Lesson 5: Other Deductions and Tax Credits

Adam owns a mansion built on the cliff of a large island overlooking the Atlantic Ocean. Each year, an international sailing race takes place around the island, and large corporations descend on the town, inviting clients and business associates to entertain them. The Stapleton Corporation, a custom designer of racing sailboats, is particularly interested in this event each year, and for the week and a half of the race, they rent Adam's mansion for $200,000. At first, Adam was hesitant to rent the home, but he decided that since it would only be a week and a half, he could go on vacation himself at that time. Adam incurs some costs associated with the rental, including storage charges for his valuables of $10,000, cleaning expenses before and after the rental of $8,000, and the estimated pro rata portion of real estate taxes for the period of the rental of $1,000. How much income from this rental activity will be included in Adam's adjusted gross income (AGI)?

$0 Because the home is rented out for 14 days or less, Adam will not be required to report any income for the rental, but he also cannot deduct any expenses associated with the rental activity.

Sara, who is single, contributed $6,000 to her Roth IRA for 2021. She had a modified adjusted gross income (MAGI) of $17,000 for 2021 and used the single filing status. She has never taken a distribution from a retirement plan. What is her maximum retirement savings credit for 2021? $0 $200 $1,000 $2,000

$1,000 Her maximum credit for 2021 is $1,000, that is, $2,000 × 50%.

Greg's daughter, Kate, completed her junior year of college in 2021. Greg paid $2,800 in qualified expenses for Kate in 2021. Assuming Greg's AGI falls below all phaseout ranges, which of the following education tax credits would he be eligible to claim? $2,500 American Opportunity Tax Credit $2,200 American Opportunity Tax Credit $2,000 Lifetime Learning Credit $2,800 Lifetime Learning Credit

$2,200 American Opportunity Tax Credit Greg would be eligible to claim the either the American Opportunity Tax Credit in the amount of $2,800 ($2,000 x 100% + $800 x 25%) or the Lifetime Learning Credit in the amount of $560 ($2,800 x 20%).

Evan raises and sells horses as a hobby and incurs the following income and expenses in the current year. How much income must Evan include in gross income from this activity?

$37,000 Since this is a hobby activity for Evan, all income must be reported ($25,000 + $12,000 = $37,000) and no deductions may be taken to reduce this income.

Roger, a 45-year-old professor, was speaking with his good friend, Grayson, who is 53 years old. The topic of retirement savings came up, and Grayson told Roger that individuals aged 50 and older could contribute $7,000 to an IRA. Roger did not review the laws for those younger than 50, which indicate the deduction limit to be $6,000, and as a result he contributed $7,000. Assuming that Roger does not correct his error, what is the amount of the tax penalty that Roger must pay for making the $7,000 contribution for 2021 to the traditional IRA? $0 $60 $1,000 $100

$60 Roger has made an excess contribution of $1,000 to his IRA. Grayson was permitted to make the contribution due to the catch-up provisions for taxpayers aged 50 or over. The excess contribution penalty is 6 percent, so Roger must pay a penalty tax of $60.

Agnes is an unmarried mother of two children, Austin and Lily. Austin is 14 years old, and Lily is 3 years old. Agnes has an adjusted gross income (AGI) of $50,000. She paid the following expenses for child care this year: $300 to Austin to care for Lily so Agnes could go out to dinner with friends $1,000 for an after-school program for Austin $3,500 to Agnes's mother for the care of Lily during the day What is the child and dependent care credit that Agnes can claim this year?

$600 The payment to Austin does not qualify because he is a dependent child of Agnes under the age of 19 and because the expense was not employment-related. The payment for Austin's after-school program does not qualify because Austin is not under the age of 13. (Note that this means there is only one qualifying dependent.) The payment to Agnes's mother does count towards eligible expenses. However, the eligible expenses are limited to $3,000 since there is only one qualifying dependent. Since Agnes has an AGI over $43,000, she is able to claim a credit of $600, or 20% × $3,000.

**Cara spent $15,000 for day-care services for her four children so that she could go to work. If her adjusted gross income (AGI) is $180,000, how much is her dependent-care credit? (Please ignore changes from the American Rescue Plan Act of 2021.) A) $0 B) $1,200 C) $3,000 D) $15,000

B) $1,200 The correct answer is (B).For taxpayers with AGI over $43,000, the dependent-care credit provides a credit of 20 percent of the cost up to $3,000 per qualifying child or $6,000 for two or more children. Therefore her credit is $1,200, that is, $6,000 × 0.20.

**Assume a taxpayer incurred business losses in 2020 and generated an NOL of $50,000 that would be carried forward to offset income in future years. Assuming the taxpayer had $20,000 of taxable income and incurred no additional business income or loss in 2021, what amount of NOLs could be recognized in 2021? A) $0 B) $16,000 C) $20,000 D)$50,000

B) $16,000 The correct answer is (B). NOLs can only be carried forward and are limited to 80 percent of taxable income. In this case, 80 percent of taxable income ($20,000) is equal to $16,000. Therefore, only $16,000 of the NOL carryforward ($50,000) can be recognized in 2021

Sid bought 10 shares of Lazy Dog, Inc., stock on January 1, 2021. Sid paid $20 for each share. At first, it appeared that Sid had made a good investment as the price of Lazy Dog stock rose to $50 per share on March 1, 2021. However, rumors of corporate wrongdoing soon started to circulate, and the price of Lazy Dog began to fall. On August 1, 2021, Lazy Dog, Inc., declared bankruptcy and announced that the stockholders should not expect to receive anything on the liquidation of the corporation. What type of loss, if any, does Sid have in 2021? A) Sid does not have a loss because he did not sell the stock. B) He has a short-term capital loss of $200. C) He has a short-term capital loss of $500. D) He has a long-term capital loss of $200.

B) He has a short-term capital loss of $200. The correct answer is (B).Section 165 creates an artificial sale date of December 31 for worthless securities. Therefore Sid is deemed to have sold the stock for $0 on December 31. Because Sid's holding period was less than one year and one day, his loss will be a short-term capital loss. The amount of Sid's loss is equal to his basis in the investment.

**Kenneth completed his freshman year of college in 2020. His parents paid $6,000 in qualified education expenses in 2021. Kenneth's parents are married-filing-jointly (MFJ) taxpayers and had an adjusted gross income (AGI) of $175,000 for 2021. What, if any, education credit will provide them with the highest credit, and how much is that credit? A) Kenneth's parents can claim an American Opportunity tax credit in the amount of $1,875. B) Kenneth's parents can claim an American Opportunity tax credit in the amount of $625. C) They are not eligible to claim any education tax credits since their AGI exceeds the phaseout. D) Kenneth's parents can claim an American Opportunity tax credit in the amount of $2,500.

B) Kenneth's parents can claim an American Opportunity tax credit in the amount of $625. The correct answer is (B). Since Kenneth's parents' AGI falls in between the American Opportunity tax credit phaseout (that is, $160,000 to $180,000), his parents are entitled to claim a partial credit. The calculation is ($175,000 − $160,000) ÷ $20,000 = 75%, which means they are not able to claim 75 percent of the credit. Since they have incurred more than $4,000 of qualifying expenses, they would normally be able to claim the maximum $2,500 credit, but now they are only able to claim $625 for the American Opportunity tax credit. $2,500 - ($2,500 × .75) = $625

Abigail completed her freshman year of college in 2021. Her parents paid $8,000 in qualified education expenses in 2021. Abigail's parents are married-filing-jointly (MFJ) taxpayers and had an adjusted gross income (AGI) of $200,000 for 2021. What, if any, education credit will provide them with the highest credit, and how much is that credit? A) Abigail's parents can claim a Lifetime Learning credit in the amount of $8,000. B) Abigail's parents can claim a Lifetime Learning credit in the amount of $1,600. C)They are not eligible to claim any education tax credits since their AGI exceeds the phaseout. D) Abigail's parents can claim an American Opportunity tax credit in the amount of $2,500.

C) They are not eligible to claim any education tax credits since their AGI exceeds the phaseout. The correct answer is (C). The modified adjusted gross income (MAGI) phaseout for both the American Opportunity tax credit and Lifetime Learning credit is $160,000 to $180,000 for MFJ taxpayers in 2021.

Mattie, a single mother, has four children, aged 6, 7, 9, and 17. How much will her Child tax credit be for the current tax year assuming she is under the adjusted gross income (AGI) threshold? (Please ignore changes from the American Rescue Plan Act of 2021.) A)$1,000 B)$2,000 C)$6,000 D)$8,000

C)$6,000 The correct answer is (C).The 17-year-old is not considered a qualifying child for the purposes of the Child tax credit. Therefore Mattie will get $6,000, or a $2,000 credit for each of her other three children.

**Rose pursued a hobby of selling used computers in her spare time. During the year she sold the computers for $3,000. She incurred expenses as follows: $2,000 for the cost of goods sold $1,200 for supplies $800 in interest on a loan to start a business $750 in advertising fees Assuming that the activity is a hobby, and that she cannot itemize this year, how should she report these items on her tax return? A)Include $3,000 in income and deduct $4,750 for adjusted gross income (AGI). B)Ignore both income and expenses since hobby losses are disallowed. C)Include $3,000 in income and deduct nothing for AGI. D)Include $3,000 in income and deduct interest of $800 for AGI.

C)Include $3,000 in income and deduct nothing for AGI. The correct answer is (C).Rose must include the $3,000 in income and deduct nothing. Hobby expenses are not deductible after 2017.

Victor and Charlie own a house at the beach. The house was rented to unrelated parties for 8 full weeks during the current year. Victor and Charlie used the house for 16 days for their vacation during the year. After properly dividing the expenses between rental and personal use, it was determined that a loss was incurred as follows: What is the correct treatment of the rental income and expenses on Victor and Charlie's joint income tax return for the current year? A) A $1,600 loss should be reported. B)The rental portion of interest and taxes can be deducted. C)The rental expenses (other than interest and taxes) are limited to the gross rental income in excess of deductions for interest and taxes allocated to the rental use. D) Since the house was used only 20 percent personally by Victor and Charlie, all expenses allocated to personal use may be deducted.

C. The rental expenses (other than interest and taxes) are limited to the gross rental income in excess of deductions for interest and taxes allocated to the rental use. The correct answer is (C).Since the amount of time the property was used for personal reasons (16 days) was more than the greater of 14 days and 10 percent of the time the property was rented out (5.6 days), the property will not qualify as primarily rental property. The property will be classified as mixed-use property. Therefore no loss is allowed.

Glen and Sandra are married-filing-jointly taxpayers with three children, aged 6, 12, and 16. Their MAGI is $68,500. What is the amount of the Child tax credit that they can claim? (Please ignore changes from the American Rescue Plan Act of 2021.) A) $2,000 B) $3,000 C)$5,000 D) $6,000

D) $6,000 The correct answer is (D).They have three children. The Child tax credit is $2,000 per child. To be eligible, the child must be under the age of 17.

Which of the following only qualifies for the exception to the 10 percent early withdrawal penalty for IRAs? A) Distribution at death B) Distributions after reaching the age of 59½ C) Distributions due to disability D) Distributions for qualifying higher education expenses

D) Distributions for qualifying higher education expenses The correct answer is (D).All of the other responses qualify as exceptions for the 10 percent early withdrawal penalty for both qualified plans and IRAs.

Which of the following statements concerning net operating losses (NOL) is correct? NOLs must be used in the current tax year to offset other income; they cannot be applied to other tax years. NOLs can be carried back up to 6 years to offset income from those prior tax years. NOLs can be carried forward indefinitely. Prior to carrying forward NOLs, a taxpayer is required to apply the NOLs against prior-year income for at least 2 years.

NOLs can be carried forward indefinitely. NOLs can be carried forward indefinitely and cannot generally be carried back for years after 2017.

Which of the following statements concerning refundable tax credits is correct? There are more refundable tax credits than nonrefundable credits. Refundable tax credits can be used only to reduce or eliminate the current year's tax. Refundable tax credits can generate a tax refund. For federal income tax purposes, refundable credits are applied before nonrefundable credits.

Refundable tax credits can generate a tax refund. Refundable credits are far fewer in number than nonrefundable credits. In addition to reducing or eliminating the current year's tax, refundable tax credits can generate a tax refund. Furthermore, nonrefundable credits are applied before refundable credits for federal income tax purposes.

Payments for employment-related care that are made to relatives of the taxpayer may qualify for the credit for child and dependent care expenses. Which of the following payments does not qualify? a. Payments for employment-related care made to the taxpayer's aunt b. Payments for employment-related care made to the taxpayer's 21-year-old married daughter. c. Payments for employment-related care made to a 17-year-old dependent child of the taxpayer. d. Payments for employment-related care made to taxpayer's 17-year-old nephew.

c. Payments for employment-related care made to a 17-year-old dependent child of the taxpayer.