Tax Planning - Practice Quiz
Which of these best describes a tax benefit associated with an active participation real estate investment?
Up to $25,000 in losses may be used to offset active or portfolio income. Active participation rental real estate allows for losses of up to $25,000 on an annual basis. The full deduction is only available if the AGI is under $100,000. There is a phaseout between $100,000 and $150,000 of AGI. It is true that the losses may be used to offset active or portfolio income, but up to $25,000 in losses may be used to offset active or portfolio income is the most complete answer.
What percentage of current-year estimated tax payments and withholding must be paid by a married taxpayer to avoid the imposition of a penalty for underpayment of estimated tax? (Assume that the taxpayer had AGI in the prior year of $110,000.)
90%
In June of the current year, Mindy sold her principal residence for a total price of $185,000—she received $100,000 in cash and the buyer assumed an $85,000 mortgage on the house. Mindy purchased the house six years ago for $120,000 and has made $80,000 in improvements to the house. Real estate commissions of $9,200 resulted from the sale. What amount of gain or loss, if any, must be recognized on the sale of Mindy's residence?
$0
On May 1, Michael is injured while riding his bicycle as part of his fitness program. The injury is severe enough that Michael is unable to work, and he collects disability payments until he returns to work 4 months later. How much of Michael's disability payment is taxable income?
$0 Because Michael pays 100% of the premium for the disability insurance, none of the payments he receives are taxable income.
Ramone has no passive income. During January of 2020, he purchased an interest in a limited partnership that will generate a $10,000 passive loss during the current tax year. How much of this passive loss, if any, is deductible by Ramone during the current tax year?
$0 Under the passive activity loss rules, the general rule is that passive losses are only deductible against passive income. In this situation, there is no passive income.
Judy's rental real estate was completely destroyed by a fire in June of 2022, and she received the reimbursement check from the insurance company later that month. If there were a gain on the conversion, when would the replacement period end?
December 31, 2024 The replacement period for a casualty or theft begins on the date the property was damaged, destroyed, or stolen and ends on the last day of the second taxable year following the year in which the taxpayer realizes a gain with respect to the property. If this was a condemnation of business or rental real estate, the replacement period would end on the last day of the third taxable year following the year in which the taxpayer realizes a gain from the property.
How much of the premium that Asher Bank & Trust pays for Michael's group term life insurance is includable in Michael's gross income?
$18.00 The premium for the first $50,000 of group term life insurance is not included in Michael's income from Asher Bank & Trust, but the Section 79 premium for the life insurance in excess of $50,000 is included. Michael must include 10 × $0.15 (Section 79 monthly cost per $1,000 of life insurance) × 12 months = $18.00.
Assume a taxpayer is faced with a tax deficiency of $10,000, along with interest on the deficiency of $4,200; the entire deficiency is the result of negligence from the taxpayer's 2020 return. What is the amount of the penalty?
$2,000 The negligence penalty is 20% of the amount of the deficiency attributable to negligence. Twenty percent of $10,000 is $2,000. The interest does not enter into the computation
William and Lisa are divorced. Under the terms of the divorce decree, William is required to pay Lisa $2,000 per month for five consecutive years. The divorce was finalized on December 15, 2018, with the first alimony payment made on January 15, 2019, and on the 15th of each month thereafter. There is no provision in the decree (or under state law) that payments terminate upon the death of the payee spouse, Lisa. How much of each payment, if any, is deductible, and why?
$0, because the payments do not terminate at death Payments that do not terminate upon the death of the payee spouse are not considered qualifying alimony. They are instead considered part of the property settlement. In the event of death, the property is payable to the estate of the deceased. This applies to all payments, even those made prior to death. Remember that, for divorces finalized prior to 2019, qualifying alimony is still deductible by the payor and taxable to the payee.
Lana filed her current income tax return three months late. The return showed a balance due of $10,000. What is Lana's penalty, if any, for late filing of her income tax return?
$1,500 The penalty for failing to file an income tax return is 5% of the amount due for each month, or part thereof, that the return is late. Lana has filed her return three months late, which results in a 15% penalty for late filing. In this case, $10,000 × 15% (5% per month for three months) results in a penalty of $1,500.
Alice is age 16 and is eligible to be claimed as a dependent on her parents' tax return. She has investment income of $4,150 and earned $1,000 babysitting in 2022. How much of Alice's income will be taxed at her individual tax rate?
$1,900 Unearned income (UI) $4,150 Earned income (EI)1,000 Gross income$5,150 Standard deduction(1,400) (earned income plus $400) Taxable income$3,750 UI taxed at parent's marginal rate (net unearned income)(1,850) ($4,150 - $2,300) Income taxed at child's rate$1,900
During the current tax year, Jamie has a $13,000 short-term capital loss and a $14,000 long-term capital gain, both from the sale of securities. Jamie also has a $10,000 long-term capital gain from the sale of collectibles. Jamie, a single taxpayer, is in the 32% marginal income tax bracket. Which of these accurately describes the result of these transactions?
$11,000 long-term capital gain taxed at 15% The $13,000 short-term capital loss is first used against the collectibles gain—the gain that would be taxed at the highest rate (28%). This eliminates the collectibles gain. The remaining $3,000 short-term capital loss is then used against the $14,000 long-term capital gain from the sale of securities. This leaves $11,000 of long-term capital gain, taxed at 15%. We know the long-term capital gain is taxed at 15%, as the top of the 32% MITB is $219,950 (2022) for a single taxpayer, and the 20% LTCG rate doesn't kick in until $459,750 for a single taxpayer.
David and Kristen are married taxpayers filing jointly. They lived in their principal residence for six months, and sold the residence because Kristen was transferred to a job out of state. They have a realized gain of $145,000 on the residence. They have not used the Section 121 exclusion in the past. What is the maximum Section 121 exclusion, if any, that they may claim?
$125,000 They are entitled to a partial exclusion as they failed to meet the two-year test due to health, job, or unforeseen circumstances. The partial exclusion is six months of ownership and use divided by the required 24-month ownership and use period, multiplied by the full exclusion amount of $500,000. Thus, 25% of $500,000 = $125,000.
Reese has the following items: Prior-year passive loss carryforward amounts: ($5,000) from XYZ limited partnership (publicly traded) ($8,000) from ABC limited partnership (nonpublicly traded) Current-year passive income and loss amounts: $2,000 from XYZ limited partnership (publicly traded) ($3,000) from GHI limited partnership (publicly traded) $12,000 from JKL limited partnership (nonpublicly traded) ($14,000) from RST limited partnership (nonpublicly traded) What is the total amount of passive losses that may be deducted during the current year?
$14,000 The general rule is that passive losses may only be deducted against passive income. The rules for publicly-traded partnerships are more restrictive—the passive income from a PTP may not be offset by passive losses arising from any other source. In addition, the passive losses from PTPs are not currently deductible—they may only be used to offset future income from that same activity. Of the $5,000 passive loss carryforward from the XYZ limited partnership, only $2,000 may be used in the current year due to the $2,000 of current-year passive income from that same PTP. A total of $12,000 in losses from the RST limited partnership may be used against the $12,000 of income from the JKL limited partnership in the current year because both are nonpublicly traded. Thus, the total of passive losses allowed for the current year is $14,000.
Three years ago, Lydia purchased specialized manufacturing equipment (seven-year property) at a cost of $66,000. She paid an additional $4,000 to have the equipment installed in her plant. She used the straight-line method, and cost recovery deductions total $30,000. Earlier this year, Lydia sold the equipment for $25,000. What is the amount and character of the gain or loss resulting from this sale?
$15,000 Section 1231 loss, treated as an ordinary loss The loss realized and recognized is the difference between the $25,000 amount realized from the sale and the adjusted basis of $40,000. The adjusted basis is the $70,000 cost basis, reduced by the $30,000 of depreciation deductions taken. Thus, the loss is $15,000. The Section 1231 loss is treated as an ordinary loss, deductible in full against any other income. Remember that the installation is a cost associated with the acquisition of an asset and must be capitalized. Thus, the original cost basis was $70,000. There is no such thing as a Section 1245 loss.
Kurt anticipates adjusted gross income of $100,000 for the current tax year. He is considering making a gift of appreciated stock to his alma mater, Regis University. His basis in this stock is $48,000. The stock has a current fair market value of $60,000. Kurt has owned the stock for four years. If Kurt gifts the stock to Regis, what is the maximum allowable charitable deduction that Kurt can receive in the current tax year?
$48,000 The deduction for a donation of long-term capital gain property to a 50% organization typically is restricted to 30% of AGI, with the deduction based on the fair market value of the asset. However, in this case, the 50% election, using the basis of the property, results in a larger current-year deduction. If the 50% election is made, the deduction amount may be up to 50% of AGI, but the basis of the property must be used.
Bernie and Louise are married and will file a joint return for the current tax year. They each have 401(k) plans through their employers, but neither they, nor their employer, will contribute to the plan this year. They have provided you with the following information. Bernie's salary$96,000 Louise's salary$74,000 Child support payments to Lowell's ex-wife$18,000 Net short-term capital loss$8,000 Home mortgage interest$17,200 IRA contribution—Bernie$6,000 IRA contribution—Louise$6,000 Bernie's divorce was finalized in 2013. Based on the information given, what is the couple's adjusted gross income for the current tax year?
$155,000 The salaries of $170,000 reduced by the $3,000 of net capital losses leaves $167,000 of total income. The $12,000 of IRA contributions is also deductible, as neither spouse is an active participant in a company-maintained retirement plan. After subtracting the $12,000 of IRA contributions, they are left with an AGI of $155,000. Even though they both have a 401(k), neither they, nor their employers, made contributions to the plans during the year, so neither spouse is treated as an active participant. The home mortgage interest is an itemized deduction and does not affect the AGI. Child support payments are not deductible.
Philip, a professor, earned a salary of $140,000 from a university in the current year. He received $35,000 in dividends and interest during the year. In addition, he incurred a loss of $25,000 from an investment in a passive activity. Assuming Philip's at-risk amount in the activity at the beginning of the current year was $15,000, what is his AGI for the current year?
$175,000 Philip's AGI, after considering the passive investment (and loss), is $175,000. This consists of $140,000 of active income and $35,000 of portfolio income. Philip cannot deduct the passive loss of $25,000 against either active or portfolio income. In addition, he is further restricted to a total possible loss of only $15,000 because of the at-risk rules.
Francisco operates a sole proprietorship from his apartment. His gross income for the current tax year is $24,000. Business expenses not associated with his home office total $22,000. Expenses associated with the home office total $2,750. How much of the home office expense, if any, may Francisco deduct for the current year?
$2,000 The home office expense deduction is limited to the earned income from the business. In other words, the home office expense deduction, in general, can neither create nor add to a loss. The only expenses that may create or add to a loss are the allocated amounts of home mortgage interest and property taxes. In this situation, the $24,000 of gross income is reduced by the $22,000 of business expenses not associated with the home office, to leave $2,000 of earned income. Thus, of the $2,750 of home office expenses, only $2,000 would be deductible in the current year. Note that the remaining $750 of home office expenses would be subject to a carryforward.
Phillip's personal automobile was completely destroyed in a hurricane that was declared a federal disaster. Insurance paid $6,000 on the loss. The auto's fair market value was $16,000, and his basis in it was $23,500. Phillip's AGI is $72,500. What is the amount of Phillip's deductible casualty loss?
$2,650 The deductible casualty loss computation begins with the lesser of the decrease in fair market value or the adjusted basis in the property. In this situation, the decrease in fair market value of $16,000 must be used. This is reduced by the insurance coverage of $6,000, and the $100 floor per occurrence. Then it is further reduced by 10% of the AGI ($7,250). Thus, $16,000 - $6,000 - $100- $7,250 = $2,650.
Dolores bought 200 shares in a mutual fund for $15 per share. Shortly after this purchase, the mutual fund went ex-distribution and declared a distribution of $.50 per share. Dolores elected to have dividend distributions from the fund reinvested to purchase additional shares at $15 per share. How much taxable gain will Dolores incur if she later sells all her shares for $16 per share?
$207 Gain is determined by the difference between the sales price of the shares held and the basis of the shares held. Basis is (200 × $15) + ($0.50 × 200), or $3,100. This represents the original cost of the 200 shares plus the reinvested dividends of $100. The number of shares owned must first be determined. The reinvested dividend of $100 is divided by the purchase price and added to the originally purchased shares. $100 ÷ $15 = 6.67 shares + 200 = 206.67 shares (these shares are then multiplied by the sales price of $16 to arrive at a total sales price of $3,307). $3,307 - $3,100 = $207 total gain on the sale.
Devonte had $175,000 of self-employment income and $25,000 in distributive share income from an S corporation. What is Devonte's self-employment tax for 2022? Round your answer to the nearest dollar.
$22,915 The distributive share of income from an S corporation is not subject to self-employment tax. (Answers may vary slightly due to rounding.) Actual earnings$175,000 Less 7.65%(13,388) Net earnings from self-employment$161,612 LESSMaximum amount of SE earnings subject to 15.3% tax (Social Security wage base)(147,000) Excess over wage base$14,612 Medicare rate× 2.9% $424 ($147,000 × 15.3%)22,491 Total$22,915 OR Schedule C net profit (business profit)$175,000 Less 7.65% of Schedule C income($13,388) Self-employment earnings subject to self-employment taxes$161,612 Social Security Tax Calculation (OASDI) Earnings subject to self-employment tax$147,000 Times tax rate12.4%(OASDI tax rate) = Equal self-employment taxes $18,228 Medicare Tax Calculation (HI) $161,612 Times tax rate 2.9% (HI tax rate) = $4,687 (Medicare taxes) Total self-employment tax$22,915 (rounded)
Which of these types of investors derives the greatest tax benefit from investing in preferred stocks?
Corporate Because 50% of the preferred dividends (and other dividends from stock) received by a corporation are exempt from federal income taxes, a corporation gains a tax advantage. The government and nonprofit organizations pay no income taxes. Mutual funds are also exempt from taxation.
Fred, age 59, is a single taxpayer. He has wage income of $90,000 for the current tax year. Fred is not an active participant in a company-maintained retirement plan. In addition, he has the following: Long-term capital gains$4,000Short-term capital losses$9,000Loss from active participation rental real estate$3,700Alimony paid to ex-wife$5,200Gambling winnings$7,100Gambling losses$4,100Interest income$3,500Sole proprietorship (Schedule C) income$2,000Self-employment tax liability$283Qualified home mortgage interest$11,890Real estate tax paid$1,840Investment interest expense$4,925Charitable contributions (cash)$2,975Total medical expenses$4,217State and local income taxes$1,625Consumer interest$2,180Unreimbursed employee business expenses$1,560IRA contribution$6,000 Fred's divorce was finalized in 2017. What is the amount of Fred's allowable itemized deductions?
$25,930 The itemized deductions total $25,930. This is composed of the qualified home mortgage interest of $11,890, the real estate tax paid of $1,840, the investment interest expense of $3,500, the charitable contributions of $2,975, the state and local income taxes of $1,625, and the gambling losses to the extent of gambling winnings ($4,100). Note that the unreimbursed employee business expenses are not deductible. Also, the medical expenses are not deductible because they do not exceed 7.5% of adjusted gross income. Also note that the investment interest expense of $4,925 is deductible only up to the amount of net investment income, which in this situation is $3,500 (the interest income). Consumer interest (interest on personal auto loans, credit card debt, etc.) is nondeductible.
Carl and Janet are married taxpayers filing a joint tax return. In 2022, their AGI is $360,000, and their net short-term capital gain and dividend income (included in the AGI) is $90,000. They have investment interest expense of $4,000 and state and local income taxes attributable to the investment income of $6,000. What is the amount of Medicare contribution tax that they must pay?
$3,040 They will pay the 3.8% Medicare contribution tax on $80,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($360,000 - $250,000, or $110,000). The net investment income is the investment income of $90,000, reduced by the investment expenses of $10,000. In this situation, the $80,000 of net investment income is subject to the Medicare contribution tax. Carl and Janet will pay a $3,040 Medicare contribution tax (3.8% on $80,000).
Jacinta, an investor, has the following items related to her investments during the current tax year: Investment interest expense$4,000 Dividend and interest income$3,500 Investment adviser's fees$1,750 Adjusted gross income$50,000 What is Jacinta's maximum allowable investment interest expense deduction for the current year?
$3,500 The investment interest expense deduction is limited to the taxpayer's net investment income of $3,500. Net investment income is simply the investment income of $3,500. The inclusion of the dividend income results in the largest investment interest expense deduction. However, including the dividends in investment income results in forgoing the potential preferential rates on the dividends. The investment adviser's fees are not deductible and do not enter into the calculation.
Kris anticipates adjusted gross income of $100,000 for the current tax year. She is considering making a gift of appreciated real estate to her church, a qualified charitable institution. Kris's adjusted basis in this real estate is $20,000. The real estate has a current fair market value of $50,000. Kris has owned the real estate for 15 years. If Kris does gift the real estate to her church, what is the maximum allowable charitable deduction she can receive in the current tax year?
$30,000 The current deduction for a contribution of long-term capital gain property to a 50% organization is based on FMV but is limited to 30% of AGI. This results in a $30,000 current year deduction with a $20,000 carryforward.
Brady and Susie, married taxpayers filing jointly, have the following itemized deductions: Home mortgage interest$17,300 State income taxes$12,100 Real estate taxes$6,150 Charitable contributions$11,000 Unreimbursed employee business expenses$7,150 Tax return preparation fee$650 Investment advisers fees$1,975 Their AGI for 2022 is $387,000. What is the amount of their allowable itemized deductions?
$38,300 The state income tax and the property tax deduction (combined—the SALT, or state and local taxes) is limited to $10,000 annually. The home mortgage interest ($17,300), the SALT deduction, and charitable contributions ($11,000) total $38,300. The unreimbursed employee business expenses are not deductible (TCJA).
Three years ago, Zhong purchased specialized manufacturing equipment (seven-year property) at a cost of $56,000. He paid an additional $4,000 to have the equipment installed in his plant. Cost recovery deductions total $40,935. This type of specialized equipment became more and more scarce, and this year, Zhong sold the equipment for $73,000. What is the amount and character of the gain resulting from this sale?
$40,935 Section 1245 gain, $13,000 Section 1231 gain The gain realized and recognized is the difference between the $73,000 amount realized from the sale and the adjusted basis of $19,065. Thus, the total gain is $53,935. The Section 1245 cost recovery recapture is the lesser of the cost recovery deductions taken ($40,935) or the gain realized ($53,935). Thus, the Section 1245 income (cost recovery recapture) is $40,935. The remaining $13,000 of gain is attributable to actual appreciation of the asset; therefore, there is $13,000 of Section 1231 gain. The other way to look at this—the gain created by the depreciation deductions ($40,935) is treated as ordinary income, and the gain attributable to the actual appreciation of the asset ($13,000) is potential long-term capital gain under Section 1231. Remember that the installation is a cost associated with the acquisition of an asset and must be capitalized (added to basis). Thus, the original cost basis was $60,000.
Sarah has two dependent children who attend Sun Valley Day Care while she is at work. She will claim a $1,200 credit for child and dependent care expenses in the current tax year. What amount of deduction would be necessary to provide a tax benefit that is equal to that provided by the child care credit if Sarah is in the 24% marginal income tax bracket?
$5,000 It would take $5,000 of deductions to equal the benefit of a $1,200 tax credit. This is determined by simply dividing the $1,200 of credit (savings) by the marginal income tax bracket of 24%.
During the current tax year, Cassandra has a long-term capital loss of $22,000 from the sale of securities. She also has a long-term capital gain from the sale of a coin collection of $10,000 and has unrecaptured Section 1250 income of $18,000. Cassandra is in the 35% marginal income tax bracket. What is the tax result of her capital transactions?
$6,000 unrecaptured Section 1250 income taxed at 25% The long-term capital loss from the securities sale is netted first against the gain that would be taxed at the highest rate. After completely offsetting the collectibles gain (potential 28% rate), the remaining $12,000 is then netted against the unrecaptured Section 1250 income, leaving $6,000 unrecaptured Section 1250 income, to be taxed at 25%.
Sam has the following items of income: Self-employment earnings$45,000 Interest income$ 4,000 Gain on the sale of a capital asset$12,000 What is the amount of self-employment tax Sam owes? Round your answer to the nearest dollar.
$6,358 Self-employment income$45,000.00 Less 7.65% of $45,000(3,442.50)$41,557.50 Times tax rate15.3% Self-employment tax$6,358.30
The following summarizes several financial events in the life of George during the current tax year. Received $100,000 from a life insurance policy due to the death of his brother Had gambling winnings of $45,000, while incurring gambling losses of $20,000 Received net royalties of $10,000 from an oil and gas investment Received $5,000 of unemployment compensation Had job-related moving expenses of $4,000 Contributed $6,000 to an IRA Assuming George is NOT a professional gambler, what is his total income for the current tax year?
$60,000 Total income is basically the starting point of the income tax calculation. The gambling winnings of $45,000, the unemployment compensation of $5,000, and the royalties of $10,000 are all included in income. Gambling losses are an itemized deduction, to the extent of gambling winnings; thus, they do not affect the total income. The life insurance proceeds received by reason of death of the insured are excluded from income. The IRA contribution is a potential adjustment to income, and does not affect the total income. Job-related moving expenses are only deductible for active duty military personnel who are undergoing a change of station.
Vernon owns a warehouse that has a fair market value of $125,000 and an adjusted basis of $62,000. He wants to acquire Nicole's duplex, which has a fair market value of $100,000 and an adjusted basis of $47,000. In the contemplated exchange, Nicole will pay Vernon $25,000 in cash. What is Vernon's substitute basis in the acquired duplex?
$62,000 We must first compute the gain realized and then the gain recognized. To compute the gain realized (the actual economic gain), use the fair market value of the property received of $125,000 ($100,000 duplex plus $25,000 cash) minus the adjusted basis of the property given up ($62,000 warehouse) to equal a gain realized of $63,000. Next, we compute the gain recognized (the gain that is subject to taxation). The gain recognized is the lesser of the gain realized ($63,000) or boot received ($25,000). Thus, the gain recognized is $25,000. To compute the substitute basis in the acquired duplex, start with the fair market value of the qualifying property received (the $100,000 duplex). This is then reduced by the amount of the gain realized but not recognized (the untaxed, or deferred, gain of $38,000). The FMV of the qualifying property received ($100,000 duplex) reduced by the deferred gain of $38,000 equals the new basis of $62,000.
Michelle has interest and short-term capital gain income of $9,000 during the current tax year. She paid brokers' commissions of $1,000, investment advisers' fees of $2,200, and had $7,700 of interest expense on funds borrowed to purchase securities. Michelle has an AGI of $105,000. What amount of investment interest expense may be deducted as an itemized deduction?
$7,700 The investment interest expense ($7,700) is deductible up to the amount of the net investment income. The net investment income is simply the investment income of $9,000. Investment interest expense may be deducted up to the amount of investment income—$7,700 in this situation. The broker's commissions do not enter into this calculation, nor do the advisor's fees. They are not a deductible expense, and they are not part of the investment income.
Bobby owns a rental office building that he purchased in 2019 for $275,000. He placed the property in service later that year. Recently, Bobby incurred the cost of a new air conditioning system for $11,300, replacement of the roof for $21,000, other miscellaneous repairs for $2,500, conversion of unused space to rental space for $16,700, cleaning services of $1,100, lawn services for $2,300, and construction to make the building handicap accessible for $23,800. Based on these expenditures, how much will be added to the cost basis of his building (capitalized) and will be depreciated?
$72,800 Expenditures that materially extend the life of an asset or adapt it to a new use are considered improvements and are added to the cost basis of the asset and depreciated in accordance with the Internal Revenue Code. As a result, these expenditures include the new air conditioning system, replacement of the roof, costs to convert unused space to rental space, and the costs to make the building handicap accessible ($11,300 + $21,000 + $16,700 + $23,800 = $72,800).
Lowell and Thelma are married and will file a joint return for the current tax year. They are contributing to their respective 401(k) plans through their employers. They have provided you with the following information. Lowell's salary (after 401(k) contributions)$75,000 Thelma's salary (after 401(k) contributions)$50,000 Alimony payments to Lowell's ex-wife$24,000 Net long-term capital loss$7,000 Property taxes$2,000 IRA contribution—Lowell$6,000 IRA contribution—Thelma$6,000 Lowell's divorce was finalized in 2015. Based on the information given, what is the couple's adjusted gross income for the current tax year?
$86,000 The salaries of $125,000 reduced by the $24,000 of alimony payments equals $101,000. This is further reduced by $3,000 of net capital losses. Remember that only $3,000 of net capital losses are deductible in a given year, with an indefinite carryforward of the excess. The $12,000 of IRA contributions is also deductible. Even though both spouses are active participants in company-maintained retirement plans, their MAGI (AGI without the IRA contributions) is only $98,000. This is under $109,000 (for 2022)—the beginning of the phaseout range for married couples filing jointly, when both spouses are active participants. The property taxes are an itemized deduction, and do not affect the AGI.
Assume that married taxpayers filing jointly have a taxable income of $470,650. What is the taxpayers' effective tax rate? You will need to use the tax rate schedule found in your materials
23.8% The effective income tax rate is the amount of income tax ($112,234) divided by the taxable income of $470,650. This gives us 23.8% (rounded). Taxable income $470,650 Less (from tax rate schedule)(431,900) Amount over $431,900 $38,750 Times (marginal rate, from tax rate schedule)35% Tax on amount over $431,900 $13,563 Plus (from tax rate schedule)98,671 Total Tax$112,234
Which of these statements is NOT correct regarding cash value life insurance products?
A MEC is not a life insurance contract. A MEC is a life insurance contract—it must meet one of the two Internal Revenue Code tests for life insurance, and the state law definition. The MEC is a life insurance contract that fails to meet the seven-pay test.
Nine years ago, Claire, age 55, purchased a deferred annuity that is estimated to pay her $850 per month for the rest of her life beginning at age 65. Her investment in the contract is a one-time payment of $50,000. The assumed rate of return on the contract is 3.5%. At this time, Claire is not sure whether she will need to withdraw any of her original investment prior to the starting date of the annuity. Which of these is an income tax implication of the deferred annuity for Claire?
A nonperiodic (lump-sum) distribution will be treated on a last-in, first-out (LIFO) basis. A nonperiodic distribution or withdrawal from a post-August 13, 1982 annuity contract is treated on a LIFO basis. In other words, to the extent that the cash surrender value exceeds the investment in the contract, taxable interest income is treated as being withdrawn first. The earnings on the investment in a commercial annuity are deferred—there is no current taxation on the earnings within the contract as long as an individual is the owner (or treated as an owner) of the contract.
Your client, Yolanda, has active income of $300,000 per year and substantial unused passive losses from a nonpublicly traded limited partnership. She would like to find an investment that would allow her to utilize her passive losses. Which of these is the most appropriate investment for Yolanda?
A nonpublicly traded limited partnership generating passive income
Your client, Eva, has active income of $300,000 per year and substantial unused passive losses from a nonpublicly traded limited partnership. She would like to find an investment that would allow her to utilize her passive losses. Which of these is the most appropriate investment for Eva?
A nonpublicly traded limited partnership generating passive income Eva needs a passive income generator. Only the nonpublicly traded limited partnership would qualify. The MLP, a publicly traded partnership, would not qualify, as income from a publicly traded partnership cannot be offset by passive losses arising from any other source. Passive losses may not be used to offset portfolio income.
Kevin is a college professor who has an accounting business on the side that he runs as a C corporation. He lives entirely off his teaching salary and has never withdrawn any salary or dividend from the accounting practice (a personal service corporation), preferring to save the money within the corporation (from which it will be withdrawn upon retirement). The corporation currently has retained earnings and profits of $500,000. With which of these should Kevin be most concerned?
Accumulated earnings tax In addition to the income tax, corporations are taxed on earnings that are accumulated and not distributed to shareholders when a valid business purpose does not exist for the accumulation. An exemption of $150,000 is allowed to C corporations that are considered personal service corporations. An accumulation of $500,000 would potentially subject the corporation to an accumulated earnings tax of 20% on the $350,000 accumulated in excess of the exemption amount.
Sally is a waitress who makes a significant amount of her income from tips. During the current year, Sally willfully underreported by 50% the amount of tips that she received. Which of these penalties, potentially applicable to Sally, would be the most costly?
Civil fraud
The Mellons are interested in investing some of their projected income from any earnings from Marie's employment in a tax efficient manner. Which of the following investments would accomplish this goal? Put as much of Marie's income as possible into a tax-advantaged retirement account. Invest as much as possible in municipal bonds.
Both I and II Both statements are correct. Generally, any retirement account distributions are taxed at a lower rate during retirement than during the taxpayer's working lifetime. Interest earned on municipal bonds is federal income tax free. If the bonds are sold at a gain, the gain is taxed at the lower capital gain rate.
Which of these is NOT a preference item or adjustment for purposes of the individual alternative minimum tax?
Investment interest in excess of net investment income
Which of these is a characteristic of a policyholder dividend paid by an insurance company?
It generally is exempt from taxation. A policyholder dividend is generally tax exempt, as a return of unused premium. It will be taxable to the extent that the dividends paid exceed the investment in the contract. Also, if the dividend is from a MEC, it is taxable if received as cash or used to pay a loan.
In an attempt to curb overzealous use of tax-sheltered investments, the government has developed rules including at-risk requirements. passive-activity loss limitations. special certification requirements for real estate investors.
I and II No special certification is required for real estate investors.
Sandra and Colby, a married couple, ask you to explain how taxable income is calculated after adjusted gross income has been determined. Which of the following is a deduction from adjusted gross income (AGI) to arrive at taxable income? Additional standard deduction Itemized deductions Exclusions Tax credits
I and II To compute the taxable income, we subtract the greater of the standard deduction (including the additional standard deduction for elderly or blind) or the itemized deductions from AGI. We also subtract the qualified business income (QBI) deduction, if any, to arrive at the taxable income. Exclusions are not reported on the return, so they don't need to be subtracted. Tax credits are deducted from the tax liability.
Yasamin has an apartment building that she would like to exchange. Which of the following assets could Yasamin receive in a like-kind exchange? A shopping center An interest in a real estate limited partnership A vacant lot Land-grading equipment
I and III In a like-kind exchange, real estate must be exchanged for other real estate. Thus, the shopping center and the vacant lot are the only assets that would be qualifying property in a like-kind exchange of realty. The land-grading equipment is personalty and thus cannot be considered like-kind property. The interest in a limited partnership is specifically not allowed as qualifying property. Remember that like-kind exchange tax treatment is limited to realty for realty.
Which of these are techniques of income shifting or splitting? An installment sale of an income-producing asset from a parent to a child Transfer of income-producing property from the grantor to a grantor trust Valid employment of a child in the parent's business
I and III Of the listed choices, only option II is not an example of income shifting or splitting. The transfer of property to a grantor trust, by definition, involves the income being taxed back to the grantor. Thus, there would be no income shifting or splitting.
Which of these below-market-interest loans would result in imputed interest to the lender? An employee borrows $12,000 from his employer, New Media, Inc., to pay medical bills, and the employee has investment income of $330 in the same year. John lends his friend, Mel, $8,000 to buy a boat, and Mel has investment income of $2,200 for the year. Faith borrows $120,000 from her father for an addition to her home. Faith has $4,400 of investment income in the same year.
I and III Statement I describes a compensation-related loan between an employer-lender and an employee-borrower. Because the loan is in excess of $10,000 and is between a corporation and an individual, it is not eligible for treatment as a loan between individuals would be. New Media, Inc. will have interest income and compensation expense in the amount of the imputed interest. In Statement III, Faith's father will have imputed interest income because the loan is in excess of $100,000 and Faith's investment income for the year exceeds $1,000. In Statement II, the loan is not in excess of $10,000, so no interest is imputed.
Which of the following statements regarding inventory valuation techniques are CORRECT? During a period of rising prices, LIFO increases the cost of goods sold. During a period of declining prices, LIFO increases the cost of goods sold. During a period of rising prices, FIFO increases the cost of goods sold. During a period of declining prices, FIFO increases the cost of goods sold.
I and IV During a period of rising prices, the last-in, first-out (LIFO) method treats the higher-priced inventory items as those first sold. This therefore increases the cost of goods sold. Conversely, during a period of declining prices, the first-in, first-out (FIFO) method matches the higher-priced inventory items against income. This naturally increases the cost of goods sold.
Which of the following are considered advantages of direct participation programs? Leverage Tax conduit Special allocations Substantial economic effect
I, II, and III All of the characteristics are advantages of a direct participation program except option IV. Substantial economic effect is actually a disadvantage that serves to limit the potential effectiveness of a direct participation program. Leverage enables the taxpayer to use losses in excess of the amount invested. A tax conduit potentially enables the taxpayer to deduct losses of the business on her individual income tax return. Special allocations allow for the optimum use of the tax benefits and deductions of a partnership.
In her capacity as a part-time independent contractor for Wright and Associates, Marie has invested in expensive and complex architectural design software as well as a high-end, more powerful computer with large dual monitors for her projects. All of her design work is done in a former guest room in the rear of the home that has been converted to an office for Marie's sole use. Marie visits job sites of ongoing projects and meets with clients for whom she is designing but usually at their offices or on the job site. She attends meetings at Wright and Associates offices as needed. Which of the following statements regarding Marie's expenses incurred for her work for Wright and Associates is CORRECT? Marie will receive a Form 1099 for income she receives from Wright and Associates. Both the software and the computer equipment are depreciable assets used in a trade or business. Some of the expenses Marie incurs regarding clients are deductible on Schedule C. Marie's part-time work is presumed a hobby until she has a profit in any three of five consecutive tax years.
I, II, and III Because Marie is an architect by trade, her business is not considered a hobby and she may use Schedule C for her income and expenses.
Under Section 1221, which of the following is a noncapital asset? An office building that is rented to others A painting bought from the artist Accounts receivable of a manufacturer Flowers for sale by a florist
I, III, and IV
Which of the following items received by a taxpayer are included in gross income? Unemployment compensation Child support payments Jury duty fees Awards
I, III, and IV Child support received is excluded, while the other choices are all included in gross income. Unemployment compensation is essentially a replacement for wages, thus taxable.
Which of the following are characteristics of a C corporation but are NOT characteristics of a sole proprietorship? Limited personal liability Tax-free formation Perpetual life Separate taxable entity
I, III, and IV The C corporation involves limited personal liability for the shareholders, potential tax-free formation, and perpetual life, and is clearly a separate taxable entity. The sole proprietorship enjoys potential tax-free formation. The other three options are not characteristics of a sole proprietorship. The sole proprietor has unlimited personal liability. The sole proprietorship does not have perpetual life, nor is it a separate taxable entity.
Larry and Sherry reside in a common law property state and recently became engaged. Larry is a retired sports executive with a considerable fortune and a son from a previous marriage. Sherry has never been married. Larry has presented Sherry with a five-carat diamond ring, contingent upon her signing of a premarital agreement. The income tax consequences of the premarital agreement depend in large part upon which of the following? The original owner of the ring Whether the transfer under the agreement is treated as a gift Local and state law Whether the transfer under the agreement is treated as a transfer for consideration
II and IV The purpose of the premarital agreement is to limit the presumed effect of the marriage on property acquired prior to, or during, the marriage. The income tax consequences of the premarital agreement depend in large part upon whether the transfer under the agreement is treated as a gift (where income tax is avoided) or as a transfer for consideration (which will probably result in the recognition of significant income by one party). State law does not impact federal income tax liability. The origin of the ring is irrelevant.
Diana has asked Alfredo to sign a premarital agreement. Alfredo is a Canadian citizen. Which of the following are characteristics of a valid and enforceable premarital agreement? Once executed, it is binding in all 50 states and Canada. It is not binding without proper disclosure. It should be used with the intention of facilitating a divorce. There should be a written agreement with the willingly executed signatures of both parties.
II and IV To be valid, a premarital agreement must be in writing and contain a complete disclosure of each party's financial situation. Enforceability requirements vary from state to state. It cannot be intentionally used to facilitate a divorce.
According to the CFP Board topics, at what point in the financial planning process is a planner when noting that a client is very concerned about his family's well-being but envisions the children working to help pay for college?
Identifying and selecting goals
Which of these types of audits is conducted on a random basis?
National Research Program (NRP) audit
This year, Irwin sold several securities that left him with the following types of gains and losses: long-term capital gain—$18,000, short-term capital gain—$11,800, long-term capital loss—$12,200, and short-term capital loss—$12,000. What is the net capital gain or loss on Irwin's security sales?
Net long-term gain of $5,600 The long-term gain and loss are netted, leaving a long-term gain of $5,800. Short-term gains and losses are netted, leaving a short-term loss of $200. Because there is a positive and a negative, these are netted to leave a net long-term capital gain of $5,600.
During early 2022, Bob, an individual taxpayer, purchased a principal residence, taking out a mortgage of $600,000. In late 2022, he utilizes a home equity loan to borrow $100,000 to pay off credit card balances and an automobile note. Which of these is CORRECT with respect to the deductibility of the interest on the home equity loan?
None of the interest is deductible because it is not considered acquisition debt. None of the interest on the home equity loan is deductible. Only interest on acquisition debt is deductible. Acquisition debt is debt incurred to purchase, build, or renovate (remodel) the residence.
Which of the following statements best describes the difference between portfolio and passive income or losses?
Portfolio income/loss is derived from investment practices, while passive income/loss is derived from ownership of rental property and activities in which there is no material participation. Portfolio income or loss is characterized as interest, dividends, or non-passive investment property. Passive income or loss is derived from passive or rental activities. A passive activity is one in which the investor does not materially participate. The deductibility of passive losses is generally limited to the amount of passive income.
Harry has a vacation home and is considering renting it to others when he is not using it. It appears that his property will be a mixed-use rental. Which of the following statements regarding mixed-use rentals is CORRECT?
Rental expenses can be deducted only to the extent of rental income. In mixed use rentals, where the residence test is met, rental expenses can be deducted only to the extent of rental income. The mortgage interest and property taxes allocable to the personal use of the vacation home are deductible on Schedule A of Form 1040 as itemized deductions. The rental income and expenses are reported on Schedule E of IRS Form 1040. There is no possibility of a $25,000 ordinary loss against income.
Joe and Carter plan to combine their respective sole proprietorships to enable them to bid on a local automobile plant's contract to provide uniforms, shoes, and safety equipment to 2,300 employees. Joe currently operates a business that sells uniforms and safety equipment. Carter has a shoe store that specializes in work shoes for many occupations. Joe and his spouse have substantial assets and are in the 35% marginal income tax bracket. Carter is single and has a moderate net worth. His annual taxable income is $136,000, excluding the business income from the shoe store. Joe and Carter anticipate net operating losses over the first two years of $30,000, to be followed by substantial profits. They plan to share the management responsibilities equally. Both Joe and Carter admit that the business is risky, as neither one of them has had any experience with such large contracts. Which of these business forms would be most appropriate for Joe and Carter at this time?
S corporation The S corporation is the best choice. This would allow the losses to flow through to the owners and would provide liability protection. The general partnership would not provide liability protection, and to form a limited partnership, there must be a general partner with unlimited liability, so neither of these options would be viable. The C corporation would not allow losses to flow through to the owners.
Rashida and Caroline both have significant net worth and are currently in the highest marginal income tax bracket. They have developed a process that allows them to neutralize toxic chemical waste. They want to form a business that will protect their net worth in case the business fails or it becomes involved in lawsuits, but they also would like to be able to offset income from other sources with the start-up losses. Furthermore, they want to share ownership with other family members if the business is successful. Which business form would be most appropriate for Rashida and Caroline at this time?
S corporation The S corporation will allow the potential losses to flow through to offset other individual income. Also, the use of the S corporation would allow for protection from lawsuits or business failure. Although the general partnership and the limited partnership would both allow for the flow-through of losses, the general partnership would not provide protection from personal liability. There is no indication that either party wants to be a general partner in a limited partnership, so general partnership is not correct. The use of a C corporation would not be appropriate because it is a separate taxable entity, and start-up losses would not flow through.
Christopher's wife, Sarah, died last year and he has been living alone in their home since then. What filing status should he use when filing his income tax return for this year?
Single
Which of these is an economic objective of the federal tax system?
Stabilizing prices
Policyholder dividends from a whole-life insurance policy are generally tax exempt. In which of these situations would the policyholder dividend be tax exempt?
The policyholder receives dividends that are less than the investment in the contract. The dividend from a life insurance policy is typically tax exempt. However, the dividend is taxable to the extent that the dividends received exceed the investment in the contract. The dividend is also taxable if it is from a MEC and received in cash, or is used to pay a loan.
Carol owns and operates a retail appliance store with annual sales of approximately $12 million. The store has an extensive selection of appliances. Approximately 80% of her sales are with extended credit terms. What method of tax accounting is most appropriate for Carol's business?
The cash method, because it provides flexibility in the timing of income and expenses The accrual method of accounting is often mandatory when inventory constitutes a significant income-producing factor. However, Carol's business qualifies for the small business exception, as average annual gross receipts are under $27 million (2022). The hybrid method is incorrect because there is no indication that service constitutes a significant portion of the business. Also, the installment sale method is not available for sales of inventory or sales with revolving credit terms. The accrual method may always be used, but it lacks any flexibility.
Which of these is CORRECT regarding the qualified education interest deduction?
The deduction may only be claimed by the taxpayer legally obligated to make the loan payments. The deduction may only be claimed by the taxpayer legally obligated to make the loan payments. If the loan is in the student's name, the parents may not claim the deduction, even if they make the payments. The deduction is taken as an adjustment to income. There is a $145,000 to $175,000 AGI phaseout for a married couple filing jointly. An individual who is eligible to be claimed as a dependent may not take the deduction.
Rami, an Augusta, Georgia taxpayer, is considering renting out his home for one week (seven days) during a golf tournament in the summer. He is unsure of the income tax consequences related to this rental income. Which of these statements is CORRECT?
The rental income is not includible in income Rentals for 14 days or less (fewer than 15 days) during the year are not required to be included in gross income. However, no deductions specific to the rental are allowed either. The mortgage interest and property tax deductions are unaffected—they are still deductible as itemized deductions.
Which of these is most often considered an advantage of an S corporation?
There is a flow-through of ordinary loss. The ability to have losses flow through to the shareholders to offset other income is one of the primary advantages of the S corporation. The limitation on the number of shareholders is not considered an advantage. Only one class of stock is permitted (although there may be differences in voting rights within that single class of stock), and the business must be a domestic corporation.
Which of these is CORRECT regarding the Lifetime Learning credit?
There is a phaseout between $160,000 and $180,000 of AGI for married taxpayers filing jointly. Qualifying expenses generally include only tuition. Amounts paid for books and supplies may be included only if required to be paid to the educational institution as a condition of enrollment. The credit is available annually for an unlimited number of years. The credit is equal to 20% of qualified tuition expenses up to $10,000. All of the listed options, except for the phaseout limits, accurately describe the American Opportunity tax credit.
Jana, age 35, is the owner of a whole life insurance policy with a face amount of $100,000. The premiums on the policy are $1,400 per year. At the end of the 12th year, it is estimated that the cash value built up within the policy will exceed the premiums paid. The beneficiary of the policy is Jana's husband, Bart. Which of these is an income tax implication of Jana's whole life insurance policy?
There is no income tax levied on the accumulation of cash value within the policy. In a whole life insurance policy, the cash value accumulation is free of current income tax. There is no taxable event, generally, unless the policy is surrendered. The proceeds payable due to death of the insured are tax-free.
Which of these best describes the role of the at-risk rules?
They limit the advantage gained through leverage. The at-risk rule limits the deductibility of losses to the amount at risk. Only certain debt establishes an amount at risk. Specifically, recourse financing and qualified nonrecourse financing (in a real estate activity only) establish amounts at risk. Conceptually, at risk is very similar to basis. A taxpayer may only deduct losses to the extent that he is at risk. The primary difference between at risk and basis is that basis includes all nonrecourse financing.
A taxpayer currently is being audited by the IRS, and the agent has proposed a tax deficiency with which the taxpayer does not agree. The client has asked you to research the issue. Which of these sources is considered to be the most authoritative and, accordingly, would have the highest precedential value in defending the taxpayer's position to the IRS?
Treasury Regulations Treasury Regulations have the full force and effect of law. A PLR is never precedential, Revenue Rulings, and Revenue Procedures are merely administrative interpretations of the statutory tax law, with lower authority than regulations.
Fred owns a package delivery business. During the current year, he purchased and placed into service $1,150,000 of equipment. Fred is in the highest marginal income tax bracket this year, and expects to be in that bracket for two more years. After that, he plans to semi-retire, but keep the business open for another three to five years. He expects to drop into the lower marginal brackets when he semi-retires. What advice would you give Fred regarding the use of various cost recovery methods?
Utilize the bonus depreciation provision The fact pattern indicates that Fred is in the highest marginal bracket for three years, and then will be in the lowest marginal bracket after that. It makes sense to maximize the depreciation deduction this year when he is in the highest marginal bracket. By utilizing the bonus depreciation provision, the entire $1,150,000 may be deducted in the year of acquisition. There is no 50% bonus depreciation provision in 2022 — a taxpayer may elect 100% bonus depreciation or forgo it entirely.
Which of the following statements regarding married couples who file joint tax returns is NOT correct?
When spouses file jointly, each spouse is liable for only one-half of the tax due.
Michael and Marie have begun to work with you, a CFP® professional, and have been going through the process of financial planning. They have received the letter establishing the client-planner relationship from you and furnished you with all of the information and documents you have requested. You have performed an analysis of their current financial status and developed recommendations you feel will meet the couple's goals and objectives. You have documented your process. What is your next step in the financial planning process with Michael and Marie?
You should present your recommendations to the couple and show how your recommendations will help Michael and Marie realize their short- and long-term financial planning goals.
The gross profit percentage in an installment sale is calculated by
dividing the gross profit by the contract price. The gross profit percentage in an installment sale is calculated by dividing the gross profit (the sale price minus the adjusted basis) by the contract price (typically the sale price). It is not determined by multiplying the marginal income tax bracket by the payments received
All of these statements regarding recapture (the taxation of certain gain from the sale of the asset as ordinary income instead of capital gain) are correct except
for real property, all depreciation claimed is always subject to recapture at the ordinary tax rate income upon the sale of the property. There is no recapture of depreciation on the sale of Section 1231 real estate. The gain created by the straight-line depreciation is referred to as unrecaptured Section 1250 income, which is a type of long-term capital gain that is taxed at a maximum rate of 25%. If the taxpayer's marginal tax rate is less than 25%, the unrecaptured Section 1250 gain will be taxed at that lower rate.
Camille, a successful trial attorney, also races stock cars professionally. Camille has never won a race, but because she races the professional circuit she claims to be in the business of racing and thus has been deducting the cost of maintaining her cars and crew from her income from practicing law. If the IRS disallows this loss, it will most likely be because of the
hobby loss rules. The tax rules most likely to be applied in this situation are the hobby loss rules, which state that the taxpayer must have a profit motive in the activity in order to deduct losses from the activity.