Tax Planning

Jacob is divorced and has full custody of his two children although they spend every other weekend with their mother. How many personal exemptions is Jacob permitted on his Form 1040? A) 1 B) 2 C) 3 D) 4

Rationale He is permitted 1 personal exemption for himself and possibly 2 dependent exemptions for the children.

Isaac is a middle school teacher with gross income this year of $35,000. Based on the following, what is Isaac's adjusted gross income? (1) $4,000 qualified education interest expense (2) $2,000 alimony received (3) $1,000 contribution to a traditional IRA A) $30,000 B) $31,500 C) $32,000 D) $33,500

Rationale Isaac's adjusted gross income is his total gross income of $35,000 - $2,500 in qualified education interest expense (the deductible amount is limited to $2,500) - $1,000 contribution to a traditional IRA = $31,500. The alimony is RECEIVED, which is included in determining his gross income of $35,000. If it was paid then there would be a deduction but that's not the case.

Veronica has determined that she needs to make a 4th quarter federal estimated income tax payment. When is this payment due? A) January 15th of next year. B) December 31st of this year. C) December 15th of this year. D) September 15th of this year.

Rationale The 4th quarter federal income tax estimated payment is due by January 15th of the year following the year the payment is being made for.

Tara is single and her taxable income is $42,750, which puts her in the 25% tax bracket. How much is her income tax liability for 2017? A) $1,275 B) $5,226 C) $6,426 D) $10,026

Rationale The calculation is as follows: Income = $42,750 Taxes = $5,226.25* + [($42,750 - $37,950*) × 25%] = $6,458.75 Based on the tax tables for 2017.

Which of the following statements regarding cafeteria plans is not correct? A) A cafeteria plan must offer at least three nontaxable benefits. B) A cafeteria plan is a written plan under which the employee may choose to receive either cash or taxable benefits as compensation or qualified fringe benefits that are excludable from wages. C) Cafeteria plans are authorized by Section 125 of the Internal Revenue Code. D) A cafeteria plan is appropriate when employee benefit needs vary within the employee group.

Rationale The correct answer is "A". A cafeteria plan must offer at least one taxable benefit, usually cash, and one qualified nontaxable benefit. All of the other statements regarding cafeteria plans are correct.

Hansel and Gretel, a married couple, manage apartments and they are required to live in the managers' apartment as a condition of their employment. Instead of providing the apartment to Hansel and Gretel rent-free, the owner of the apartment building gives Hansel and Gretel a housing allowance of $600, which they use to pay rent on the managers' apartment. Hansel and Gretel pay $600 per month in rent. If they did not live in the managers' apartment, Hansel and Gretel could live in another apartment building where they would only pay $500 in rent. What amount, if any, must be included in Hansel and Gretel's gross income? A) $0. B) $100. C) $500. D) $600.

Rationale The correct answer is "A". An employee is allowed to exclude from gross income the value of lodging furnished by an employer to the employee if the lodging is furnished (1) on the employer's business premises, (2) for the convenience of the employer, and (3) the employee is required to accept the lodging as a condition of employment. It does not matter that Hansel and Gretel were paid a housing allowance, which they were then required to pay back to the employer for rent. Hansel and Gretel can exclude the entire value of their housing from their gross income.

Kevin owns a modified endowment contract. Kevin recently reassessed his insurance needs and decided that he would like to exchange his current modified endowment contract for a different insurance product. Which of the following transactions might result in gain realization and recognition? A) If Kevin trades his modified endowment contract for a life insurance policy. C) If Kevin trades his modified endowment contract for an annuity. D) None of the above transactions would result in the realization and recognition of gain.

Rationale The correct answer is "A". If Kevin trades his modified endowment contract for a life insurance policy, the transaction will not be eligible for the deferral of gain under Section 1035 of the Internal Revenue Code. B) If Kevin trades his modified endowment contract for a different modified endowment contract.

Franco and Giada are trying to calculate their gross income for the current year. Which of the following items should they exclude from their gross income? I. $60,000 in cash inherited by Giada from her mother. II. $20,000 borrowed by Franco and Giada from First City Bank. III. $12,000 gain from the sale of Franco and Giada's boat. IV. $400 of interest earned on a loan made by Franco to his cousin Vinnie. A) I and II only. B) III and IV only. C) I, II and III only. D) I, II and IV only.

Rationale The correct answer is "A". Inherited cash or property is excluded from gross income; therefore, option "I" is correct. Borrowed money is also excluded from gross income; therefore, option "II" is also correct. Gain on the sale of assets (option "III") and interest income (option "IV") are both included in gross income.

Under what circumstances is a taxpayer required to use a calendar year tax period? A) If the taxpayer does not keep books or accounting records. B) If the taxpayer opens a new business. C) If the taxpayer has an initial tax year of less than 12 months. D) If the taxpayer receives reporting documents such as Forms W-2 and 1099.

Rationale The correct answer is "A". Option "B" is incorrect because there is no requirement for new businesses to use a calendar year tax period. Option "C" is incorrect; a taxpayer may use a fiscal year tax period and have a tax year of less than 12 months in the first year. Option "D" is incorrect; although most taxpayers who receive such documents use the calendar year tax period, the receipt of such documents does not in and of itself require them to do so.

Britney owned an office building in Los Angeles that she rented out to several production companies. The building was destroyed by a fire and was a complete loss. Britney received a settlement from her insurance company and would like to reinvest in a new property. Britney wants to make sure that she is eligible for nontaxable exchange treatment. Which of the following is not correct regarding the requirements for nontaxable exchange treatment on Britney's transaction? A) Because Britney rented out the building instead of using the property directly, the replacement property must meet the functional use test. B) Britney must invest the proceeds in a replacement property that has a similar use to the property that was destroyed in the fire. C) Britney must reinvest the insurance proceeds within two years from the end of the year in which she received the insurance proceeds. D) Since Britney received cash as a result of the involuntary conversion, nonrecognition treatment is not mandatory even if she meets all of the requirements.

Rationale The correct answer is "A". The replacement property must meet the taxpayer use test, not the functional use test, since Britney did not use the property directly. The taxpayer use test requires replacement property to be used by the taxpayer in an activity which is treated the same for tax purposes in order to qualify for nontaxable exchange treatment. All of the other statements regarding the nontaxable exchange treatment of Britney's transaction are correct.

Paul (age 35) and his wife Stacey (age 33) are married with three young children. They both work outside the home. Paul is a corporate executive with Wellstar and Stacey is an executive assistant with a small local company. Paul fully participates in his company's qualified retirement plan by contributing $17,500 of his salary, which is matched 100% up to 3% of compensation. Stacey's employer does not offer a retirement plan. In addition, during the year they had the following items of income and expense: Paul's gross salary: $150,000 Stacey's gross salary: $32,000 Stacey's cash gift to her mother: $5,000 Interest from a joint savings account: $100 Federal income taxes withheld from paychecks: $30,000 State income taxes withheld from paychecks: $12,000 Charitable contributions made: $3,400 Rent paid for apartment: $24,000 Contribution to Paul's traditional IRA: $5,500 Contribution to Stacey's traditional IRA: $5,500 What is Paul and Stacey's adjusted gross income? A) $159,100 B) $164,600 C) $176,600 D) $182,000

Rationale The correct answer is "A." 150,000 Paul's gross salary +32,000 Stacey's gross salary 182,000 + 100 Interest 182,100 -17,500 His 401K 164,600 -5,500 Her IRAs 159,100 AGI

Billy, single and age 42, has the following items of income and expense for the current tax year. Wages: $60,000 Interest: $1,000 Inheritance: $50,000 Alimony paid: $10,000 Child support paid: $8,000 Federal taxes paid: $5,000 State income taxes paid: $2,000 Medical expenses: $7,500 Tickets from his employer for one basketball game: $100 What is the medical expense deduction that will actually be utilized for the current year? A) $0 B) $2,400 C) $5,100 D) $7,500

Rationale The correct answer is "A." Wages $60,000 Interest $1,000 less Alimony <$10,000> AGI $51,000 Medical expenses = $7,500 - ($51,000 x 10%) = $2,400 Medical expenses + taxes paid ($2,400 + $2,000) is less than $6,350 therefore, you will use the standard deduction.

Two years ago, Green Corporation, a cash basis taxpayer, sold services to Albert for $25,000. During the prior year, Green collected $10,000 from Albert. In the current year, Green collected $5,000 from Albert in final settlement of the debt. The proper treatment for the bad debt deduction is: A) $0 for the prior year and $0 for the current year. B) $0 for the prior year and $10,000 for the current year. C) $15,000 for the prior year and $0 for the current year. D) $15,000 for the prior year and $5,000 income for the current year.

Rationale The correct answer is "A." A cash basis taxpayer does not recognize income not received. Since the bad debt was never recognized as income, it cannot be recognized as a loss or a bad debt expense.

Which of the following best describes depreciation cost recovery? A) It is periodic expensing of tangible property, including real and personal property used in business. B) It is periodic expensing of the cost of intangible and tangible assets. C) It is the periodic expensing of natural resources, tangible and intangible assets, as they are being used up. D) It is an expense that fluctuates with the actual taking of the resource from the land.

Rationale The correct answer is "A." Cost recovery is a periodic expensing of tangible property, including real and personal property used in business. Amortization is a periodic expensing of the cost of intangible assets. Depletion is the expensing of natural resources as they are being used up. This expense will fluctuate with the actual taking of the resource from the land.

Frank's automobile, which is used exclusively in his business, was damaged in an accident. The adjusted basis prior to the accident was $8,000. The fair market value before the accident was $10,000 and the fair market value after the accident is $500. Insurance proceeds of $10,000 less his $2,000 deductible are received by Frank. What can Frank deduct as a result of the accident? A) $0 B) $1,500 C) $8,000 D) $9,500

Rationale The correct answer is "A." Frank is not entitled to any "deduction" since the net insurance proceeds were equal to his adjusted taxable basis.

If an individual who may otherwise qualify as a dependent does not spend funds that he or she has received (i.e., social security, wages), what is the IRS position regarding these unexpended amounts in terms of their application to the support test and their inclusion in being applied to the gross income test? A) Income received but not spent is applicable to the gross income test but not the support test. B) Income received but not spent is not applicable to the gross income test nor to the support test. C) Income received but not spent is applicable to the gross income test and to the support test. D) Income received but not spent is not applicable to the gross income test but is applicable to the support test.

Rationale The correct answer is "A." Income received but not spent is applicable to the gross income test but not the support test.

Which is the best source for obtaining a plain language understanding about the current tax law? A) Commerce Clearing House Federal Tax Guide. B) Congressional Tax Committee Reports. C) Treasury Regulations. D) Tax Court Reports.

Rationale The correct answer is "A." Option "A" is correct because Commerce Clearing House (CCH) provides plain language interpretation of tax law. Option "B" is incorrect as the Congressional Committee Reports (sometimes known as the Blue Book) provides congressional reasoning for enacting tax law. This language is often very technical and difficult to understand. Option "D" is incorrect because Tax Court Reports provide rulings of the U.S. Tax Court in the form of case law.

In the current year, Susan and Tom had three preschool-aged children who require daycare so that Susan and Tom work. Their total daycare costs for all three children was $6,500. While at daycare, 1/3 of the time is education while the remainder is custodial care. Assuming that Susan and Tom have an AGI of $110,000, what is the dependent care credit amount? A) $1,200 B) $1,300 C) $4,800 D) $6,500

Rationale The correct answer is "A." Sue and Tom will be able to take a credit of $1,200 ($6,000 x 20%). Although not normally allowable as deductible child care, education expenses for children preschool through kindergarten are qualified expenses.

Howard is 53 years old and has decided to purchase Long-term Care Insurance. Which of the following most accurately describes the tax benefits of premiums paid on a long term care policy? I. The policy must be guaranteed renewable or non-cancelable for the premiums to be deductible. II. Since Howard is less than age 62, only 10% of premiums paid are deductible. III. Premiums paid are deductible but limited based upon age. IV. The long term care insurance deduction is for AGI. A) I and III only. B) III only. C) II and III only. D) I, II, III and IV.

Rationale The correct answer is "A." The IRS provides guidelines for the amount of premiums that are deductible based upon the insured's age. The amount of premiums paid is included in the medical expense deduction for total expenditures exceeding 10% of AGI and is from AGI. The policy must be guaranteed renewable or non-cancelable to be qualified.

Maria Blue spent $12,000 in day care services for her 4 children to allow her to work. If her adjusted gross income is $100,000, how much is her dependent care credit? A) $1,200 B) $2,400 C) $6,000 D) $12,000

Rationale The correct answer is "A." The dependent care credit is not phased out and provides a credit of 20% on up to $3,000 per qualifying child with a maximum of $6,000 for two or more children. Therefore her credit is $1,200 = $6,000 X 0.20.

Which of the following is not generally one of the four main categories of itemized deductions? A) State income, property, and sales taxes. B) Charitable contributions. C) Casualty losses. D) Qualified personal residence mortgage and home equity interest.

Rationale The correct answer is "A." The statement is incorrect since you can deduct state income tax OR state sales tax. The rest are all below-the-line and thus, itemized.

Sara and Bill have rental property that was rented this year to a family whose primary bread winner lost his job. As a result they had uncollected rent for 2 months before they began the eviction process and 1 additional month before the family was finally evicted. If the rent was $800 per month, how much of a deduction may Sara and Bill claim on their income tax return for the uncollected rent? A) None, uncollected rent is not deductible. B) $800 of uncollected rent for the month it took to evict the renters. C) $1,600 of uncollected rent before action was taken to evict the renters. D) $2,400 of uncollected rent for the entire delinquency.

Rationale The correct answer is "A." They cannot deduct from ordinary income an amount that was never included in taxable income. Therefore, Sara and Bill will not receive any deduction for the uncollected rents.

After 1989, Donna purchased series EE savings bonds for $2,500 at the age of 25. This year she redeemed the bonds for $5,000 and paid qualified higher education expenses for her daughter in the amount of $3,000. How much interest will Donna be required to include in her gross income this year? A) $0. B) $1,000. C) $1,500. D) $2,500.

Rationale The correct answer is "B". Because Donna did not use all of the proceeds from the bond redemption to pay for qualified education expenses, she will be required to include part of the interest income from the bonds in her gross income. Donna may exclude $1,500 of interest income from her gross income [($3,000 / $5,000) x $2,500]. Therefore, Donna must include $1,000 in her gross income ($2,500 - $1,500).

Cary invested $100,000 in an annuity contract. This year, Cary annuitized the contract. The insurance company agreed to pay Cary $520.83 per month for 20 years. Assuming that Cary receives eight payments this year, how much can Cary exclude from his gross income this year? A) $833.33. B) $3,333.31. C) $4,164.64. D) $6,249.96.

Rationale The correct answer is "B". Cary's expected return is $125,000 (20 years x 12 months x $520.83). Therefore, his exclusion ratio is 80% ($100,000 / $125,000). Cary will receive $4,166.64 in annuity payments this year (8 payments x $520.83), of which $3,333.31 can be excluded. Therefore, Cary must include $833.33 in his income this year.

Dina loans $24,000 to her daughter Erin and does not charge any interest. Erin has investment income of $1,400 and investment expenses of $300. The applicable federal rate is 5%. How much interest must be imputed on the loan? A) $1,000. B) $1,100. C) $1,200. D) $1,400.

Rationale The correct answer is "B". Erin has net investment income of $1,100. Therefore, the amount of imputed interest is the lesser of net investment income or interest calculated using the AFR less interest calculated using the stated rate of the loan. Since the stated rate of interest on the loan is 0%, the amount of imputed interest is the lesser of $1,100 or $1,200 ($24,000 x 0.05). Therefore, $1,100 of interest must be imputed on the loan.

Nancy and Oliver had been married for 25 years when Oliver died suddenly in February of the current year. Although Nancy was deeply depressed about Oliver's death, she knew that Oliver would want her to move on with her life and she began dating again. It wasn't long before Nancy was swept off of her feet by Paul. After a romantic weekend in the Catskills, Paul and Nancy got married in November of the current year. What filing status will be used for Nancy and Oliver for the current year? A) Nancy and Oliver must both use the single filing status. B) Nancy will use the married filing jointly status, and Oliver will use the married filing separately status.. C) Nancy and Oliver will both use the married filing jointly status. D) Nancy will use the surviving spouse filing status, and Oliver will use the married filing jointly status.

Rationale The correct answer is "B". Option "A" is incorrect because Nancy is eligible to use the married filing jointly status with Paul. Option "C" is incorrect; Oliver cannot use the married filing jointly status because Nancy was married to someone else at the end of the year. Option "D" is incorrect because Nancy is not eligible to use the surviving spouse filing status. Therefore, Option "B" is the best choice

Which of the following is not an exception to the passive activity rules for rental activities? A) If the average period of customer use is seven days or less, the activity could be considered an active trade or business. B) If the average period of customer use is 30 days or less but the taxpayer does not provide significant personal services in concert with the rental activity, the activity may be classified as an active trade or business. C) The activity will be considered an active trade or business if the rental of property is incidental to the non-rental activity of the taxpayer. D) A rental activity that the taxpayer customarily makes available during business hours for nonexclusive use by customers will be classified as the active conduct of a trade or business, provided the taxpayer materially participates.

Rationale The correct answer is "B". Option "B" is correct because the taxpayer must provide significant personal services in concert with the rental activity and must materially participate in the activity in order to classify the activity as an active trade or business.

Sammy owned a home in south Florida that was severely damaged by a hurricane. Sammy had purchased the home for $150,000, and the fair market value of the home prior to the hurricane was $500,000. His homeowners insurance policy had lapsed one month before the hurricane hit and Sammy had not obtained any other insurance. After the hurricane, the property had a fair market value of $100,000. Assuming that Sammy's AGI was $115,000 this year, what is Sammy's casualty loss deduction? A) $38,100. B) $138,400. C) $388,400. D) $400,000.

Rationale The correct answer is "B". Sammy's casualty loss is the lesser of the decline in FMV or adjusted taxable basis. $150,000 vs. ($500,000 - $100,000) = $400,000 $150,000 - $100 - $11,500 = $138,400

All of the following statements concerning the AMT as it applies to individual taxpayers are correct EXCEPT: A) Some itemized deductions taken for regular tax purposes must be added back to regular income to determine income under AMT. B) Taxpayers are permitted to take the standard deduction for both regular and AMT tax purposes. C) All adjustments made to itemized deductions when calculating AMT result in a permanent increase in tax. D) Charitable deductions are claimed in the same manner for regular tax and for AMT tax purposes.

Rationale The correct answer is "B". Taxpayers who do not itemize deductions take the standard deduction for regular tax purposes, but this is added back to alternative minimum taxable income for AMT purposes. All of the other statements are correct.

Homer and Marge have been unable to have a baby. They decided last year that adoption would be the best choice for them. They adopted, Maggie, a 4 year old child this year. They paid $15,000 in qualifying adoption expense for the current year. Their MAGI is $170,000 and their tax due before the application of the qualified adoption credit is $11,000. What is Homer and Marge's available adoption credit for the current year? A) $9,000. B) $11,000. C) $13,570. D) $15,000.

Rationale The correct answer is "B". They are limited to the least of a) qualifying adoption expenses (15,000), b) adoption credit of $13,570 for 2017, or c) amount of tax due ($11,000). The adoption credit is not refundable.

Frank is considering selling a parcel of raw land located in South Dakota that he owns. If Frank sells the land, he would like to invest the proceeds in another piece of real property and would like to qualify for like-kind exchange treatment. Which of the following assets would not qualify as like-kind property for the sale of raw land? A) Raw land located in Florida. B) Raw land located in Canada. C) New land located in South Dakota. D) An industrial warehouse located in California.

Rationale The correct answer is "B". U.S. real estate and foreign real estate are not like-kind assets for income tax purposes. Therefore, if Frank exchanges his raw land in South Dakota for raw land in Canada, he will not qualify for like-kind exchange treatment.

Paul (age 35) and his wife Stacey (age 33) are married with three young children. They both work outside the home. Paul is a corporate executive with Wellstar and Stacey is an executive assistant with a small local company. Paul fully participates in his company's qualified retirement plan by contributing $18,000 of his salary, which is matched 100% up to 3% of compensation. Stacey's employer does not offer a retirement plan. In addition, during the year they had the following items of income and expense: Paul's gross salary: $150,000 Stacey's gross salary: $32,000 Stacey's cash gift to her mother: $5,000 Interest from a joint savings account: $100 Federal income taxes withheld from paychecks: $30,000 State income taxes withheld from paychecks: $12,000 Charitable contributions made: $3,400 Rent paid for apartment: $24,000 Contribution to Paul's traditional IRA: $5,500 Contribution to Stacey's traditional IRA: $5,500 What is Paul and Stacey's taxable income? A) $117,400 B) $122,950 C) $131,500 D) $143,200

Rationale The correct answer is "B." 150,000 Paul's gross salary +32,000 Stacey's gross salary 182,000 + 100 Interest 182,100 -18,000 His 401K 164,100 -5,500 Her IRA (his is not deductible) 158,600 AGI -12,000 State Income Tax Withheld -3,400 Charitable 143,200 -20,250 P& D Exemptions (5 x $4,050) 122,950 Taxable Income

Jason has three capital transactions for the current year: Short-term capital loss of $5,000 Short-term capital gain of $3,000 Long-term capital loss of $2,000 What is the net effect on Jason's taxes if he is in the 35% tax bracket? A) $1,400 tax reduction B) $1,050 tax reduction C) $850 tax reduction D) $450 tax reduction

Rationale The correct answer is "B." Net the STCG and STCL = $2,000 STCL. The $2,000 LTCL plus the $2,000 STCL = Total Loss of $4,000. He can only utilize $3,000 to offset ordinary income at 35% = $3,000 X 0.35 = $1,050. The remaining $1,000 is a long-term capital loss carryover.

John Donne was a client whom you had assisted with his tax preparation earlier this year. He received a notice from the IRS that his filing was to be audited for entertainment expenses. He has called you in a panic, wondering which documents he will be required to bring to authenticate his deduction. You tell him to bring which of the following? I. Mileage log of miles driven for business purposes. II. Dates and names of entertainment expenses. III. Receipts from expenses and business purpose. IV. Receipts for meals. A) I, II and III only. B) II and III only. C) II, III and IV only. D) I, II, III and IV.

Rationale The correct answer is "B." Business miles and meals are not considered entertainment expenses.

Janice had a car accident in which the other car's driver was cited for reckless driving. An appraisal established that the fair market value of Janice's car declined by $4,000 as a result of the accident. To have the car repaired, Janice paid $5,000. Her insurance company reimbursed her $500. If Janice's AGI for the year was $20,000, determine her deductible casualty loss on the car. A) $2,500 B) $1,400 C) $1,500 D) $2,400

Rationale The correct answer is "B." Casualty loss expense for non-business losses are the excess of 10% of the taxpayers AGI less $100. The loss is calculated as follows: $4,000 (decline in fair market value) - $500 (insurance reimbursement) - $100 (decrease for non-business losses) - $2,000 (10% of $20,000 AGI) = $1,400 in deductible loss.

Which of the following taxes generates the largest percentage of gross collections for the Internal Revenue Service? A) The Corporate income tax. B) The Individual income tax. C) The Estate tax. D) The Employment tax.

Rationale The correct answer is "B." Individual income taxes make up nearly 50% of the gross collections by the Internal Revenue Service.

This year, Gail had a Section 179 deduction carryover of $7,800 from last year. This year, she elected Section 179 for an asset acquired at a cost of $10,000. Determine Gail's Section 179 deduction for this year. Her net income is $135,000 for the current year. A) $10,000 B) $17,800 C) $13,900 D) $7,800

Rationale The correct answer is "B." Section 179 carryover to subsequent years will be limited by the business income before the deduction and the year's Section 179 limitation. In 2017, the limit for Section 179 is $510,000. Therefore, the entire amount of $17,800 ($7,800 carryover + $10,000 current year's deduction) is allowable.

Elaine incurred $26,000 of margin interest on her $600,000 investment portfolio. Her portfolio income consists of $10,000 in interest, $15,000 in qualified dividends, $3,000 in ordinary dividends, $6,000 in short-term capital gains, and $11,000 in long-term capital gains. How much of the margin interest is deductible on Elaine's tax return assuming no special elections? A) $17,000 B) $19,000 C) $24,000 D) $26,000

Rationale The correct answer is "B." She can deduct up to her net investment income which = $10,000 + 3,000 + 6,000 = $19,000 without making a special election. If she elected to treat the long-term capital gains and qualified dividends as ordinary income she could deduct it all. However, DO NOT assume that the election is made. The question would have to specify that information or ask "what is the maximum she can deduct?"

Scary Berries, Inc. is a C corporation that specializes in carving berries into frightening images. The company's primary profit generation is the sale of berries and they generate $4 million in annual revenue on average. What accounting method may Scary Berries, Inc. utilize for tax purposes? A) Cash basis B) Accrual basis C) Either cash or accrual D) Units of production

Rationale The correct answer is "B." Since Scary Berries generates its income from inventory (the berries) they must file under the accrual basis even though their revenues are under the $5 million accrual basis.

Matt owned stock in Whitline Corporation that he donated to a university (a qualified charitable organization) on May 1 of this year. What is the amount of Matt's charitable income tax deduction assuming that he had purchased the stock for $3,500 on March 3 of this same year, and the stock had a value of $4,600 when he made the donation? His AGI was $8,100. A) $1,100 B) $3,500 C) $4,050 D) $4,600

Rationale The correct answer is "B." Taxpayers who donate short term gain property are required to use the lesser of fair market value or adjusted basis for the determination of the charitable income tax deduction. In this case, Matt only owned the stock for 2 months, therefore it will be short term. The basis ($3,500) in less than the FMV ($4,600).

Which of the following credits are fully refundable? I. The Earned Income credit. II. The American Opportunity credit. III. Lifetime Learning credit. IV. Child Tax. V. Adoption credit. A) I, IV and V only. B) I only. C) I and V only. D) None of the choices.

Rationale The correct answer is "B." The Earned Income credit is refundable; able to create a negative tax liability. The remaining credits are not refundable. The American Opportunity credit may be partially refundable. Lastly, the "additional child tax credit" is refundable, not to be confused with the "child tax credit."

Under the First in First Out (FIFO) inventory system: A) The first good purchased is the first good sold. B) The cost of goods sold is based on the costs of the first goods purchased. C) FIFO reduces the probability of scrap or obsolescence. D) All of the above.

Rationale The correct answer is "B." The FIFO method is concerned with movement of costs through inventory, not goods. The cost of the first units purchased are the first costs to be transferred to cost of goods sold when the goods are sold.

To which of the following entities does the term "pass-through" entity apply? I. LLC. II. C corporation. III. Not for Profit Corporation. IV. S corporation. V. Partnership. A) I, III and IV only. B) I, IV and V only. C) I, III, IV and V only. D) II and III only.

Rationale The correct answer is "B." The S corporation, LLC and Partnership are considered "pass through" entities. "Pass through" means that the entity is not taxed separately from its owners, but passes its profits and losses through to the owners in their pro rata share of ownership.

George failed to pay $5,000 of income tax due with his return, which was timely filed on April 15th. He waits for 2 months after April 15th to pay the tax. How much will his penalties be? A) $25 B) $50 C) $55 D) $75

Rationale The correct answer is "B." The amount for failure to pay is point five percent (0.5%) per month = $5,000 X .005 X 2 = $50

Junior is 8 years old and has an UGMA account that has been funded with various bonds by Senior. Junior's interest income is $5,000 for the current tax year. If Senior is in the 35% tax bracket, how much tax is owed on Junior's income? A) $1,050 B) $1,120 C) $1,150 D) $1,750

Rationale The correct answer is "B." The calculation is as follows: Unearned income $5,000 Standard deduction ($1,050) @ 0% tax = $0 Remainder $5,000 - $1,050 =$ 3,950 Taxed at Junior's rate ($1,050) @ 10% tax = $105 Remainder $3,950 - $1,050 = $2,900 @ 35% tax = $1,015 $105 + $1,015 = $1,120

One of the five tests which must be met to qualify for dependency exemption is: A) The age of the dependent. B) The dependent is either a member of the taxpayers household or meets the criteria for family relationship. C) The taxpayer is a U.S. citizen. D) All of the above.

Rationale The correct answer is "B." The five dependency tests are: 1) Gross Income Test, 2) Support Test, 3) Member of Household or Family Member Test, 4) Citizenship Test (U.S., Canada or Mexico), and 5) Joint Filing Test.

Bill and Renee are married and in community property but living apart and filing separate federal income tax returns. Each earned a salary of $25,000 and Renee received $5,000 in interest on money she inherited from her deceased mother after her marriage to Bill. Which of the following is correct? A) In some states, Bill's gross income is $55,000. B) In some states, Renee's gross income is $27,500. C) In all community property states, Bill's gross income is $25,000. D) In all community property states, Renee's gross income is $30,000.

Rationale The correct answer is "B." The inherited property may be considered separate property, and therefore, in some community property states the income earned from it is separate. In others, it is community.

The accrual method of accounting generally must be used to report income earned by: A) A C corporation that made a S election. B) A general partnership with a corporate partner. C) A LLC that has business in most or all states. D) None of the above.

Rationale The correct answer is "B." The key is the question of when the accrual system "Must" be applied. C Corporations must use the accrual method. Therefore, any entity where a C corporation is a partner or owner must use the accrual method. The correct answer is "B" - Partnerships with corporations as owners must use the accrual method. Option "D" is automatically eliminated because S corporations are not required to use the accrual method of accounting.

Ron sells two personal use assets during the taxable year. A gain of $3,000 is realized on the sale of one asset and a loss of $9,000 is realized on the sale of another asset. What is his gain or loss for the year? A) ($3,000) loss B) $3,000 gain C) ($6,000) loss of which only $3,000 is deductible this year. D) ($9,000) loss of which only $3,000 is deductible, the $6,000 is carried over indefinately.

Rationale The correct answer is "B." The loss on sale of a personal asset (one not used in business) is not deductible. The sale of a personal asset at a gain is included in income. Therefore, the $9,000 loss does not offset the $3,000 gain.

Alice owns land "A" with an adjusted basis of $250,000, subject to a mortgage of $50,000. On July 1st, Alice exchanges land "A" and its mortgage for $300,000 in cash, a promissory note for $300,000, and property "B" that has a fair market value of $75,000 with Betty. What is the amount realized by Alice? A) $675,000 B) $725,000 C) $925,000 D) $975,000

Rationale The correct answer is "B." The realized amount not only includes the monies and fair market value of property "B" received (and any indebtedness the buyer has to the seller), but also any liabilities for the seller is relieved. In this case, the seller received $675,000 in cash, property, and notes (buyers indebtedness to the seller) as well as relief from $50,000 in mortgage. The total amount realized is $725,000.

Veronica borrowed $300,000 to acquire a parcel of land to be held for investment purposes. During the year, she paid interest of $30,000 on the loan. She had AGI of $70,000 for the year. Other items related to Veronica's investments include the following: Investment income = $15,200 Long-term gain on the sale of stock = $6,000 Investment counsel fees = $900 Veronica is unmarried and elected to itemize deductions. She had no miscellaneous deductions other than the investment counsel fees. Determine Veronica's maximum investment interest deduction. A) $30,000 B) $21,200 C) $16,100 D) $15,200

Rationale The correct answer is "B." The taxpayer's investment interest deduction is limited to the investment income. The investment income is $15,200 plus she can add the capital gains of $6,000 and deduct $21,200. The excess investment interest ($30,000 - $21,200) can be carried over to next year.

Martha gives her niece a machine to use in her business with a fair market value of $4,200 and a basis of $4,400. What is the niece's basis for depreciation (cost recovery)? A) $0; Gift property is not depreciable. B) $4,200 C) $4,300 D) $4,400

Rationale The correct answer is "B." Your basis for depreciation is the lower of FMV or adjusted basis for depreciation.

Under which of the following circumstances is a trip outside the United States considered to be purely for business? I. The taxpayer does not have control over the timing or arrangements for the trip. II. The trip outside the United States lasts for less than seven days. III. Less than 50 percent of the time spent on the trip was personal. IV. Vacation was not a primary consideration for the trip. A) I only. B) II and III only. C) I, II and IV only. D) I, II, III, and IV

Rationale The correct answer is "C". A trip outside the United States is considered to be purely for business when less than 25 percent of the time spent on the trip was personal. All of the other statements regarding travel outside the United States are correct.

Which of the following is a tax credit that reduces the tax calculated on taxable income? I. Dependency credit. II. Child tax credit. III. Earned income credit. IV. Credit for estimated tax payments. A) I, II and III only. B) II and III only. C) II, III and IV only. D) III, and IV.

Rationale The correct answer is "C". Although there is a dependency exemption, there is no such thing as a dependency credit. All of the other items are credits against the calculated tax.

Vince, a single individual, is one of the founders and original shareholders of Security Consulting, Inc., a corporate security consulting firm. The company was initially capitalized with $200,000, and Vince was a 50 percent owner. The company was structured as a C corporation and filing requirements and permissible tax elections that could benefit the owners were made at the time the company was created. After several years of successful operations, Security Consulting lost market share to large national firms, and eventually closed down operations. Since it had no assets other than the goodwill of the business, there was nothing left to distribute to the shareholders. Assuming that there were no changes to Vince's ownership interest over the period of his ownership, and that Vince has no capital transactions in the current year, by how much can Vince reduce his adjusted gross income this year due to the company becoming worthless? A) $3,000. B) $50,000. C) $53,000. D) $100,000.

Rationale The correct answer is "C". Because it was capitalized with less than $1 million and Vince was an original shareholder, the stock is Section 1244 stock in Vince's hands. Vince can deduct up to $50,000 of losses as an ordinary loss in any one tax year and the remaining loss is treated as a capital loss. Therefore, Vince will be able to deduct $50,000 of his loss as a Section 1244 loss against ordinary income and will qualify for an additional $3,000 long-term capital loss deduction. The remaining capital loss of $47,000 will be carried forward to future tax years.

Donna sells stock in Martin Corporation to her brother David for $1,800. Donna purchased the stock four years ago for $3,000 and the current fair market value of the stock is $1,800. David paid Donna $1,800 for the stock. Which of the following statements is correct regarding the tax consequences of this transaction? A) If David subsequently sells the stock to an unrelated party for $3,500, he will realize a gain of $1,700. B) Donna has a recognized loss of $1,200. C) If David subsequently sells the stock to an unrelated party for $2,200, he will have no gain or loss D) If David subsequently sells the stock to an unrelated party for $3,500, he will have no gain or loss.

Rationale The correct answer is "C". David will have a double basis in the stock, determined as follows: If the purchaser's sale price is less than FMV between the original basis & FMV greater than the original basis Then the purchaser's basis used is $1,800 (Loss Basis) no gain or loss $3,000 (Gain Basis)

John, Jay and Jeff each have an ownership interest in Three Guys Burgers, Inc. Based on the following information, which of them is/are considered to have materially participated in the conduct of the Three Guys Burgers business this year? I. John dedicated more than 500 hours this year to Three Guys Burgers. II. Jay devoted 150 hours to Three Guys Burgers this year. III. Jeff devoted 115 hours to Three Guys Burgers this year, but also devoted more than 100 hours to several other activities, for a total of 520 hours in all of the activities combined. A) I only. B) II and III only. C) I and III only. D) I, II and III.

Rationale The correct answer is "C". Jay has not materially participated. Although Jay devoted more than 100 hours to the activity, he did not devote more hours than anyone else because John worked at Three Guys Burgers for more than 500 hours. Jeff is also a material participant because he devoted more than 100 hours to the activity and also devoted more than 100 hours to several other activities, for a total of more than 500 hours in all of the activities combined.

Payments for employment-related care that are made to relatives of the taxpayer may qualify for the credit for child and dependent care expenses. Which of the following payments does not qualify? A) Payments for employment-related care made to the taxpayer's aunt. B) Payments for employment-related care made to the taxpayer's 21-year-old daughter (who is not a dependent of the taxpayer). C) Payments for employment-related care made to a dependent of the taxpayer.

Rationale The correct answer is "C". Payments for employment-related care made to a dependent of the taxpayer do not qualify for the credit for child and dependent care expenses. All of the other options are qualifying payments. D) Payments for employment-related care made to taxpayer's 17-year-old niece.

Arrange the following statutes of limitation from shortest to longest: I. Collection of deficiency by the IRS. II. Fraud. III. General Statue of Limitations under Section 6501. IV. Substantial Understatement of Income greater than 25%. A) I, II, III, IV. B) II, III, IV, I. C) III, IV, I, II. D) I, IV, III, II.

Rationale The correct answer is "C". The statute of limitations for the collection of a deficiency by the IRS is 10 years. There is no statute of limitations for fraud. The general statute of limitations under Section 6501 is 3 years. The statute of limitations for a substantial understatement of income greater than 25% is 6 years.

Brenda purchased 50 shares of Walsh Co. stock three years ago for $1,000. Brenda recently gifted the stock to her brother, Brandon. On the date of the gift, the stock had a fair market value of $750. Six months after receiving the stock from Brenda, Brandon decides to sell the stock. Which of the following statements is correct? A) If Brandon sells the stock for $700, he will have a long-term capital loss. B) If Brandon sells the stock for $1,100, he will have a short-term capital gain. C) If Brandon sells the stock for $675, he will have a short-term capital loss. D) If Brandon sells the stock for $800, he will have a long-term capital gain.

Rationale The correct answer is "C." (A) If Brandon sells the stock for $700 he will have a short-term capital loss of $50 (basis is $750). (B) If Brandon sells the stock for $1,100 he will have a long-term capital gain of $100 (basis is $1,000). (C) If Brandon sells the stock for $675 he will have a short-term capital loss of $75 (basis is $750). (D) If Brandon sells the stock for $800 he will have no gain or loss.

Michelle's husband passed away in January this year. She does not remarry and still maintains a residence for herself and her son who is 10 years old. When she is filing her tax return for this year she may file as: I. Single II. Married filing jointly III. Married filing separately IV. Qualifying widower A) I only B) IV only C) II and III only D) II, III, and IV only

Rationale The correct answer is "C." (I) Since Michelle's spouse died during the year she is considered married for the year. (II) and (III) Since Michelle is considered married for the full year (she was married but her spouse died during the year and she did not remarry) she may file MFS or MFJ. (IV) She does not currently qualify for filing qualifying widower since this status applies for the 2 years following the year of a spouse's death.

Mel made the following contributions to charity during the past year: Used clothing of the taxpayer and family - Basis = $900 and FMV = $300 Stock in GMC held as an investment for 13 months - Basis = $8,000 and FMV = $7,000 Stock in United Corp. held as an investment for 9 months - Basis = $9,000 and FMV = $10,000 Real estate held as an investment for six years - Basis = $10,000 and FMV = $25,000 The used clothing was donated to the Salvation Army; the other items of property were donated to a Methodist seminary. Disregarding any percentage limitations, Mel's charitable contribution deduction is: A) $43,300 B) $42,900 C) $41,300. D) $26,300

Rationale The correct answer is "C." A donation of short-term capital assets is recognized as a charitable expense at the lower of the FMV or basis. Donations of appreciated long-term assets are recognized as a charitable expense at the fair market value unless basis is chosen. In this question, the United Corp stock is a short-term investment that was held for less than 12 months, therefore, it will be expended as a charitable contribution at the donor's basis of $9,000. The remainder of the donated assets are expensed for charitable purposes at their fair market value

Mackenzie has two apartment units that are occupied by tenants all year long. In December, the tenants in unit 2 paid him in advance for the next January's rent. The regular rent is $1,000 per month for each of the units. How much rental income must Mackenzie include in taxable income this year? A) $12,000 B) $24,000 C) $25,000 D) It depends on which accounting method he uses

Rationale The correct answer is "C." According to Publication 17, "Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use."

Alimony is not: A) Deductible for income taxed purposes by the payor spouse. B) Ordinary income to the recipient using the constructive receipt rule. C) Deductible paid to a third party if owed by recipient spouse without agreement. D) Recaptured in the third year if a front loaded property settlement.

Rationale The correct answer is "C." Alimony is deductible by the payor spouse and taxable to the payee spouse. There are no gift tax consequences related to qualifying alimony not deductible if paid to a third party without agreement by the recipient spouse.

Which of the following are preference items or adjustments for purposes of the individual alternative minimum tax? I. Qualified private-activity municipal bond interest. II. The excess of percentage depletion over the property's adjusted basis. III. Investment interest in excess of net investment income. IV. Qualified housing interest. A) I only. B) II and IV only. C) I and II only. D) II and III only.

Rationale The correct answer is "C." By definition, investment interest expense in excess of net investment income and qualified housing interest are not preference items or adjustments for purposes of the alternative minimum tax.

Charlie's daughter Deborah is enrolled as a full-time student at Northwestern University. Her enrollment began this past summer and she is in her freshman year of studies. Charlie is paying Deborah's tuition. What credits are available to help Charlie off-set the tuition expense? I. American Opportunity credit. II. Lifetime Learning credit. III. Education IRA credit. IV. College Cost credit. A) I only. B) II and IV only. C) I and II only. D) II and III only.

Rationale The correct answer is "C." Charlie can use the American Opportunity credit for Deborah's first four years as a full-time student. After that, Charlie can switch to the Lifetime Learning credit. He cannot use both at the same time for the same person. Choices III and IV do not exist.

Which of the following personal income tax planning techniques are used to defer (postpone) taxation? I. Itemizing deductions. II. Contributing to an individual retirement account. III. Using the child care credit. IV. Owning cash value life insurance. A) I and II only. B) II only. C) II and IV only. D) III and IV only.

Rationale The correct answer is "C." IRAs and cash value insurance both involve deferral techniques. The other options are avoidance or elimination techniques.

Ima Clipper, a well-known artist, donated one of her original bronze creations to a local charity, which auctioned the piece for $3,000. Ima totaled her costs as follows: Bronze = $425 Other materials = $150 Pro-rata overhead = $125 Furnace/casting fees = $200 Artistic contribution = $2,100 Assuming this is Ima's only charitable contribution and based on an annual income of $150,000, what is the maximum amount of charitable income tax deduction available to her? A) $3,000 B) $2,100 C) $775 D) $900

Rationale The correct answer is "C." Only materials and expenses are deductible, not artistic contribution or time. No deduction is allowed for use of property; therefore, the pro-rata overhead would likely not be allowed.

Chelsea had to put more money into her rental property this year. She had the exterior of the rental home painted and the roof replaced at a cost of $12,500 and $18,000, respectively. How much is depreciable? A) $0 B) $12,500 C) $18,000 D) $30,500

Rationale The correct answer is "C." Painting, inside or out, is considered a repair, which is immediately expensed. The roof replacement is an improvement that substantially prolongs the asset's life, which is capitalized and depreciated over the useful life.

Payton owns farm land in west Texas where he raises cattle. In March of this year Austin approaches Payton about renting 25% of Payton's land for purposes of growing wheat. Payton and Austin agree that Austin will only pay 3 months of rent at an amount of $8,000 per month if Austin will build a barn on the land, which is the equivalent to 6 months of rent. How much will Payton recognize as rental income this year? A) $8,000 B) $24,000 C) $72,000 D) $96,000

Rationale The correct answer is "C." Payton's rental income is the cash received of $24,000 ($8,000 × 3) plus the fair market value of any property received. Since they agreed that 6 months of rent would equal the fair market value of the barn, the additional value is $48,000 ($8,000 × 6).

During the current year, Justin, a self-employed individual, paid the following amounts: Federal income tax = $5,000 State income tax = $3,000 Real estate taxes on land in a neighboring state (held as an investment) = $800 State sales taxes = $600 State occupational license fee = $400 What amount can Justin deduct as taxes by itemizing his deductions? A) $3,000 B) $3,400 C) $3,800 D) $4,800

Rationale The correct answer is "C." State income and real estate taxes are deductible as itemized deductions. Federal income taxes paid are deductible from the tax liability, but are not an itemized deduction. Sales taxes, unless a business expense, are not deductible. Occupational license fees are deductible as a direct business cost in which they are deducted for AGI not as itemized deductions.

Sources of "substantial authority" available for tax research include: I. Internal Revenue Code. II. Congressional Committee Reports (Blue Book). III. Treasury Regulations. IV. Private Letter Rulings. A) I and II only. B) I, II, and III only. C) I, II, III and IV. D) I, III and IV only.

Rationale The correct answer is "C." Substantial authority is official words and rulings which can be relied on to support a tax opinion or position. All of these can be relied on by someone.

Alisha Syrmos, a CFP licensee and fee-only financial planner, has assisted Bob Martin, a self-employed physician in tax and investment planning during the year. Identify the schedule(s) on which Alisha's fee may be deductible by Bob on his federal income tax return. I. Schedule A - itemized deductions. II. Schedule C - profit or loss from business. III. Schedule D - capital gains and losses. A) I only. B) II only. C) I and II only. D) I, II and III.

Rationale The correct answer is "C." Tax planning fees may be deducted against a taxpayer's itemized deduction, Schedule A. In addition, because the taxpayer is self-employed, the portion of services related to the business and not personal may be taken as a deductible on the taxpayer's Schedule C.

Chris works for a company where he travels constantly. The company does not reimburse him for all of his expenses so he has $14,000 of unreimbursed employee business expenses. If Chris' adjusted gross income is $75,000, how much of these expenses may he deduct? A) $7,000 B) $7,500 C) $12,500 D) $14,000

Rationale The correct answer is "C." The $14,000 of unreimbursed employee business expenses are miscellaneous itemized deductions subject to 2% of AGI floor. Therefore the deduction is $14,000 - ($75,000 X 0.02) = $12,500.

Kevin's 12 year old daughter, Angel, has a brokerage account that generates $13,000 of interest income and $2,000 of qualified dividends for the current year. How much tax is owed on this investment income if Kevin is in the 35% tax bracket? A) $1,950 B) $3,943 C) $4,262 D) $4,650

Rationale The correct answer is "C." The calculation is as follows: Dividends to Interest Ratio = 2,000/15,000 = 13.33% is dividends; 86.67 is interest Unearned Income = 15,000 Less Standard Deduction = greater of 1,050 or EI + 350 (so use 1,050) Taxable Income = 13,950 Amount at Parents Rate = All unearned income over 2,100 = 12,900 Allocate between dividends and interest Dividends = 12,900 X 13.33% = 1,719.57 X 15% = 258 Interest = 12,900 X 86.67% = 11,180.43 X 35% = 3,913 Amount at kids rate = 13,950 - 12,900 = 1,050 Allocate between dividends and interest Dividends = 1,050 X 13.33% = 139.97 X 0% = 0 Interest = 1,050 X 86.67% = 910.04 X 10% = 91 Total Tax = 4,262

Lauren has purchased a home worth $1.5 million with an interest-only mortgage of $1.2 million. She is currently only paying interest on the mortgage in the amount of $60,000 per year. What amount may she deduct as home mortgage interest on Schedule A of her individual income tax return? A) $45,000 B) $50,000 C) $55,000 D) $60,000

Rationale The correct answer is "C." The calculation is calculated by dividing the qualified mortgage over the total mortgage times the interest paid. (1,100,000/1,200,000) X 60,000 = 55,000 Note that this reflects the new stance of the IRS that if a home acquisition is over 1 million then the individual may deducat another interest on the next $100,000 as home equity indebtedness as long as there is equity in the home.

What is the effective income tax rate? A) The highest marginal rate paid by a taxpayer based on income. B) The highest rate that is paid by an individual. C) The average rate a taxpayer pays based on taxable income. D) The tax rate considered for tax planning purposes.

Rationale The correct answer is "C." The effective tax rate is the average tax an individual pays. The rate is determined by dividing the tax liability by the taxable income. The tax rate for planning purposes may be the effective or the highest marginal rate depending on the issue.

In year 1 Justin earns $700 from delivering papers for a newspaper company and he is treated as self-employed. In year 2 the newspaper company hires him as an employee and pays him $700 as W-2 income with no federal or state income tax withholding. Does Justin have to file a tax return in either year? A) Year 1: Yes Year 2: Yes B) Year 1: No Year 2: Yes C) Year 1: Yes Year 2: No D) Year 1: No Year 2: No

Rationale The correct answer is "C." The rule is that a taxpayer must file if he has greater than or equal to $400 of net earnings from self-employment. If the taxpayer does not have self-employment income there is no requirements to filing unless your income exceeds the standard deduction and personal exemption for that year.

Under what circumstances will the child of divorced parents be treated as the qualifying child of the noncustodial parent? I. The parents are divorced. II. The child receives over one-half of his support for the year from his parents. III. The child is in the custody of the parents for more than half the year. IV. The custodial parent signs a statement that he will not claim the child as a dependent for the year and the noncustodial parent attaches the statement to his return. A) I only. B) I, II and III only. C) II, III, and IV only. D) I, II, III, and IV only.

Rationale The correct answer is "D". All of the options are requirements that must be met in order for a child of divorced parents to be treated as a qualifying child of the noncustodial parent.

Which of the following imposed the first constitutional federal income tax? A) Revenue Act of 1861. B) 16th Amendment. C) Revenue Act of 1916. D) None of the above.

Rationale The correct answer is "D". Answer "A" is incorrect because although the Revenue Act of 1861 did impose a federal income tax, it was later found to be unconstitutional because Congress did not have the power to levy an individual income tax at that time. Answer "B" is incorrect because the 16th Amendment gave Congress the power to impose an individual income tax, but did not itself impose that tax. Answer "C" is incorrect because the Revenue Act of 1916 raised the rates previously imposed under the Revenue Act of 1913. Therefore, answer "D" is correct because the Revenue Act of 1913 imposed the first constitutional income tax.

The carrybacks and carryforwards associated with the general business credit must be used in a specific order. Which of the following correctly describes that order? A) The business credit carrybacks to the current year; the amount of the current year business credit; and the business credit carryforwards to the current year. B) The business credit carrybacks to the current year; the business credit carryforwards to the current year; and the amount of the current year business credit. C) The amount of the current year business credit; the business credit carrybacks to the current year; and the business credit carryforwards to the current year. D) The business credit carryforwards to the current year; the amount of the current year business credit; and the business credit carrybacks to the current year.

Rationale The correct answer is "D". Answer "D" correctly describes the sequence in which the carrybacks and carryforwards associated with the general business credit must be used.

Which of the following statements regarding the deduction of costs associated with investigating the purchase of a new line of business is not correct? A) If the new line of business is not purchased, no deduction is permissible. B) If the new line of business is purchased and it is in the same line of business as the current trade or business operation, the cost of investigating the new business is fully deductible. C) The ability to deduct the cost of investigating a new line of business is often overlooked by taxpayers. D) If the new line of business is purchased and it is in a different line of business as the current trade or business operation, there is no way to recoup the costs of investigation.

Rationale The correct answer is "D". If the new line of business is purchased and it is in a different line of business as the current trade or business operation, the costs of investigation are recouped by capitalizing the expenses and amortizing it ratably over a 60-month period.

Which of the following statements concerning hobby activities is correct? A) Any activity which does not generate a profit within three years must be treated for income tax purposes as a hobby activity. B) The IRS must prove that the taxpayer does not have a profit motive to treat an activity as a hobby activity. C) Expenses associated with the hobby activity can offset, without limitation, the income generated from the activity. D) Hobby income is included in gross income above the line, while hobby expenses are deducted below the line and are subject to a 2% hurdle.

Rationale The correct answer is "D". Income generated from a hobby activity is included in gross income, and expenses associated with the hobby may be deducted (to the extent of the hobby income) as a miscellaneous itemized deduction. Miscellaneous itemized deductions are subject to a limitation - the 2% floor. Until the taxpayer exceeds the 2% floor, the otherwise allowable expenses will not reduce taxable income. If the activity earns a profit in three out of five years, the IRS has the burden of proof of showing that there is no profit motive, but if there has not been a profit in three out of the last five years, the taxpayer has the burden of proof. There is no bright line test that requires an activity to be treated as a hobby activity based on the income trend of an activity.

Which of the following taxpayers can use the standard deduction? A) Zeke, who files a separate return from his wife Yasmine. Yasmine itemizes deductions on her return. B) Xavier, who is a nonresident alien. C) William, who files a tax return for less than 12 months because he changed his annual accounting period. D) Violet, who is a non-citizen spouse but files MFJ.

Rationale The correct answer is "D". Only answer D describes a taxpayer who is permitted to use the standard deduction. All of the other taxpayers are required to itemize their deductions.

Ford's federal income tax return was due on April 15 of the current year, but Ford did not file his return or pay his taxes until June 30 of the current year. Ford's unpaid tax balance during this period was $400. What is the total penalty that will be imposed on Ford for his failure to file and failure to pay? A) $60. B) $66. C) $129. D) $135.

Rationale The correct answer is "D". The failure to file penalty is 5% of the unpaid tax balance for each month or part thereof that the tax return is late (up to 25% of the unpaid tax balance). Therefore, Ford's failure to file penalty is $60 (3 months x $400 x 5%). However, if a tax return is filed more than 60 days late (as it is in Ford's case), the minimum failure to file penalty is the lower of $135 or the amount of the tax due. Therefore, Ford's failure to file penalty is actually $135. Ford is also subject to a failure to pay penalty of 0.5% per month or part thereof. Therefore, Ford's failure to pay penalty is $6 (3 months x $400 x 0.5%). Note that the failure to file penalty is reduced by the failure to pay penalty. Therefore, Ford's total penalty is $135 ($129 failure to file penalty and $6 failure to pay penalty).

James and Marilyn Herbert are married and own a vacation home on the beach in Florida. Each summer they are able to rent the property for $1,000 per week. This year they rented the property to six different parties and the total rental period was 133 days. James and his family vacationed there in the fall for three weeks. Expenses for the entire year totaled: Mortgage Interest: $13,500 Mortgage Principal: $4,200 Real Estate Taxes: $6,400 Utilities: $2,300 Trash: $300 Management Fees: $3,800 Depreciation: $10,000 What is the Herbert's profit or loss, and its nature, associated with this property for the current year? A) $21,500 loss, not deductible. B) $8,000 loss, deductible. C) $12,350 loss, not deductible. D) $2,414.87 loss, not deductible.

Rationale The correct answer is "D." Interest and taxes are accrued daily. $13,500 + $6,400 = $19,900 x (133÷365) = $7,251.23 Other costs are deducted according to use time (133 + 21 = 154) $16,400 x (133 ÷ 154) = $14,163.64 Total Costs $21,414.87 - Total Revenue $19,000 (133 ÷ 7 = 19 x $1,000) = Loss $2,414.87 not deductible due to mixed use.

Tikia, Inc. is filing their corporate income tax return for last year with a tax-year end of September 29. What is their tax accounting period? A) Fiscal B) Calendar C) Part-year D) 52-53 week

Rationale The correct answer is "D." A fiscal year ends on the last day of a month other than December. A calendar year ends on the last day of December. A party-year is for a time span less than 1 year. A 52-53 week year ends on a specified day of the week (such as Friday) that occurs in the last week of the last month of the tax year.

Alice purchased 100 shares of Big Monkey, Inc. stock and set up a dividend reinvestment plan with the company. The company provides a 10% discount on share purchases through dividend reinvestment. During the year Big Monkey, Inc. paid a dividend of $1 per share, which bought Alice 10 new shares in the company. How much must Alice report as dividend income for the year? A) None B) $100 C) $110 D) $111

Rationale The correct answer is "D." Alice has dividend income equal to the fair market value of the stock she received at the time of the dividend payment. The company allows a 10% discount and she had $100 to purchase shares with. Therefore, the total purchase price must have been $100 ÷ (1 - 0.1) = $111.11. Working that out, $111.11 × 0.10 discount = $11.11 so it would cost her $100 to buy $111.11 worth of stock.

Chuck purchases land for $250,000. He incurs legal fees of $1,000 associated with the purchase. He subsequently incurs additional legal fees of $15,000 having the land rezoned from agricultural to residential. He subdivides the land and installs streets and sewers at a cost of $500,000. What is Chuck's basis for the land and the improvements? A) $250,000 B) $750,000 C) $765,000 D) $766,000

Rationale The correct answer is "D." All costs of making property ready for use are capitalized. Here, the acquisition cost, plus legal fees to consummate the acquisition, rezoning costs and property improvement for streets and sewers are capitalized and become a part of the property's basis. The total basis is $766,000.

Alberto Sanchez purchased a piece of equipment last year for his computer business. Which of the following depreciation methods would provide Alberto with the least depreciation during the period in question? A) MACRS. B) ACRS. C) Units of production. D) Straight line.

Rationale The correct answer is "D." Although available as a tax depreciation method, straight line will provide the least depreciation expense for a given period. Option "A" provides the most depreciation, as well as one which will yield the greatest expense in the early portion of the asset's life. Option "B" is incorrect because ACRS application was discontinued in 1987. Option "C" is incorrect because it is not applicable to the type of equipment in question.

Edward told his nephew that if the nephew would care for Edward in his old age, the nephew could have all of Edward's securities when he died. At the time of the promise, the securities had a fair market value of $50,000. The nephew took good care of Edward, whose will left the securities to the nephew. The fair market value of the securities at the time of Edward's death was $80,000. Edward could have gone to a nursing home and obtained the same services as provided by the nephew for $40,000. The nephew's gross income from the above is: A) $0; this is an inheritance. B) $40,000; this is earned income at the fair market value. C) $50,000; this is earned income as of the time of the promise. D) $80,000; this is earned income equal to the date of death value.

Rationale The correct answer is "D." Because the agreement was to compensate Edward for his services, even though the transfer occurred following death, it is not a gift or bequest. It is compensation for services performed. Compensation of property has a value equal to its fair market value on the date of transfer. The fact that Edward died and a step up in basis would ordinarily occur is immaterial.

Which of the following are below the line deductions? I. Medical expenses. II. Alimony paid. III. Moving expenses. IV. Penalties for early withdrawal of savings. V. Tax preparation fees. A) I, III and V only. B) I, IV and V only. C) I, II and IV only. D) I and V only.

Rationale The correct answer is "D." Below the line deductions include all itemized deductions. Alimony, moving and penalties for early withdrawal are above the line deductions found in the Adjustment section of the 1040.

Capital recoveries include: A) The initial outlay for capital improvements. B) Repair and maintenance expenditures. C) Salvage value. D) Amortization of bond premium.

Rationale The correct answer is "D." Capital recovery is the expensing of certain acquisition costs. Bonds purchased at a premium are amortized over their life to expense the premium paid. The theory is that when they mature, their basis will be equal to their face value and not the face plus premium. Bond expenditures are, therefore, a recovery of capital.

Which of the following miscellaneous itemized deductions is not subject to the 2% of the AGI floor: A) Union dues. B) Appraisal fees for establishing a casualty loss. C) Job hunting expenses. D) Gambling losses to the extent of gambling gains. .

Rationale The correct answer is "D." Gambling losses are not subject to the 2% AGI floor. The remaining answers are subject to the floor making the amount in excess of the floor deductible

On January 1st of this year, Linda sold a piece of land she had had for years to George. Linda's basis in the land was $75,000 and she sold it for $100,000. It was agreed that George would pay Linda $10,000 as a down payment and would make installment payments of $10,000 for the next 9 years plus 10% interest. His second payment was due and payable December 31 of this year. What is Linda's tax consequence of this transaction this year? A) $20,000 of ordinary income B) $20,000 of long term capital gain C) $2,500 of long term capital gain and $9,000 of ordinary income D) $5,000 of long term capital gain and $9,000 of ordinary income

Rationale The correct answer is "D." George is paying her $100,000. Her amount invested is $75,000. Therefore, over 10 years, her total profit will be $25,000 or $2,500 per year except for the down payment. There are two payments at the end of the year. An interest payment of 10% x $90,000*=$9,000 (ordinary income). The second payment, $10,000, consists of $2,500 capital gain and $7,500 of return of basis. *Recall the amount paid was $100,000 less a down payment of $10,000, so $90,000 was outstanding.

Can money paid for child support be structured in a divorce as to be deductible to the payor spouse? A) Yes, if the decree stipulates such. B) No, unless the taxpayer gets a letter ruling from the IRS. C) No, child support payments can never be made deductible. D) Yes, if the money to be considered as child support is included as alimony which is deductible.

Rationale The correct answer is "D." If an agreement is reached between former spouses where the decreed amount of alimony is increased to include child support, then the additional alimony would be taxable to the recipient and deductible to the payor. The additional money cannot be based on any contingency such as with the child reaching the age of majority or death.

Which of the following is not an add-back item for purposes of calculating the Alternative Minimum Tax (AMT)? A) Depreciation of property placed in service after 1986. B) The standard deduction, if taken in lieu of itemized deductions. C) Passive activity losses. D) Installment sales undertaken before March 1, 1986.

Rationale The correct answer is "D." Installment sales executed after March 1, 1986 but not before, are add-back items.

Wanda is employed as a retail store manager. For the last calendar year, she had a $100,000 AGI and paid $7,600 in medical insurance premiums. During the year, she paid the following other medical expenses: Doctor and hospital bills for Bob and Sara (Wanda's parents) = $12,000 Doctor and dentist bills for Wanda = $6,400 Prescribed medicines for Wanda = $1,600 Non-prescribed insulin for Wanda = $700 Bob and Sara did not qualify as Wanda's dependents because they have income that requires they file a joint return. Wanda's medical insurance policy does not cover them. Wanda filed a claim for $4,200 for her own expenses with her insurance company in December of last year. She received the $4,200 reimbursement this January. What is Wanda's maximum allowable medical expense deduction for last year? A) $5,600 B) $6,300 C) $17,600 D) $18,300

Rationale The correct answer is "D." Medical expenses are an itemized deduction subject to a floor of 10% above AGI. The question here is whether non-prescribed insulin is a deductible medical expense. The answer is yes, non-prescribed insulin is deductible as a medical expense. The second issue is that the reimbursement was received this year and the question concerns last year's expenses. The total medical expenses are $28,300 less $10,000 ($100,000 AGI x 10%) = $18,300. The code allows a person to deduct the medical expenses for individuals who would be dependents except for income. (Very special exception).

Which of the following is a true statement regarding a current Net Operating Loss (NOL)? A) A NOL can be carried back three years prior to the loss year. B) A NOL can only be carried forward for 20 years or less. C) A NOL deduction is available the year the loss occurs. D) An affirmative election must be made to forgo the carryback period. .

Rationale The correct answer is "D." NOL losses currently have a two-year carryback and a 20-year carry forward. NOL deduction is NOT available the year the loss occurs, and it is for portions of the loss that have NOT been previously applied. An affirmative election must be made to forgo the carryback period

Which of the following is correct? A) Realized gains are always recognized and realized losses are never recognized. B) Realized gains and realized losses on the sale of personal use assets are not recognized. C) Realized gains and realized losses on the sale of personal use assets are recognized. D) In an involuntary conversion, the date of realization, not the payment date, determines the date of recognition.

Rationale The correct answer is "D." Option "A" is incorrect because realized gains may, in some instances, be deferred or excluded such as the gain on sale of a personal residence. Option "B" is incorrect because realized gains on some personal use assets are recognized unless excluded. Option "C" is incorrect because realized losses on personal use assets are not recognized.

Tab owns an apartment building and a DVD rental business. He participates for approximately 600 hours in the apartment building operations and approximately 1,000 hours in the DVD rental activity. Which of the following statements is correct? A) Both the apartment building and the DVD rental businesses are passive activities. B) Neither the apartment building nor the DVD rental business is a passive activity. C) The DVD rental business is a passive activity, but the apartment building is not. D) The apartment building is a passive activity, but the DVD rental business is not.

Rationale The correct answer is "D." Rental real estate is by definition a passive activity, therefore, the apartment rental business is passive. The DVD rental business is not a passive activity in that DVD rentals are short-term. To be considered as passive activities, other rental activity of goods and equipment must be long-term. According to code, short-term is defined as less than seven days.

Which of the following distributions of IRC Section 1245 recapture property may result in the immediate recapture of some or all of previous depreciation deductions? A) A distribution by a partnership to one of its partners. B) A non-simultaneous like-kind exchange. C) A disposition at death. D) A sale for an interest-bearing note.

Rationale The correct answer is "D." Section 1245 recapture is applied to the sale of depreciated assets. Option "A" is incorrect because the distribution is a property distribution and not a sale. Option "B" is incorrect because there is no "sale" as part of a like-kind exchange. Option "C" is incorrect because the property transferred at death is not classified as a sale. Option "D" is correct because it is a sale, regardless for cash, notes, either or both.

Assuming an asset is sold for a gain, when would Section 1250 ordinary income occur? A) Depreciable property is sold at a gain. B) Depreciable property is sold regardless of whether there is a gain or loss. C) Straight line depreciation is used on real property subject to ACRS. D) Real property subject to ACRS and accelerated depreciation was used.

Rationale The correct answer is "D." Section 1250 gain applies to the realized gain on real property where the accelerated method was used. The gain is the excess of accelerated over straight line (ACRS). Section 1250 gain is taxed as ordinary income. Under current law (MACRS), only straight line depreciation of real property is used.

Under the accrual method of accounting, the taxpayer (seller) recognizes income when: A) The bill is received by the buyer. B) The goods are accepted by the buyer. C) The goods are loaded on the truck at the seller's facility. D) The seller writes and sends the invoice after sending the goods.

Rationale The correct answer is "D." The accrual accounting method recognizes income when the taxpayer has a right to collect. This occurs usually after the completion of a job and in no case later than when the invoice is prepared and sent.

Earl entertains one of his clients on January 1, this year. Expenses paid by Earl are as follows: Cab fare = $22 Cover charge at supper club = $40 Dinner at club = $190 Tips to waiter = $38 Presuming proper substantiation, Earl's deductions for the night will be... A) $114 B) $134 C) $145 D) $156

Rationale The correct answer is "D." The cab fair is deductible as a transportation expense at the full cost. The remainder of the costs are either meals or entertainment. In either case, 50% of the total meals and entertainment expenses are allowable deductions. = $22 + [.50 ($40 + $190 + $38) = $22 + $134 = $156

Ned, a college professor, owns a separate business in which he participates during the current year. He has one employee who works part-time in the business. Which of the following statements is correct? A) If Ned participates for 120 hours and the employee participates for 120 hours during the year, Ned does not qualify as a material participant. B) If Ned participates for 95 hours and the employee participates for 5 hours during the year, Ned probably does not qualify as a material participant. C) If Ned participates for 500 hours and the part-time employee participates for 520 hours during the year, Ned still qualifies as a material participant. D) If Ned participates for 600 hours and the part-time employee participates for 1,000 hours during the year, Ned nevertheless qualifies as a material participant.

Rationale The correct answer is "D." The rules for material participation are: 1. More than 500 hours of participation 2. Taxpayer is the only one who substantially participates 3. Taxpayer spends greater than 100 hours in the tax year and no one else spends more 4. Taxpayer has materially participated in any 5 of the previous 10 years 5. The activity is a personal services activity and the individual has materially participated in any 3 prior years 6. Taxpayer participates 100 or more hours in this activity and total participation in all such activities exceeds 500 hours A is incorrect because he would be a material participant. The rule is > 100 hours and no one spends more. They can spend the same, but not more. (#3) B is incorrect because he is the only one who substantially participates (#2) C is incorrect because he needs to spend more than 500 hours or at least the same as the highest working person to be a material participant. (#1, #3) D is correct because he spent more than 500 hours (#1)

Freda purchased a stereo system for her son Wes, age 16. The stereo was placed in Wes' room and is used exclusively by him. Freda also purchased a new sports car in her own name, that was used 90% of the time by Wes. Which of the cost of these items may be considered as support in determining whether Freda may claim Wes as a dependent? A) Both the stereo and the car qualify as support because of the use test. B) Neither the stereo nor the car qualify as support because the car is Freda's and the stereo is diminimus. C) The stereo does not qualify for support but the car does because he uses it 90% of the time. D) The stereo qualifies for support, but the car does not even though it is de minimus.

Rationale The correct answer is "D." The stereo system purchased and GIVEN to Wes qualifies as support. Because the car was not GIVEN to Wes (although he is allowed to use it) it will not be considered support. However, maintenance costs, such as gas and insurance that the taxpayer provides for his use of the car will qualify as support.

Which of the following is a condition for receiving a dependent care credit? A) The taxpayer must provide over 1/2 cost of maintaining the household, which is also the principal residence of the child. B) The child must be a dependent. C) If married, both parents must work or go to school. D) All of the above.

Rationale The correct answer is "D." These are all conditions for claiming the dependent care credit.

Which of the following statements correctly reflects the automatic mileage method (as used to arrive at automobile expenses)? A) The rate includes parking fees and tolls. B) The method does not preclude the later use of MACRS on the same vehicle. C) The election of the automatic mileage method precludes a later change to the actual operating cost method. D) The method can be used on a car that is either purchased or leased by the taxpayer.

Rationale The correct answer is "D." You can still deduct parking fees and tolls, MACRS is not permitted--nor is bonus depreciation such as 179--and you may switch between the standard mileage method and the actual operating cost method. The method does allow use on leased autos but the only exception is "If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period."

Lucy and Lou are married and normally file a joint return. Under which of the following circumstances are they not required to file a tax return? A) If Lucy is 64 and Lou is 66 and their gross income is $23,000. B) If Lucy and Lou are both 35 and have one dependent and their gross income is $23,000. C) If Lucy is 64 and Lou is 66, Lou is blind, and their gross income is $23,000. D) None of the above.

Rationale The correct option is "D". Option "A" is not correct; Lucy and Lou must file a tax return because their gross income exceeds $22,050 ($4,050 x 2-- personal exemption + $12,700 standard deduction + $1,250 additional standard deduction for Lou's age). Option "B" is not correct; Lucy and Lou must file a tax return because their gross income exceeds $20,800 ($8,100 personal exemption + $12,700 standard deduction). The dependency exemption is not taken into account in determining whether Lucy and Lou are required to file a tax return. Option "C" is not correct; Lucy and Lou must file a tax return because their income exceeds $22,050 ($4,050 x 2-- personal exemption + $12,700 standard deduction + $1,250 additional standard deduction for Lou's age). The additional standard deduction for Lou's blindness is not taken into account in determining whether Lucy and Lou are required to file a tax return.

Blake is a CFP® licensee and prepares tax returns for his clients. He prepared his brother's income tax return for $1,000 and he willfully neglects to include $30,000 of income since his brother did not receive a 1099 for consulting work. Blake is aware that his brother earned the $30,000 but fails to report it since he doesn't believe the IRS will catch the understatement of income. The additional tax on this $30,000 of income would have been $7,500. How much of a penalty may Blake be subject to for the understatement of income? A) None, but his brother will be subject to penalties. B) $3,750 C) $5,000 D) $7,500

Rationale The preparer penalty for willful or reckless conduct is the greater of $5,000 or 50% of the income derived by the preparer for the return.

Aurora had the following cash inflows during the current taxable year: (1) Wages: $45,000 (2) Loan Proceeds: $2,000 (3) Child Support: $5,000 (4) Stock Sale Proceeds: $3,000 (5) U.S. Government Bond Interest: $1,000 What is her gross income for income tax purposes if her adjusted tax basis in the stock was $2,000? A) $45,000 B) $47,000 C) $49,000 D) $51,000

Rationale Wages plus stock sale proceeds less basis in the stock plus U.S. government bond interest = $45,000 + $3,000 - $2,000 + $1,000 = $47,000. Loan proceeds are not taxable income and neither is child support.