home for the child, 5.The taxpayer could have filed a joint return in the year the spouse died.

During Year 9, Ash had the following cash receipts: Wages $ 13,000 Interest income from U.S. Treasury bonds 350 Workers' compensation following a job-related injury 8,500 What is the total amount that must be included in gross income on Ash's Year 9 income tax return? a. $13,350 b. $21,850 c. $21,500 d. $13,000

Choice "a" is correct. The total amount that must be included in gross income is $13,350 ($13,000 in wages plus $350 in interest income on U.S. Treasury bonds). Rule: Wages and interest on U.S. Treasury bonds are includible in gross income and must be reported as part of gross income on a taxpayer's income tax return. Rule: Damages for personal injury (i.e., workers' compensation for a job-related injury) are specifically excluded from gross income. Choices "d", "c", and "b" are incorrect, per the above rules.

Robert Corp. granted an incentive stock option for 200 shares to Beverly, an employee, on March 14, Year 12. The option price and FMV on the date of grant was $150. Beverly exercised the option on August 2, Year 14, when the FMV was $180 per share. She sold the stock on September 20, Year 15, for $250 per share. How much gross income did Beverly recognize in Year 15? a. $20,000 b. $30,000 c. $150 d. $0

Choice "a" is correct. This is the gain Beverly will recognize upon the sale of the stock. The purchase was 200 shares at $150 per share, or $30,000. The sale was 200 shares at $250 per share, or $50,000. This gain is not recognized until the sale occurs in Year 15. Choice "b" is incorrect. This is simply the purchase price of the stock upon exercise of 200 shares at $150 per share. Choice "c" is incorrect. This is simply the option price per share on the date of grant. Choice "d" is incorrect. The realized gain on the sale must be recognized in the year of the sale per the above explanation.

Tom and Sharlene had the following items of income and expense during the taxable year: Self-Employment Activity Gross income $35,000 Business license fees 500 Marketing Expenses 2,000 Salary paid to Sharlene 10,000 Tom's wages from his Job 67,000 Interest from money market 1,500 Gain from sale of securities owned for 3 months 15,000 What is Tom & Sharlene's gross income before adjustments? a. $116,000 b. $131,500 c. $128,500 d. $106,000

Choice "a" is correct. Tom & Sharlene's gross income is calculated as follows: Net self-employment income $ 32,500 Tom's wages 67,000 Interest 1,500 Gain from sale 15,000 Total gross Income $ 116,000 Note: Sharlene's salary is not included as income as 100% of the net self-employment activity is taxable to her. Her salary is considered a draw and is not an allowable business deduction against the gross income of the self-employment activity.

Which of the following is subject to the Uniform Capitalization Rules of Code Sec. 263A? a. Warehousing costs incurred by a manufacturing company with $12 million in annual gross receipts. b. Mine development and exploration costs. c. Editorial costs incurred by a freelance writer. d. Research and experimental expenditures.

Choice "a" is correct. Uniform capitalization rules apply to the following: (1) real or tangible personal property produced by the taxpayer for use in his or her trade or business; (2) real or tangible personal property produced by the taxpayer for sale to his or her customers; and (3) real or tangible personal property acquired by the taxpayer for resale, provided the taxpayer's annual average gross receipts for the preceding three years exceeds $10,000,000. Warehousing costs incurred by a manufacturing company (making inventory for sale to its customers) are subject to the Uniform Capitalization Rules. Further, they are the only item on the list that is real or tangible personal property. In this case, the inventory is not acquired for resale (it is produced by the taxpayer for sale to his or her customers), so the fact that the annual sales are $12,000,000 does not matter in this case. The sales could have been less than $10,000,000 annually, and the Uniform Capitalization Rules would still have applied. Choices "c", "d", and "b" are incorrect, based on the above discussion.

Under a $150,000 insurance policy on her deceased father's life, May Green is to receive $12,000 per year for 15 years. Of the $12,000 received in the current year, the amount subject to income tax is: a. $1,000 b. $2,000 c. $0 d. $12,000

Choice "b" is correct. $2,000. Death benefit $ 150,000 Amount received in the current year $ 12,000 Less: Return of principal ($150,000 ÷ 15 years) (10,000) Taxable interest $ 2,000

Mort and Mindy met at a New Year's Eve party held December 31, Year 1. They instantly bonded, fell madly in love, and were married at 11:38 p.m. that night. Sadly, Mort passed away November 15, Year 2. In January, Year 3, Mindy gave birth to triplets Mark, Mandy, and Maureen. Assuming that Mindy has not remarried, what filing status should she use for Year 4? a. Single. b. Surviving spouse. c. Married filing jointly. d. Head of household.

Choice "b" is correct. Because Mindy does not remarry and she maintains a principal residence for her dependent children for the entire year, she may file using the surviving spouse (qualifying widow) status for the two taxable years following Mort's death (but may not claim Mort as a personal exemption, because he was not alive for any part of those taxable years). In Year 4, the second year after Mort's death, Mindy should file as a qualifying widow. Choices "a", "c", and "d" are incorrect, based on the above explanation.

An individual taxpayer reports the following items for the current year: Ordinary income from partnership A, operating a movie theater in which the taxpayer materially participates $ 70,000 Net loss from partnership B, operating an equipment rental business in which the taxpayer does not materially participate (9,000) Rental income from building rented to a third party 7,000 Short-term capital gain from sale of stock 4,000 What is the taxpayer's adjusted gross income for the year? a. $77,000 b. $74,000 c. $72,000 d. $70,000

Choice "b" is correct. Except in the year in which an individual, estate, trust, or closely-held C corporation disposes of an entire interest in a passive activity investment, such taxpayers cannot deduct passive activity expenses and losses against income and gain attributable to non-passive activities. A passive activity is (i) any activity in which such taxpayers do not materially participate and (ii) as a general rule, such taxpayers' rental real estate investments, regardless of the extent of such taxpayers' involvement with the rental real estate operations. A limited exception (the "Mom and Pop Exception") regarding rental real estate activities is available to individuals, but the facts of this question do not provide any information which would entitle the taxpayer to the benefits of this exception. Hence, the taxpayer can deduct, against the profit from the taxpayer's $7,000 passive activity rental income from the building rented to a third party, only $7,000 of the $9,000 net loss from partnership B which is operating an equipment rental business in which the taxpayer does not materially participate. Computation of adjusted gross income for the year: Ordinary income from partnership A, operating a movie theater in which the taxpayer materially participates $ 70,000 Rental income from building rented to a third party (a passive activity) 7,000 Net loss from partnership B, operating an equipment rental business in which the taxpayer does not materially participate (per the above rule the taxpayer can deduct only $7,000 of the $9,000 passive activity loss) (7,000) Short-term capital gain from sale of stock (fully taxable) 4,000 Adjusted gross income for the year $ 74,000

Thompson's spouse died in Year 1. Thompson did not remarry in Year 2 and lived alone the entire year. What is Thompson's Year 2 filing status? a. Head of household. b. Single. c. Surviving spouse. d. Married filing jointly.

Choice "b" is correct. Filing status is determined as of the last day of the year. At the end of Year 2, Thompson is not married and does not qualify for any other filing status. Therefore, his status is single. Choice "d" is incorrect. When a spouse dies during the year, the surviving spouse can file married filing jointly for that year under an exception to the end-of-year test. But this question is about Year 2, the year after death. Thompson is single for Year 2. Choice "c" is incorrect. Surviving spouse status, also known as qualifying widow(er), can be claimed for the two years after year of death. However, it requires the presence of a dependent child, which is not part of the facts here. Thompson is single for Year 2. Choice "a" is incorrect. Head of household status could apply in certain circumstances where there is a dependent and surviving spouse status does not apply. That is not the case here. Thompson is single for Year 2.

Which of the following statements is not correct? a. For an Incentive Stock Option, once exercised, the stock must be held at least two years after the grant date and at least one year after the exercise date. b. The recipient of an Incentive Stock Option will generally have to report compensation income in the year that the option is received. c. Employee Stock Purchase Plans are a type of qualified stock option plan. d. The employer may recognize a deductible expense for a nonqualified stock option in the same year that the employee will recognize ordinary income.

Choice "b" is correct. Generally there is no recognition of compensation expense with an Incentive Stock Option. Choices "c", "d", and "a" are incorrect as these are all true statements.

Smith has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities. What amount of the rental losses may Smith deduct in determining taxable income? a. $20,000 b. $15,000 c. $40,000 d. $0

Choice "b" is correct. Generally, none of the passive losses from real estate are deductible against nonpassive income. However, Smith actively participates, which means that the "mom and pop" exception of up to $25,000 will apply. This exception is phased out over AGI of $100,000 through $150,000. That is 50 cents on the dollar. Smith's AGI is $120,000. That is $20,000 into the phaseout range. So $10,000 of the $25,000 is phased out and Smith may deduct $15,000 of the $40,000 passive loss.

Joe and Barb are married, but Barb refuses to sign a Year 12 joint return. On Joe's separate Year 12 return, an exemption may be claimed for Barb if: a. Barb was a full-time student for the entire Year 12 school year. b. Barb had no gross income and was not claimed as another person's dependent in Year 12. c. Barb attaches a written statement to Joe's income tax return, agreeing to be claimed as an exemption by Joe for Year 12. d. Barb was under the age of 19.

Choice "b" is correct. If a married individual files a separate return, a personal exemption may be claimed for his or her spouse if the spouse has no gross income and is not claimed as a dependent of another taxpayer. Choice "a" is incorrect. The spouse does not have to be a full-time student. Choice "c" is incorrect. The wife does not have to attach a written statement agreeing to be claimed by her husband. Choice "d" is incorrect. The spouse does not have to be under the age of 19.

In Year 4, after Mindy's three children have grown and moved out of the house, Mindy (unmarried) moved her mother, Mary, into an assisted living facility for which Mindy pays 75% of the cost. Mindy had not previously lived with Mary, and Mary paid for her own living expenses while she lived in her own home. What filing status should Mindy use for Year 4, assuming Mary moved into the assisted living facility on August 1, Year 4? a. Head of household. b. Single. c. Married filing jointly. d. Surviving spouse.

Choice "b" is correct. Mindy should file using the single status. She does not qualify for more favorable filing status. Choice "c" is incorrect. Mindy is not married. Choice "a" is incorrect. Mindy does not qualify for head of household status. Had Mary moved into the assisted living home for the entire year, Mindy would have been eligible for head of household status. Mindy did not provide more than half of Mary's support and for Year 4 is ineligible for head of household status. Choice "d" is incorrect. Mindy has not had a spouse die in the past two years.

Mort and Mindy met at a New Year's Eve party held December 31, Year 1. They instantly bonded, fell madly in love, and were married at 11:38 p.m. that night. Sadly, Mort passed away November 15, Year 2. What filing status should Mindy use for Year 2? a. Head of household. b. Married filing jointly. c. Surviving spouse. d. Single.

Choice "b" is correct. Mindy will be able to use the married filing jointly status for the year Mort passed away (Year 2) even though she was not married at year-end. Also, note that Mindy will be able to claim Mort as a personal exemption on the joint return in the year of death. Choices "d", "a", and "c" are incorrect, based on the above explanation.

Hall, a divorced person and custodian of her 12-year-old child, filed her current year federal income tax return as head of a household. She submitted the following information to the CPA who prepared her return: •The divorce agreement, executed seven years ago, provides for Hall to receive $3,000 per month, of which $600 is designated as child support. After the child reaches 18, the monthly payments are to be reduced to $2,400 and are to continue until remarriage or death. However, for the current year, Hall received a total of only $5,000 from her former husband. Hall paid an attorney $2,000 in the current year in a suit to collect the alimony owed. •In June of the current year, Hall's mother gifted her 100 shares of a listed stock. The donor's basis for this stock, which she bought 20 years ago, was $4,000, and market value on the date of the gift was $3,000. Hall sold this stock in July of the current year for $3,500. The donor paid no gift tax. •During the year, Hall spent a total of $1,000 for state lottery tickets, and her lottery winnings totaled $200. •Hall earned a salary of $25,000 in the current year. Hall was not covered by any type of retirement plan, but contributed $2,000 to an IRA this year. •During the year, Hall sold an antique that she bought 10 years ago to display in her home. Hall paid $800 for the antique and sold it for $1,400, using the proceeds to pay a court-ordered judgment. •Hall paid the following expenses in the current year pertaining to the home that she owns: realty taxes, $3,400; mortgage interest, $7,000; casualty insurance, $490; assessment by city for construction of a sewer system, $910; interest of $1,000 on a personal, unsecured bank loan, the proceeds of which were used for home improvements. Hall does not rent out any portion of the home. What amount should be reported in Hall's current year tax return as alimony income? a. $36,000 b. $0 c. $28,800 d. $5,000

Choice "b" is correct. None of the payments received should be considered alimony income. Hall would only claim alimony income if total receipts from her former spouse exceeded $7,200 (the required child support). Rule: In the event of payments consisting of both child support and alimony, child support obligations will be satisfied first. Amount designated as monthly child support $ 600 Number of months × 12 Amount of required child support 7,200 Payments actually received (5,000) Amount of payments considered alimony $ 0

Clark bought Series EE U.S. Savings Bonds after 1989. Redemption proceeds will be used for payment of college tuition for Clark's dependent child. One of the conditions that must be met for tax exemption of accumulated interest on these bonds is that the: a. Bonds must be bought by a parent (or both parents) and put in the name of the dependent child. b. Purchaser of the bonds must be the sole owner of the bonds (or joint owner with his or her spouse). c. Bonds must be transferred to the college for redemption by the college rather than by the owner of the bonds. d. Bonds must be bought by the owner of the bonds before the owner reaches the age of 24.

Choice "b" is correct. One of the conditions that must be met for tax exemption of accumulated interest on the bonds is that the purchaser of the bonds must be the sole owner of the bonds (or joint owner with his or her spouse). Other conditions include, for post-1989 bonds, the taxpayer is over age 24 when issued and is used to pay for higher education, reduced by tax-free scholarships, of the taxpayer, spouse, or dependents. Choice "a" is incorrect. The bonds must be bought and put in the name of the owner or co-owner, not in the name of the dependent child. Choice "d" is incorrect. The owner must be at least 24 years old before the bonds issue date. Choice "c" is incorrect. There is no requirement that the bonds must be transferred to the college for redemption by the college rather than by the owner of the bonds.

A review of Bearing's Year 2 records disclosed the following tax information: Wages $ 18,000 Taxable interest and qualifying dividends 4,000 Schedule C trucking business net income 32,000 Rental (loss) from residential property (35,000) Limited partnership (loss) (5,000) Bearing actively participated in the rental property and was a limited partner in the partnership. Bearing had sufficient amounts at risk for the rental property and the partnership. What is Bearing's Year 2 adjusted gross income? a. $19,000 b. $29,000 c. $14,000 d. $54,000

Choice "b" is correct. Passive activity losses (PALs) can only be deducted up to passive activity income. There is no passive activity income indicated. Therefore, the passive loss from the partnership is not deductible. $25,000 of the $35,000 rental real estate loss is deductible under the "mom and pop" exception because Bearing actively participates in the rental property and the AGI is below the phaseout amounts. The AGI is calculated as follows: Wages $ 18,000 Taxable interest and qualifying dividends 4,000 Schedule C trucking business net income 32,000 Rental loss from residential property (25,000) Adjusted gross income (AGI) $ 29,000

Seth Silver had the following items of income during the taxable year: Interest income from a checking account $ 1,000 Interest income from a money market account 2,050 Interest income from a municipal bond he purchased during the current year 250 Interest income from federal bonds he purchased 2 years ago 750 On his current year tax return, what amount is taxable income? a. $3,050 b. $3,800 c. $3,300 d. $4,050

Choice "b" is correct. Taxable interest includes amounts received from general investment accounts as well as interest on federal obligations. Interest received from state and municipal bonds is not taxable.

Charles and Marcia are married cash-basis taxpayers. In Year 8, they had interest income as follows: •$500 interest on federal income tax refund. •$600 interest on state income tax refund. •$800 interest on federal government obligations. •$1,000 interest on state government obligations. What amount of interest income is taxable on Charles and Marcia's Year 8 joint income tax return? a. $500 b. $1,900 c. $2,900 d. $1,100

Choice "b" is correct. The $500 interest on federal income tax refund, the $600 interest on state income tax refund, and the $800 interest on federal government obligations are taxable, for a total of $1,900. The $1,000 interest on state government obligations is normally not taxable. Choice "a" is incorrect. The $600 interest on state income tax refund and the $800 interest on federal government obligations is also taxable. Choice "d" is incorrect. The $800 interest on federal government obligations is also taxable. Choice "c" is incorrect. The $1,000 interest on state government obligations is normally not taxable.

Mosh, a sole proprietor, uses the cash basis of accounting. At the beginning of the current year, accounts receivable were $25,000. During the year, Mosh collected $100,000 from customers. At the end of the year, accounts receivable were $15,000. What was Mosh's gross taxable income for the current year? a. $110,000 b. $100,000 c. $75,000 d. $90,000

Choice "b" is correct. The facts state that cash collections from customers were $100,000 and as a cash basis taxpayer this is the amount of Mosh's gross taxable income for the year. Note that according to the formula BASE - we can determine the amount of sales = $90,000, but that would give us accrual, not cash basis, income. Beginning A/R $ 25,000 Add―Sales 90,000 accrual basis taxable income 115,000 Subtract―Cash collections (100,000) cash basis taxable income Ending A/R $ 15,000 Choices "c" and "a" are incorrect. See explanation above. Choice "d" is incorrect. $90,000 is the amount of sales that would be Mosh's taxable income if Mosh were an accrual basis taxpayer.

In the current year Jensen had the following items: Salary $ 50,000 Inheritance 25,000 Alimony from ex-spouse 12,000 Child support from ex-spouse 9,000 Capital loss on investment stock sale (6,000) What is Jensen's AGI for the current year? a. $62,000 b. $59,000 c. $44,000 d. $84,000

Choice "b" is correct. The question asks for AGI, but all of the items in the list are items of potential gross income. There are no adjustments included in the list; therefore, in this case, AGI is the same as gross income. The calculation is as follows: Salary $ 50,000 Inheritance 0 [not taxable] Alimony from ex-spouse 12,000 Child support from ex-spouse 0 [not taxable] Capital loss on investment stock sale (3,000) [maximum deductible--covered in a later lecture] AGI $ 59,000 Choices "c", "a", and "d" are incorrect, per the above calculation.

The rule limiting the allowability of passive activity losses and credits applies to: a. Partnerships. b. Personal service corporations. c. S corporations. d. Widely held C corporations.

Choice "b" is correct. The rule limiting the allowability of passive activity losses and credits applies to personal service corporations. Choice "a" is incorrect. The passive activity limitations apply to the various partners in the partnership as opposed to the partnership itself. Choice "c" is incorrect. The passive activity limitations apply to the various shareholders in the S corporation as opposed to the corporation itself. Choice "d" is incorrect. The passive activity rules do not apply to widely held C corporations.

Logan, an employee of Argon Industries, earned a salary of $60,000 in Year 2. In addition, the following two transactions between Logan and Argon occurred in Year 2: Logan received a bonus of 100 shares of publicly traded stock worth $13,000 with a basis to Argon of $8,000, and Logan purchased 1,000 shares of unrestricted Argon stock pursuant to a nonqualifying stock option plan for $10 per share when stock was valued at $25 per share. What amount of compensation should Argon report in Logan's Form W-2 for Year 2? a. $93,000 b. $88,000 c. $60,000 d. $73,000

Choice "b" is correct. The salary of $60,000 is included in the Form W-2. The FMV of the bonus of $13,000 is included in the Form W-2. Because the stock option was nonqualifying, the bargain element is included in Form W-2 as well. The stock is worth $25 per share and the option price is $10 per share. That is a bargain element of $15 per share on 1,000 shares. That is $15,000. $60,000 + $13,000 + $15,000 = $88,000. Choice "c" is incorrect. $60,000 ignores the bonus and the stock option. Choice "d" is incorrect. $73,000 ignores the stock option. Choice "a" is incorrect. $93,000 is not correct based on the above rule.

Under the uniform capitalization rules applicable to property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions are met? Marketing costs Off-site storage costs a. Yes Yes b. No Yes c. Yes No d. No No

Choice "b" is correct. Under the uniform capitalization rules, purchasers of inventory for resale may deduct their marketing costs but must capitalize their off-site storage costs. Choices "a", "c", and "d" are incorrect. Marketing costs are deductible, but off-site storage must be capitalized.

Which payment(s) is (are) included in a recipient's gross income? I. Payment to a graduate assistant for a part-time teaching assignment at a university. Teaching is not a requirement toward obtaining the degree. II. A grant to a Ph.D. candidate for his participation in a university-sponsored research project for the benefit of the university. a. II only. b. Neither I nor II. c. Both I and II. d. I only.

Choice "c" is correct. I. A payment to a student for a part-time teaching assignment is taxable income just as a payment for any other campus job would be. This is not a scholarship or fellowship. II. There is no exclusion in the tax law for amounts paid to a degree candidate for participation in university-sponsored research.

Nicole and Andrew Harris contribute to more than half of the support of their three children, Travis, Luke, and John. Travis, age 20, worked full time at the local deli and earned $20,000. Luke, 18, is a part-time college student who earned $5,000 working as a resident assistant in the student dormitory where he lived half of the year. John, age 25, is an aspiring actor who lives at home with Nicole and Andrew. John earned $2,500 for the three commercials he starred in. How many exemptions can Nicole and Andrew claim on their Year 1 joint tax return? a. Two. b. Three. c. Four. d. Five.

Choice "c" is correct. Nicole and Andrew can claim two personal exemptions for themselves. Travis does not qualify for a dependency exemption. Travis is not a full-time student, so at age 20 he is not a qualifying child. Although Nicole and Andrew provide more than half of his support, Travis makes more than the exemption amount, so he is not considered as a qualifying relative, either. Luke is a qualifying child of Nicole and Andrew because he is under the age of 19 and lives at home at least part of the year. There is no gross income or support test that needs to be satisfied in the case of a qualifying child. John is a qualifying relative of Nicole and Andrew because they supplied over half of his support and his taxable income is less than the exemption amount. Choices "a", "b", and "d" are incorrect, based on the above explanation.

Ben Flood, attorney at law, is a sole proprietor and files Schedule C with his federal Form 1040. Which of the following is not a deductible expense on Schedule C? a. $30 business tax payable to the city in which he practices. b. Salaries paid to the paralegal who works for him. c. Health insurance for him and his family. d. Depreciation on the computer used by his assistant.

Choice "c" is correct. A rule of thumb is that personal expenses are not allowed as deductions on the Schedule C. For instance, personal use of an automobile is considered a personal expense, not a deductible expense on Schedule C. Schedule C items should be only those related to the operation of the business itself. Health insurance for himself and his family is actually an adjustment to arrive at adjusted gross income. Choice "a" is incorrect. Business tax items are deductible expenses which should be reported on Schedule C. Choice "b" is incorrect. Salaries and commissions paid to others as part of the business are expenses allowed on Schedule C. Choice "d" is incorrect. Depreciation on business assets is an allowable deduction.

As a result of a divorce, a taxpayer received the following during the current year: Cash from the property settlement $100,000 Child support 12,000 Alimony payments 30,000 What amount, if any, must be included in gross income for the current year? a. $130,000 b. $0 c. $30,000 d. $142,000

Choice "c" is correct. Alimony payments are included in gross income. Child support and cash from property settlements are not included in gross income. Choice "b" is incorrect. Zero is not correct because the alimony payments are included in gross income. Choice "a" is incorrect. $130,000 would be correct if the cash settlement from the property settlement was included in gross income, but it is not. Choice "d" is incorrect. $142,000 would be correct if the cash settlement from the property settlement and the child support were included in gross income, but they are not.

John and Mary were divorced last year. The divorce decree provides that John pay alimony of $10,000 per year, to be reduced by 20% on their child's 18th birthday. During the current year, John paid $7,000 directly to Mary and $3,000 to Spring College for Mary's tuition. What amount of these payments should be reported as income in Mary's current year income tax return? a. $5,600 b. $8,600 c. $8,000 d. $10,000

Choice "c" is correct. Alimony would be income to Mary while child support would not. Funds qualify as child support only if 1) a specific amount is fixed or is contingent on the child's status (e.g., reaching a certain age), 2) it is paid solely for the support of minor children, and 3) it is payable by decree, instrument or agreement. The actual use of the funds is irrelevant to the issue. In this case, $2,000 (20% × $10,000) qualifies as child support. The other $8,000 is alimony, which would be income to Mary. Choice "a" is incorrect. Take 80% of the $10,000 paid, not 80% of the $7,000 received by Mary. Choice "b" is incorrect. Only $8,000 would be alimony per the divorce decree (80% × $10,000). Choice "d" is incorrect. The 20% reduction when the child turns 18 makes 20% of the $10,000 payment, or $2,000, child support, which is nontaxable to Mary.

Darr, an employee of Sorce C Corporation, is not a shareholder. Which of the following would be included in a taxpayer's gross income? a. Employer-provided medical insurance coverage under a health plan. b. The fair market value of land that the taxpayer inherited from an uncle. c. The dividend income on shares of stock that the taxpayer received for services rendered. d. A $10,000 gift from the taxpayer's grandparents.

Choice "c" is correct. An individual receiving common stock for services rendered must recognize the fair market value as ordinary income. Any dividends received on that stock would also result in income recognition. Choice "a" is incorrect. Employer-provided medical insurance is a tax-free fringe benefit. Choices "d" and "b" are incorrect. Gifts and inheritances are both tax-free to the recipient. (Remember, tax is often paid by the person giving the gift or the estate at death.)

Cobb, an unmarried individual, had an adjusted gross income of $200,000 in the current year before any IRA deduction, taxable Social Security benefits, or passive activity losses. Cobb incurred a loss of $30,000 in the current year from rental real estate in which he actively participated. What amount of loss attributable to this rental real estate can be used in the current year as an offset against income from nonpassive sources? a. $30,000 b. $25,000 c. $0 d. $12,500

Choice "c" is correct. Cobb may not use any of the loss attributable to his rental real estate as an offset against income from nonpassive sources in the current year because he does not qualify for the "Mom and Pop" exception. Under this exception, up to $25,000 of passive losses and the deduction equivalent of tax credits that are attributable to rental real estate may be used as an offset against income from nonpassive sources. This $25,000 allowance is reduced, but not below zero, by 50% of the amount by which the individual's modified AGI exceeds $100,000. The $25,000 is therefore completely phased out when modified AGI reaches $150,000. Because Cobb's AGI was $200,000, he did not qualify for the exception. Choices "d", "b", and "a" are incorrect. Rental activities are passive activities and generally are not allowed to use any of the loss attributable to the rental activity to offset any income produced from nonpassive sources. There is a limited exception in the case of losses from rental real estate in which the taxpayer actively participates, but Cobb did not qualify for it.

Clark filed Form 1040EZ for the Year 8 taxable year. In July, Year 9, Clark received a state income tax refund of $900 plus interest of $10, for overpayment of Year 8 state income tax. What amount of the state tax refund and interest is taxable in Clark's Year 9 federal income tax return? a. $910 b. $0 c. $10 d. $900

Choice "c" is correct. Except for interest from state and local government bonds, interest income is fully taxable, so the $10 is included in income. Filing Form 1040EZ means that Clark did not itemize in the prior year, and therefore, did not deduct any state income taxes last year. Under the tax benefit rule, the refund is not taxable this year since Clark did not deduct the tax last year.

During the year Kay received interest income as follows: On U.S. Treasury certificates $ 4,000 On refund of prior year's federal income tax 500 The total amount of interest subject to tax in Kay's current year tax return is: a. $0 b. $500 c. $4,000 d. $4,500

Choice "d" is correct. Interest income from U.S. obligations is generally taxable. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed. Choice "c" is incorrect. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed. Choice "b" is incorrect. Interest income from U.S. obligations is generally taxable. Choice "a" is incorrect. Interest income from U.S. obligations is generally taxable. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed.

Mr. and Mrs. Williams decided during the tax year to purchase their first new home. The fair market value of the home was $275,000, and a 20% down payment was required to secure a mortgage in the amount of $220,000 at 5% for 30 years. The Williams' decided to utilize $10,000 that was kept in an Individual Retirement Account owned by Mrs. Williams. This amount was withdrawn on June 12 and used to fund the down payment on July 1. These amounts had been previously deducted as an adjustment by her on an individual tax return in the year of contribution. The remaining $12,000 for the down payment was drawn from a savings account. How much of the distribution from the Individual Retirement Account is subject to the premature distribution penalty tax, and how much must be included in the Williams' joint tax return in the year of distribution as gross income? Penalty Tax Gross Income a. $0 $0 b. $10,000 $0 c. $0 $10,000 d. $10,000 $10,000

Choice "c" is correct. Generally, a premature distribution (prior to retirement or other allowable age) from an individual retirement account is subject to a 10% penalty tax. Certain exceptions to this tax are available and are contained in the mnemonic "HIM DEAD." Home buyer (1st time) $10,000 max if used toward first home Insurance (medical) Medical expenses in excess of 10% of AGI (or 7.5% if 65 or over) Disability Education And Death The amount removed from the IRA qualifies under the "H" exception above. However, the question states that these amounts had been previously deducted on Mrs. Williams' individual tax return, thus this is a distribution from a traditional, deductible IRA. When distributed, funds held in a traditional, previously deducted IRA are taxable to the recipient as ordinary income and thus would be included as gross income on the Williams' joint tax return in the year of distribution. Choice "a" is incorrect. The distribution would be included in the Williams' gross income. Choice "b" is incorrect. The amount qualifies for an exception to the penalty tax and would be included in the Williams' gross income. Choice "d" is incorrect. The amount qualifies for an exception to the premature distribution penalty tax.

DAC Foundation awarded Kent $75,000 in recognition of lifelong literary achievement. Kent was not required to render future services as a condition to receive the $75,000. What condition(s) must have been met for the award to be excluded from Kent's gross income? I. Kent was selected for the award by DAC without any action on Kent's part. II. Pursuant to Kent's designation, DAC paid the amount of the award either to a governmental unit or to a charitable organization. a. I only. b. II only. c. Both I and II. d. Neither I nor II.

Choice "c" is correct. Generally, the fair market value of prizes and awards is taxable income. However, an exclusion from income for certain prizes and awards applies where the winner is selected for the award without entering into a contest (i.e., without any action on their part) and then assigns the award directly to a governmental unit or charitable organization. Therefore, conditions "I" and "II" must be met in order for Kent to exclude the award from his gross income. Choice "a" is incorrect. "II" is a necessary condition as well. See explanation above. Choice "b" is incorrect. "I" is a necessary condition as well. See explanation above. Choice "d" is incorrect. "I" and "II" are both necessary conditions. See explanation above.

Freeman, a single individual, reported the following income in the current year: Guaranteed payment from services rendered to a partnership $ 50,000 Ordinary income from an S corporation 20,000 What amount of Freeman's income is subject to self-employment tax? a. $70,000 b. $20,000 c. $50,000 d. $0

Choice "c" is correct. Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to self-employment tax. Payments not guaranteed are merely another way to distribute partnership profits. The ordinary income reported from an S corporation is taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).

Janet and Ted have two children, Mary (age 10) and Seth (age 12). Janet's Aunt Martha resides with the family in an apartment over the garage. Martha's only income is $1,500 a month in Social Security benefits. Janet and Ted receive no rent payments from Martha and provide all remaining support for her living arrangements. How many exemptions are Janet and Ted entitled to in filing their joint tax return? a. 2 b. 3 c. 5 d. 4

Choice "c" is correct. Janet and Ted are entitled to dependency exemptions for themselves, their two children and Aunt Martha. Aunt Martha is a "qualified relative." The qualifications to take an exemption for a qualifying relative are found in the "SUPORT" mnemonic. Support (over 50%) test Under a specific amount of (taxable) gross income test Precludes dependent filing a joint tax return test Only citizens (residents of US/Canada or Mexico) test Relative test OR Taxpayer lives with individual for whole year test The two children meet the test for a qualifying child. In addition, Aunt Martha, a relative, qualifies because she does not have any taxable income (social security is not taxed at this low level of income), is not filing a joint tax return with another, is a citizen of the US, and is a qualifying relative. In this instance, note that Martha would not have to reside with the family. Only nonrelative members of a household must reside with the taxpayer for the entire year in order for the taxpayer to be entitled to a dependency exemption for that individual. Choices "a", "b", and "d" are incorrect per the above explanation.

An individual client asks a CPA to determine whether the client is solvent for federal tax purposes. The client has assets consisting of cash and marketable securities with a basis of $250,000 and a fair market value of $155,000. The client has liabilities of $175,000, which include $130,000 of nondischargeable liabilities under the Bankruptcy Code. Which of the following statements is correct? a. The client is solvent because the fair market value of the client's assets exceeds the client's nondischargeable debt by $25,000. b. The CPA is unable to determine whether the client is solvent or insolvent because the CPA is not an accredited appraiser. c. The client is insolvent since the client's liabilities exceed the fair market value of the client's assets by $20,000. d. The client is solvent because the basis of the client's assets totals $250,000 and exceeds the client's liabilities by $75,000.

Choice "c" is correct. Solvency is based on the FMV of all assets less the value of all liabilities. Here that is $155,000 - $175,000 = ($20,000). Choice "b" is incorrect. The CPA does not need to be an accredited appraiser to determine solvency. Choice "a" is incorrect. It is irrelevant whether the debts are dischargeable in bankruptcy or not. Choice "d" is incorrect. This answer incorrectly uses the basis of the assets instead of the FMV.

Jim and Kay Ross contributed to the support of their two children, Dale and Kim, and Jim's widowed parent, Grant. For Year 27, Dale, a 19-year-old full-time college student, earned $4,500 as a babysitter. Kim, a 23-year-old bank teller, earned $12,000. Grant received $5,000 in dividend income and $4,000 in nontaxable Social Security benefits. Grant and Kim are U.S. citizens and were over one-half supported by Jim and Kay, but neither of the two currently reside with Jim and Kay. Dale's main place of residence is with Jim and Kay, and he is currently on a temporary absence to attend school. How many exemptions can Jim and Kay claim on their Year 27 joint income tax return? a. Two b. Four c. Three d. Five

Choice "c" is correct. Taxpayers are now entitled to an exemption for each qualifying child and qualifying relative (two tests are "CARES" or "SUPORT"). For Dale, he does meet the residency requirement because there is an exception for a temporary absence while attending school. Therefore, he is a qualifying child under the CARES test. Kim does not qualify as a qualifying child (CARES test) because, although she is under age 24, she is not a full-time student. Therefore, the income limitations of the SUPORT test apply, and she does not qualify under that test either. Likewise, Grant's taxable income of $5,000 exceeds the minimum. Thus, 3 total exemptions can be claimed (Jim, Kay, and Dale).

Johnson worked for ABC Co. and earned a salary of $100,000. Johnson also received, as a fringe benefit, group term-life insurance at twice Johnson's salary. Assume the annual IRS-established uniform cost of insurance is $2.76 per $1,000. What amount must Johnson include in gross income? a. $100,276 b. $100,000 c. $100,414 d. $100,552

Choice "c" is correct. The first $50,000 of group term life insurance is a nontaxable fringe benefit. Amounts exceeding this are taxable based on IRS tables. The total group term life insurance here is $200,000 (twice the salary of $100,000). The amount exceeding $50,000 is $150,000. The cost given here is $2.76 per $1,000 of insurance. 150 × $2.76 = $414. So the total amount included in gross income is $100,414 ($100,000 + $414). Choice "b" is incorrect. $100,000 does not include any of the taxable amount of group term life insurance. Choice "a" is incorrect. $100,276 only includes $100,000 of the group term life insurance instead of $150,000. Choice "d" is incorrect. $100,552 includes the entire $200,000 of the group term life insurance instead of only $150,000.

A taxpayer's spouse dies in August of the current year. Which of the following is the taxpayer's filing status for the current year? a. Head of household. b. Qualified widow(er). c. Married filing jointly. d. Single.

Choice "c" is correct. The joint return rates apply for two years following the death of a spouse, if the surviving spouse does not remarry and maintains a household for a dependent child. There is nothing in this question that says whether or not the surviving spouse maintains a household for a dependent child. However, since the question is asking about the current year, the surviving spouse is considered to be married (and thus able to file as married filing jointly) for the entire current year even if the spouse dies earlier in the year (in this case in August). Choice "d" is incorrect. The filing status is not single for the current year. Choice "b" is incorrect. The filing status is not qualified widow(er) for the current year. Choice "a" is incorrect. The filing status is not head of household for the current year.

Which of the following costs is not included in inventory under the Uniform Capitalization rules for goods manufactured by the taxpayer? a. Quality control. b. Taxes excluding income taxes. c. Research. d. Warehousing costs.

Choice "c" is correct. Uniform Capitalization rules provide guidelines with respect to capitalizing or expensing certain costs. With regard to inventory, direct materials, direct labor, and factory overhead should be capitalized as part of the cost of inventory. Warehousing costs, quality control and taxes, excluding income taxes, are all considered factory overhead items. The research should be expensed.

Parker, whose spouse died during the preceding year, has not remarried. Parker maintains a home for a dependent child. What is Parker's most advantageous filing status? a. Head of household. b. Married filing separately. c. Single. d. Qualifying widow(er) with dependent child.

Choice "d" is correct. A qualifying widow(er) is a taxpayer who may use the joint tax return standard deduction and rates (but not the exemption for the deceased spouse) for each of two taxable years following the year of death of his or her spouse, unless he or she remarries. The surviving spouse must maintain a household that, for the whole entire taxable year, was the principal place of abode of a son, stepson, daughter, or stepdaughter (whether by blood or adoption). The surviving spouse must also be entitled to a dependency exemption for such individual. Parker may file as a qualifying widow(er) since her spouse died in the previous tax year, she did not remarry and she maintained a home for a dependent child. Since qualifying widow(er) is the most advantageous status and Parker qualifies, Parker would file as a qualifying widow(er). Choice "c" is incorrect. Even though Parker would qualify as single, filing single would give Parker a higher tax liability than the qualifying widow(er) status and therefore is not most advantageous. Choice "a" is incorrect. Parker would not qualify as head of household for the first two years after the death of Parker's spouse because one of the requirements for Head of Household status is that the taxpayer is NOT a surviving spouse. (Also, note that the likely reason for this requirement is that filing as Head of Household status would give the qualifying surviving spouse taxpayer a higher tax liability than the Qualifying Widow(er) status, which would be less advantageous.) Choice "b" is incorrect. Parker would not qualify to file married filing separately.

Which of the following costs are subject to the Uniform Capitalization Rules of Code Sec. 263A for manufactured tangible personal property? a. Research. b. Advertising. c. Marketing. d. Off-site storage.

Choice "d" is correct. Costs required to be capitalized under the uniform capitalization rules include direct materials, direct labor, and applicable indirect costs. Applicable indirect costs include utilities, warehousing costs, repairs, maintenance, indirect labor, rents, storage, depreciation and amortization, insurance, pension contributions, engineering and design, repackaging, spoilage and scrap, and administrative supplies. Choice "b" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "a" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "c" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services.

Rich is a cash basis self-employed air-conditioning repairman with current year gross business receipts of $20,000. Rich's cash disbursements were as follows: Air conditioning parts $ 2,500 Yellow Pages listing 2,000 Estimated federal income taxes on self-employment income 1,000 Business long-distance telephone calls 400 Charitable contributions 200 What amount should Rich report as net self-employment income? a. $14,900 b. $14,100 c. $13,900 d. $15,100

Choice "d" is correct. Deductions to arrive at net self-employed income include all necessary and ordinary expenses connected with the business. Estimated federal income tax payments are not an expense. Charitable contributions by an individual are only deductible as an itemized deduction on Schedule A. This assumes the contribution was not made with the "expectation of commensurate financial return." Receipts $ 20,000 Parts (2,500) Listing (2,000) Telephone (400) Net self-employment income $ 15,100 Choice "a" is incorrect. Charitable contributions are an itemized deduction unless there is an expectation of commensurate financial return. Choice "b" is incorrect. Federal income taxes paid are not a deductible expense. Choice "c" is incorrect. Charitable contributions are an itemized deduction unless there is an expectation of commensurate financial return. Federal income taxes paid are not a deductible expense.

Under the uniform capitalization rules applicable to taxpayers with property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions have been met? Repackaging costs Off-site storage costs a. No Yes b. No No c. Yes No d. Yes Yes

Choice "d" is correct. Direct material, direct labor, and factory overhead (applicable indirect costs) are capitalized with respect to inventory under the uniform capitalization rules for property acquired for resale. Applicable indirect costs include depreciation and amortization, insurance, supervisory wages, utilities, spoilage and scrap, design expenses, repair and maintenance and rental of equipment and facilities (including offsite storage), some administrative costs, costs of bonus and other incentive plans, and indirect supplies and other materials (including repackaging costs). Choices "c", "a", and "b" are incorrect, per the above discussion.

Robert Corp. granted an incentive stock option for 200 shares to Beverly, an employee, on March 14, Year 12. The option price and FMV on the date of grant was $150. Beverly exercised the option on August 2, Year 14, when the FMV was $180 per share. She sold the stock on September 20, Year 15, for $250 per share. How much gross income did Beverly recognize in Year 12? a. $150 b. $30,000 c. $20,000 d. $0

Choice "d" is correct. Due to the fact that this is a qualified stock option, there is no recognition of income in the year of grant. Choice "b" is incorrect. This is the purchase price of the stock upon exercise of 200 shares at $150 per share. It is not income in the year of grant as per the above explanation. Choice "a" is incorrect. This is simply the option price per share on the date of grant. Choice "c" is incorrect. This is the gain Beverly will recognize upon the sale of the stock. The purchase was 200 shares at $150 per share, or $30,000. The sale was 200 shares at $250 per share, or $50,000. This gain is not recognized until the sale occurs in Year 15.

A couple filed a joint return in prior tax years. During the current tax year, one spouse died. The couple has no dependent children. What is the filing status available to the surviving spouse for the first subsequent tax year? a. Surviving spouse. b. Married filing separately. c. Head of household. d. Single.

Choice "d" is correct. For the first subsequent tax year (and all other subsequent tax years) after the death of a spouse with no dependent children, filing status is single. Choice "a" is incorrect. Filing status is not "surviving spouse" because there are no dependent children. Choice "b" is incorrect. Filing status is not "married filing separately" in the first subsequent tax year after the death of a spouse since the couple is no longer married. Choice "c" is incorrect. Filing status is not "head of household" because there are no dependent children and no other qualifying dependents.

The Jacksons, who file a joint return, actively participate in a solely-owned rental real estate activity that produces a $30,000 loss during the current year. Their adjusted gross income was $120,000 before considering the rental activity. How much of the rental loss, if any, are the Jacksons entitled to deduct? a. $0 b. $30,000 c. $25,000 d. $15,000

Choice "d" is correct. Generally, passive losses are only deductible against other passive income, and there is no passive income in the facts of this question. However, the "mom and pop" exception will apply because the Jacksons actively participate in the activity. This exception allows up to $25,000 of passive losses to be deducted against other nonpassive income. There is a phase-out over an adjusted gross income (AGI) range of $100,000 to $150,000. The Jacksons' AGI is $120,000, and that is 40% into the phase-out range. Therefore, 40% of the $25,000 exception amount is phased out, and the deduction is $15,000 [$25,000 - ($25,000 × 40%)]. Choice "a" is incorrect. $0 would be correct if the "mom and pop" exception did not apply or was completely phased out. Choice "c" is incorrect. $25,000 would be the correct answer if the entire "mom and pop" exception applied. Choice "b" is incorrect. $30,000 would only be correct if at least that amount of other passive income existed.

In a tax year where the taxpayer pays qualified education expenses, interest income on the redemption of qualified U.S. Series EE Bonds may be excluded from gross income. The exclusion is subject to a modified gross income limitation and a limit of aggregate bond proceeds in excess of qualified higher-education expenses. Which of the following is (are) true? I. The exclusion applies for education expenses incurred by the taxpayer, the taxpayer's spouse, or any person whom the taxpayer may claim as a dependent for the year. II. "Otherwise qualified higher-education expenses" must be reduced by qualified scholarships not includible in gross income. a. I only. b. II only. c. Neither I nor II. d. Both I and II.

Choice "d" is correct. Interest earned on Series EE bonds issued after 1989 may qualify for exclusion. One requirement is that the interest is used to pay tuition and fees for the taxpayer, spouse, or dependent enrolled in higher education. The interest exclusion is reduced by qualified scholarships that are exempt from tax and other nontaxable payments received for educational expenses (other than gifts and inheritances).

John earned $500,000 in his business during the current year, and his wife received investment income of $15,000. John provides more than half of the support of his widowed sister, who lives with John and earned $45,000 in salary. John also provides full support for his two children, an 18-year-old daughter and a 20-year-old son, who is a full-time college student. The family employs a live-in housekeeper and a live-in butler to assist them with their residence. Both the live-in housekeeper and the live-in butler provided all of their own support. What is the maximum number of personal and dependency exemptions that John and his wife are eligible to claim? a. Seven exemptions. b. Two exemptions. c. Five exemptions. d. Four exemptions.

Choice "d" is correct. John and his wife may claim personal exemptions for themselves as well as dependency exemptions for their two children. Both children are "qualifying" children as they are either under the age of 19 or under the age of 24 and a full-time student. Choice "b" is incorrect. John and his wife may claim personal exemptions for themselves as well as dependency exemptions for their two children. Both children are "qualifying" children as they are either under the age of 19 or under the age of 24 and a full-time student. Choice "c" is incorrect. John and his wife may not claim a dependency exemption for John's sister because her gross income is in excess of the exemption amount. John and his wife may also not claim dependency exemptions for their live-in housekeeper or live-in butler as John and his wife did not provide more than one-half of either's support. Choice "a" is incorrect. John and his wife may not claim a dependency exemption for John's sister because her gross income is in excess of the exemption amount. John and his wife may also not claim dependency exemptions for their live-in housekeeper or live-in butler as John and his wife did not provide more than one-half of either's support.

In Year 4, after Mindy's three children have grown and moved out of the house, Mindy (unmarried) moved her mother, Mary, into an assisted living facility for which Mindy pays 75% of the cost. Mindy had not previously lived with Mary, and Mary paid for her own living expenses while she lived in her own home. What filing status should Mindy use for Year 4, assuming Mary moved into the assisted living facility on January 1, Year 4? a. Single. b. Married filing jointly. c. Surviving spouse. d. Head of household.

Choice "d" is correct. Mindy qualifies for and should use head of household status in Year 4, because she maintained more than half of the upkeep on Mary's principal residence for the entire taxable year (note that Mindy is not required to live with her mother to qualify for head of household status). It is the most favorable filing status for which she qualifies. Choice "a" is incorrect. Mindy qualifies for a more favorable filing status than single. Choice "b" is incorrect. Mindy is not married. Choice "c" is incorrect. Mindy has not had a spouse die in the past two years.

In Year 1, Smith, a divorced person, provided over one half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During Year 1, Ruth did not live with Smith. She received $9,000 in Social Security benefits. Clay, a 25-year-old full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return for Year 1, owing an additional $500 in taxes on his wife's income. How many exemptions was Smith entitled to claim on his Year 1 tax return? a. 1 b. 4 c. 3 d. 2

Choice "d" is correct. Smith is entitled to an exemption for himself. He is also entitled to an exemption for his mother Ruth (qualifying relative). Ruth has $9,000 in Social Security payments during Year 1, but because that is her only income, the Social Security is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent. Clay cannot be taken as a dependent because he filed a joint return with his wife. Because the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay. Smith is entitled to two exemptions. Choice "b" is incorrect. Clay cannot be taken as a dependent because he filed a joint return with his wife. Because the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay. Choice "c" is incorrect. Clay cannot be taken as a dependent because he filed a joint return with his wife. Because the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay. Choice "a" is incorrect. Smith is entitled to an exemption for his mother, Ruth. Ruth has $9,000 in Social Security payments during Year 1, but because that is her only income, the Social Security income is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent.

In the current year, a taxpayer reports the following items: Salary $ 50,000 Income from partnership A, in which the taxpayer materially participates 20,000 Passive activity loss from partnership B (40,000) During the year, the taxpayer disposed of the interest in partnership B, which had a suspended loss carryover of $10,000 from prior years. What is the taxpayer's adjusted gross income for the current year? a. $70,000 b. $30,000 c. $60,000 d. $20,000

Choice "d" is correct. The $50,000 salary and income from partnership activity of $20,000 are taxable. Typically, passive activity losses, whether in the current or prior years, may only be used to offset passive activity income. The exception to this is in the year the passive activity is disposed of (sold), if still unused, passive activity losses are fully deductible in the year of disposal: Salary $ 50,000 + Income from partnership A 20,000 - PAL from partnership B (40,000) - Loss carryover from partnership B (10,000) Adjusted gross income $ 20,000

Chris, age 5, has $3,000 of interest income and no earned income this year. Assume the current applicable standard deduction is $950, how much of Chris' income will be taxed at Chris' parents' maximum tax rate? a. $0 b. $3,000 c. $2,050 d. $1,100

Choice "d" is correct. The amount of income for a child under 18 that is taxable at the parents' maximum tax rate is deemed the "kiddie tax." To calculate the amount that is taxed at the parents' highest rate, take the child's total interest income ($3,000 in this question) and reduce it by the child's standard deduction ($950 in this case). The next $950 is then taxed at the child's rate, and the balance of $1,100 ($3,000 - $950 - $950 = $1,100) is taxed at the parents' highest rate. (Note that although $950 is not the current standard deduction for a dependent, the question tells us to use it.) Choice "a" is incorrect. The $0 indicates that nothing is taxed at the parents' maximum tax rate. Taxing something at the parent's tax rate is the whole idea of the "kiddie tax." Choice "c" is incorrect. The $2,050 uses only the $950 standard deduction, but the next $950 would be taxed at the child's rate. Choice "b" is incorrect. The $3,000 indicates that the entire $3,000 interest income is taxed at the parents' maximum tax rate.

With regard to the inclusion of social security benefits in gross income, for the Year 8 tax year, which of the following statements is correct? a. The social security benefits in excess of the modified adjusted gross income over a threshold amount are included in gross income. b. The social security benefits in excess of modified adjusted gross income are included in gross income. c. The social security benefits in excess of one half the modified adjusted gross income are included in gross income. d. Eighty-five percent of the social security benefits is the maximum amount of benefits to be included in gross income.

Choice "d" is correct. The amount of social security benefits that is taxed is dependent on whether the combined income (AGI plus interest on tax-exempt bonds and 50% of the social security benefits) is greater than a threshold amount. If the combined income is less than the threshold, the amount taxed is the lesser of 1) 50% of the benefits or 2) 50% of the excess of the combined income over the threshold. If the combined income is greater than the threshold, the amount taxed is the lesser of 1) amount calculated above plus 85% of the excess of the combined income over the threshold or 2) 85% of the benefits. Thus, 85% of the benefits is the maximum amount of benefits that may be included in gross income.

Wade Inc. granted a nonqualified stock option for 100 shares at $50 per share to Mary, an employee, on May 1, Year 12. On that date, the option was selling on an established market for $4 per share. Mary exercised the option on August 2, Year 13, when the FMV was $80 per share. She sold the stock on September 2, Year 14, for $100 per share. How much gross income and what type did Mary recognize in Year 12? a. $400 capital gain b. $5,000 ordinary income c. $5,000 capital gain d. $400 ordinary income

Choice "d" is correct. The employee receiving a nonqualified stock option must recognize as ordinary income the value of the option if traded on an established market. Here, that is 100 shares at $4 per share, or $400. Choice "a" is incorrect. This is the correct amount, but it is ordinary income and not a capital gain. Choices "b" and "c" are incorrect per the above explanation.

During the current year, Adler had the following cash receipts: Wages $ 18,000 Interest income from investments in municipal bonds 400 Unemployment compensation 3,900 What is the total amount that must be included in gross income on Adler's current year income tax return? a. $18,000 b. $18,400 c. $22,300 d. $21,900

Choice "d" is correct. The wages of $18,000 and unemployment compensation are both includable in gross income on Adler's current year income tax return. Choice "a" is incorrect. The unemployment compensation must be included in gross income. Choice "b" is incorrect. Municipal bond interest income is excluded from gross income, and the unemployment compensation must be included in gross income. Choice "c" is incorrect. Municipal bond interest income is excluded from gross income.

In a tax year where the taxpayer pays qualified education expenses, interest income on the redemption of qualified U.S. Series EE Bonds may be excluded from gross income. The exclusion is subject to a modified gross income limitation and a limit of aggregate bond proceeds in excess of qualified higher-education expenses. Which of the following is (are) true? I. The exclusion applies for education expenses incurred by the taxpayer, the taxpayer's spouse, or any person whom the taxpayer may claim as a dependent for the year. II. "Otherwise qualified higher-education expenses" must be reduced by qualified scholarships not includible in gross income. a. Both I and II. b. Neither I nor II. c. II only. d. I only.

Explanation Choice "a" is correct. Both I and II are true per the following rule. Rule: Qualified higher education expenses are tuition and fees required for the enrollment or attendance of the taxpayer, the taxpayer's spouse, or any dependent for whom the taxpayer is allowed a dependency exemption, at an eligible educational institution. The expenses otherwise taken into account must be reduced by the total amounts received for excludable qualified scholarships, certain educational assistance allowances, and other tax-exempt payments (other than gifts, bequests, devises, or inheritances).

For a cash basis taxpayer, gain or loss on a year-end sale of listed stock arises on the: a. Trade date. b. Date of delivery of stock certificate. c. Date of receipt of cash proceeds. d. Settlement date.

Explanation Choice "a" is correct. Trade date. Gain or loss on a year-end sale of listed stock arises on the trade date. Rule: Whether on the cash or accrual method of accounting taxpayers who sell stock or securities on an established securities market must recognize gains and losses on the trade date, rather than on the settlement date. Choices "d", "c", and "b" are incorrect, per the above rule.

Merrill and Joe divorced in June of the current year. As part of the settlement, Joe received the following: Alimony $3,000 /per month Child support 1,000 /per month Lump-sum payment as the property settlement 125,000 Payments began in July; however, Merrill only paid a total of $15,000 during the year. For the current year, what amount must Joe include in income on his Form 1040? a. $134,000 b. $9,000 c. $140,000 d. $15,000

Explanation Choice "b" is correct. Alimony is an item of gross income; child support is not. Joe was to receive $3,000 per month in alimony for the remaining six months of the year (July - December), for a total of $18,000. Child support is non-taxable as are lump-sum property settlements made pursuant to a divorce. When total payments received do not equal the total due, the amounts are first allocated to child support. Thus, of the $15,000 paid by Merrill, $6,000 is first allocated to child support. The remaining $9,000 would constitute alimony and would be taxable. Choice "d" is incorrect. The $15,000 must first be allocated between the types of payments received. Any amounts are first used to satisfy any child support requirement, and the remainder would be classified as alimony. Choice "a" is incorrect. This answer includes both the $9,000 (discussed above) and the property settlement (which is non-taxable). Choice "c" is incorrect. This answer includes the total amount received, $15,000 payments (child support and alimony) and the property settlement. Lump-sum property settlements are not taxable to the recipient in a divorce.

Randolph is a single individual who always claims the standard deduction. Randolph received the following in the current year: Wages $ 22,000 Unemployment compensation 6,000 Pension distribution (100% taxable) 4,000 A state tax refund from the previous year 425 What is Randolph's gross income? a. $32,425 b. $32,000 c. $22,000 d. $28,425

Explanation Choice "b" is correct. Each item listed here is included in gross income except for the state tax refund from a prior year. The taxpayer always claims the standard deduction. This means that the state tax was not deducted in the year it was paid. Under the tax benefit rule, the refund of that tax is not taxable. Wages $ 22,000 Unemployment compensation 6,000 Pension distribution (100% taxable) 4,000 Total $ 32,000

Nan, a cash basis taxpayer, borrowed money from a bank and signed a 10-year interest-bearing note on business property on January 1 of the current year. The cash flow from Nan's business enabled Nan to prepay the first three years of interest attributable to the note on December 31 of the current year. How should Nan treat the prepayment of interest for tax purposes? a. Capitalize the interest as part of the basis of the business property. b. Deduct the current year's interest and amortize the balance over the next two years. c. Capitalize the interest and amortize the balance over the 10-year load period. d. Deduct the entire amount as a current expense.

Explanation Choice "b" is correct. Interest paid in advance by a cash basis taxpayer on business loans cannot be deducted until the tax period to which the interest relates. In other words, the interest must be both paid and incurred in order to be deducted.

Mort and Mindy met at a New Year's Eve party held December 31, Year 1. They instantly bonded, fell madly in love, and were married at 11:38 p.m. that night. Identify Mort's filing status for Year 1. a. Single. b. Head of household. c. Married filing jointly. d. Surviving spouse.

Explanation Choice "c" is correct. Mort and Mindy were married as of midnight on December 31, Year 1. Therefore, Mort's only options are to file as married either jointly or separately, and because "joint" is the only option presented that qualifies, choice "c" is correct. Choices "a", "b", and "d" are incorrect, based on the above explanation.

The Uniform Capitalization Rules of Code Sec. 263A apply to retailers whose average gross receipts for the preceding three years exceed what amount? a. $2,500,000 b. $1,000,000 c. $10,000,000 d. $5,000,000

Explanation Choice "c" is correct. The uniform capitalization rules do not apply to inventory acquired for resale if the taxpayer's average gross receipts for the preceding three tax years do not exceed $10,000,000.

John and Theresa are in the process of obtaining a divorce. Although they are not legally separated, John moved out of the family home in October of Year 1 and moved into an apartment nearby. John and Theresa's two children, Jenna and Stella, lived with Theresa in the family home for more than half of the tax year. What filing status can Theresa use to file her Year 1 tax return? a. Surviving spouse (qualifying widow). b. Head of household. c. Single. d. Married filing jointly/separately.

Explanation Choice "d" is correct. John and Theresa are still married at year-end, not legally separated, and have not lived apart for the last six months of the taxable year. Theresa must file as married, but may choose to do so either jointly with John or separately. Choice "b" is incorrect. Head of household status is not an option because the couple is not legally separated at year-end and John did not live apart from Theresa for the last six months of the taxable year. Choice "a" is incorrect. Surviving spouse (qualifying widow) is not an option for Theresa, as John is still alive. Choice "c" is incorrect. Filing as single is not an option, because John and Theresa are still married and not legally separated at year-end.

Which of the following should be included when determining adjusted gross income? a. Compensation for injuries or sickness. b. Tuition scholarship. c. Alimony received. d. Rental value of parsonages.

Explanation Rule: IRC Sections 71, 62, and 215 control the taxation of alimony. Payments for the support of a spouse (alimony) are income to the spouse receiving the payments and are deductible to arrive at adjusted gross income (AGI) by the spouse making the payments. To be alimony: 1.Payments must be legally required pursuant to a written divorce or separation agreement, 2.Payments must be in cash or its equivalent. 3.Payments cannot extend beyond the death of the payee-spouse, 4.Payments cannot be made to members of the same household. 5.Payments must not be designated as anything other than alimony, and 6.The spouses may not file a joint tax return. Choice "c" is correct. Alimony received is definitely considered part of income and of adjusted gross income. Choice "a" is incorrect. Compensation for injuries or sickness is excluded from income and thus adjusted gross income. Choice "d" is incorrect. The rental value of parsonages (furnished by churches or synagogues) is excluded from the income of a minister and thus that minister's adjusted gross income. Choice "b" is incorrect. A scholarship for tuition is excluded from income and thus adjusted gross income. There are certainly limits or restrictions such as the student has to be a degree-seeking student and amounts must actually be spent on tuition, fees, books, and supplies, but, as a general statement, the amount is excluded.

Kant, a cash-basis individual, owns and operates an office building. Kant received the following payments during the current year: Current rents $ 30,000 Advance rents for the next year 10,000 Security deposits held in a segregated account 5,000 Lease cancellation payments 15,000 What amount is included in gross income? a. $40,000 b. $30,000 c. $60,000 d. $55,000

Explanation Rule: The basic formula for determination of net rental income or loss follows: Gross rental income Prepaid rental income Rent cancellation payments Improvements in lieu of rent (Rental expenses) Net rental income (loss) If security deposits are held separately and not available to be applied to last month's rent (as in a segregated account), they are a liability of the taxpayer and not included in income in the year received. Choice "d" is correct. The calculation of gross income for the year follows: Current rents $ 30,000 Advance rents for the next year 10,000 Security deposits held in a segregated account − Lease cancellation payments 15,000 Gross income from the rental activity $ 55,000 Choice "b" is incorrect. This answer option incorrectly includes only the current rents as part of gross income, when advance rents and lease cancellation payments also must be included. Choice "a" is incorrect. This answer option incorrectly includes only the current rents and the advance rents as part of gross income, when lease cancellation payments also must be included. Choice "c" is incorrect. This answer option incorrectly includes all of the payments collected for the rental activity in the year, when the security deposits that are held in a segregated account are excluded from gross income.

An individual received $50,000 during the current year pursuant to a divorce decree. A check for $25,000 was identified as annual alimony, checks totaling $10,000 as annual child support, and a check for $15,000 as a property settlement. What amount should be included in the individual's gross income? a. $0 b. $40,000 c. $50,000 d. $25,000

Explanation Rules: Payments for the support of a spouse are income to the spouse receiving the payments and are deductible to arrive at adjusted gross income by the contributing spouse. Child support is not taxable. Property settlements are not taxable. Choice "d" is correct. Only the $25,000 in alimony is included in the gross income of the receiving spouse. Choice "c" is incorrect. This answer option incorrectly includes all of the payments received in the year. The child support ($10,000) and the property settlement ($15,000) are NOT included in the gross income of the receiving spouse. Choice "b" is incorrect. This answer option incorrectly includes the payments received in the year for alimony and property settlement for the year [$25,000 + $15,000 = $40,000]. The property settlement ($15,000) is NOT included in the gross income of the receiving spouse. Choice "a" is incorrect. The amount received for alimony ($25,000) is included in the gross income of the receiving spouse.

Which one of the following will result in an accruable expense for an accrual-basis taxpayer? a. A repair completed prior to year end and paid upon completion. b. A signed contract for repair work to be done and the work is to be completed at a later date. c. An invoice dated prior to year end but the repair completed after year end. d. A repair completed prior to year end but not invoiced.

RULE: An accruable expense is one is which the services have been received/performed but have not been paid for by the end of the reporting period. Choice "d" is correct. The facts indicate that a repair was completed prior to year end but not yet invoiced. If it has not yet been invoiced, it is assumed that it has also not yet been paid for. Therefore, this is a situation in which the repair expense would be accrued at year end. Services have been performed, but they have not been paid for, as they have not even been invoiced yet. Choice "c" is incorrect. If the repair was completed after year end, then the expense is not accruable, as the benefit of the services hasn't been received as of year end. The fact that the repair was invoiced prior to year end does not impact the situation. Choice "a" is incorrect. If a repair was completed and paid for prior to year end, no accrual is appropriate. On the accrual basis, the expense is taken in the year the repair is completed and the benefit is received. In this case, the account payable was also paid in the same year, but this has no effect on the expense. Choice "b" is incorrect. The facts indicate that the work is to be completed at a date later than year end. Therefore, the expense is not accruable at year end, as the benefit of the repair hasn't been received as of year end. It is reasonable that a signed contract for the repair work exists, but this has no effect on the accrual.

Porter was unemployed for part of the year. Porter received $35,000 of wages, $6,400 from a state unemployment compensation plan, and $2,000 from his former employer's company-paid supplemental unemployment benefit plan. What is the amount of Porter's gross income? a. $43,400 b. $35,000 c. $41,400 d. $37,000

RULE: Gross income includes all income unless it is specifically excluded in the tax code. Choice "a" is correct. Wages and all unemployment compensation are not excluded from being taxable; therefore, they are included in the taxpayer's gross income for tax purposes. Wages received $ 35,000 State unemployment compensation 6,400 Employer's unemployment compensation plan 2,000 $ 43,400 Choice "b" is incorrect. All forms of unemployment compensation are included as part of gross income. Choice "d" is incorrect. The $6,400 of state unemployment compensation received is included as part of gross income. Choice "c" is incorrect. The $2,000 of his former employer's company-paid supplemental unemployment benefit plan is included as part of gross income.

Barkley owns a vacation cabin that was rented to unrelated parties for 10 days during the year for $2,500. The cabin was used personally by Barkley for three months and left vacant for the rest of the year. Expenses for the cabin were as follows: Real estate taxes $ 1,000 Maintenance and utilities 2,000 How much rental income (loss) is included in Barkley's adjusted gross income? a. $(1,500) b. $(500) c. $500 d. $0

RULE: If a vacation residence is rented for less than 15 days per year, it is treated as a personal residence. The rental income is excluded from income, and mortgage interest (first or second home) and real estate taxes are allowed as itemized deductions. Depreciation, utilities, and repairs are not deductible. Choice "d" is correct. Applying the RULE above, if a vacation residence is rented for less than 15 days per year, it is treated as a personal residence. The rental income ($2,500 in this case) is excluded from income. A Schedule E is not filed for this property (i.e., no income is reported, the taxes are reported as itemized deductions, and the maintenance and utilities are not deductible), so the effect on AGI is zero. Choice "c" is incorrect. This assumes that the property taxes are reported as itemized deductions but that the rental income ($2,500) less the maintenance and utilities ($2,000) are reported net on Schedule E. Per the above RULE, the rental income is excluded from income, and the maintenance and utilities are not deductible. Choice "b" is incorrect. This assumes that all of the items shown are reported net on the Schedule E-$2,500 - $1,000 - $2,000 = ($500). Per the above RULE, the rental income is excluded from income, the maintenance and utilities are not deductible, and the property taxes are reported on Schedule A as an itemized deduction. Choice "a" is incorrect, per the above RULE and discussion.

In which of the following situations may taxpayers file as married filing jointly? a. Taxpayers who were legally separated but lived together for the entire year. b. Taxpayers who were married but lived apart during the year. c. Taxpayers who were married but lived under a legal separation agreement at the end of the year. d. Taxpayers who were divorced during the year.

RULE: In order to file a joint return, the parties must be MARRIED at the end of the year. Exception: If the parties are married but are LEGALLY SEPARATED under the laws of the state in which they reside, they cannot file a joint return (they will file either under the single or head of household filing status). Choice "b" is correct. Per the above rule, taxpayers who are married but lived apart during the year are allowed to file a joint return for the year. The fact that they did not live together during the year has no bearing on the issue. Choice "c" is incorrect. Per the above rule, taxpayers who are married but lived under a legal separation agreement at the end of the year may not file a joint return. They will generally file either under the single or head of household filing status. Choice "d" is incorrect. Per the above rule, taxpayers who were divorced during the year may not file a joint return together, as they are not married at the end of the year. [Note, however, that they may become married again in the year and file a joint return with the new spouse.] Choice "a" is incorrect. Per the above rule, taxpayers who were legally separated but lived together for the entire year may not file a joint return. They will generally file either under the single or head of household filing status.

A 33-year-old taxpayer withdrew $30,000 (pretax) from a traditional IRA. The taxpayer has a 33% effective tax rate and a 35% marginal tax rate. What is the total tax liability associated with the withdrawal? a. $10,500 b. $10,000 c. $13,500 d. $13,000

Rule: Generally, unless an exception applies, retirement money cannot be withdrawn until the individual reaches the age of 59 ½. If retirement money (without an exception) is withdrawn before the age of 59 ½, the premature distribution is subject to a 10% penalty tax (in addition to the applicable regular income tax that applies to all distributions of traditional IRA money). Choice "c" is correct. The taxpayer is under the age of 59 ½, and the facts do not indicate that an exception applies; therefore, the taxpayer is subject to the 10% penalty on the IRA distribution in addition to the regular income tax. The regular income tax that applies is the marginal rate (the rate for the next dollar of taxable income). The effective tax rate is simply the total tax divided by the total taxable income. In this case, the taxpayer would have to pay the regular tax on the distribution at the 35% marginal rate PLUS the 10% penalty on early distribution without an exception. The calculation to arrive at the total tax associated with the withdrawal follows: Regular Income Tax $ 30,000 × 35% $ 10,500 Penalty Tax 30,000 × 10% 3,000 Total Tax $ 13,500 Choice "b" is incorrect. This answer option assumes the effective income tax rate (rounded, assuming 33.33%) applied to the $30,000 distribution. It uses the incorrect tax rate (the marginal rate should be used) and omits the inclusion of the applicable 10% penalty tax. [$30,000 × 33.33% = $10,000] Choice "a" is incorrect. This answer option includes the $30,000 distribution multiplied by the (proper) marginal tax rate, but it omits the inclusion of the applicable 10% penalty tax. [$30,000 × 35% = $10,500] Choice "d" is incorrect. This answer option assumes the effective income tax rate (rounded, assuming 33.33%) applied to the $30,000 distribution plus the applicable 10% penalty tax [($30,000 × 33.33%) + ($30,000 × 10%) = $13,000]. It uses the incorrect tax rate (the marginal rate should be used).

Lane, a single taxpayer, received $160,000 in salary, $15,000 in income from an S Corporation in which Lane does not materially participate, and a $35,000 passive loss from a real estate rental activity in which Lane materially participated. Lane's modified adjusted gross income was $165,000. What amount of the real estate rental activity loss was deductible? a. $35,000 b. $0 c. $15,000 d. $25,000

Rule: Passive activity is any activity in which the taxpayer does not materially participate. A net passive activity loss generally may not be deducted against other types of income (e.g., wages, other ordinary or active income, portfolio income (interest and dividends), or capital gains). In other words, passive losses may generally only offset passive income for a tax year-the remaining net loss is generally "suspended" and carried forward to a year when it may be used to offset passive income (or when the final disposition of the property occurs). However, there is an exception (the "mom and pop exception," as we refer to it in the textbooks) to this general rule. Taxpayers who own more than 10% of the rental activity, have modified AGI under $100,000, and have active participation (managing the property qualifies), may deduct up to $25,000 annually of net passive losses attributable to real estate. There is a phase-out provision for modified AGI from $100,000 − $150,000, and the deduction is completely phased-out for modified AGI in excess of $150,000. Choice "c" is correct. Per the above rule, unless an exception exists (and it does not in this case, as Lane's modified adjusted gross income is in excess of $150,000), passive losses may only offset passive income for a tax year (i.e., no "net loss" may exist). In this case, Lane has a $20,000 net loss from passive activity [$15,000 S Corporation income (passive, in this case because the facts state Lane does not materially participate) minus the $35,000 rental real estate loss]. Thus, only $15,000 of the passive loss from real estate rental activity may be used to offset the $15,000 income from the S Corporation. The remaining $20,000 passive activity loss is carried forward to be used in future years. Choice "b" is incorrect. Per the above rule, passive losses may generally only offset passive income for a tax year. Lane has passive income of $15,000 in the year; thus, passive loss up to $15,000 may be deducted from passive income. Choice "d" is incorrect. This answer option is an attempt to confuse the candidate into using the "mom and pop" exception, which applies when taxpayers who actively participate, own more than 10% of the rental activity, and have modified AGI under $100,000 are able to deduct up to $25,000 annually of net passive losses attributable to real estate. There is a phase-out provision for modified AGI from $100,000 − $150,000, and the deduction is completely phased-out for modified AGI in excess of $150,000. In this case, the facts state that Lane's modified adjusted gross income is $165,000; thus, Lane does not qualify to use the exception. Choice "a" is incorrect. This answer option assumes that the full amount of the rental real estate loss is deductible against the passive income from the S Corporation, and, thus, against Lane's other taxable income. As indicated in the rule above, unless an exception applies (it does not in this case), a net passive activity loss may not be deducted against other types of income (e.g., wages, other ordinary or active income, portfolio income (interest and dividends), or capital gains). Thus, the full $35,000 rental real estate loss is not deductible in the year by Lane.