Chapter 11 Personal Income Tax

8. Losses associated with personal-use assets, sales to related parties, and wash sales are not currently deductible.

TRUE

9. Capital loss carryovers for individuals are carried forward indefinitely.

TRUE

25. One primary difference between corporate and U.S. Treasury bonds is: A. Treasury bonds always pay interest periodically B. Corporate bonds always pay interest periodically C. Interest from Treasury bonds is exempt from federal taxation D. Interest from corporate bonds is exempt from state taxation E. None of these

A

27. Which of the following is not a tax advantage of a Series EE Saving Bond? A. taxes are paid as the original issue discount on the bond is amortized B. interest earned is exempt from state taxation C. taxes are deferred until the bond is cashed in at maturity D. interest is exempt from federal taxation when used for qualifying educational expenses E. None of these

A

34. The maximum amount of net capital losses individuals may deduct against their ordinary income per year is: A. $3,000 B. $5,000 C. Zero, losses are not deductible D. There is no maximum. All losses are allowed to be deducted. E. None of these

A

53. Investment interest expense does not include: A. interest expense from loans to purchase municipal bonds. B. interest expense from loans to purchase corporate bonds. C. interest expense from loans to purchase stocks. D. interest expense from loans to purchase U.S. savings bonds and interest expense from loans to purchase corporate bonds. E. interest expense from loans to purchase corporate bonds and interest expense from loans to purchase stocks.

A

57. What is the correct order of the loss limitation rules? A. tax basis, at-risk amount, passive loss limits B. at-risk amount, tax basis, passive loss limits C. passive loss limits, at-risk amount, tax basis D. tax basis, passive loss limits, at-risk amount E. passive loss limits, tax basis, at-risk amount

A

32. In X8, Erin had the following capital gains (losses) from the sale of her investments: $2,000 LTCG, $25,000 STCG, ($9,000) LTCL, and ($15,000) STCL. What is the amount and nature of Erin's capital gains and losses? A. $3,000 net short-term capital gain B. $3,000 net long-term capital loss C. $4,000 net short-term capital gain D. $4,000 net long-term capital loss E. None of these

A $2,000 (LTCG) + ($9,000) (LTCL) = ($7,000) (NLTCL); $25,000 (STCG) + ($15,000) (STCL) = $10,000 (NSTCG); ($7,000) (NLTCL) + $10,000 (NSTCG) = $3,000 (NSTCG).

36. Ms. Fresh bought 1,000 shares of ABC Corporation stock for $5,000 on January 15, 2011. On December 31, 2015 she sold all 1,000 shares of her ABC stock for $4,500. Based on a hot tip from her friend, she bought 1,000 shares of ABC stock on January 23, 2015 for $3,000. What is Ms. Fresh's recognized loss on her 2015 sale and what is her basis in her 1,000 shares purchased in 2015? A. $-0- LTCL and $3,500 basis B. $200 LTCL and $3,300 basis C. $300 LTCL and $3,200 basis D. $400 LTCL and $3,100 basis E. $500 LTCL and $3,000 basis

A $4,500 amount realized from ABC sale - $5,000 tax basis in ABC shares = $500 realized loss on sale of ABC stock. Loss is not currently deductible because the ABC shares were reacquired within 30 days of the original sale (wash sale). $500 nondeductible loss from original ABC sale + $3,000 purchase price for new ABC shares = $3,500 tax basis in new ABC shares.

42. Kevin has the option of investing in a municipal bond that provides a 4.5 percent return or a taxable bond that provides a 7 percent return. Assuming Kevin's marginal tax rate is 35 percent, what investment should he choose and why? A. Taxable bond; provides a 4.55 percent return versus 4.5 percent return for the municipal bond B. Taxable bond; provides a 7 percent return versus 4.5 percent return for the municipal bond C. Taxable bond; provides a 4.55 percent return versus 2.9 percent return for the municipal bond D. Municipal bond; provides a 4.5 percent return versus 4.2 percent return for the taxable bond E. None of these

A Municipal bond = 4.5 percent; Taxable Bond = (.07 × (1 - .35)) = 4.55 percent.

23. Which of the following types of interest income is not taxed as it is earned? A. interest from savings accounts B. original issue discounts on corporate bonds C. accrued market discount on bonds D. interest from money market accounts E. All of these

C

26. The amount of interest income a taxpayer recognizes when he redeems a U.S. savings bond is: A. the excess of the taxpayer's basis in the bonds over the bond proceeds B. the bond proceeds C. the excess of the bond proceeds over the taxpayer's basis in the bonds D. the taxpayer's basis in the bonds E. None of these

C

39. The longer the holding period on growth stocks, ____________ the after-tax rate of return. A. the lesser B. the greater C. there is no difference between

B

41. When 529 plan distributions are not used for qualified higher education expenses, these distributions are subject to an additional penalty of: A. 5% B. 10% C. 15% D. 25% E. None of these

B

45. Maximum yearly contributions per beneficiary to Coverdell Savings Accounts are limited to: A. $1,500 B. $2,000 C. $5,000 D. No limit on amount you contribute yearly E. None of these

B

61. A taxpayer's at-risk amount in an activity is increased by: A. a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying B. cash contributions to the activity C. cash distributions from the activity D. a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying and cash contributions to the activity E. a reduction in the amount of debt related to the activity that the taxpayer is responsible for paying and cash distributions from the activity

B

55. Doug and Sue Click file a joint tax return and decide to itemize their deductions. The Click's income for the year consists of $90,000 in salary, $2,000 interest income, $800 long-term capital loss. The Click's expenses for the year consist of $1,500 investment interest expense. Assuming that the Click's marginal tax rate is 35%, what is the amount of their investment interest expense deduction for the year? A. $1,200 B. $1,500 C. $2,000 D. $2,300 E. None of these

B $2,000 >= investment interest expense ($1,500).

29. If Adam invested $25,000 in a stock paying annual dividends equal to 5% of his investment, what would the value of his investment be 10 years from now assuming that he reinvested his after-tax dividends each year? Assume Adam's marginal ordinary tax rate is 15%. A. $26,940 B. $40,722 C. $37,905 D. $101,139 E. None of these

B ATRR = .05 (.05 × (1 - 0)); $25,000 × (1.05)10 = $40,722.

37. Kevin bought 200 shares of Intel stock on January 1, 2015 for $50 per share with a brokerage fee of $100. Then, Kevin sells all 200 shares for $75 per share on December 12, 2015. The brokerage fee on the sale was $150. What is the amount of the gain/loss Kevin must report on his 2015 tax return? A. $4,500 B. $4,750 C. $5,000 D. $5,250 E. None of these

B Amount Realized = (200 shares × $75) - $150 = $14,850; Adjusted Basis = (200 shares × $50) + $100 = $10,100; Gain = $14,850 - $10,100 = $4,750

58. Sue invested $5,000 in the ABC Limited Partnership and received a 10 percent interest in the partnership. The partnership had $20,000 of qualified nonrecourse debt and $20,000 of debt she is not responsible to repay because she is a limited partner. Sue is allocated a 10 percent share of both types of debt resulting in a tax basis of $9,000 and an at risk amount of $7,000. During the year, ABC LP generated a ($90,000) loss. How much of Sue's loss is disallowed due to her tax basis or at-risk amount? A. Zero; all of her loss is allowed to be deducted. B. $2,000 disallowed because of her at-risk amount C. $2,000 disallowed because of her tax basis D. $4,000 disallowed because of her tax basis. E. $4,000 disallowed because of her at-risk amount

B Loss allowed = $7,000 amount at risk.

47. John holds a taxable bond and a municipal bond. Which fees are considered part of John's investment expense? A. attorney and accounting fees on municipal bond B. safe deposit box rental fees on taxable bond C. interest expense on taxable bond D. attorney and accounting fees on municipal bond and safe deposit box rental fees on taxable bond E. safe deposit box rental fees on taxable bond and interest expense on taxable bond

B The interest expense on the taxable bond is considered investment interest expense.

38. If an individual taxpayer's marginal tax rate is 35 percent and he holds the following assets for more than one year, which gain will be taxed at the highest rate at the time of sale? A. gain from investment land B. gain from personal-use property C. gain from a coin collection D. gain from the sale of qualified small business stock held for 3 years E. gain attributable to tax depreciation taken on real property

C

51. Brandon and Jane Forte file a joint tax return and decide to itemize their deductions. The Forte's income for the year consists of $120,000 in salary, $1,000 interest income, $1,500 nonqualifying dividends, and $1,000 long-term capital gains. The Forte's expenses for the year consist of $3,000 investment interest expense and $900 tax preparation fees. Assuming that the Forte's marginal tax rate is 30%, what is the amount of investment interest expense deduction for the year? A. Zero; investment interest expense is below two percent of AGI. B. $1,000 C. $2,500 D. $3,000 E. None of these

C $1,000 + $1,500 = $2,500 <= investment interest expense ($3,000). The long-term capital gains are not considered investment income because this income is taxed at a preferential rate.

48. Bill would like some tax benefits for his investment expenses incurred this year. His AGI is $190,000. Currently, his expenses consist of: (1) $1,000 investment advice fees, (2) $1,500 unreimbursed employee business expenses (a miscellaneous itemized deduction), and (3) $600 tax return preparation fees. How much more, if any, must Bill spend for investment expenses this year before he receives any tax benefit? A. Zero, Bill is already receiving a benefit B. More than $500 C. More than $700 D. More than $900 E. None of these

C $190,000 × .02 = $3,800; $1,000 + $1,500 + $600 = $3,100; $3,800 - $3,100 = $700.

60. Michelle is an active participant in the rental condominium property she owns. During the year, the property generates a ($15,000) loss; however, Michelle has sufficient tax basis and at-risk amounts to absorb the loss. If Michelle has $115,000 of salary, $10,000 of long-term capital gains, $3,000 of dividends, and no additional sources of income or deductions, how much loss can Michelle deduct? A. Zero; losses from rental property are passive losses and can only be offset by passive income. B. $4,000 C. $11,000 D. $15,000 E. None of these

C $25,000 (exception) - $14,000 (phase-out: ($128,000 - $100,000) × .5) = $11,000.

44. Jim (life expectancy is 20 years) decides to purchase a life insurance policy for $75,000 that promises a 9 percent annual return. Jim decides to cash in the policy after five years while still living. Assuming Jim's marginal tax rate is 35 percent, what are his after-tax proceeds? (Round all interim calculations to the nearest whole number) A. $14,139 B. $40,397 C. $101,258 D. $115,397 E. None of these

C (1) $75,000 × (1 + .09)5 = $115,397; (2) $115,397 - $75,000 = $40,397; (3) $40,397 × .35 (tax rate) = $14,139; (4) $115,397 - $14,139 = $101,258.

43. What explicit tax rate would keep Jason indifferent between purchasing a municipal bond with a 3.0 percent return and a taxable bond with a 4.5 percent before-tax return? (Round your answer to the nearest percent) A. 25% B. 30% C. 33% D. 36% E. None of these

C .045 × (1 - tax rate) = .03; tax rate = 33 percent.

59. Which taxpayer would not be considered a material participant of an activity? A. taxpayer materially participated in the activity for any five of the preceding ten years B. taxpayer participated on a regular, continuous, and substantial basis last year C. taxpayer participated 95 hours last year and participation is not less than any other participants for the year D. taxpayer participated in the activity for 995 hours last year E. None of these

C The individual must participates in the activity more than 500 hours during the year to be considered a material participant.

28. When a bond is purchased in the secondary bond market at a discount, the amount of discount treated as interest income when the bond is sold prior to maturity is the: A. market premium B. market discount C. accrued market premium D. accrued market discount E. None of these

D

30. When selling stocks, which method of calculating basis provides the greatest opportunity for minimizing gains or increasing losses? A. LIFO B. FIFO C. Weighted average D. Specific identification E. None of these

D

31. Long-term capital gains can be taxed at a maximum rate of: A. 20 percent B. 28 percent C. Both 20 percent and 28 percent D. All of these.

D

33. When the wash sale rules apply, the realized loss is: A. recognized at time of sale B. not recognized at time of sale and does not affect basis of newly acquired stock C. recognized at time of sale and added to basis of the newly acquired stock D. not recognized at time of sale and added to basis of the newly acquired stock E. not recognized at time of sale and subtracted from the basis of the newly acquired stock

D

50. Unused investment interest expense: A. expires after the current year B. is carried back two years C. is carried forward twenty years D. is carried forward indefinitely E. None of these

D

52. Investment expenses treated as miscellaneous itemized deductions do not include: A. expenses incurred to generate tax-exempt income B. investment interest expense C. expenses for investment advice D. expenses incurred to generate tax-exempt income and investment interest expense E. investment interest expense and expenses for investment advice

D

54. Assume that Joe has a marginal tax rate of 35 percent and decides to make the election to include long-term capital gains and qualified dividends as investment income. What rate must Joe use when calculating the tax on these two items? A. 20% B. 25% C. 28% D. 35% E. None of these

D

24. If Tom invests $60,000 in a taxable corporate bond that provides a 5 percent before-tax return, how much will Tom's investment be worth in either 8 or 20 years from now when the bond matures? Assume Tom's marginal tax rate is 35 percent. A. $88,647; $159,198 B. $92,782; $178,414 C. $79,621; $121,716 D. $77,495; $113,750 E. None of these

D ATRR = .0325 (.05 × (1 - .35)); $60,000 × (1.0325)8 = $77,495; $60,000 × (1.0325)20 = $113,750.

40. Tom, from Nebraska, and Jill, from Missouri, recently got married. To earn a decent return on all their wedding gifts, they decide to invest in some municipal bonds issued by the state of Missouri. Assuming they both qualify as Missouri residents, the bond interest Tom and Jill earn will be subject to the following taxes: A. federal income taxes only B. federal and Missouri state income taxes C. Missouri state income taxes only D. Nebraska state income taxes only E. None of these

E

46. Life insurance policies have nontax factors that limit their desirability as an investment vehicle. Some of these factors include: A. waiting for the insured individual's death B. low expense to return ratios C. high commission costs D. waiting for the insured individual's death and low expense to return ratios E. waiting for the insured individual's death and high commission costs

E

49. When calculating net investment income, gross investment income includes: A. interest income B. net short-term capital gains C. non-qualified dividends D. royalty income E. All of these

E

35. In the current year, Norris, an individual, has $50,000 of ordinary income, a Net Short Term Capital Loss (NSTCL) of $10,000 and a Net Long Term Capital Gain (NLTCG) of $2,800. From his capital gains and losses, Norris reports: A. an offset against ordinary income of $10,000 B. an offset against ordinary income of $3,000 and a NSTCL carryforward of $7,000 C. an offset against ordinary income of $2,800 and a NSTCL carryforward of $7,200 D. an offset against ordinary income of $3,000 and a NSTCL carryforward of $7,200 E. an offset against ordinary income of $3,000 and a NSTCL carryforward of $4,200

E $2,800 NLTCG -$10,000 NSTCL = $7,200 NSTCL; Use $3,000 NSTCL to reduce ordinary income leaving $4,200 as a NSTCL carryforward.

56. Bob Brain files a single tax return and decides to itemize his deductions. Bob's income for the year consists of $75,000 of salary, $3,000 long-term capital gain, and $1,500 interest income. Bob's expenses for the year consists of $800 investment advice fees, $700 unreimbursed employee business expenses (a miscellaneous itemized deduction), and $250 tax return preparation fees. What is Bob's actual deduction for miscellaneous itemized deductions? A. Zero; Bob's investment expenses do not exceed two percent of AGI floor. B. $1,590 C. $1,500 D. $1,750 E. None of these

E ($75,000 + $3,000 + $1,500) × .02 = $1,590; ($800 + $700 + $250) - $1,590 = $160.

5. The capital gains (losses) netting process for taxpayers without 25 or 28 percent capital gains requires them to (1) net short-term and long-term gains, (2) net short-term and long-term losses, and (3) net the outcome to yield a final gain or loss to place on the tax return.

FALSE - (1) net short-term gains and short-term losses, (2) net long-term gains and long-term losses, and (3) net the outcome to yield a final gain or loss to place on the tax return.

11. §529 plans are limited to a yearly contribution of $2,000 for each beneficiary and can only be used to pay for qualified educational costs incurred from kindergarten through 12th grade.

FALSE - 529 plans allow individuals to contribute up to the maximum allowed by state sponsored 529 plans to fund the qualified educational costs of future college students.

3. When a taxable bond is issued at a premium, the taxpayer must calculate and apply the yearly amortization amount to reduce a portion of the actual interest payments that taxpayers include in gross income.

FALSE - If the bond was issued at a premium, taxpayers may elect to amortize the premium

7. Dave and Jane file a joint return. They sell a capital asset at a $150,000 loss. Even though they have no capital gains, $6,000 of the loss can still be deducted in the current year.

FALSE - Individual taxpayers (including married filing jointly) may deduct up to $3,000 of net capital losses against ordinary income in a given year.

4. Qualified dividends are always taxed at a 15 percent preferential rate.

FALSE - Qualified dividends may be taxed at a rate as low as 0 percent depending on the taxpayer's ordinary income tax rate.

2. Interest earned on U.S. savings bonds is interest received at sale or maturity but must be taxed annually.

FALSE - Taxpayers may recognize interest income when they redeem the bonds or may elect to include the increase in bond redemption value in income each year.

16. Investment expenses and investment interest expense are for AGI deductions.

FALSE - both are itemized deductions

13. Nondeductible investment expenses (other than investment interest expenses) are carried forward indefinitely.

FALSE - deducted in the ear incurred or lost forever.

1. Generally, interest income is taxed at preferential capital gains rates and dividend income is taxed at ordinary rates.

FALSE - interest income is taxed at ordinary rates and dividend income is taxed at preferential rates.

20. A loss from a passive activity is fully deductible as long as the taxpayer has sufficient tax basis in the activity.

FALSE - must also clear the at-risk hurdle and the passive activity loss rules.

22. To qualify under the passive activity rental real estate exception, the taxpayer must (1) own at least 15 percent of the property and (2) participate in the process of making management decisions.

FALSE - must own at least 10% of the rental property

18. Generally, losses from rental activities are considered to be active losses.

FALSE - participants in rental activities (including rental real estate) and limited partners in partnerships are generally deemed to be passive participants.

15. When electing to include long-term capital gains and qualified dividends in net investment income, taxpayers must include all long-term capital gains and dividends recognized for that year.

FALSE - taxpayers may selectively include a portion of long-term capital gains and/or dividends recognized for that year.

6. Two advantages of investing in capital assets are (1) gains are generally deferred and (2) gains are generally taxed at preferential rates.

TRUE

10. All life insurance proceeds given to the beneficiary at the time of death of the insured are excluded from gross income.

TRUE

12. High-marginal rate taxpayers generally prefer municipal bonds and low-marginal rate taxpayers generally prefer taxable corporate bonds.

TRUE

14. Taxpayers may make an election to include long-term capital gains and qualified dividends in net investment income and deduct more investment interest expense currently if they are willing to subject these sources of income to ordinary tax rates.

TRUE

17. The investment interest expense deduction is limited to the amount of net investment income for the year.

TRUE

19. Passive losses that exceed passive income are deferred until the taxpayer generates passive income to offset these passive losses.

TRUE

21. A passive activity is any activity that involves a trade or business or rental activity in which the taxpayer does not materially participate.

TRUE