Tax Planning #4
Kaito is age 30, single, and is covered by a qualified retirement plan. He provided the following information for his 2023 income tax return: Salary $30,750 Contribution to a Roth individual retirement account $3,200 Total itemized deductions $6,700 What is Kaito's taxable income for 2023? A) $20,300 B) $23,500 C) $16,900 D) $14,450
$30,750 − $13,850 standard deduction (2023) = $16,900. All Roth IRA contributions are nondeductible. Kaito should use the standard deduction because it is greater than his itemized deductions.
Carol and Max are married and file jointly. They have 2 children, ages 7 and 5 who attend private school. The children's tuition is financed and they paid $400 in interest this year on the loan. Carol and Max also have student loans they are repaying for their college educations on which they paid interest of $3,200 in the same tax year. Their AGI is $110,000. If the couple does not itemize deductions, how much of the education loan interest can they deduct this year? A) $2,500 B) $2,900 C) $3,600 D) $0
A
Ron has 3 separate passive activities and has an at-risk amount in excess of $100,000 for each. During the year, the activities produced the following income (losses): First activity ($40,000) Second activity ($20,000) Third activity $15,000 Net passive loss ($45,000) Ron's suspended losses are as follows: A) $22,500 to activity 1; $22,500 to activity 2. B) $0 to activity 1; $0 to activity 2. C) $40,000 to activity 1; $20,000 to activity 2. D) $30,000 to activity 1; $15,000 to activity 2.
($40,000 ÷ $60,000) × $45,000 = $30,000 to activity 1. ($20,000 ÷ $60,000) × $45,000 = $15,000 to activity 2. Losses are allocated on their percentage of the total loss.
Chip files a timely tax return but is later required to pay an additional $15,000 in tax. Of this amount, $6,000 is attributable to Chip's negligence. The negligence penalty will be: A) $1,200; a 20% penalty is applied to the $6,000. B) $500; there is a maximum of $500 penalty. C) $3,000; a 20% penalty is applied to all tax due. D) $0; there is no penalty because the return was filed timely.
A 20% penalty ($6,000 × 0.20 = $1,200) applies to the negligence component.
Bob and his brother, George, are interested in forming a business together. However, they are concerned that the business will have losses for the next 3 years, whether the business would continue if one brother died, and whether they will have some limited liability protection. On the basis of the concerns of the brothers, which form of business entity is the most appropriate? A) Partnership. B) S corporation. C) C corporation. D) Limited partnership. Explanation
An S corporation will allow losses to flow through to the brothers, will continue if one brother dies, and will have the liability protection of a C corporation.
Carter, an unmarried individual, has an adjusted gross income (AGI) of $180,000 in the current year before any IRA deduction, taxable Social Security benefits, or passive activity losses. Carter has incurred a loss of $30,000 from rental real estate in which he actively participated. What amount of the loss attributable to this rental real estate may be used in the current year as an offset against income from nonpassive sources? A) $0. B) $30,000. C) $25,000. D) $12,500.
An exception to passive loss limits regarding real estate allows individuals to deduct up to $25,000 of losses from real estate activities against active and portfolio income. However, the annual $25,000 deduction is reduced by 50% of the taxpayer's AGI in excess of $100,000. The deduction is entirely phased out at an AGI of $150,000.
Ricardo, age 47 and unmarried, purchased a variable annuity in 2005 and has a modified AGI of $350,000. The annuity is in the accumulation period. Ricardo's basis is $50,000, and the contract has $100,000 in earnings. This year, he withdraws $60,000 from the annuity. Which of the following statements regarding the tax consequences of this withdrawal is CORRECT? A) Ricardo must include $10,000 in gross income and pay a penalty of $1,000. B) Ricardo is not required to include the amount of the withdrawal in gross income but must pay a penalty of $1,000. C) Ricardo must include $60,000 in gross income, pay a penalty of $6,000, and the $60,000 is subject to the 3.8% Medicare contribution tax. D) The withdrawal is tax-free and penalty-free.
Because Ricardo purchased the annuity on or after Augst 14, 1982, the withdrawal is subject to last in, first out (LIFO) taxation. Under LIFO, withdrawals are treated as coming from earnings first and are taxed to the extent of earnings. Premature distrubtions (prior to age 59½) are also subject to a 10% penalty. In addition, the $60,000 taxable gain is also subject to the 3.8% Medicare contribution tax that applies to net investment income of single taxpayers with a MAGI exceeding $200,000.
jim, recently retired, is 62 years old and expects to be in the maximum federal and state tax bracket. He plans to liquidate three of the investments listed below. Assume that each investment is worth $50,000 and has grown from an original investment of $25,000 over a period of more than three years. Which of the following would likely result in the lowest tax liability for Jim? A) A blue-chip stock B) A U.S. savings bond C) A Traditional IRA (all pre-taxed contributions) D) CD paying 4%
Because the interest on the CD was taxable each year, the basis in the CD would be equal to the value. Therefore, no federal or state income taxes would result upon liquidation. The appreciation of the blue-chip stock would be taxed, but at favorable capital gains rates that are still more than a CD. For U.S. savings bonds, the appreciation would be taxed at ordinary income tax rates for federal income tax purposes. However, savings bonds are not subject to state income taxes. For the traditional IRA, the appreciation only (the client has a basis for the contributions because they were nondeductible) would be taxed at both federal and state ordinary income tax rates.
Sylvia purchased several assets for her small business in the first quarter of the year. Which of the listed assets are considered capital expenditures? A) Enough inventory (fabrics and thread) to cover three years of manufacturing her product B) A new laptop to help with business administrative tasks C) A lot in the suburbs on which she will build a new warehouse D) A commercial sewing machine that will have to be replaced in nine months
Capital expenditures pertain to the acquisition of assets that will last for more than one year. Capital expenditures are not currently deductible and must be capitalized over the useful life of the asset. Assets, such as land, that do not have a useful life cannot be deducted until they are sold or exchanged, but are capital expenditures. Inventory is also not a capital expenditure, but an asset for the production of income.
Scott just sold a building for $180,000 that had a basis of $80,000. The property had suspended passive losses of $50,000. Scott manages a portfolio of private activity bonds that paid interest of $25,000. As a substitute high school physics teacher, Scott earns $25,000, of which he contributes $10,000 to his tax-sheltered annuity (TSA). What is Scott's AGI? A) $65,000 B) $15,000 C) $40,000 D) $115,000
Capital gain of $100,000 is included in AGI (although it may be taxed at a preferential rate). The passive loss of $50,000 is allowed because of the disposition of the property. Municipal bond interest is not included in AGI, although it could be AMT issue. Scott's salary of $25,000 is included in AGI. The TSA contribution of $10,000 reduces current income because TSAs are tax-deferred retirement savings plans. $100,000 − $50,000 + $25,000 − $10,000 = $65,000.
Boyd, a shareholder in the Pivitz Corporation, owns 50% of the shares of stock in the company. This year, Pivitz had current and accumulated earnings and profits of $50,000. Pivitz paid its shareholders a cash dividend of $50,000, of which Boyd is to receive 50%. How much dividend income must Boyd report on his income tax return? A) $0 B) $25,000, less his basis in the stock C) $25,000 D) $50,000
Dividends are taxable to the recipient as dividend income, but only to the extent of the corporation's current and accumulated earnings and profits. Pivitz had earnings and profits of $50,000 and paid a dividend of $50,000, of which the entire dividend is taxable as dividend income to the recipients. If Boyd received half of that amount, he realized $25,000 of taxable dividend income.
Max is the sole shareholder in the ABC Corporation. This year, ABC has accumulated earnings and profits of $40,000. Max's basis for the stock he owns in the company is $7,000. ABC makes a distribution of $60,000 to Max. How much of this distribution is taxable to Max as a capital gain? A) $0 B) $7,000 C) $13,000 D) $20,000
Earnings and profits of the corporation are considered to be the first source of the distribution and are considered dividends. The first $40,000 is treated as a dividend. From the remaining $20,000, Max deducts his tax-free return of basis of $7,000. The net amount remaining of $13,000 will be treated as a capital gain.
Vicki, age 70, retired from Austin Industries several years ago. In the current year, Vicki purchased an annuity for $26,000 to provide her with an additional source of retirement income. Under the contract, Vicki will receive $300 each month for the rest of her life. According to actuarial estimates, Vicki will live to receive 100 payments and will receive a 3% return on her original investment. Which of the following statements regarding payments received under the annuity is CORRECT? A) If Vicki lives to collect more than 100 payments, all amounts received after the 100th payment must be included in her gross income. B) If Vicki lives to collect more than 100 payments, she must amend her prior years' tax returns to increase her taxable portion of each payment received in the past. C) If Vicki collects $3,000 in the current year, the $3,000 is treated as a recovery of capital and, thus, is not taxable. D) If Vicki
If Vicki lives longer than her actuarial life expectancy, the subsequent annuity payments received will be fully taxable as ordinary income. Statement 1 is incorrect because a portion of each payment will be taxable as ordinary income, and a portion will be treated as a tax-free return of capital. Statement 2 is incorrect because if Vicki dies during her actuarial life expectancy, the unrecovered basis in her annuity may be deducted as a miscellaneous itemized deduction on her final income tax return. Statement 3 is incorrect because if Vicki lives longer than her actuarial expectancy, the subsequent annuity payments received will be fully taxable as ordinary income. There is no need to amend prior tax returns.
Bradley loaned his friend, Karl, $25,000 for a down payment on a home in a zero-interest loan early in the current year. Bradley had investment income of $750 and Karl had investment income of $1,200 in the same year. The federal interest rate is 3.5%. Karl has been making payments each month. What recommendations do you, a CFP® professional, make for accounting for the loan made to Karl by Bradley? A) Because Bradley's investment income is less than $1,000 this year, no interest is imputed to the loan. B) Bradley must develop an amortization schedule using the Federal rate of 3.5% to account for Karl's payments of principal and interest. C) Because this is a gift loan greater than $10,000 but less than or equal to $100,000, no interest will be imputed to the loan. D) Imputed interest is calculated on the loan to Karl and is considered a gift to Karl from Bradley.
In a gift loan, the lender makes a gift to the borrower in the amount of the imputed interest. For gift loans greater than $10,000 and less than or equal to $100,000, no interest is imputed if the borrower's net investment income for the year does not exceed $1,000. For a gift loan of more than $100,000, the prevailing federal rate of interest will be imputed. For this loan, Karl's investment income exceeds $1,000 and interest will be imputed on this gift loan.
Which of the following statements regarding recapture (the taxation of certain gain from the sale of the asset as ordinary income instead of capital gain) is CORRECT? A) For real property, all depreciation claimed is always subject to recapture at the ordinary tax rate income upon the sale of the property. B) Under MACRS, the amount of depreciation recaptured as ordinary income for residential property is only the amount of depreciation claimed in excess of the amount allowable under the straight-line method. C) For real property placed in service under MACRS, it is recaptured as ordinary income because it is depreciated under the straight-line method. D) For depreciable tangible personal property, all depreciation claimed is generally subject to recapture as capital gains upon the sale of the property, regardless of the depreciation method used.
Recapture of depreciation on the sale of Section 1231 real estate is referred to as unrecaptured Section 1250 capital gain and taxed at a maximum rate of 25%. If the taxpayer's marginal tax rate is less than 25%, the Section 1250 gain will be taxed at that lower rate. The depreciation recapture of tangible personal property is subject to recapture at ordinary income rates.
Ben, a CFP® professional, is compiling separate financial statements for each of Margery's businesses, which are all sole proprietorships. When reviewing the balance sheets for each business, which of the following assets are considered Section 1231 assets? A) Color copier used in a business office B) Jewelry storeowner's inventory of stock of diamonds C) U.S. government publications D) Copyrights
Section 1231 assets are certain assets used in a taxpayer's trade or business that is held for the long-term. Assets include depreciable tangible and intangible personal property, real property, timber, certain livestock, and unharvested crops. Not included: inventory, copyrights, property held for sale to customers, and U.S. government publications.
The S corporation is least likely to benefit which of the following individuals? A) Mark, a stockholder who is not an employee. B) Karl, who wishes to direct funds to support a 22-year-old son, a college student. C) Carol, a retiree, wishes income from the corporation without double taxation. D) Jim, who wishes to transfer income to his higher-income-earning brother.
The S corporation business form avoids double taxation in a number of ways; one of which is when a shareholder is not an employee. In a traditional corporation, the shareholders are paid dividends, which are taxed twice (once to the corporation and once to the shareholder). In the S corporation, the earnings are not taxable to the corporation and the shareholder's receipt of the earnings is only taxed once. S corporations are also commonly used for retirement purposes, allowing the retiree to draw a salary and avoid double taxation. The S corporation is also a useful tool when transferring income to a lower-income family member, because making the family member a stockholder allows items of income and expense to be transferred to the family member stockholder on the K-1.
Carol is a CFP® professional who has established a new client-planner relationship with Debbie. Carol has received documentation from Debbie regarding her financial assets. Among other assets, Debbie has shares of ABC Corporation, Inc. Debbie purchased the stock from ABC Corporation in 2011, for a total purchase price of $60,000. During 2017, ABC paid Debbie a tax-free distribution of $10,000. During 2020, ABC paid Debbie dividends totaling $5,000. Debbie indicated in their earlier meeting that when she considered the distributions she had received from ABC, she was confused as to what her current basis was in the stock and has asked Carol for clarification. What basis amount should Carol determine for Debbie in 2023? A) $50,000 B) $60,000 C) $55,000 D) $45,000
The basis for stocks must be adjusted by the amount of any tax-exempt distributions received. Dividends are not tax-exempt distributions and Debbie should have paid income taxes on the dividends during the year in which she received them. The dividends are not applicable in calculating the adjusted basis for the year. The tax-exempt distribution, however, must be deducted. Debbie's 2023 basis is $60,000 − $10,000 tax-free distribution, or $50,000.
Which of the following is NOT a step in the tax calculation process? A) Deduct the greater of itemized deductions or the standard deduction. B) Calculate federal tax on federal taxable income. C) Subtract adjustments to income from total income to get adjusted gross income. D) Subtract exclusions from AGI.
The following are involved in the income tax computation: subtracting adjustments to income from total income to get AGI, and deducting the greater of itemized deductions or the standard deduction from AGI to arrive at taxable income. Subtracting exclusions from AGI is not a step in the tax calculation process. Excluded amounts simply do not show up as income on the return
Betty and Wilma are friends and business associates. Betty gives Wilma a piano that has a FMV of $10,000. In exchange, Wilma excuses a $15,000 debt that Betty owes her. If Betty's original purchase price of the piano was $4,000, what is her realized gain in this transaction? A) $15,000 B) $11,000 C) $6,000 D) $10,000
The gain realized is the difference between the amount realized and the adjusted basis. Betty had a total cost basis in the piano of $4,000. The FMV of the piano when she gave it to Wilma was $10,000. If Betty had instead sold the piano at that time, she would have had a net gain of $6,000. In addition to this gain, she had a $15,000 debt excused for the price of the $10,000 piano. She not only earned the $6,000, but also received an additional $5,000 in non-cash consideration for a total gain of $11,000.
Which of the following statements regarding an S corporation is CORRECT? A) Capital losses incurred by an S corporation will be reported on the S corporation's tax return and taken against S corporation income. B) One of the disadvantages of an S corporation is that the dividends paid to shareholders are subject to double taxation. C) Shareholders of S corporations receive an IRS Schedule K-1 each year. D) S corporation shareholders can establish a self-employed (Keogh) retirement plan as a result of the S corporation income.
The income from an S corporation is not considered self-employment income. Therefore, the shareholders cannot establish a self-employed retirement plan, but can establish an employer-sponsored retirement account such as a 401(k) plan. Note that a shareholder with self-employment income from another source can establish a self-employed (Keogh) retirement plan. Dividends from a C (not S) corporation are subject to double taxation. Capital losses from an S corporation flow through to the individual shareholders and will be utilized on the shareholder's tax return.
Mark is forming a new business and is seeking investors. He is considering using either an S corporation or a limited liability company. He would like to limit the investors' liability to creditors. His father, Eric, who has a grantor retained annuity trust, has agreed to buy shares of the S corporation stock and contribute the shares to his GRAT as a good income generator for the trust. Mark's cousin, Karl, is citizen and resident of Germany and is also interested in investing in shares of the business. Mark's sister, Sara, would like to buy shares through her partnership, Road Crew, to support her brother's business venture. Candace is Mark's friend who is also interested in buying shares in the business. Mark has discussed this list of potential investors with his planner and his planner sees some potential problems. What should Mark's planner tell him? A) Mark should choose the limited liability company entity fo
The only entity form that will limit investor liability and accommodate all of Mark's investors is the limited liability company form. Karl is a nonresident alien and cannot be a shareholder in an S corporation. Sara's partnership is also prohibited from being an S corporation investor. If the owner of a GRAT may invest in a business entity, then the GRAT may also invest as the grantor is treated as the owner of the GRAT for income tax purposes. A limited liability company taxed as a partnership would limit liability for all of the investors in the business. While a limited partnership form would protect the any limited partners, there must be at least one general partner who would have unlimited liability.
Kris Swenson anticipates adjusted gross income of $100,000 for the current tax year. She is considering making a gift of a painting to the American Red Cross in the current tax year. Kris's basis in the painting is $35,000. The painting has a current fair market value of $50,000. Kris has owned the painting for 15 years. If Kris does gift the painting to the American Red Cross this year, what is the maximum allowable charitable deduction she can receive in the current tax year? A) $20,000 B) $50,000 C) $30,000 D) $35,000
The painting would be considered use-unrelated tangible personalty. The deduction for use-unrelated tangible personalty is limited to basis, with a 50% of AGI limitation. Thus, the current-year deduction is $35,000. If the painting had been donated to an art museum, for example, the contribution would be of use-related tangible personalty. Since the painting had been held for the long-term holding period, the deduction would have been $30,000 (long-term capital gain property to a 50% organization uses FMV with a 30% of AGI limitation) with a $20,000 carryforward.
Jack is a sole proprietor of a shampoo factory. During the year, he sold a mixing machine for $13,000 he had purchased 5 years earlier. The mixer had an adjusted basis of $10,000. He also sold a bottling machine he had owned for 11 years. His adjusted basis for the bottling machine was $50,000, and he sold it for $42,000. What is his net loss on the property and how will it be treated for tax purposes? A) $8,000 loss; treated as a long-term capital loss. B) $8,000 loss; treated as an ordinary loss. C) $5,000 loss; treated as a long-term capital loss. D) $5,000 loss; treated as an ordinary loss.
The properties in question fall under the Code Section 1231. Section 1231 specifies that the net loss on the sale of all such property is treated as an ordinary loss. Jack's net loss is $5,000, because he had a gain of $3,000 on the first sale, but lost $8,000 on the second sale. He is entitled to treat the $5,000 net loss as an ordinary loss for income tax purposes.
Which of the following statements regarding tax deduction limits on passive activity excess losses is CORRECT? A) Excess passive activity losses are the excess of otherwise allowable deductions from the taxpayer's passive activities over the amount of income from the taxpayer's passive activities. B) Losses from one non publicly traded passive activity may not offset income from another non publicly traded passive activity. C) Excess passive activity losses are allowed on the taxpayer's current tax return. D) Excess passive activity losses are partially allowed in the year in which the taxpayer disposes of their entire interest in the passive activity in a taxable transaction.
The taxpayer's non publicly traded passive losses and non publicly traded passive income are aggregated for purposes of the limitation, so that losses from one non publicly traded passive activity may offset income from another non publicly traded passive activity. Excess passive losses must be deferred into future tax years, but fully deductible in the year the taxpayer disposes of the passive activity in a taxable transaction.
Brittany, age 17, earns $5,000 in salary. Kate, age 7, has $2,600 in dividends from a mutual fund. Tony, age 3, has $1,250 in interest from a savings account. Amanda, age 19 and not a full-time student, has $2,000 in dividends and interest. Which of these children have income subject to their parents' marginal income tax rates? A) Kate and Tony B) Brittany C) Kate D) Kate, Tony, and Amanda
This question is related to the kiddie tax, which applies to unearned income in excess of $2,500 (for 2023), by a child under the age of 19 or a full-time student under age 24. Although Brittany is younger than 19, she has only earned income. Amanda, age 19, is not subject to kiddie tax because her unearned income does not exceed $2,500. Tony, age 3, had unearned income less than $2,500. Therefore, the correct answer is Kate, who at age 7, had unearned income of $2,600.
On October 15, 2022, Erin purchased stock in Glennan Irish Ale Corporation for $2,000 (the stock is not small business stock). On June 15, 2023, the stock became worthless. How should Erin treat the loss in 2023? A) $1,000 short-term capital loss Incorrect Answer B) $2,000 long-term capital loss Correct Answer C) $2,000 short-term capital loss Incorrect Answer D) $1,000 long-term capital loss
Worthless securities are treated as becoming worthless at year-end. Therefore, the loss is a long-term capital loss even though the stock became worthless after only eight months.
