Tax Accounting - Chapter 6
Up to what amount of qualified educational expenses can be deducted for AGI? (Deductions for AGI)
$4,000 can be deducted for AGI
There are two types of interest expense that may be deductible as itemized deductions:
(1) interest on indebtedness secured by a qualified residence or home (2) investment interest
Taxpayers can only deduct the lesser of
(1) the property's fair market value or (2) the property's adjusted basis when making a charitable donation of ordinary income
Taxpayers are allowed to deduct for AGI, subject to certain limitations:
-Interest expense on qualified educational loans -Qualified education expenses
Other Itemized Deductions (Deductible):
-gambling losses and expenses to the extent of gambling income -casualty and theft losses on investment property, and -unrecovered cost of a life annuity at death
Other Itemized Deductions (Not Deductible):
-unreimbursed employee business expenses, -tax preparation fees, -investment expenses, and -hobby expenses
Panel B: Phase-Out Percentage* (Deductions for AGI)
1. Filing Status: Single or head of household Phase-out Percentage: (Modified AGI − $70,000)/$15,000 2. Filing Status: Married filing jointly Phase-out Percentage: (Modified AGI − $140,000)/$30,000 3. Married taxpayers filing separately are ineligible for the deduction.
Three categories of deductions for AGI
1. Deductions Directly related to business activities 2. Deductions Indirectly related to business activities 3. Deductions Subsidizing specific activities
Trade or business expenses must be: (Deductions for AGI)
1. Directly connected to the business activity 2. Ordinary and necessary for the activity (e.g., appropriate and helpful for generating a profit) 3. Reasonable in amount (not extravagant)
Summary of Limitations on Deduction of Interest on Education Loans (Deductions for AGI)
1. Modified AGI Level: Not over $70,000 ($140,000 for married filing jointly) Deduction: Amount paid up to $2,500 2.Modified AGI Level: Above $70,000 ($140,000 for married filing jointly) but below $85,000 ($170,000 for married filing jointly) Deduction: Amount paid up to $2,500 reduced by the phase-out amount. The phase-out amount is the amount paid up to $2,500 times the phase-out percentage (see Panel B for the phase-out percentage computation). 3. Modified AGI Level: Equal to or above $85,000 ($170,000 for married filing jointly) Deduction: Zero
Profit-motivated activities are classified as: (Deductions for AGI)
1.Business activities (called "trade or business") 2.Investment activities
Which of the following expenses is most easily bunched, or accelerated, into one year, so that the itemized deductions can be used in one year and the standard deduction can be used the following year? Multiple choice question. A. Charitable contributions B. State income taxes C. Mortgage interest expense E. Gambling losses
A. Charitable contributions
Which of the following expenses are deductible FOR AGI? (Check all that apply.) Multiple select question. A. Expenses generated by rental and royalty activities B. Most expenses generated by investment activities C. Unreimbursed employee business expenses D. Most expenses generated by business activities
A. Expenses generated by rental and royalty activities D. Most expenses generated by business activities
Which of the following statements is correct? Multiple choice question. A. The revenues and expenses from a business are reported on Schedule C and the resulting profit or loss is transferred to Form 1040. B. A business calculates net income or loss for tax purposes. Details do NOT have to be reported on the tax return, but records must be retained by the company to present in the event of an audit. C. Businesses attach financial accounting income statements to tax returns and report the profit or loss reported directly on Form 1040.
A. The revenues and expenses from a business are reported on Schedule C and the resulting profit or loss is transferred to Form 1040.
Taxpayers have a choice of deducting the standard deduction or their itemized deductions. Therefore, ______ AGI deductions are considered to be beneficial to more taxpayers because: Multiple choice question. A. for; they are available to all eligible taxpayers, not just those that itemize deductions. B. for; these deductions increase the amount of the standard deduction. C. from; they result in a lower AGI which reduces the limitations based on AGI that decrease some tax benefits. D. from; these deductions reduce a taxpayer's tax liability dollar for dollar.
A. for; they are available to all eligible taxpayers, not just those that itemize deductions.
Which of the following types of donations would be deductible as charitable contributions? (Check all that apply) A. Cash donated to United Way B. Checks made payable to (and as a donation to) The Boy Scouts of America C. Volunteering 4 hours (personal services) at a local Goodwill store D. Land donated to a state university
Answer: - Cash donated to United Way - Checks made payable to (and as a donation to) The Boy Scouts of America - Land donated to a state university
In the current year, Ellen sold investment stock that she had owned for five years. The sale generated a loss of $5,000. Assuming she had no other asset sales during the year, how should Ellen handle the loss for the current tax year purposes? Multiple choice question. A. Ellen can deduct $3,000 for AGI. B. Ellen can deduct $5,000 from AGI. C. Ellen can deduct $5,000 for AGI. D. Ellen can deduct $3,000 from AGI.
Answer: A. Ellen can deduct $3,000 for AGI.
Which of the following types of taxes may be deducted from AGI as itemized deductions? (Check all that apply.) Multiple select question. A. Personal property tax on the value of a car B. Excise taxes paid on cigarette and alcohol purchases C. State and local income taxes D. Federal income taxes E. Real estate taxes on a primary residence
Answer: A. Personal property tax on the value of a car C. State and local income taxes E. Real estate taxes on a primary residence
Markita donated stock that she has held for less than a year to a qualified charitable organization. Her basis in the stock is $1,000 and the fair market value of the stock is $1,200. In regards to the donation, the stock is ______. Multiple choice question. A. ordinary income property and Markita can deduct $1,000 B. ordinary income property and Markita can deduct $1,200 C. capital gain property and Markita can deduct $1,000 D. capital gain property and Markita can deduct $1,200
Answer: A. ordinary income property and Markita can deduct $1,000 Reason: Since the stock has been held for less than one year, it is ordinary income property and, therefore, limited to the lesser of the property's FMV or adjusted basis.
Certain contributions of capital gain property do NOT qualify for a fair market value deduction. Which of the following characteristics of the contribution will cause the asset to NOT qualify for a fair market value deduction? Multiple choice question. A. The asset is intangible, such as stock or bonds. B. The tangible personal property's use is unrelated to the charity's operations. C. The asset is real property, such as land or a building. D. The asset was held by the donor for a total of 367 days.
Answer: B. The tangible personal property's use is unrelated to the charity's operations.
Which of the following statements is INCORRECT regarding charitable donations of capital gain property? A. To qualify as capital gain property, the asset must have appreciated in value. B. The taxpayer must include the appreciation of the asset in gross income. C. To qualify as capital gain property, the asset must have been owned by the taxpayer for more than one year.
Answer: B. The taxpayer must include the appreciation of the asset in gross income.
Excess charitable contributions can be carried forward ______ year(s) before expiring. Multiple choice question. A. one B. five C. two D. three
Answer: B. five
In the current year, Ellen sold investment stock that she had owned for five years. The sale generated a loss of $5,000. Assuming she had no other asset sales during the year, how should Ellen handle the loss for the current tax year purposes? Multiple choice question. A. Ellen can deduct $5,000 for AGI. B.Ellen can deduct $3,000 from AGI. C. Ellen can deduct $3,000 for AGI. D. Ellen can deduct $5,000 from AGI.
Answer: C. Ellen can deduct $3,000 for AGI.
Mike sold equipment he is no longer using in his business at a loss of $4,000, and he sold investments at a loss of $8,000. Mike had no other sales of property in the current year. What are the tax implications of these losses to Mike? Multiple choice question. A. Deduct the $4,000 loss on equipment but not the $8,000 investment loss as this is considered a personal asset. B. Deduct the $4,000 loss on equipment and $3,000 of the loss on investment in the current year. The remaining investment loss is carried forward. C. Deduct $3,000 of the loss on equipment and $3,000 of the loss on investment in the current year. The remaining losses are carried forward. D. Deduct both losses in their entirety in the current year.
Answer: Deduct the $4,000 loss on equipment and $3,000 of the loss on investment in the current year. The remaining investment loss is carried forward.
Penalties for early-withdrawal of savings are deductible_____AGI, and interest reported in gross income________(includes/excludes) the interest forfeited for the penalty.
Answer: For Includes
Which of the following medical costs would be deductible as qualified medical expenses? A. Tummy Tuck B. Laser eye surgery C. Over-the-counter medications D. Eyeglasses E. Dental work
Answer: Laser eye surgery Eyeglasses Dental work
Isabella, age 50, pays $500 each month for health insurance premiums with after-tax dollars. She is not self-employed. During 2020, she also incurred $200 in doctor bills and $50 in over-the-counter medications. Her AGI is $45,000. What amount will she be able to deduct as an itemized deduction after the AGI floor is applied? A. $1,700 B. 0 C. $6,200 D. $2,825
Answer: Reason: [($500 × 12) + $200] = $6,200 - ($45,000 × 7.5%) = $2,825
Bruce is a CPA who operates his tax service business as a sole proprietorship. He files a joint tax return with his wife. Their tax return reported $361,600 in taxable income and $375,000 in profit from the tax service, before the deduction for qualified business income (QBI). How much of the income from Bruce's tax services is eligible for the QBI deduction? A. $243,750 B. 0 C. $326,600 D. $235,040
Answer: A Reason: Since their taxable income is above the $326,600 threshold for MFJ but below $426,600, the phase-out rules apply. ($361,600 - $326,600) = $35,000 ÷ $100,000 phase out = 35% is not eligible for the QBI deduction. $243,750 is eligible ($375,000 × 65%).
Which of the following statements are CORRECT when comparing For AGI deductions to From AGI deductions? (Choose all that apply.) Multiple select question. A. From AGI deductions are generally preferred over deductions for AGI. B. Certain from AGI deductions may not have an effect on taxable income despite the taxpayer incurring the expense. C. For AGI deductions are also called deductions "below the line" or "itemized deductions." D. Deduction for AGI reduce AGI thus reducing the limitations on other tax benefits that are decreased or phased out for higher income taxpayers. E. For AGI deductions are subtracted directly from adjusted gross income.
Answer: B and D B. Certain from AGI deductions may not have an effect on taxable income despite the taxpayer incurring the expense. D. Deduction for AGI reduce AGI thus reducing the limitations on other tax benefits that are decreased or phased out for higher income taxpayers.
True or False: Hobby expenses are deductible to the extent of hobby income reported in AGI.
Answer: False Reason: Hobby expenses are generally not deductible even though hobby revenue is included in gross income.
Bruce is a CPA who operates his tax service business as a sole proprietorship. He files a joint tax return with his wife. Their tax return reported $445,000 in taxable income before any QBI deduction. Is Bruce eligible to claim the deduction for QBI for his tax service? A. Yes B. No
Answer: No Reason: Since their taxable income is above the $326,600 threshold for MFJ + $100,000, Bruce may not claim the QBI deduction.
Bruce is a CPA who operates his tax service business as a sole proprietorship. He files a joint tax return with his wife. Their tax return reported $330,000 in net profit from his tax business and $300,000 in taxable income before the deduction for qualified business income (QBI). Will Bruce's tax business be deemed a qualified trade or business for purposes of the QBI deduction? A. Yes B. No
Answer: Yes Reason: Since their taxable income is below the $326,600 threshold for MFJ, the business is eligible for the QBI deduction.
Which of the following statements is accurate when referring to hobby expenses? A. Hobby expenses are deductible FOR AGI, but only to the extent of the revenue generated by the hobby. B. Hobby expenses are NOT deductible, but revenues generated by the hobby are taxable. C. Hobby expenses are NOT deductible because revenues generated from hobbies are not taxable. D. Hobby expenses are deductible against the revenue generated by the hobby and will result in a deductible loss if they exceed revenues. E. Hobby expenses are deductible as itemized deductions but only to the extent of the revenue generated by the hobby.
B. Hobby expenses are NOT deductible, but revenues generated by the hobby are taxable.
Which of the following is CORRECT concerning the deduction of qualified medical expenses for the 2020 tax year? Multiple choice question. A. Most individuals are able to deduct medical expenses. B. The expenses must be reduced by 7.5% of AGI. C. The expense can be increased by 7.5% of AGI. D. The expenses are fully deductible.
B. The expenses must be reduced by 7.5% of AGI.
Standard Deduction Amounts: Married filing separately
Basic Standard Deduction: $12,400 Additional Standard Deduction for Age and/or Blindness at End of Year: $1,300
Standard Deduction Amounts: Single
Basic Standard Deduction: $12,400 Additional Standard Deduction for Age and/or Blindness at End of Year: $1,650
Standard Deduction Amounts: Head of household
Basic Standard Deduction: $18,650 Additional Standard Deduction for Age and/or Blindness at End of Year: $1,650
Standard Deduction Amounts: Married filing jointly
Basic Standard Deduction: $24,800 Additional Standard Deduction for Age and/or Blindness at End of Year: $1,300
The overall limitation for cash charitable contribution deductions for individual taxpayers is Blank 1% of AGI. The limit is reduced to Blank 2 ,% for ordinary gain property other than cash, and Blank 3% for long-term capital gain property. (Enter your answers as whole numbers.)
Blank 1 60% Blank 2 50% Blank 3 30%
A loss from a sudden, unexpected, or unusual event such as a fire, storm, or shipwreck that occurs as part of a ________ __________ disaster is a(n)____________ loss.
Blank 1: federally, federal, president, presidental, or providentially Blank 2: declared or declare Blank 3: casualty
Which of the following descriptions BEST defines business activities? Multiple choice questions. A. Motivated primarily by personal enjoyment and requires a high level of effort from the taxpayer B. Motivated primarily by personal enjoyment but does not require a high level of effort from the taxpayer C. Profit-motivated and requiring a high level of effort from the taxpayer D. Profit-motivated, but not requiring a high level of effort from the taxpayer
C. Profit-motivated and requiring a high level of effort from the taxpayer
Contributions for retirement accounts (Deductions for AGI)
Contributions to a qualified retirement account are deductible for AGI to encourage savings.
Which of the following statements are CORRECT when comparing For AGI deductions to From AGI deductions? (Choose all that apply.) A. For AGI deductions are also called deductions "below the line" or "itemized deductions." B. From AGI deductions are generally preferred over deductions for AGI. C. Deduction for AGI reduce AGI thus reducing the limitations on other tax benefits that are decreased or phased out for higher income taxpayers. D. For AGI deductions are subtracted directly from adjusted gross income. E. Certain from AGI deductions may not have an effect on taxable income despite the taxpayer incurring the expense.
Correct: C and E C. Deduction for AGI reduces AGI thus reducing the limitations on other tax benefits that are decreased or phased out for higher-income taxpayers. E. Certain from AGI deductions may not have an effect on taxable income despite the taxpayer incurring the expense. False: A,B,D
Which of the following statements related to investment interest expense is INCORRECT? A. Investment interest expense not deductible in the current year may carry forward to a subsequent year. B. Investment interest expense due to investments in tax-exempt securities is NOT deductible. C. Investment interest expense is limited to investment income. D. Interest on loans to purchase land held for investment is NOT deductible
D. Interest on loans to purchase land held for investment is NOT deductible
Investment-Related Expense Deductions for AGI, from AGI, and Not Deductible (Deductions for AGI)
Deduction Type: Deduction for AGI: Rental and royalty expenses Deduction Type: Deduction from AGI (itemized deduction): Investment interest expense Not Deductible: Other investment expenses
Individual Business-Related Expense Deductions for AGI, from AGI, and Not Deductible (Deductions for AGI)
Deduction Type: Deduction for AGI: Self-employed business expenses Deduction Type: Deduction from AGI (itemized deduction): N/A Not Deductible: Unreimbursed employee business expenses
Flow-Through Entities (Deductions for AGI)
Expenses and losses incurred by this entity pass through to the entity owners, who typically report these amounts on Schedule E, then Schedule 1, line 5, and then combine with other items and include on Form 1040 (page 1), line 7a.
Investment interest expense is deducted_______AGI while self-employed business expenses are deducted_______AGI.
From and for
Investment activities (Deductions for AGI)
Involve investing in property for appreciation or for income payments (Low involvement).
The total itemized deduction for state and local taxes is limited to? (itemized deductions: taxes)
Is limited to $10,000 ($5,000 married filing separate). The deduction for foreign income taxes is not subject to this cap
Excess of Business Loss (Deduction for AGI)
Is the excess of aggregate business deduction for the year over the sum of aggregate business gross income or gain of the taxpayer plus a threshold amount.
Medical Expense Deduction Limitation (Itemized deductions)
It is limited to the amount of unreimbursed qualified medical expenses paid during the year (no matter when the services were provided) reduced by 7.5 percent of the taxpayer's AGI.
Taxpayers traveling for the primary purpose of receiving essential and deductible medical care may deduct some or all of the costs of
Lodging and transportation
Which of the following terms describes business expenses that would be deductible by the taxpayer? (Check all that apply.) Multiple select questions. A. Ordinary B. Crucial C. Appropriate D. Repetitive in nature E. Authorized F. Necessary G. Helpfu
Ordinary Appropriate Necessary Helpful
Alimony payments (Deductions for AGI)
Payments are deductible for AGI to maintain equity if paid pursuant to a divorce or separation agreement executed before 2019.
What is the Penalty for Early Withdrawal of Savings? (Deductions for AGI)
Reduces the taxpayer's net interest income to the amount actually received
Trade/Business activities (Deductions for AGI)
Require a relatively high involvement or effort from the taxpayer, whereas investment activities do not.
Sales tax deduction (itemized deduction: taxes)
State and local sales taxes can be deducted in lieu of state and local income taxes.
Excess Business Loss Limitation (Deductions for AGI)
Taxpayers are not allowed to deduct an excess business loss for the year but rather are carried forward to subsequent years.
Hospitals and Long-Term Care Facilities (Itemized deductions)
Taxpayers may deduct the costs of actual medical care whether the care is provided at hospitals or other long-term care facilities.
For individuals claimed as a dependent on another return
The 2020 standard deduction is the greater of (1) $1,100 or (2) $350 plus earned income not to exceed the standard deduction amount of those who are not dependents.
Qualified education expenses (Deductions for AGI)
The deduction is reduced for taxpayers with modified AGI over $65,000 ($130,000 married filing jointly) and eliminated for taxpayers with modified AGI exceeding $80,000 ($160,000 married filing jointly).
Bunching Itemized Deductions
The system of shifting itemized deductions into one year such that the amount of itemized deductions exceeds the standard deduction for the year, and then deducting the standard deduction the next year is known as
Qualified education expenses are limited to? (Deductions for AGI)
Tuition and fees required for enrollment at a post-secondary institution of higher education
Individuals may deduct itemized deductions payments for the following taxes (itemized deductions: taxes)
a) State, local, and foreign income taxes b) State and local real estate taxes on property held for personal or investment purposes c) State and local personal property taxes that are assessed on the value of the specific property
Rental and Royalty Expenses (Deductions for AGI)
•Claimed above the line (for AGI) •Could either be an investment activity or a trade activity depending on facts •Taxpayers report expenses and revenue on Schedule E and transfer the net income or loss from Schedule E to Schedule 1, line 5, and then combine with other items and include on Form 1040 (page 1), line 7a.
Charitable Contributions (Itemized deductions)
•Contribution of money or property must be made to a qualified domestic charity. •Special rules apply to charitable contributions of property depending on the type of property. a) Capital gain property b) Ordinary income property
Deductions for Individual Retirement Accounts (Deductions for AGI)
•Deductible contributions to traditional IRAs are for AGI deductions. The deduction amount depends on a number of factors. •Distributions from traditional IRAs are taxed as ordinary income and early distributions (before age 59½) are generally subject to a 10 percent penalty •Nondeductible contributions can be made. On distribution, the taxpayer is taxed on the earnings generated by nondeductible contributions but not on the actual nondeductible contributions.
Health Insurance Deduction by Self-Employed Taxpayers (Deductions for AGI)
•Deduction provides equity with employees who receive health insurance as a qualified fringe benefit. •Self-employed taxpayers can claim personal health insurance premiums for: • the taxpayer •the taxpayer's spouse, •the taxpayer's dependents (the taxpayer's children under age 27 ) The deduction is for AGI, but only to the extent of the self-employment income derived from the specific trade or business.
Self-Employment Tax Deduction (Deductions for AGI)
•Employers deduct the Social Security and Medicare taxes they pay on employee salaries. •Self-employed individuals are required to pay self-employment tax in lieu of Social Security tax. This tax represents both the employee's and the employer's share of Social Security and Medicare taxes. •Self-employed taxpayers are allowed to deduct the employer portion of the self-employment tax they pay to compensate for employers deducting their portion of Social Security.
Deduction is limited to qualified trade or business
•Excludes specified service trade or business (except for taxpayers with taxable income below $163,300; $326,600 joint returns; $163,300 married filing separately). •Deduction is subject to wage limitation and taxable income limitation.
Expenses are claimed on Schedule C. (Deductions for AGI)
•Revenues from the same activity are also reported on the same Schedule C. •The net income or loss from Schedule C is transferred to Schedule 1, line 3, and then combined with other items and included on Form 1040 (page 1), line 7a.
Bunching Itemized Deductions
•Tax benefit can be gained by implementing a simple timing tax planning strategy. -For taxpayers with itemized deductions that fall just short of the standard deduction amount and thus do not produce any tax benefit. •The basic strategy consists of shifting itemized deductions into one year such that the amount of itemized deductions exceeds the standard deduction for the year, and then deducting the standard deduction in the next year (or vice versa).
Directly Related to Business Activities (Deductions for AGI)
•Taxpayers are allowed to deduct expenses incurred to generate business income. For tax purposes, activities are either 1. profit-motivated or 2. Motivated by personal objectives.
Losses (Deductions for AGI)
•Taxpayers disposing of trade or business assets at a loss are allowed to deduct the loss for AGI. •Losses from investment assets (called capital assets) are offset against capital gains. •If capital losses exceed capital gains, this is called a net capital loss. •A net capital loss is deducted for AGI but limited to $3,000. (Losses in excess of the $3,000 limit are carried forward indefinitely to subsequent years.)
Medical Expenses (Itemized deductions)
•Taxpayers may deduct medical expenses incurred to treat themselves, their spouse, and their dependents. •Qualifying medical expenses include unreimbursed payments for care, prevention, diagnosis, or cure of injury, disease, or bodily function. •Taxpayers using personal automobiles for medical transportation purposes may deduct a standard mileage allowance (17 cents per mile in 2020) in lieu of actual costs.
Interest (Itemized deductions)
•Two itemized deductions for interest expense a) Deduction of investment interest is limited to a taxpayer's net investment income. b) Any investment interest in excess of the net investment income limitation carries forward to the subsequent year. •Home mortgage interest a) Interest on acquisition indebtedness of $1 million if incurred before December 16, 2017 b) Interest on acquisition indebtedness of $750,000 if incurred after December 15, 2017
Deduction for interest on qualified education loans (Deductions for AGI)
•Up to $2,500 of interest on education loans is deductible for AGI. •The interest deduction is phased out for taxpayers with AGI exceeding $70,000 ($140,000 filing jointly). •The deduction is eliminated for taxpayers with AGI exceeding $85,000 ($170,000 filing jointly).