CFP Tax planning Practice Exam

Which of these is NOT a step in the tax research process? A) Obtaining a letter ruling from the IRS if the issue is novel B) Obtaining all the facts C) Diagnosing the problem from the facts D) Communicating the answer

Communicating with the IRS is not a typical step in the research process. LO 8.1.1

Under the imputed interest rules, which of the following statements is CORRECT? A) Tax avoidance loans must be less than $10,000 to avoid the imputed interest rules. B) A loan between a lender-employer and a borrower-employee follow the same rules as gift loans between individuals. C) If the borrower's net investment income for the year does not exceed $1,000, then $1,000 is the maximum interest that can be imputed on loans of $100,000 or less. D) On gift loans between individuals in the amount greater than $10,000 and less than or equal to $100,000, the imputed interest cannot exceed the borrower's net investment income.

On gift loans between individuals in the amount greater than $10,000 and less than or equal to $100,000, the imputed interest cannot exceed the borrower's net investment income. If the borrower's net investment income for the year does not exceed $1,000, then no interest can be imputed on loans of $100,000 or less. A loan between a lender-employer and a borrower-employee is considered a compensation-related loan and the $10,001-$100,000 exception does not apply. If the principal purpose of a loan is tax avoidance none of the exceptions to the imputed interest rules apply. LO 3.3.1

Ted is 21 and is preparing to file his annual federal income tax return. He received the following during the calendar year: Autographed guitar won from a radio station Cash received for cutting grass in the summer Tuition scholarship to Private University Which items are excluded from gross income on his tax return? A) III only B) I, II, and III C) I only D) II and III

Only the tuition scholarship is excluded from gross income. The prize and the cash received for cutting grass are included. LO 2.4.1

Which of these are allowable itemized deductions for purposes of computing the alternative minimum tax (AMT)? Charitable deductions Qualified housing interest Medical expenses in excess of 7.5% of AGI Real estate taxes A) II, III, and IV B) I, II, and III C) I and II D) II and III

Option IV, real estate taxes, is the only itemized deduction listed that is not allowed for AMT purposes.

Which of these rules or doctrines may limit the availability of income tax benefits from a particular investment? Tax conduit The substantial economic effect doctrine The at-risk rule The passive activity loss rule A) II and III B) I and III C) I and IV D) II, III, and IV

The substantial economic effect doctrine limits the ability to use special allocations in a partnership. The at-risk rule limits the ability to use leverage by attacking the use of nonrecourse financing. The passive activity loss rule limits the ability to deduct losses from activities in which the taxpayer does not materially participate. LO 7.1.2

Troy and Myrna are married and file a joint income tax return. They have two dependent children who attend day care so that Troy and Myrna can work outside the home. Their adjusted gross income was $140,000 last year. On last year's tax return, the couple claimed a $960 credit for child care expenses. They are in the 22% marginal income tax bracket. What amount of deductions would be required to equal the tax benefit of the $960 child care credit? A) $4,364 B) $749 C) $211 D) $1,230

The $960 credit is divided by the marginal income tax rate of 22% to equal $4,364. The other way to look at this is that a $4,364 deduction in a 22% tax bracket will save the taxpayer $960.

Which these statements is CORRECT regarding the Section 121 exclusion? A) In order to qualify for a full exclusion, the exclusion may not be used more than once in a three-year period. B) The maximum exclusion for a married couple filing jointly is $250,000. C) The exclusion may not be used if the residence was acquired in a like-kind exchange within the last five years. D) A taxpayer must be age 55 or older to qualify for the exclusion.

The Section 121 exclusion may not be used if the residence was acquired in a like-kind exchange within the last five years. The maximum exclusion for a married couple filing jointly is $500,000. There is no age limit for the Section 121 exclusion. The exclusion may be used every two years. LO 6.2.5

ABC Corporation purchased various items of depreciable tangible personal property, with a total cost of $3.42 million, for use in its business during 2024. Assume that ABC has taxable income (without regard to the Section 179 expense) of $290,500 this year. What is the maximum Section 179 deduction that ABC may claim in the current year? A) $3,260,000 B) $1,160,000 C) $370,000 D) $290,500

The Section 179 election is first reduced by the amount that property placed in service during the tax year exceeds $3.05 million. The $370,000 excess reduces the maximum election to $850,000 ($1.22 million maximum Section 179, reduced by the $370,000 excess). The maximum deduction is then limited to taxable income (or earned income), which in this case is $290,500. LO 6.1.5

Amy bought a small print shop for $40,000. In the current year, as a result of depreciation deductions taken on previous income tax returns, her adjusted basis for the print shop was $38,000. Also in the current year, she added a new wing to the print shop, which cost $40,000. What is her adjusted basis for the building in the current year after the addition to the building? A) $80,000, less the actual cost of construction of the new addition B) $78,000, less the actual cost of construction of the new addition C) $80,000 D) $78,000

The Tax Code requires that certain items must be included when calculating adjusted basis. Two of the items included are expenditures affecting the capital account (i.e., the cost of an addition) and any depreciation deductions taken. When Amy first bought the building, her basis was $40,000. Her adjusted basis without the new addition, but including the $2,000 depreciation, would be $38,000. The cost of the new addition is not deductible from income, but is instead a capital expenditure that must also be depreciated. The $40,000 basis of the addition is added to the original basis of the building, resulting in an adjusted basis of $78,000. LO 6.1.2

Kevin and Karen are married taxpayers filing a joint tax return. In 2024, their AGI is $320,000, and their net long-term capital gain 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? A) $3,420 B) $3,040 C) $2,660 D) $2,280

They will pay the 3.8% Medicare contribution tax on $70,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($320,000 - $250,000, or $70,000). The net investment income is the investment income of $90,000, reduced by the investment expenses of $10,000. In this situation, the $70,000 excess of the AGI over the threshold amount is subject to the Medicare contribution tax. Kevin and Karen will pay a $2,660 Medicare contribution tax (3.8% on $70,000). LO 2.3.1

Derrick is about to begin receiving payments from a deferred fixed annuity that he purchased many years ago. His investment in the annuity contract was $202,500. He is to receive $1,500 per month for the rest of his life. His current life expectancy, based on IRS tables, is 15 years. What amount, if any, of each monthly payment is taxable to Derrick? A) $1,500 B) $0 C) $1,125 D) $375

Derrick is expected to receive $270,000 ($1,500 × 12 × 15). His investment in the contract ($202,500) is then divided by the total amount expected to be received ($270,000) to determine the excludible portion of each payment. $202,500 ÷ $270,000 = 75% exclusion ratio × $1,500 = $1,125 excludible from each payment. Thus, the remaining $375 of each payment is taxable. ($202,500 investment/ $270,000 expected return)= 75% x $1,500 payment = $1,125 excluded

Barney had an adjusted basis of $15,000 in an antique automobile that he had purchased as an investment. He sold the auto for $45,000. This year, the buyer made a down payment of $12,000 and made the first of three annual installment payments of $11,000. What amount, if any, of installment sale income must Barney recognize in the current year? A) $7,667 B) $23,000 C) $7,334 D) $15,333

Dividing the profit by the total contract price yields the gross profit percentage, or ratio. In this case, the gross profit was $30,000 and the contract price was $45,000. The profit of $30,000 divided by $45,000 equals a gross profit percentage of 66.67%. This tells us that 66.67% of each dollar received is profit. This percentage is multiplied by the $23,000 received during the year to yield a taxable amount of $15,333. LO 6.2.4

Case Study Question Which of the following tax credits are the Mellons qualified to use against their income tax liability this year? Child and dependent care credit Child tax credit A) I only B) II only C) Both I and II D) Neither I nor II

Explanation The Mellons are qualified to use a child tax credit for their children. The child and dependent care credit, which is for dependent care expenses that allow the taxpayer to work, is limited to 20% of expenses incurred for the couple because their combined income is greater than $43,000. LO 9.2.1

During 2024, Gabe purchased equipment for his manufacturing business (a C corporation) for $3,100,000. His business will have taxable income of $1,500,000 (without regard to the Section 179 expense) for the year. What is the maximum Section 179 expense election for Gabe in the current year? A) $1,170,000 B) $1,750,000 C) $1,220,000 D) $1,500,000

Explanation The Section 179 expense election is limited based on the dollar amount of qualifying property placed in service during the tax year. To the extent that more than $3,050,000 (for 2024) of qualifying property is placed into service during the tax year, the benefit of the Section 179 election is reduced on a dollar-for-dollar basis. In this situation, there was $50,000 extra placed into service, so the $1,220,000 maximum Section 179 election is reduced by the $50,000, leaving a $1,170,000 Section 179 election. In this situation, there is sufficient taxable (earned) income to allow this deduction. LO 6.1.5

Two years ago, Maxwell purchased a computer (five-year property) for use in his business at a cost of $12,000. Cost recovery deductions total $7,392. The computer was sold for $6,000. What is the amount of cost recovery deductions, if any, that must be recaptured? A) $1,392 B) $6,000 C) $7,392 D) $0

Explanation The adjusted basis of $4,608 is subtracted from the $6,000 sale price to give a realized gain of $1,392. This is compared to the cost recovery deductions taken of $7,392. The lesser of the two amounts is the ordinary income, or cost recovery recapture. (The adjusted basis is the cost basis of $12,000 reduced by the cost recovery deductions taken of $7,392.) LO 6.1.4

In 2024, Sonja, age 16, is claimed as a dependent on her parents' income tax return and has $5,850 of short-term capital gains and interest income from a UGMA account that was established by her grandparents many years ago. Sonja's parents, who file jointly, have taxable income of $400,000. What is Sonja's income tax liability for 2024? A) $1,170 B) $0 C) $862 D) $1,396

Explanation The first $1,300 of unearned income is sheltered by the child's limited standard deduction. The next $1,300 is taxed to the child at the child's marginal income tax bracket. All unearned income in excess of $2,600 (for 2024) is taxed to the child at the parents' rates. $5,850unearned income(1,300)standard deduction(1,300)taxed at child's rate of 10%: $1,300 × 10% =$130$3,250taxed at parents' marginal rate 32%$1,040Total$1,170 LO 8.2.3

In March of the current year, Susan sold her principal residence for a total price of $450,000. Susan purchased the house 15 years ago for $80,000. She has not made any improvements to the house. Real estate commissions of $27,500 resulted from the sale. Sixteen months later, Susan bought a new residence for $225,000. What amount of gain, if any, must be recognized on the sale of Susan's residence? A) $0 B) $92,500 C) $120,000 D) $342,500

Explanation The gain recognized is the amount taxable—it is the amount after the Section 121 exclusion. This is computed as follows: Gain realized:Amount realized:Sale price$450,000Selling expenses(27,500)Total amount realized$422,500Less adjusted basis(80,000)Gain realized$342,500Gain recognized:Gain realized$342,500Less exclusion(250,000)Gain recognized$ 92,500 The purchase of the new residence is not relevant to the Section 121 exclusion. If there had been a loss on the sale of the principal residence, it would not be deductible. The loss on a personal-use asset is nondeductible. LO 6.2.5

Yukiko, an investor, has the following items related to her investments during the current tax year: Investment interest expense$4,000Dividend and interest income$3,500Investment adviser's fees$1,750Adjusted gross income$50,000 What is Yukiko's maximum allowable investment interest expense deduction for the current year? A) $4,000 B) $3,500

Explanation 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. LO 2.2.1

Which of these statements regarding long-term capital gains rates is NOT correct? A) Net long-term capital gains are generally subject to a maximum rate of 15% or 20%. B) A 28% maximum capital gains rate applies to the gain on collectibles held for more than one year. C) A 25% maximum capital gains rate applies to unrecaptured Section 1250 income. D) The long-term capital gain holding period is one year.

Explanation The long-term capital gain holding period is more than 12 months. The other statements are correct.

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 $4,000 Short-term capital losses$9,000 Loss from active participation rental real estate $3,700 Alimony paid to ex-wife $5,200 Gambling winnings$7,100 Gambling losses$4,100 Interest income$3,500 Sole proprietorship (Schedule C) income $2,000 Self-employment tax liability $283 Qualified home mortgage interest $11,890 Real estate tax paid$1,840 Investment interest expense$4,925 Charitable contributions (cash)$2,975 Total medical expenses$4,217 State and local income taxes$1,625 Consumer interest$2,180 Unreimbursed employee business expenses $1,560 IRA contribution$6,000 Fred's divorce was finalized in 2017. What is the amount of Fred's allowable itemized deductions?Fred's divorce was finalized in

From the $95,900 of total income, we would subtract the adjustments to income. The adjustments to income total $12,341. This is comprised of the $5,200 of alimony payments, one-half of the self-employment tax liability ($141), and the IRA contribution of $7,000. Note that the IRA contribution is deductible in this situation because Fred is not an active participant in a company-maintained retirement plan. Subtracting the $12,341 from the total income of $95,900 leaves us with $83,559. The total income is computed by starting with the wage income of $90,000. To that $90,000, we add the interest of $3,500, the self-employment income of $2,000, and the gambling winnings of $7,100. Of the $9,000 of short-term capital losses, the first $4,000 would offset the long-term capital gains. Of the remaining $5,000 net capital loss, only $3,000 would be deductible in computing the current year total income. The $3,700 active participation real estate loss is fully deductible, as the AGI (computed without regard to the active participation loss) is less than $100,000. Thus, the total income is $95,900. Total (gross) income$95,900Adjustments to incomeAlimony paid$5,200½ self-employment tax$141IRA deduction$7,000Total adjustments$12,341Adjusted gross income$83,559

All of the following are permitted to represent taxpayers before the IRS in an audit proceeding except A) CFP® certificants without additional credentials. B) licensed attorneys. C) certified public accountants. D) enrolled agents.

A CFP® certificant without additional credentials is not permitted to represent taxpayers before the IRS in an audit.

Tony and Paulette are married and will file a joint return. They have one dependent son, Ben, who was born earlier this year. When Ben was born, Paulette's father gave Tony and Paulette a cash gift of $50,000. Tony is not an active participant in a company-maintained retirement plan. Tony paid child support to a former spouse. They have provided you with the following information. Tony's salary $170,600 Tony's IRA contribution $7,000 Itemized deductions $24,000 Child support paid $12,000 Workers' compensation received $6,000 Based on the information given, what is the couple's taxable income for the 2024 tax year? A) $134,400 Correct Answer B) $152,400 Incorrect Answer C) $158,400 Incorrect Answer D) $140,400

A taxpayer is allowed to deduct the greater of the standard deduction ($29,200 for 2024) or total itemized deductions ($24,000). The IRA is deductible because neither spouse is an active participant in a company-maintained retirement plan. The child support payments made are not deductible. The workers' compensation benefits are excluded from income. The gift received is also excluded from income. Salary $170,600 Less: IRA deduction (7,000) AGI $163,600 Less: Standard deduction (29,200) Taxable income $134,400

Alicia is age 16 and her total income was $6,000 in qualified dividends in 2024. Her parents' marginal tax rate is 12%. What is the tax on the dividends at Alicia's rate? (Round the answer to the nearest dollar.) A) $30 B) $100 C) $150 D) $0

Alicia can use the long-term capital gains tax rate on qualified dividends received. At her parents' marginal rate, the long-term capital gains tax rate is 0%. LO 2.2.2

Which of the following married couples may NOT file their federal income tax return using the married filing jointly (MFJ) status? A) Terry and Edie moved into separate homes in November of this year but have not yet started legal proceedings to end their marriage. Incorrect Answer B) Paul and Josie were married this year on New Year's Eve. Incorrect Answer C) Sara has income for the tax year but Jack does not. Incorrect Answer D) Mark and Beth are both self-employed and have different fiscal years to accommodate their businesses.

Because Mark and Beth have different fiscal years to accommodate their businesses, their tax years do not begin on the same date and they may not file as MFJ. The other three couples are eligible to use the MFJ filing status.

Darryl owns two houses he has rented to tenants. He has hired Property Managers, Inc., to collect rents, provide maintenance, and pay mortgages on the properties. His approval is required for all disbursements and any repairs or changes made to the houses. Which of the following statements regarding Darryl's rental activities are CORRECT? Darryl is a small investor who meets the definition of active participation in the rental activity. Subject to AGI limitations, Darryl may deduct up to $25,000 in real estate losses against active and/or portfolio income annually. A) Neither I nor II B) I only C) Both I and II D) II only

Both statements are correct. Darryl meets both of the tests for an active participant in real estate activities and qualifies for the $25,000 deduction. The tests are as follows: The small investor must actively participate in the activity; note that active participation is a lesser standard than that of material participation and requires only that the investor participate in management decisions regarding the real property. The investor must own at least 10% in value of all interests in the activity during the taxable year. LO 7.2.1

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?

Christopher may only file as a single taxpayer. He has no dependent children or other dependents in his household and does not qualify for either qualifying widower or head of household status.

Pat's son, Alex, has been severely disabled since he was a small child. He has just turned 22 and Pat has provided all of his support until this January when he was placed in an extended care facility. With the increased expense not covered by insurance, Pat must split his support with his paternal grandmother and his aunt who have provided the other two-thirds equally. Because this is a new situation this tax year, Pat has come to her financial planner to understand who can list Alex on their tax return for the purposes of filing status and possible credits. What does their planner tell the Pat? A) Only Pat, as his mother, can list Alex on her return. B) No one may list Alex on their return because no one has paid more than half of Alex's support. C) The three relatives are free to agree among themselves who will list Alex on their return. D) While one of the taxpayers may list Alex as a dependent in an agreed upo

Eligible taxpayers are generally free to agree among themselves (via a multiple support agreement) who will list an individual as a dependent and who also will claim any available credits when an individual can be claimed by more than one taxpayer.

Grant and Kelly, who file as married filing jointly, sold Section 1244 stock for a $122,000 loss in the current year. What is the character of this loss for the year? A) $50,000 ordinary and $72,000 capital B) $100,000 ordinary and $22,000 capital C) $122,000 ordinary D) $122,000 capital

Explanation A married couple filing jointly who sells Section 1244 stock can treat $100,000 of the loss as ordinary. The remaining loss is a capital loss, which may be netted against capital gains in the year of the loss. Also, in the year of loss, any remaining capital loss after netting against capital gains is deductible against ordinary income as a capital loss to a maximum of $3,000, with any remaining capital loss amounts carried forward to future years and treated as any other capital loss. LO 6.2.1

Which of these statements are CORRECT with respect to active participation rental real estate? The interest may be held through a limited partnership. A deduction-equivalent tax credit of up to $25,000 is available. The taxpayer must hold a 10% or greater ownership interest. The taxpayer must participate in the management of the property in a bona fide sense. A) I and II B) I, II, and III C) II and IV D) III and IV

Explanation Active participation real estate requires involvement in a bona fide sense. The taxpayer must, at least, make the major management decisions. Also, by definition, the taxpayer must have a 10% or greater ownership interest in the property. Up to a $25,000 loss, not deduction-equivalent tax credit, may be claimed on an annual basis. The interest specifically may not be a limited partnership interest. LO 7.2.3

ABC Corporation has the following items of income and expense: Taxable income$210,000Federal income tax$59,000Dividends paid in current year$10,000Accumulated earnings and profits at the end of the preceding tax year$190,000 Assume ABC is not a personal service corporation and cannot establish a valid business purpose for its excess accumulations. What is the amount, if any, of accumulated earnings tax payable? A) $10,200 B) $0 C) $28,200 D) $16,200

Explanation Taxable income $210,000 Federal income tax (59,000) Dividends paid (10,000) Accumulated earnings credit ($250,000 - $190,000) (60,000) Excess accumulations $81,000 Accumulated earnings tax rate × .20 Accumulated earnings tax $16,200 LO 5.2.1

Ted and Sophie are divorcing in the current year and Sophie is questioning her planner about the tax impact of the financial aspects of the divorce decree. Ted will be paying alimony to Sophie for the next four years unless she remarries first. Ted will pay child support to Sophie for their only son, Mark, until he reaches age 18. Sophie and Mark will continue to live in the family home and Ted's interest in the home will be transferred to Sophie. Which statement concerning the income tax implications of Ted and Sophie is not correct? A) When the family home is transferred to Sophie by Ted, it does not affect her income. B) The child support payments are not taxable income to the recipient and are nondeductible by the payer. C) In the event that she later sells the home, Sophie must consider Ted's adjusted basis prior to the transfer. D) The alimony paid by Ted is deductible as an itemized deduction on his income tax

Explanation Alimony is not (and never has been) an itemized deduction. For divorce agreements after 2018, alimony is no longer an above-the-line deduction for the payor nor taxable income to the payee. LO 4.2.3

Herman is a single taxpayer. On January 1, 2024, he received a gift from his grandfather of a house that immediately became his principal residence. Eighteen months later, he sold this home for a realized gain of $220,000. He sold the home because he received a job promotion and was transferred to a new location out of state. What is the amount of gain, if any, that may be recognized? A) $32,500 B) $220,000 C) $55,000 D) $0

Explanation An exception to the general rule is available for a taxpayer who fails to use the residence for the required two-year period because of unforeseen circumstances, or a health- or job-related move. A pro rata exclusion, based on the full $250,000 exclusion multiplied by the percentage of the required time period that was completed, is available. In this situation, the full exclusion of $250,000 multiplied by 75% (18 months of use divided by the 24 months of required use) results in a maximum exclusion of $187,500. The realized gain of $220,000 reduced by the Section 121 exclusion of $187,500 leaves a gain recognized (subject to tax) of $32,500. LO 6.2.5

Case Study Question Michael took several executives to dinner to discuss business issues. The executives are from companies he hoped would move their business to his bank. Asher Bank uses an accountable-type plan to reimburse employees for business expenses. Michael invited four potential clients to a business dinner and incurred the following expenses: Dinner: $425 Tip: $80 Limo rental: $125 Asher Bank reimbursed Michael $630. How much, if any, must Michael include in his gross income? A) $377.50 B) $630.00 C) $315.00 D) $0.00

Explanation Asher Bank uses an accountable plan and can reimburse all of the expenses Michael incurred. Michael is not required to include any of the reimbursement in his income. However, Asher Bank may only deduct 50% of the meal and the tip as a business expense. LO 9.1.2

LMN Corporation owns 5% of the outstanding stock of the STU Corporation. During the current year, LMN receives $10,000 of dividends from STU Corporation. Both corporations are domestic corporations. Which of the following correctly identifies the tax treatment of the dividends received by LMN? A) The dividends may be 80% excluded. B) The dividends are fully included. C) The dividends received are fully excluded. D) The dividends may be 50% excluded.

Explanation Fifty percent of the dividends received from a qualifying corporation may be excluded if the recipient corporation owns 20% or less of the distributing corporation; there is a 65% exclusion with 20% to 80% ownership; and there is a 100% exclusion if the recipient corporation has over 80% ownership. LO 5.2.1

Which these is a requirement for a valid S corporation election? A) There may be no more than 75 shareholders. B) There may be no more than two classes of stock. C) All shareholders must be U.S. citizens or residents or be one of certain qualifying trusts. D) A simple majority of shareholders must consent to the election.

Explanation For a valid S corporation election, all shareholders must be U.S. citizens or residents or be certain qualifying trusts. There may be no more than 100 shareholders, and there may be no more than one class of stock, although differences in voting rights are allowed within the single class of stock. Also, to elect S corporation status, all shareholders must consent to the S corporation election. LO 5.2.2

Denise earns $155,000 annually. The following summarizes her other income tax information for the current tax year: Made a $7,000 IRA contribution Received $1,700 interest from a private-activity municipal bond Received $300 for jury duty Received $12,000 of alimony from her former spouse (divorced in 2016) Received child support of $24,000 Denise has a 401(k) available through her employer, but neither she nor her employer has ever contributed to the account. Based on the information given, how much total income does Denise have for tax purposes? A) $192,700 B) $149,500 C) $161,800 D) $167,300

Explanation Her total income (the starting point for the federal income tax calculation) is composed of the $155,000 wages received, the $12,000 alimony received, and the $300 of jury duty fees. The private-activity municipal bond interest generally is an AMT preference item, but is excluded for regular income tax purposes. The child support received is also excluded from income. The IRA contribution would be deductible, as she is not an active participant, but it is deductible in arriving at the adjusted gross income, not the total income.

Cecille received 1,000 shares of stock from her grandfather, Ernesto. Ernesto purchased the stock six years ago for $60 per share. The fair market value on the date of the gift to Cecille was $25 per share, and she recently sold the stock for $42 per share. What is the amount of Cecille's gain or loss from the sale of the stock? A) $18,000 loss B) $17,000 gain C) $0 D) $3,500 loss

Explanation If the fair market value on the date of the gift is less than the donor's basis, and the sale price is between the fair market value on the date of the gift and the donor's basis, then there is no gain or loss on the sale. The basis is tied to the sale price of the asset. LO 2.2.2

Dave owns an office building that has a fair market value of $450,000 and an adjusted basis of $280,000. Through an exchange, he acquires a fourplex from Frances that has a fair market value of $485,000 and an adjusted basis of $350,000. In the exchange, Dave pays Frances $35,000. What is Dave's substitute basis in the acquired property? A) $485,000 B) $280,000 C) $315,000 D) $450,000

Explanation In a like-kind exchange, the substitute basis of the acquired asset is the fair market value of the like-kind asset acquired reduced by any gain realized but not recognized. In this situation, the fair market value of the acquired asset is $485,000. There is $170,000 of gain realized but not recognized; therefore, $315,000 is the substitute basis in the acquired asset. The gain realized is the FMV of the property received ($485,000) minus his adjusted basis of $280,000 and the cash paid of $35,000, or $170,000. The gain recognized is $0, as the gain recognized is always the lesser of the gain realized ($170,000) or the boot received ($0). LO 6.2.2

Elliot is an accountant with his own business, E&J Tax Service. The business was organized and is currently operated as a sole proprietorship. Elliot is presently in the maximum marginal income tax bracket. As a tax planning device, he is considering reorganizing the tax service into an S corporation with himself and his 18-year-old son, Bill, as shareholders. Elliot is hopeful that Bill's status as a corporate shareholder will encourage him to eventually join the business. What is one income tax implication of the proposed S corporation as an intrafamily transfer? A) All of the income will be taxed to Elliot as an improper assignment of personal service income. B) Bill will owe self-employment tax on his share of the income. C) A proportion of the income will be taxed to Bill as a percentage owner of the corporation. D) A proportion of the income will be taxed to Bill under the family attribution rules in tax law.

Explanation In order for an S corporation (or partnership) to function as an income-splitting device, capital must be a material income-producing factor. In the case of a tax service, the performance of personal service by Elliot is the material income-producing factor. Thus, the income would be taxed to Elliot. The flow-through of income from the S corporation is not subject to the self-employment tax. LO 5.2.2

Carol has investment interest expenses of $11,000 from her margin account. She had municipal bond interest income of $6,000, corporate bond interest income of $5,000, and qualified dividends of $2,000. She will not forgo the 15% tax rate on the qualified dividends. What is her investment interest expense deduction? A)$5,000 B) $7,000 C) $11,000 D) $13,000

Explanation Investment interest expense is deductible up to the amount of investment income. Carol is limited to a $5,000 investment interest deduction or only the amount of bond taxable bond interest, which is her investment income. She may not treat qualifying dividend income for which she uses the 15% long-term capital gain rate as investment income, nor can she include nontaxable municipal bond interest as investment income. LO 2.2.1

Joy is transferring ownership in a $250,000 whole life insurance policy on herself to her former spouse Jack, pursuant to their divorce decree. At the time of transfer to Jack, Joy's basis in the policy was $47,500 and the cash value was $60,000. What is Jack's basis in the life insurance policy on Joy? A) $60,000 B) $0 C) $12,500 D) $47,500

Explanation Jack's basis in the policy is the same as Joy's basis: $47,500. A transfer of assets between spouses incident to a divorce is income tax free and the transferee assumes the transferor's basis in the property on the date of transfer.

In February 2024, Jerry's manufacturing equipment was completely destroyed in a fire. Jerry determined that the adjusted basis of the equipment was $30,000. The original cost of the equipment was $200,000. In November 2024, he received a check of $200,000 from the insurance company. When does the replacement period end for the involuntary conversion? A) November 30, 2026 B) December 31, 2025 C) December 31, 2026 D) December 31, 2024

Explanation Jerry has until December 31, 2026, to purchase the replacement property because the replacement period for a casualty or theft ends on the last day of the second taxable year following the year in which the gain was realized. LO 6.2.3

Kate is an investor in a nonpublicly traded limited partnership. She invested $50,000 in cash and is personally liable for $5,000 of the partnership's debt. What is Kate's capital at risk in the partnership? A) $5,000 B) $55,000 C) $0 D) $50,000

Explanation Kate's at-risk amount in the nonpublicly traded limited partnership is $55,000. This includes the $50,000 in cash she invested and the $5,000 in partnership debt for which she is personally liable (recourse financing). LO 7.2.2

Which of the following types of income are subject to the self-employment tax? Net income from a real estate rental Investment income from a general partnership Net income from a sole proprietorship Flow-through of income from an S corporation A) I and III B) II and III C) III only D) I, II, III, and IV

Explanation Options I, II, and IV are specifically excluded from the self-employment tax. The investment income that flows through from a partnership (or S corporation) is a separately stated item that retains its character as it flows through from the entity to the individual taxpayer on the K-1. The net income from a sole proprietorship is definitely self-employment income. LO 5.3.1

During January 2014, Jacinto purchased an interest in a nonpublicly traded limited partnership that will generate a $10,000 passive loss for the current tax year. He also owns an interest in a publicly traded limited partnership that will generate passive income of $6,000 for the current tax year. How much of this passive loss, if any, is deductible by Jacinto during the current tax year? A) $4,000 B) $6,000 C) $0 D) $10,000

Explanation Publicly traded limited partnership income may not be offset by other passive losses. Thus, the $6,000 income is simply taxable in the current year. The $10,000 passive loss is carried forward, and, assuming Jacinto buys no other partnerships, may be used when that same partnership generates income, or is fully deductible upon a taxable disposition of the partnership. LO 7.2.2

Which of these is allowable in the computation of total income on the Form 1040? A) Net capital losses of up to $3,000 B) Penalty on the early withdrawal of savings C) Investment interest expense D) Deductible IRA contributions

Explanation Remember that the total income is the starting point for the federal income tax calculation on the Form 1040. The total income is essentially all income that is taxable reduced by several deductions, such as net capital losses up to $3,000, rental losses allowable under the active participation rental real estate provision, Schedule C losses, and other business losses that flow through and are deductible by the taxpayer. It is the amount before the deduction for adjustments to income. The deductible IRA contribution and the penalty on the early withdrawal of savings are adjustments to income. Investment interest expense is an itemized deduction. LO 1.2.1

Brent and Sheila are married and will file a joint return. They have provided you with the following information. Brent's salary$80,000Sheila's salary$65,650Alimony payments to Brent's ex-wife$20,000Brent's child support paid$12,000Itemized deductions$13,000 Brent's divorce decree from his previous marriage was finalized in 2016. Based on the information given, what is the couple's taxable income for the 2024 tax year? A) $111,750 B) $88,450 C) $111,450 D) $96,450

Explanation The $145,650 in salaries is reduced by the alimony payment of $20,000 to give an AGI of $125,650. The AGI is reduced by the greater of the itemized deductions ($13,000) or the standard deduction ($29,200 in 2024), to equal $96,450. The child support paid is not a deductible item.

Frank, a single taxpayer, has a flow-through of net income from a general partnership of $190,000 for 2024. He also has a flow-through of $12,000 of interest and dividends from an investment partnership. What is the amount of self-employment tax that Frank must pay? Round your answer to the nearest dollar. A) $25,995 B) $23,217 C) $23,295 D) $23,643

Explanation Self-employment income $190,000 Less 7.65% (14,535) Net earnings from self-employment $175,465 Less wage base (168,600) $6,865 Medicare rate 2.9% $199 Add 15.3% of $168,600 25,796 Self-employment tax $25,995 OR Schedule C net profit (business profit) $190,000 Less 7.65% of Schedule C income ($14,535) Self-employment earnings subject to self-employment taxes $175,465 Social Security Tax Calculation (OASDI) Medicare Tax Calculation (HI) Earnings subject to self-employment tax $168,600 $175,465 Times tax rate 12.4%(OASDI tax rate) = 2.9% (HI tax rate) = Equal self-employment taxes $20,906 (Social Security taxes) $5,089 (Medicare taxes) Total self-employment tax $25,995 (rounding) The flow-through of investment income is not subject to the self-employment tax. LO 5.3.1

Case Study Question Marie is considering hiring an office assistant who will take on the clerical duties involved in her new consulting business. The employee will begin with part-time hours and, if there is enough business, progress to full-time hours in the future. Which of the following statements regarding the employment of an assistant is CORRECT? Marie will be able to deduct the employee's compensation plus one-half of the FICA tax paid on the employee's compensation. Because Marie is self-employed, her assistant will also be considered self-employed. A) Neither I nor II B) Both I and II C) I only D) II only

Explanation Statement I is correct. Statement II is incorrect. An office assistant hired by Marie would be a compensated employee whose wages would not be self-employment income to the employee.

Case Study Question Which of these are some of the effects of Marie's projected $50,000 of net income on the Mellons' finances in 2024? The Mellons will have a self-employment tax itemized deduction of $7,065 in 2024. The Mellons should keep you informed if Marie's earnings are higher than projected because their income tax bracket could change. Marie's income and expenses will be reported on Schedule E of the couple's Form 1040 for 2024. Marie will need to make estimated tax payments quarterly to avoid an underpayment penalty on their 2024 income tax return. A) I, II, III, and IV B) I and III C) I only D) II and IV

Explanation Statement I is incorrect. A deduction for the employer's share (1/2) of the self-employment tax is an adjustment to income, a deduction for AGI, not an itemized deduction. If Marie's self-employment earnings are $50,000, the self-employment tax is $7,065, and the employer share deduction for AGI is $3,532.50 (half of the self-employment tax). Statement II is correct. Increases in Marie's net self-employment income could trigger a change to a higher income tax bracket and should be monitored. Statement III is incorrect. Marie will be using Schedule C of Form 1040 to report her earnings and expenses. Statement IV is correct. Because Marie is self-employed, she must make quarterly estimated tax payments to avoid an underpayment penalty. LO 9.2.2

Which of the following statements about industry/regulatory relationships are true? The insurance industry is primarily regulated by each of the 50 states. The majority of banks are subject to federal regulation by the Federal Reserve System and the Federal Deposit Insurance Corporation. Pension plan funds are primarily subject to federal regulation. The organized stock exchanges, such as the New York Stock Exchange, are primarily regulated by the individual states in which they are incorporated. A) I, II, and III B) I and III C) I, II, III, and IV D) II and IV

Explanation Statement IV is false because the organized stock exchanges, such as the New York Stock Exchange, are not regulated by the individual states in which they are incorporated. LO 9.3.1

Which of these statements regarding the kiddie tax is not correct? The standard deduction for a child with both earned and unearned income is always earned income plus $450. The child's tax rate is 10% for all income received. The excess of unearned income above $2,600 is tax to the child at the parent's marginal tax rate. The kiddie tax provision limits income shifting, wherein families are prevented from transferring large amounts of unearned income to children and making the shift effective for income tax purposes. A) III and IV B) II only C) I, II, and III D) I and II

Explanation Statements I and II are incorrect. The standard deduction for a child with both earned and unearned income is the greater of $1,300, or earned income plus $450 but limited to the standard deduction for a single taxpayer, $14,600 in 2024. The child's tax rate is determined by the amount of taxable income the child has. Statements III and IV are correct. LO 3.2.1

Case Study Question You have presented a series of recommendations to Michael and Marie to help them realize their financial planning goals. What are your next steps in the financial planning process with them? Create a prioritized financial plan with a timeline. Because the clients are too young to consider estate and retirement planning, you should concentrate on the tax and investments goals and implement those recommendations now. The recommendations should be implemented by you, with the assistance of any other professional as authorized who may be needed, or the client, as agreed upon between the parties. Once you have developed the recommendations, leave it to the couple to implement them. A) I and III B) II only C) IV only D) III only

Explanation Statements I and III are correct. This is the implementing the recommendations step in the financial planning process. Statement II is incorrect. Estate planning and retirement planning should not be ignored unless the client has specifically left it out of the engagement. There are things that may be done now, as well as in the future in both of these areas. Statement IV is incorrect. You and your clients will define responsibilities for implementing the recommendations in this step, as well as decide how the plan will be monitored, how often, and who is responsible for monitoring which aspects. LO 9.3.2

Investments that were intended to defer or eliminate taxes for the investor and, possibly, generate tax losses in excess of the taxpayer's basis are called A) passive activity investments. B) at-risk investments. C) tax shelter investments. D) deductible investments.

Explanation Tax-shelter investments were intended to defer or eliminate taxes for the investor and, sometimes, generate tax losses considerably in excess of taxpayer's basis. Before Congress restricted the practice, paper losses in excess of the amount of capital invested in an activity (particularly by limited partner investors) allowed a considerable benefit to taxpayers who were otherwise not liable if the investment failed. LO 7.1.1

Which of these is NOT a goal of the federal income tax system? A) Monetary policy B) Economic growth C) Inflation control D) Price stability

Explanation The Federal Reserve System controls monetary policy. Income tax policy is used to influence all of the other goals. LO 8.1.2

During the current tax year, Kendra sold several securities that resulted in the following types of gains and losses: long-term capital gain—$6,700; short-term capital gain—$7,000; long-term capital loss—$1,900; and short-term capital loss—$9,200. What is the net capital gain or loss on Kendra's security sales? A) Net short-term gain of $2,600 B) Net long-term gain of $2,600 C) Net long-term gain of $4,800 and net short-term loss of $2,200 D) Net short-term loss of $2,500 and net long-term gain of $5,100

Explanation The long-term items are netted, leaving a long-term capital gain of $4,800. The short-term items are netted, leaving a short-term capital loss of $2,200. The long-term capital gain is netted with the short-term capital loss to result in a net long-term capital gain of $2,600. LO 6.2.1

During the current tax year, Ken sold several securities that resulted in the following types of gains and losses: long-term capital gain—$6,700; short-term capital gain—$7,000; long-term capital loss—$7,700; and short-term capital loss—$9,200. What is the net capital gain or loss on Ken's security sales? A) Net short-term loss of $3,200 B) Net long-term loss of $1,000 and net short-term loss of $2,200 C) Net long-term gain of $1,000 and net short-term loss of $2,200 D) Net short-term loss of $1,200

Explanation The long-term items are netted, leaving a long-term capital loss of $1,000. The short-term items are netted, leaving a short-term capital loss of $2,200. These are kept separate, as the short-term losses are used first to make up the $3,000 net capital loss limit. LO 6.2.1

Sally has AGI of $250,000. In addition, she currently has passive income of $30,000 and passive losses of $48,000, $30,000 of which she uses to offset the passive income and $18,000 of which is suspended. Which of these activities has the greatest potential for reducing Sally's tax liability? A) Investing in a newly created limited partnership involved in low-income housing that is producing deduction-equivalent tax credits B) Investing in active participation rental real estate that is producing a loss C) Investing in an equipment leasing limited partnership that is producing passive losses D) Investing in an oil and gas limited partnership that is generating losses

Explanation The low-income housing credit is not subject to an AGI limitation if the low-income property was placed in service after December 31, 1989. Thus, she could use the deduction-equivalent tax credits to offset her tax liability. The active participation deduction is eliminated at $150,000 of AGI. The oil and gas limited partnership and the equipment leasing limited partnership would produce more passive losses that are nondeductible. The oil and gas limited partnership cannot be an oil and gas working interest, as the form of ownership would limit Sally's personal liability. LO 7.2.3

Ayesha timely filed her 2022 income tax return, but her negligent failure to report gambling income resulted in an additional tax liability of $20,000. What is Ayesha's negligence penalty? A) $1,000 B) $2,000 C) $4,000 D) $15,000

Explanation The negligence penalty is 20% of the deficiency due to the taxpayer's negligence. For a $20,000 tax deficiency, 20% results in a negligence penalty of $4,000. LO 8.2.3

Mike and Molly reside in a community property state and recently became engaged. Each has three children from a previous marriage. Which of the following are characteristics of a valid and enforceable premarital agreement? It is very common for first marriages. The purpose of the premarital agreement is to limit the presumed effect of the marriage on property acquired prior to or during the marriage. It may contravene public policy. If one party alleges duress or coercion at the time of the agreement's implementation, it is likely that the agreement will not be binding. A) I and II B) III and IV C) II and III D) II and IV

Explanation The purpose of the premarital agreement is to limit the presumed effect of the marriage on property acquired prior to, or during, the marriage. If one party alleges duress or coercion at the time of the agreement's implementation, it is likely that the agreement will not be binding. Premarital agreements are uncommon in first marriages, but very common in second marriages especially when there are children from prior marriages. A premarital agreement is, however, void if it contravenes public policy. LO 4.2.2

The substitute basis of a qualifying asset received in a like-kind exchange is the asset's A) fair market value reduced by the gain realized but not recognized. B) fair market value increased by the gain realized but not recognized. C) basis reduced by the gain realized but not recognized. D) basis increased by the gain realized but not recognized.

Explanation The substitute basis of a qualifying asset received in a like-kind exchange is the asset's fair market value reduced by the deferred gain (the gain realized but not recognized). This deferred gain reduces the basis of the acquired asset, such that when that asset is sold, there is a larger gain recognized. LO 6.2.2

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$283IRA contribution$7,000 Fred's divorce was finalized in 2014. What is the amount of Fred's total income? A) $98,900 B) $99,600 C) $95,900 D) $93,900

Explanation The total income is computed by starting with the wage income of $90,000. To that $90,000, we add the interest of $3,500, the self-employment income of $2,000, and the gambling winnings of $7,100. Of the $9,000 of short-term capital losses, the first $4,000 would offset the long-term capital gains. Of the remaining $5,000 net capital loss, only $3,000 would be deductible in computing the current year total income. The $3,700 active participation real estate loss is fully deductible, as the AGI (computed without regard to the active participation loss) is less than $100,000. Thus, the total income is $95,900. The IRA contribution, if deductible, and half of the self-employment tax are deductible after total income, as adjustments to income. Wages $90,000 Interest income $3,500 Sole proprietorship income $2,000 Gambling winnings $7,100 Net capital loss ($3,000) Active participation loss ($3,700) Total income $95,900 LO 3.2.2

Hanna owns 750 shares in Portman Manufacturing, Inc., that she purchased on February 10, 2019. The basis of her investment in this fund is $13,700, while the fair market value is only $6,200. She sells these shares on October 25, 2024. After hearing a positive earnings report, she purchases 750 shares of Portman on November 5, 2024, for $6,500. As her planner, what can you accurately tell her about the basis and the holding period of the shares acquired on November 5? A) The basis is $14,000, and the holding period begins on October 25, 2024. B) The basis is $6,500, and the holding period begins on November 5, 2024. C) The basis is $6,500, and the holding period begins on October 25, 2024. D) The basis is $14,000, and the holding period begins on February 10, 2019.

Explanation The wash sale rule disallows a loss if substantially identical securities are purchased within a period of 30 days before to 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the $7,500 disallowed loss. Her basis in the new shares is $14,000. Her holding period is determined by reference to the holding period of the shares sold in the wash sale. Thus, her holding period for the November 5 shares begins on February 10, 2019. LO 2.1.2

Hayley owns 500 shares in the XYZ Growth Mutual Fund. The basis of her investment in this fund is $3,700, while the fair market value is only $1,200. She wants to sell her shares to lock in the $2,500 loss, but she is considering buying 500 shares of the same fund the following week because she believes that the value is going to increase significantly over a longer period. As her planner, what can you accurately tell her about this scenario? A) If she purchased shares in the ABC Value Mutual Fund within 30 days after the sale of the old shares, the $2,500 loss would be disallowed. B) The basis in the newly acquired shares would be the amount paid for those shares, increased by the $2,500 disallowed loss. C) She should wait a minimum of 60 days after the sale to repurchase the shares so that the loss may be recognized. D) The loss would be a fully deductible capital loss.

Explanation The wash sale rule disallows a loss if substantially identical securities are purchased within a period of 30 days before to 30 days after the sale that resulted in the loss. The basis of the acquired securities is increased by the amount of the disallowed loss. The mutual fund with a different orientation (growth versus value) should not be considered substantially identical. LO 2.1.3

When the IRS imposes penalties on federal income tax returns, the 75% penalty that is imposed on the tax underpayment that is attributable to fraud is said to be due to A) civil fraud. B) criminal fraud. C) negligence. D) a frivolous return.

Explanation This is essentially taxpayer fraud that does not rise to the level of criminal fraud. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud.

Nate and Teddi own a house at the beach. They rented the house to unrelated parties for eight full weeks during the current year. Nate and Teddi used the house 16 days for their vacation during the year. After properly dividing the expenses between rental and personal use, a rental loss from the house was incurred as follows: Gross rental income $6,400Less mortgage interest and property taxes($7,000)Less other allocated expenses (operating expenses of $400 and depreciation of $600) ($1,000) Net rental loss ($1,600) What is the CORRECT tax treatment of the rental income and expenses on Nate and Teddi's joint income tax return for the current year? A) The other allocated rental expenses deduction is limited to the gross rental income in excess of the deductions for interest and taxes allocated to the rental use. B) The $7,000 rental portion of mortgage interest and property taxes can be deducted. C) A $1,600 loss shoul

Explanation This is mixed-use property. The expenses must be allocated between rental use and personal use. The residence test is met—the personal use exceeds the greater of 14 days or 10% of the number of rental days. The rental expenses are only deductible to the extent of any rental income received. In this case, because mortgage interest and property taxes exceed the rental income, none of the other allocated expenses may be deducted, and only $6,400 of the allocated mortgage interest and taxes may be deducted against rental income. The remaining unused expenses may be carried forward until there is sufficient rental income to offset.

Which of these is NOT a requirement for claiming a home office expense deduction? A) The home office generally must be the principal place of business. B) The trade or business must be the wholesale selling of products or services. C) The use of the home office must be exclusive to the business. D) The home office must be used on a regular basis.

Explanation To claim a home office deduction, the office must be used regularly and exclusively as the principal place of business (or for storing supplies, as a day-care facility, or as a place where administrative or management activities take place, if there is no other fixed location where those activities may occur). LO 5.4.1

Which of these is a CORRECT statement regarding the FIFO method of accounting for inventory? A) During a period of declining inventory prices, higher taxable income will result. B) During periods of declining inventory prices, lower taxable income will result. C) During periods of increasing inventory prices, lower taxable income will result. D) During periods of increasing inventory prices, the cost of goods sold will be higher.

Explanation Under the FIFO method, more expensive (earlier-purchased) inventory will be treated as sold first during a period of declining prices. This results in an increased cost of goods sold (COGS), thus lowering taxable income. LO 5.1.1

Arthur has a vacation home in Florida that he rents out periodically. He has the following expenses related to the vacation home for the tax year: Rental income$14,000Less:Allocated mortgage interest and property taxes ($5,000) Allocated utilities and other expenses($4,000)Depreciation expense($6,000) Net rental loss ($1,000) Number of days rented at fair market value = 147 Number of days Arthur used for personal use = 13 Arthur's adjusted gross income is $95,000. How would the rental income and expenses be treated on his federal income tax return? A) A $1,000 loss should be reported on Schedule E. B) The $1,000 loss will be reduced due to Arthur's personal use. C) Interest expense and taxes and should be reported on Schedule A as an itemized deduction. D) No rental income or expenses will be reported.

Explanation When a vacation home is used as a residence in any tax year, there are limitations on the deductions attributable to the rental use. For a home to be considered primarily rental use, the home must be rented for at least 15 days a year and the owner's use for personal reasons can't exceed the longer of 14 days or 10% of the rental days. Because Arthur's home is primarily for rental use and his AGI is less than $100,000, the entire $1,000 loss is deductible. The income and expenses for the rental property would be reported on Schedule E.

Irma purchased a deferred fixed annuity for $15,000. The annuity will provide monthly payments of $150. At the time the distributions are to begin, Irma's life expectancy will be 20 years. How much of each payment will be excluded from taxation? A) $62.50 B) $100.00 C) $50.00 D) $87.50

Irma is expected to receive $36,000 ($150 × 12 × 20). Her investment in the contract ($15,000) is then divided by the total amount expected to be received ($36,000) to determine the exclusion ratio of 41.67%. 41.67% exclusion ratio × $150 = $62.50 excludible from each payment. $15,000 investment / $36,000 expected return = 41.67% * $150 payment = $62.50 excluded

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?

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.

Robin and Marian, who are both age 33, are trying to calculate their taxable income. Which items from the IRS Form 1040 are deducted from the couple's adjusted gross income (AGI) to arrive at their taxable income? 100% of self-employment taxes paid Ordinary and necessary business expenses Student loan interest Medical expenses in excess of 7.5% of AGIA) I and III B) I, II, III, and IV C) IV only D) II only

Statement IV is correct. The medical expenses are part of the itemized deductions. Only the greater of standard or itemized deduction are deductible from AGI to arrive at taxable income. One-half of the self-employment tax and student loan interest are items deducted from gross income to arrive at adjusted gross income. The ordinary and necessary business expenses (Schedule C expenses) are deducted in arriving at total income.

Omega Corporation, which is NOT a personal service corporation, has the following items of income and expense: Taxable income$310,000Federal income tax$80,000Dividends paid$20,000Accumulated earnings and profits at the end of the prior year$190,000 Omega Corporation cannot establish a valid business purpose for excess accumulations. How much accumulated earnings tax is payable by Omega? A) $30,000 B) $34,000 C) $42,000 D) $70,000

The accumulated earnings tax applies to corporate accumulated earnings in excess of $250,000 for which there is no valid business reason for accumulating the funds. Expenditures for dividends and federal income tax were paid out of the corporate income, so those amounts reduce the total current accumulations. Taxable income$310,000Federal income tax(80,000)Dividends paid(20,000)Total current accumulations$210,000Less accumulated earnings credit(60,000)Taxable amount$150,000× 20%$30,000 The accumulated earnings credit is $250,000 (or in the case of a personal service corporation, $150,000), reduced by the accumulated earnings and profits at the end of the preceding tax year. The 20% rate is the highest tax rate for qualified dividends. LO 5.2.2

Mary is a single taxpayer, age 67. She has these itemized deductions: Home mortgage interest (first mortgage) $15,950 State income taxes $3,120 Property taxes $1,480 Charitable contributions $2,000 Gambling losses $1,500 Unreimbursed employee business expenses $4,600 Tax return preparation fee $400 Medical expenses $24,080 Mary's AGI for 2024 is $318,000. Included in the AGI is $500 of gambling winnings. What is the amount of her allowable itemized deductions? A) $44,250 Incorrect Answer B) $22,820 Incorrect Answer C) $23,280 Correct Answer D) $23,050 Incorrect Answer

The allowable itemized deductions total $23,280. The unreimbursed employee business expenses are not deductible. The medical expenses are deductible only to the extent that they exceed 7.5% of AGI. That 7.5% of AGI is $23,850. The medical expenses exceed that amount by $230. Home mortgage interest (first mortgage) $15,950 State income taxes $3,120 Property taxes $1,480 Charitable contributions $2,000 Gambling losses (to extent of winnings) $500 Medical expenses $230 Allowable itemized deductions $23,280

Which of the following assets is NOT generally considered a capital asset? A) A personal residence B) A personal auto C) U.S. government securities held for investment D) A computer used in a business

The business computer is Section 1231 property, not a capital asset. A capital asset is any asset that is not a copyright or creative work, accounts or notes receivable, depreciable property used in a trade or business or for production of income (such as a computer), or inventory.

Margaret purchased a used pickup truck at a cost of $12,400 and sales taxes of $600 to use in her floral business. She purchased the pickup (five-year property) and placed it in service on June 1 of the current tax year. Assume that Margaret opts out of bonus depreciation. Using MACRS, what is the first-year cost recovery deduction that Margaret can claim? A)$2,600 B) $1,240 C) $5,200 D) $1,300

The first-year percentage for five-year property from the MACRS table is 20%. This is multiplied by the basis of $13,000 (including the capitalized cost, the sales taxes of $600) to give a deduction of $2,600. The half-year convention is built into the MACRS table. (The MACRS table will be provided on the end-of-course exam.) LO 6.1.3

Raphael has Schedule C net income of $55,000 for the current year. In addition, he has a flow-through of interest and dividends of $27,000 from an investment partnership. What is Raphael's self-employment tax for 2024? Round your answer to the nearest dollar. A) $11,586 B) $6,755 C) $8,415 D) $7,771

The flow-through of interest and dividends is not subject to the self-employment tax. (Answers may vary slightly due to rounding.) Actual earnings $55,000.00 Less 7.65% (4,207.50) Net earnings from self-employment $50,792.50 × 15.3% Self-employment tax $7,771.25 LO 5.3.1

Karl 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, Ohio State University (OSU). His basis in this stock, purchased four years ago, is $18,000. The stock has a current fair market value of $70,000. If Karl gifts the stock to OSU, what is the maximum allowable charitable deduction that Kurt can receive in the current tax year? A) $21,000 B) $50,000 C) $18,000 D) $30,000

The deduction for a donation of LTCG property to a 50% organization (public charity) typically is restricted to 30% of AGI, with the deduction based on the fair market value of the asset. The 50% election would not make sense in this situation, as the deduction would be based on the basis of the stock of $18,000. LO 3.2.2

Pascal's classic automobile was seriously damaged in an earthquake that was declared a federal disaster. Unfortunately, his insurance paid only $12,000, while the fair market value before the earthquake was $30,000, and the value after the earthquake was $8,000. His basis in the automobile was $17,000. Pascal's AGI is $35,000. What is the amount, if any, of Pascal's deductible casualty loss? A) $0 B) $1,400 C) $6,000 D) $1,500

The deduction is based on the lesser of basis or the decrease in FMV—reduced by the insurance, the $100 floor per occurrence, and 10% of AGI. Lesser of decrease in FMV ($22,000) or adjusted basis ($17,000) $17,000Less insurance coverage(12,000)$5,000Less $100 floor(100)$4,900Less 10% of AGI(3,500)Deductible loss on Schedule A$1,400 LO 6.2.3

Miranda is involved in the business of breeding show horses on a part-time basis as a sole proprietor. She has shown a significant net loss in this business every year for the last six years, and she has used these losses to reduce the tax liability on the salary she has earned from her law practice. With which of these potential tax traps should Miranda be most concerned? A) Passive activity B) Assignment of income C) Hobby loss D) Substance over form

The fact that this business has not been profitable and is merely a side business increases the likelihood it could be reclassified as a hobby loss. Miranda has operated the business only part time and has not demonstrated that she is attempting to make it a profitable business. The fact that huge losses have occurred every year likely overrides the presumption that Miranda is in the business to make a profit.

Maya owns and operates a business as a sole proprietor. Several years ago, she purchased office furniture at a cost of $9,000 to use in her business. She used the straight-line method to recover the cost of the furniture. She claimed $3,214 of cost recovery deductions. She sold the furniture for $10,500. What is the amount and nature (character) of the gain resulting from this disposition? A) $4,714 Section 1245 gain, no Section 1231 gain B) $1,500 Section 1245 gain, $3,214 Section 1231 gain C) No Section 1245 gain, $4,714 Section 1231 gain D) $3,214 Section 1245 gain, $1,500 Section 1231 gain

The gain realized and recognized is the difference between the $10,500 amount realized from the sale and the adjusted basis of $5,786. Thus, the total gain is $4,714. The Section 1245 cost recovery recapture is the lesser of the cost recovery deductions taken ($3,214) or the gain realized ($4,714). Thus, the Section 1245 recapture is $3,214. The remaining $1,500 of gain is attributable to actual appreciation of the asset; therefore, there is $1,500 of Section 1231 gain. LO 6.1.4

Which of these statements regarding the child tax credit is not CORRECT? A) A qualifying child is generally defined as an individual under the age of 17 (as of the close of the calendar year) for whom the taxpayer may claim a dependency exemption. B) A qualifying child includes a child or a descendant of a child, a stepchild, or an eligible foster child. C) The maximum credit is $1,000 per qualifying child for 2024. D) The phaseout of the credit begins at $400,000 for a married couple filing jointly.

The maximum credit is $2,000, not $1,000, per qualifying child. A qualifying child is generally defined as an individual under the age of 17 (as of the close of the calendar year) who may be treated as a dependent. A qualifying child includes a child or a descendant of a child, a stepchild, or an eligible foster child. The credit is phased out by $50 for each $1,000 of AGI over the threshold of $400,000 for a married couple filing jointly ($200,000 for single taxpayers).

Piotr and Lisa reside in a New York and recently became engaged. Piotr is a U.S. resident alien with a considerable fortune in oil stock. Lisa has never been married. While vacationing in Europe, the couple drinks several bottles of wine. Piotr then presents Lisa with a diamond ring and a premarital agreement drafted by a local attorney. Which of these are characteristics of a valid and enforceable premarital agreement? International law applies to premarital agreements. 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 signer's health is not a factor at the time of signing. If one party alleges duress or coercion at the time of the agreement's implementation, it is likely that the agreement will not be binding. A) II and III B) II and IV C) III and IV D) I and II

The purpose of the premarital agreement is to limit the presumed effect of the marriage on property acquired prior to or during the marriage. There are no international treaties to set standards for such agreements. A U.S. domiciled court may not recognize it as valid. The signer's health and mental state can also be a factor in determining the validity of an agreement. If one party alleges duress or coercion at the time of the agreement's implementation, it is likely that the agreement will not be binding. Premarital agreements are uncommon in first marriages, but very common in second marriages especially when there are children from prior marriages. A premarital agreement is, however, void if it contravenes public policy.

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)$75,000Thelma's salary (after 401(k) contributions)$50,000Alimony payments to Lowell's ex-wife$24,000Net long-term capital loss$7,000Property taxes$2,000IRA contribution—Lowell$7,000IRA contribution—Thelma$7,000 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?

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 $14,000 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 $123,000 (for 2024)—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.

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 $7,000 to an IRA Assuming George is not a professional gambler, what is his total income for the current tax year?

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.

Which of these is the main advantage of using the accrual basis of accounting? A) A deduction may be taken for an expense not yet paid. B) Total income recognized is generally less than under the cash method. C) The constructive receipt doctrine defers income. D) Income is recognized before it is received.

Total income recognized will be the same under either the cash or accrual method. The timing of the income recognition may be different between the two methods, but the total will be the same over time. The constructive receipt doctrine is typically relevant to the cash method of accounting, and it accelerates, not defers, income. LO 5.1.1

Dion and Issa are married filing jointly. Issa receives compensation from her employer who deducts federal withholding taxes and remits them to the IRS. Dion is self-employed and made only one quarterly deposit of his federal taxes this year. At the time of filing, the couple owed an unpaid tax liability equal to two-thirds of what Dion should have remitted to the IRS. What does this mean for the couple? Issa and Dion owe the remaining tax liability jointly and the IRS may require either, or both to pay it. If Issa is unwilling to pay the tax liability based on Dion's earnings, she automatically qualifies for innocent spouse relief. A) II only B) Both I and II C) I only D) Neither I nor II

Under the Tax Code, spouses who file a joint income tax return have joint and several liability for the payment of the taxes owed, no matter who the unpaid balance may be attributed to. Innocent spouse relief is granted only if certain conditions are met and is not granted automatically. LO 4.1.1

Which of these forms of business is generally recognized as having the most readily available access to additional capital? A) C corporation B) General partnership C) S corporation D) Sole proprietorship

With the ability to access capital from a potentially large number of shareholders as well as borrow from banks, C corporations are generally recognized as having better access to capital than any other form of business. LO 5.2.3