7 CHAPTER DEDUCTIONS AND LOSSES: CERTAIN BUSINESS EXPENSES AND LOSSES
Instructor: The test items in both the print Test Bank and ExamView test-creation software are numbered by question type within each chapter. Thus, users of ExamView can more easily preview their selections using the printed Test Bank in the same numbering system. Status: Present Topic TRUE OR FALSE 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 Bad debt: loss amount Bad debts Bad debts: tax benefit rule Reserve method Bad debt: collection Proof of worthlessness Nonbusiness bad debt Nonbusiness bad debt versus business bad debt Nonbusiness bad debt: corporation Business bad debt: classification Nonbusiness bad debt Bona fide debt Worthless security Worthless securities Worthless securities Gain on 1244 small business stock Loss on 1244 small business stock Gain and loss on 1244 small business stock Rental loss Casualty loss: defined Casualty loss: taxpayer Casualty loss: defined Theft loss: amount Theft loss: time of deduction Casualty loss: reimbursement Casualty loss: amount of deduction Casualty loss: amount of deduction Casualty loss: amount of deduction Casualty loss: amount of deduction Casualty loss: personal use property Casualty loss: no insurance claim filed Casualty loss: classification Casualty loss: 10% adjusted gross income floor Theft loss: classification 7-1 New Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged 2 3 4 6 7 8 10 11 12 13 14 15 17 18 19 20 22 23 24 25 26 28 29 30 32 33 34 Edition Q/P in Prior Edition
Question/ Problem
7-2 35 Question/ Problem 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
2009 Annual Edition/Test Bank Research and experimental expenditures Unchanged Status: Present Edition New Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged New Unchanged Unchanged New Unchanged Unchanged Unchanged 35 Q/P in Prior Edition 37 38 39 40 42 43 45 46 48 49 50
Topic Research and experimental expenditures Research and experimental expenditures Domestic production activities deduction: calculation Domestic production activities deduction: carryover Domestic production activities deduction: W-2 wage limit Net operating loss: defined Net operating loss: carryback period Net operating loss: farming Net operating loss: farming Net operating loss: nonbusiness income Net operating loss: personal casualty loss Net operating loss: computation Net operating loss: computation Net operating loss: computation Net operating loss: classification MULTIPLE CHOICE
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Bad debts Bad debts: cash basis taxpayer Nonbusiness bad debt Business bad debt Bad debts: purchased debt instrument Bad debts: specific charge-off method and tax benefit rule Bad debts: related parties Bad debts: related parties Loss on worthless securities Loss on worthless securities: 1244 stock Loss on 1244 small business stock: positive AGI Loss on 1244 small business stock: worthless securities Loss on 1244 small business stock: individual shareholder Casualty loss: definition Casualty loss: personal use property Casualty loss: business use property Casualty loss: personal use property and insurance Casualty loss: personal use property Casualty loss: personal use property Casualty loss: personal use property Casualty loss: business and personal use property
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Deductions and Losses: Certain Business Expenses and Losses 22 23 Question/ Problem 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 Topic Casualty loss: insurance recovery Casualty loss: business use property Casualty loss: production of income property and personal use property Research and experimental expenditures Research and experimental expenditures Research and experimental expenditures Domestic production activities deduction: calculation Domestic production activities deduction: W-2 wage limit Domestic production activities deduction: effect of NOL carryforward Net operating loss: adjustments Net operating loss: carryback and carryover periods Net operating loss: adjustments Net operating loss: calculation Net operating loss: calculation Net operating loss: calculation Net operating loss: calculation Net operating loss: calculation Net operating loss: adjustments Net operating loss: adjustments Net operating loss: adjustments PROBLEMS 1 2 3 4 5 6 7 8 9 10 11 12 Nonbusiness bad debt and tax benefit rule Nonbusiness bad debt, 1244 stock, casualty gain, and worthless securities Nonbusiness bad debt, casualty gain, and casualty loss Casualty loss: personal use property and investment property Casualty gains and losses Theft loss Casualty gains and losses Research and experimental expenditures Domestic production activities deduction Net operating loss: calculation Net operating loss: calculation Net operating loss: calculation Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Casualty loss: investment and personal use property Casualty loss: personal and business use auto Unchanged Unchanged Status: Present Edition New Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Modified Unchanged Unchanged Modified Unchanged Unchanged Modified
7-3 22 23 Q/P in Prior Edition 25 26 27 29 30 31 32 34 35 36 37 38 39 40 41 42 43
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2009 Annual Edition/Test Bank
Question/ Problem Topic ESSAY 1 2 3 4 5 6 7 8 9 Classification as bona fide loan versus a gift Casualty loss: disaster area loss Casualty loss: property associated with a transaction entered into for profit Research and experimental expenditures Domestic production activities deduction: statutory purpose Domestic production activities deduction: calculation of QPAI Net operating loss: farm loss Net operating loss: nonbusiness deductions Net operation loss: calculation of remaining NOL
Status: Present Edition
Q/P in Prior Edition
Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged New
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Deductions and Losses: Certain Business Expenses and Losses
TRUE/FALSE
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1. James is in the business of debt collection. He purchased a $20,000 account receivable from Green Corporation for $15,000. During the year, James collected $13,000 in final settlement of the account. James can take a $7,000 bad debt deduction in the current year. ANS: F James has a basis of $15,000 in the account receivable and hence, his bad debt is limited to $2,000 ($13,000 $15,000). PTS: 1 REF: p. 7-3 | p. 7-4
2. If a business debt previously deducted as partially worthless becomes totally worthless this year, only the amount not previously deducted can be deducted this year. ANS: T PTS: 1 REF: p. 7-3
3. If an $8,000 nonbusiness loan was written off and netted against a $10,000 long-term capital gain last year, the taxpayer need not include the amount in gross income this year if the entire $8,000 is collected in the current year. ANS: F The taxpayer must include the nonbusiness loan previously written off as income in the current year to the extent the deduction yielded a tax benefit in the year of the deduction. PTS: 1 REF: p. 7-4
4. Accrual basis taxpayers can use the reserve method for computing deductions for bad debts. ANS: F Taxpayers can use only the specific charge-off method in accounting for bad debts. The reserve method is not permitted. PTS: 1 REF: p. 7-3
5. If an account receivable written off during the current year is subsequently collected during the current year, the write-off entry is reversed. ANS: T PTS: 1 REF: p. 7-4
6. Legal proceedings must always be initiated to prove that a debt is worthless. ANS: F Legal proceedings need not be initiated to prove that a debt is worthless. PTS: 1 REF: p. 7-4
7. A nonbusiness bad debt is a debt unrelated to the taxpayers trade or business either when it was created or when it became worthless. ANS: T PTS: 1 REF: p. 7-4
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2009 Annual Edition/Test Bank
8. In determining whether a debt is a business or nonbusiness bad debt, the debtors use of the borrowed funds is not important. ANS: T The use of the funds by the debtor is of no consequence in making the determination. The determination is made at the creditor level. PTS: 1 REF: p. 7-4
9. A corporation which makes a loan to a shareholder can have a nonbusiness bad debt deduction. ANS: F The nonbusiness bad debt provisions do not apply to corporations. PTS: 1 REF: p. 7-5
10. A business bad debt can offset an unlimited amount of capital gain with any excess nonbusiness bad debt then offsetting ordinary income. ANS: F A business bad debt is classified as an ordinary deduction. PTS: 1 REF: p. 7-5
11. The amount of complete worthlessness on a nonbusiness bad debt is deducted at final settlement. ANS: T A taxpayer is entitled to deduct the net amount of the loss upon final settlement of the debt. PTS: 1 REF: p. 7-5
12. A bona fide debt arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed sum of money. ANS: T PTS: 1 REF: p. 7-5
13. An account receivable that is uncollectible will be treated as a worthless security and hence, produce a capital loss. ANS: F An account receivable is not a security and hence, will produce an ordinary loss. PTS: 1 REF: p. 7-3 | p. 7-6
14. A loss from a worthless security is always treated as a long-term capital loss. ANS: F The last day treatment increases the likelihood that the capital loss will be classified as long term, but is not automatic. PTS: 1 REF: p. 7-6
Deductions and Losses: Certain Business Expenses and Losses
15. A loss is allowed for a security that declines in value. ANS: F A loss is allowed for securities that become completely worthless during the tax year. PTS: 1 REF: p. 7-6
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16. An individual taxpayer must treat a gain on the sale of 1244 small business stock as ordinary gain. ANS: F Gain on 1244 small business stock is treated as capital gain. PTS: 1 REF: p. 7-7
17. Taxpayers must sell or exchange their 1244 stock in order to recognize an ordinary loss (does not apply to stock becoming worthless). ANS: F Section 1244 loss treatment also applies to 1244 stock becoming worthless. PTS: 1 REF: p. 7-6
18. Al, who is single, has a gain of $30,000 on the sale of 1244 stock (small business stock) and a loss of $60,000 on the sale of 1244 stock. As a result, Al has a $20,000 net capital gain and a $50,000 ordinary loss. ANS: T The $30,000 gain on the sale of the 1244 stock is classified as a capital gain. The $60,000 loss on the sale of the 1244 stock is classified as an ordinary loss to the extent of $50,000. The balance of the 1244 stock loss of $10,000 is classified as a capital loss. PTS: 1 REF: p. 7-7
19. An individual may deduct a loss on rental property only if it meets the definition of a casualty loss. ANS: F Only an individuals loss on personal use property must meet the definition of a casualty to be deductible. PTS: 1 REF: p. 7-8
20. Other casualty means casualties similar to those associated with fires, storms, or shipwrecks. ANS: T PTS: 1 REF: p. 7-8
21. A father cannot claim a casualty on his daughters personal use property. ANS: T PTS: 1 REF: p. 7-8
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2009 Annual Edition/Test Bank
22. A casualty loss deduction is not allowed for losses resulting from a decline in value rather than an actual loss of property. ANS: T PTS: 1 REF: p. 7-9
23. If the amount of the insurance recovery for a theft loss is greater than the assets adjusted basis but less than its fair market value, no gain is recognized. ANS: F Gain is recognized if the amount of the insurance recovery is greater than the assets adjusted basis. PTS: 1 REF: p. 7-11 | p. 7-13
24. A theft loss is taken in the year of discovery of the theft. ANS: T PTS: 1 REF: p. 7-9
25. If a taxpayer receives reimbursement for a casualty loss sustained and deducted in a previous year, the total reimbursement must be included in gross income on the return for the year in which the reimbursement is received. ANS: F The reimbursement need only be included to the extent the previous deduction resulted in a tax benefit. PTS: 1 REF: p. 7-9
26. If rental property is completely destroyed, the amount of the loss is the lesser of the fair market value of the property or the adjusted basis of the property at the time of the destruction. ANS: F The amount of the loss is equal to the adjusted basis of the property. PTS: 1 REF: p. 7-10
27. The cost of repairs to damaged property may be acceptable as a measure of the loss in value of the property. ANS: T PTS: 1 REF: p. 7-11
28. If a storm damages a taxpayers residence and car, the loss on the residence and the loss on the car must each be reduced by $100. ANS: F The $100 floor is per event. PTS: 1 REF: p. 7-11
29. The amount of loss for partial destruction of business property is the lesser of the adjusted basis or the decline in fair market value. ANS: T PTS: 1 REF: p. 7-10
Deductions and Losses: Certain Business Expenses and Losses
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30. If personal casualty losses (after deducting the $100 floor) exceed personal casualty gains, the itemized deduction is always equal to the losses, to the extent they exceed 10% of adjusted gross income. ANS: F The losses are subject to the 10% of adjusted gross income floor only to the extent they exceed the gains. PTS: 1 REF: p. 7-14
31. The amount of a casualty loss on insured personal use property is reduced by the insurance coverage if no claim is made against the insurer. ANS: T PTS: 1 REF: p. 7-11
32. Losses on rental property are classified as deductions for AGI . ANS: T PTS: 1 REF: p. 7-13
33. When a nonbusiness casualty loss is spread between two taxable years, the loss in the second year is reduced by 10% of adjusted gross income for the second year. ANS: T PTS: 1 REF: p. 7-11
34. A theft loss of investment property is a miscellaneous itemized deduction subject to the 2%-ofAGI floor. ANS: F A theft loss is a separately stated item on Schedule A of Form 1040. It is not subject to the 2%of-AGI floor. PTS: 1 REF: p. 7-13
35. A deduction is not available for research and experimental expenditures which are capitalized. ANS: F A deduction is available when the project is abandoned. PTS: 1 REF: p. 7-15
36. Expenses in connection with the acquisition of land are not research and experimental expenditures. ANS: T PTS: 1 REF: p. 7-15
37. If an election is made to defer deduction of research expenditures, the amortization period is based on the expected life of the research project. ANS: F The amortization period is not less than 60 months. PTS: 1 REF: p. 7-16
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2009 Annual Edition/Test Bank
38. For tax years beginning in 2008, the domestic production activities deduction (DPAD) is calculated by multiplying 6% times the lesser of (1) qualified production activities income (QPAI) or (2) taxable (or modified adjusted gross) income or alternative minimum taxable income. ANS: T PTS: 1 REF: p. 7-17
39. If qualified production activities income (QPAI) cannot be used in the calculation of the domestic production activities deduction in 2008 because of the taxable income limitation, the product of the amount not allowed multiplied by 6% can be carried over for 5 years. ANS: F In this case, any amount not allowed is lost forever. PTS: 1 REF: p. 7-17
40. The domestic production activities deduction (DPAD) for 2008 cannot exceed 50% of all W-2 wages paid by the taxpayer during the tax year. ANS: F Only wages paid to employees engaged in qualified domestic production activities can be used for the 50% limit. PTS: 1 REF: p. 7-17 | p. 7-18
41. A theft or other casualty of personal use property can create an NOL for an individual. ANS: T PTS: 1 REF: p. 7-19
42. A taxpayer must carry any NOL incurred back two years. ANS: F A taxpayer may elect to forgo the carryback period. PTS: 1 REF: p. 7-21
43. A farming NOL may be carried back 5 years. ANS: T PTS: 1 REF: p. 7-20
44. The amount of a farming loss cannot exceed the amount of the taxpayers NOL for the taxable year. ANS: T PTS: 1 REF: p. 7-20
45. Nonbusiness income for net operating loss purposes includes such items as dividends and interest income. ANS: T PTS: 1 REF: p. 7-22
Deductions and Losses: Certain Business Expenses and Losses
46. A personal casualty loss can create or increase a net operating loss for an individual. ANS: T PTS: 1 REF: p. 7-20
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47. An NOL carryforward is used in determining the current years NOL. ANS: F An NOL carryforward is not used in determining the current years NOL. PTS: 1 REF: p. 7-21
48. The excess of nonbusiness capital losses over nonbusiness capital gains must be added to taxable income to compute the net operating loss of an individual. ANS: T PTS: 1 REF: p. 7-21
49. An individual taxpayer who does not itemize deductions uses the standard deduction to compute the excess of nonbusiness deductions over the sum of nonbusiness income and net nonbusiness capital gains for purposes of computing net operating loss. ANS: T PTS: 1 REF: p. 7-22
50. When a net operating loss is carried back to a non-loss year, the net operating loss is a miscellaneous itemized deduction. ANS: F An NOL is a business loss. Therefore, the deduction is a deduction for AGI. PTS: 1 REF: p. 7-23
MULTIPLE CHOICE 1. Mable is in the business of factoring accounts receivable. Last year, she purchased a $20,000 account receivable for $15,000. This year, the account was settled for $18,000. How much loss can Mable deduct and in which year? a. $2,000 for the current year. b. $2,000 for the prior year and $3,000 for the current year. c. $3,000 for the current year. d. $5,000 for the current year. e. None of the above. ANS: E Mables basis in the debt is $15,000. Therefore, her gain for the current year is $3,000 ($18,000 $15,000). PTS: 1 REF: p. 7-3
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2009 Annual Edition/Test Bank
2. Jed is an electrician. Jed and his wife are cash basis taxpayers and file a joint return. Jed wired a new house for Alison and billed her $15,000. Alison paid Jed $10,000 and refused to pay the remainder of the bill, claiming the fee to be exorbitant. Jed took Alison to Small Claims Court for the unpaid amount and was awarded a $2,000 judgement. Jed was never able to collect the judgement nor the remainder of the bill from Alison. What amount of loss may Jed deduct in the current year? a. $0. b. $2,000. c. $3,000. d. $5,000. e. None of the above. ANS: A Jed is a cash basis taxpayer and therefore, has no basis in the $5,000 not collected. PTS: 1 REF: p. 7-3
3. On May 1, 2007, Mary loaned John $20,000. In 2008, John filed for bankruptcy. At that time, it was revealed that Johns creditors could expect to receive 60 cents on the dollar. In March 2009, final settlement was made, and Mary received $5,000. How much loss can Mary deduct and in which year? a. 2007$15,000. b. 2008zero; 2009$15,000. c. 2008$12,000; 2009$3,000. d. 2008$8,000; 2009$7,000. e. None of the above. ANS: B This debt was not incurred in connection with a trade or business. Therefore, Mary can claim a bad debt deduction in the following years: 2007zero. 2008zero. 2009$15,000 [$20,000 (loan) $5,000 (proceeds)]. PTS: 1 REF: p. 7-3 to 7-5
4. Jones Corporation incurred a $10,000 bad debt in the current year. Jones Corporation also had a $6,000 long-term capital gain during the current year. How should Jones report the bad debt deduction on the tax return? a. $0 bad debt deduction. b. $3,000 bad debt deduction. c. $4,000 bad debt deduction. d. $10,000 bad debt deduction. e. None of the above. ANS: D The entire $10,000 loss on the bad debt is classified as an ordinary loss. PTS: 1 REF: p. 7-5
Deductions and Losses: Certain Business Expenses and Losses
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5. Last year, Lucy purchased a $100,000 account receivable for $80,000. During the current year, Lucy collected $85,000 on the account. What are the tax consequences to Lucy associated with the collection of the account receivable? a. $0. b. $5,000 gain. c. $10,000 loss. d. $15,000 loss. e. None of the above. ANS: B The amount collected is $5,000 ($85,000 $80,000) in excess of Lucys basis in the receivable. PTS: 1 REF: p. 7-3
6. Two years ago, Gina loaned Tom $50,000. Tom signed a note the terms of which called for monthly payments of $2,000 plus 6% interest on the outstanding balance. Last year, when the balance owing on the loan was $18,000, Tom defaulted on the note. As of the end of last year, there appeared to be no reasonable prospect of Gina recovering the $18,000. As a consequence, Gina claimed the $18,000 as a nonbusiness bad debt. Last year, Gina had AGI of $60,000 which included $5,000 net long-term capital gains and $4,000 of qualified dividends. Gina did not itemize her deductions. During the current year, Tom paid Gina $13,000 in final settlement of the loan. How should Gina account for the payment in the current year? a. File an amended tax return for last year. b. Report no income for the current year. c. Report $8,000 of income for the current year. d. Report $12,000 of income for the current year. e. Report $13,000 of income for the current year. ANS: C Income should be reported based on the tax benefit rule. The tax benefit was $8,000 ($5,000 offsets capital gains and $3,000 offsets ordinary income). PTS: 1 REF: p. 7-4
7. Five years ago, Tom loaned his son John $20,000 to start a business. A note was executed with an interest rate of 8%, which is the Federal rate. The note required monthly payments of the interest with the $20,000 due at the end of ten years. John always made the interest payments until last year. During the current year, John notified his father that he was bankrupt and would not be able to repay the $20,000 or the accrued interest of $1,800. Tom is a cash basis taxpayer whose only income is salary and interest income. The proper treatment for the nonpayment of the note is: a. No deduction. b. $3,000 deduction. c. $20,000 deduction. d. $21,800 deduction. e. None of the above. ANS: B This is a bona fide loan to his son; therefore, Tom is entitled to a bad debt of $20,000. The deduction for the current year is limited to $3,000, since the bad debt is classified as a short-term capital loss. No deduction is allowed for the $1,800 of accrued interest receivable because Tom is a cash basis taxpayer.
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2009 Annual Edition/Test Bank
PTS: 1 REF: p. 7-3 to 7-5 8. Three years ago, Sharon loaned her sister $30,000 to buy a car. A note was issued for the loan with the provision for monthly payments of principal and interest. Last year, Sharon purchased a car from the same dealer, Hanks Auto. As partial payment for the car, the dealer accepted the note from Sharons sister. At the time Sharon purchased the car, the note had a balance of $18,000. During the current year, Sharons sister died. Hanks Auto was notified that no further payments on the note would be received. At the time of the notification, the note had a balance due of $15,500. What is the amount of loss, with respect to the note, that Hanks Auto may claim on the current year tax return? a. $0. b. $3,000. c. $15,500. d. $18,000. e. None of the above. ANS: C This is a business bad debt for Hanks Auto and therefore, the loss is $15,500. PTS: 1 REF: p. 7-3 to 7-5
9. On September 3, 2007, Able purchased stock in Red Corporation (the stock is not small business stock) for $6,000. On December 31, 2007, the stock was worth $8,500. On August 15, 2008, Able was notified that the stock was worthless. How should Able report this item on his 2007 and 2008 tax returns? a. 2007$0; 2008$6,000 short-term capital loss. b. 2007$0; 2008$6,000 long-term capital loss. c. 2007$2,500 short-term capital loss; 2008$8,500 short-term capital loss. d. 2007$2,500 short-term capital gain; 2008$3,800 long-term capital loss. e. None of the above. ANS: B The loss cannot be recognized until the year the stock is completely worthless. That year is 2008 for Able. The loss is treated as having occurred on the last day of that tax year. Hence, the $6,000 loss is a long-term capital loss in 2008. PTS: 1 REF: p. 7-6
10. On February 20, 2007, Bill purchased stock in Pink Corporation (the stock is not small business stock) for $1,000. On May 1, 2008, the stock became worthless. During 2008, Bill also had an $8,000 loss on 1244 small business stock purchased two years ago, a $9,000 loss on a nonbusiness bad debt, and a $5,000 long-term capital gain. How should Bill treat these items on his 2008 tax return? a. $4,000 long-term capital loss and $9,000 short-term capital loss. b. $4,000 long-term capital loss and $3,000 short-term capital loss. c. $8,000 ordinary loss and $3,000 short-term capital loss. d. $8,000 ordinary loss and $5,000 short-term capital loss. e. $8,000 long-term capital loss and $6,000 short-term capital loss.
Deductions and Losses: Certain Business Expenses and Losses
ANS: C Ordinary loss (small business stock) Long-term capital gain Less long-term capital loss (worthless securities) Net long-term capital gain Less short-term capital loss (nonbusiness bad debt) Net short-term capital loss Short-term capital loss limited to PTS: 1 REF: p. 7-4 to 7-7 $5,000 (1,000) $4,000 (9,000) ($5,000) ($3,000)
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($8,000)
11. John files a return as a single taxpayer. In 2008, he had the following items: Salary of $70,000. Loss of $65,000 on the sale of 1244 stock acquired two years ago. Interest income of $8,000. Determine Johns AGI for 2008. a. $13,000. b. $25,000. c. $28,000. d. $75,000. e. None of the above. ANS: B Salary Interest income Ordinary loss ( 1244 ordinary loss) Long-term capital loss (limited to $3,000)* AGI $70,000 8,000 (50,000) (3,000) $25,000
*$15,000 ($65,000 $50,000) is long-term capital loss. Of this amount, $3,000 can be used to offset ordinary income. $12,000 ($15,000 $3,000) will be carried forward. PTS: 1 REF: p. 7-4 to 7-7
12. Bruce, who is single, had the following items for the current year: Salary of $90,000. Gain of $30,000 on the sale of 1244 stock acquired two years earlier. Loss of $75,000 on the sale of 1244 stock acquired three years earlier. Worthless stock of $7,000. The stock was acquired on February 1 of the prior year and became worthless on January 15 of the current year.
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2009 Annual Edition/Test Bank
Determine Bruces AGI for the current year. a. $37,000. b. $38,000. c. $42,000. d. $47,000. e. None of the above. ANS: B Salary 1244 ordinary loss Long-term capital gain Long-term capital loss Excess 1244 loss ($75,000 $50,000) Worthless security Net long-term capital loss (limited to $3,000) Adjusted gross income PTS: 1 REF: p. 7-6 | p. 7-7 $90,000 (50,000) $30,000 $25,000 7,000 (32,000) (2,000) $38,000
13. On July 20, 2006, Matt (who files a joint return) purchased 3,000 shares of Orange Corporation stock (the stock is 1244 small business stock) for $24,000. On November 10, 2007, Matt purchased an additional 1,000 shares of Orange Corporation stock for $150,000. On September 15, 2008, Matt sold the 4,000 shares of stock for $80,000. How should Matt treat the sale of the stock on his 2008 return? a. $94,000 ordinary loss. b. $100,000 ordinary loss; $6,000 net capital gain. c. $100,000 ordinary loss; $30,000 STCL. d. $130,000 ordinary loss; $36,000 LTCG. e. None of the above. ANS: B Amount realized (1,000 shares x $20 per share) Less: basis Recognized loss 1244 ordinary loss STCL Amount realized (3,000 shares $20 per share) Less: basis Recognized gain (LTCG) $ 20,000 (150,000) ($130,000) ($100,000) ($ 30,000) $ 60,000 (24,000) $ 36,000
Hence, Matt has a $100,000 ordinary loss and a $6,000 net capital gain ($36,000 LTCG $30,000 STCL). PTS: 1 REF: p. 7-7
Deductions and Losses: Certain Business Expenses and Losses
14. Which of the following events would produce a deductible loss? a. Erosion of personal use land due to rain or wind. b. Termite infestation of a personal residence over a several year period. c. Damages to personal automobile resulting from a taxpayers willful negligence. d. A stolen diamond ring. e. None of the above. ANS: D A loss may be taken for the theft of personal use property (the diamond ring). PTS: 1 REF: p. 7-8 | p. 7-9
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15. During the year, Rick had the following insured personal casualty losses (arising from one casualty). Rick also had $18,000 AGI for the year. Asset A B C Adjusted Basis $ 500 3,000 700 Fair Market Value Before After $ 700 $300 2,000 -0900 -0Insurance Recovery $100 500 200
Ricks casualty loss deduction is: a. $400. b. $600. c. $1,000. d. $1,400. e. None of the above. ANS: A Asset A Asset B Asset C Less: Statutory floor Less: AGI limitation (10% $18,000) Casualty loss deduction PTS: 1 REF: p. 7-10 to 7-13 $ 300 1,500 500 $2,300 (100) (1,800) $ 400
16. Jim had a car accident in which his car was completely destroyed. At the time of the accident, the car had a fair market value of $30,000 and an adjusted basis of $40,000. Jim used the car 100% of the time for personal use. Jim received an insurance recovery of 80% of the value of the car at the time of the accident. If Jims AGI for the year is $50,000, determine his deductible loss on the car. a. $900. b. $6,000. c. $10,900.
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d. $30,000. e. None of the above.
2009 Annual Edition/Test Bank
ANS: A The car is used for personal use and hence, the amount of the loss is $30,000 (FMV) reduced by the insurance recovery ($24,000). The $6,000 loss is subject to the $100 floor per event and the 10%-of-AGI limitations. PTS: 1 REF: p. 7-11 | p. 7-13 17. Norms car, which he uses 100% for personal purposes, was completely destroyed in an accident. The cars adjusted basis at the time of the accident was $13,000. Its fair market value was $11,500. The car was covered by a $2,000 deductible insurance policy. Norm did not file a claim against the insurance policy because of a fear that reporting the accident would result in a substantial increase in his insurance rates. His adjusted gross income was $14,000 (before considering the loss). What is Norms deductible loss? a. $500. b. $2,000. c. $9,500. d. $8,000. e. None of the above. ANS: A Amount (lesser of adjusted basis or FMV decline) Less: Insurance recovery as if the claim had been filed Statutory floor AGI limitation (10% $14,000) Deductible loss PTS: 1 REF: p. 7-10 to 7-13 $11,500 (9,500) (100) (1,400) $ 500
18. During the year, Grants personal residence was damaged by fire. Grant was insured for 90% of his actual loss, and he received the insurance settlement. Grant had adjusted gross income, before considering the casualty item, of $30,000. Pertinent data with respect to the residence follows: Cost basis Value before casualty Value after casualty What is Grants allowable casualty loss deduction? a. $0. b. $6,900. c. $10,000. d. $76,900. e. $80,000. $170,000 250,000 150,000
Deductions and Losses: Certain Business Expenses and Losses
ANS: B The proceeds received are $90,000 [($250,000 $150,000) 90%]. Loss ($100,000 $90,000) Less: $100 floor 10% AGI (10% $30,000) Casualty loss deduction PTS: 1 REF: p. 7-10 to 7-13 $10,000 (100) (3,000) $ 6,900
7-19
19. John had adjusted gross income of $60,000. During the year his personal use summer home was damaged by a fire. Pertinent data with respect to the home follows: Cost basis Value before the fire Value after the fire Insurance recovery $250,000 400,000 100,000 270,000
John had an accident with his personal use car. As a result of the accident, John was cited with reckless driving and willful negligence. Pertinent data with respect to the car follows: Cost basis Value before the accident Value after the accident Insurance recovery What is Johns deductible casualty loss? a. $0. b. $15,800. c. $15,900. d. $35,900. e. None of the above. ANS: A Gain on home ($270,000 $250,000) Loss on car Total gain $20,000 (-0-) $20,000 $80,000 30,000 20,000 -0-
No casualty loss can be recognized on the car since John was cited with reckless driving and willful negligence. PTS: 1 REF: p. 7-8 to 7-14
20. During the current year, Ned and Mary had the following items: Salary Personal use casualty gain Personal use casualty loss (after $100 floor) Other itemized deductions $40,000 10,000 17,000 4,000
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2009 Annual Edition/Test Bank
Assuming that Ned and Mary file a joint return, determine their taxable income for the current year. a. $22,100. b. $26,000. c. $27,200. d. $30,200. e. None of the above. ANS: A Salary Personal use casualty gains in excess of personal use casualty losses ($10,000 $10,000) Adjusted gross income Less: Deductions Itemized deductions Casualty loss ($17,000 $10,000) AGI floor (10% $40,000) Deductible casualty loss Other itemized deductions Total itemized deductions Standard deduction (larger than itemized deductions) Personal exemption ($3,500 2) Taxable income PTS: 1 REF: p. 7-10 to 7-14 $40,000 -0$40,000 $7,000 (4,000) $3,000 4,000 $7,000 (10,900) (7,000) $22,100
21. During the year, Morley, a single taxpayer, had an AGI of $30,000 before considering the following items: Loss from damage to rental property Loss from theft of bonds Personal casualty gain Personal casualty (after loss $100 floor) Determine the amount of Morleys itemized deduction from the losses. a. $0. b. $2,900. c. $5,120. d. $5,600. e. None of the above. ($6,000) (3,000) 4,000 (9,000)
Deductions and Losses: Certain Business Expenses and Losses
ANS: D AGI before casualties Rental property loss Personal casualty gain Personal casualty loss Adjusted gross income Itemized deductions Casualty loss [($9,000 $4,000) (10% $24,000)] Miscellaneous itemized deductions Total itemized deductions
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$30,000 (6,000) $4,000 (4,000) -0$24,000
$2,600 3,000 $ 5,600
The bonds are property held for the production of income, but not attributable to rents or royalties. Therefore, the loss is a miscellaneous itemized deduction not subject to the 2%-of-AGI floor. PTS: 1 REF: p. 7-10 to 7-14
22. During the year, Theo had a salary of $30,000 and experienced the following losses: Loss from damage to rental property Loss from theft of securities Personal casualty gain Personal casualty loss (after $100 floor) Determine the amount of Theos itemized deduction from these losses. a. $0. b. $2,800. c. $2,900. d. $4,580. e. None of the above. ANS: E Salary Rental loss Personal casualty gain Personal casualty loss AGI $30,000 (10,000) $4,000 (3,000) 1,000 $21,000 ($10,000) (5,000) 4,000 (3,000)
The securities are property held for the production of income, but not attributable to rents or royalties. Therefore, the loss is a miscellaneous itemized deduction not subject to the 2%-of-AGI floor. Loss on theft of securities PTS: 1 REF: p. 7-13 | p. 7-14 $5,000
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2009 Annual Edition/Test Bank
23. Alicia was involved in an automobile accident. Her car was used 50% for business and 50% for personal use. The car had originally cost $40,000. At the time of the accident, the car was worth $20,000 and Alicia had taken $8,000 of depreciation. The car was totally destroyed and Alicia had let her car insurance expire. If Alicias AGI is $50,000 (before considering the loss), determine her itemized deduction for the casualty loss. a. $2,100. b. $5,900. c. $6,100. d. $16,900. e. None of the above. ANS: C Cost Less: depreciation Basis Fair market value Loss AGI Less: Business loss Modified AGI Personal casualty loss Less: $100 floor 10% of AGI (10% $38,000) Itemized deduction PTS: 1 REF: p. 7-10 to 7-14 Business Use $20,000 (8,000) $12,000 $10,000 $12,000 Personal Use $20,000 -0$20,000 $10,000 $10,000 $50,000 (12,000) $38,000 $10,000 (100) (3,800) $ 6,100
24. Last year, Sarah (who files a joint return) had silverware worth $10,000 (basis $6,000) stolen from her home. Sarahs insurance company told her that her policy did not cover the theft. Sarahs other itemized deductions last year were $4,000. She and her husband had AGI of $30,000 last year. In August of the current year, Sarahs insurance company decided that Sarahs policy did cover the theft of the silverware and they paid Sarah $5,000. Determine the tax treatment of the $5,000 received by Sarah during the current year. a. None of the $5,000 should be included in gross income. b. $2,900 should be included in gross income. c. $5,000 should be included in gross income. d. Last years return should be amended to include the $5,000. e. None of the above. ANS: A Sarah would have taken the standard deduction ($10,700) last year. Hence, none of the $5,000 should be included in gross income this year because there was no tax benefit from the loss in the prior year. PTS: 1 REF: p. 7-10 to 7-14
Deductions and Losses: Certain Business Expenses and Losses
7-23
25. Alma is in the business of dairy farming. During the year, one of her barns was completely destroyed by fire. The adjusted basis of the barn was $90,000. The fair market value of the barn before the fire was $75,000. The barn was insured for 95% of its fair market value, and Alma recovered this amount under the insurance policy. Alma has adjusted gross income for the year of $40,000 (before considering the casualty). Determine the amount of loss she can deduct on her tax return for the current year. a. $3,750. b. $14,650. c. $14,750. d. $18,750. e. None of the above. ANS: D Amount of loss (adjusted basis for business property that is completely destroyed) Less: Insurance proceeds received ($75,000 95%) Business loss A business casualty loss is classified as an ordinary loss. PTS: 1 REF: p. 7-7 to 7-11 $90,000 (71,250) $18,750
26. During the current year, Juans home was burglarized. Juan had the following items stolen: Securities worth $15,000. Juan purchased the securities four years ago for $20,000. New tools which Juan had purchased two weeks earlier for $6,000. Juan uses the tools in making repairs at an apartment house that he owns and manages. An antique worth $12,000. Juan inherited the antique (a family keepsake) when the property was worth $9,000.
Juans homeowners policy had a $50,000 deductible clause for thefts. If Juans salary for the year is $60,000, determine the amount of his itemized deductions as a result of the theft. a. $3,500. b. $6,000. c. $23,500. d. $28,900. e. None of the above. ANS: C Salary Less: Loss on theft of tools AGI Personal use property theft loss Less: $100 floor 10% of AGI (10% $54,000) Deductible loss Loss on securities Total itemized deductions PTS: 1 REF: p. 7-10 to 7-13 $60,000 (6,000) $54,000 $ 9,000 (100) (5,400) $ 3,500 20,000 $23,500
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2009 Annual Edition/Test Bank
27. Regarding research and experimental expenditures, which of the following are qualified expenditures? a. Costs of improving an existing pilot model. b. Costs to develop a plant process. c. Costs of developing a formula. d. a., b., and c. e. None of the above. ANS: D PTS: 1 REF: p. 7-15
28. Blue Corporation incurred the following expenses in connection with the development of a new product: Salaries Utilities Materials Advertising Market survey Depreciation on machine $100,000 18,000 25,000 5,000 3,000 9,000
Blue expects to begin selling the product next year. If Blue elects to expense research and experimental expenditures, determine the amount of the deduction for research and experimental expenditures for the current year. a. $0. b. $118,000. c. $143,000. d. $152,000. e. $160,000. ANS: D A deduction of $152,000 ($100,000 + $18,000 + $25,000 + $9,000) is permitted in the year of incurrence for the research and experimental expenditures. PTS: 1 REF: p. 7-15 | p. 7-16
29. Last year, Green Corporation incurred the following expenditures in the development of a new plant process: Salaries Materials Utilities Quality control testing costs Management study costs Depreciation of equipment $200,000 80,000 10,000 30,000 5,000 15,000
Deductions and Losses: Certain Business Expenses and Losses
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During the current year, benefits from the project began being realized in March. If Green Corporation elects a 60 month deferral and amortization period, determine the amount of the deduction for the current year. a. $50,833. b. $55,833. c. $56,667. d. $61,000. e. None of the above. ANS: A Salary Materials Utilities Depreciation Research and experimental costs Current deduction $50,833 [($305,000 60) 10 months] Neither the quality control testing costs nor the management study costs are research and experimental expenditures. PTS: 1 REF: p. 7-15 | p. 7-16 | Example 21 $200,000 80,000 10,000 15,000 $305,000
30. Ivory, Inc., has taxable income of $300,000 and qualified production activities income (QPAI) of $200,000 in 2008. Ivorys domestic production activities deduction is: a. $6,000. b. $9,000. c. $12,000. d. $18,000. e. None of the above. ANS: C DPAD is calculated for Ivory for 2008 as the lesser of the following: $200,000 6% = $12,000 $300,000 6% = $18,000 So the DPAD is $12,000. PTS: 1 REF: p. 7-17
31. Amber operates her business as a sole proprietorship during 2008. Her domestic production activities deduction (DPAD) before any effect of the wage expense limitation is $70,000. The total W2 wages that her sole proprietorship pays for the tax year are $110,000. The wages paid to employees not engaged in qualified domestic production activities are $20,000. Ambers DPAD for 2008 is: a. $0. b. $45,000. c. $55,000. d. $70,000. e. None of the above.
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2009 Annual Edition/Test Bank
ANS: B Ambers DPAD is limited to 50% of the W-2 wages that her sole proprietorship pays to employees engaged in qualified domestic production activities. 50% $90,000 = $45,000 PTS: 1 REF: p. 7-17 | p. 7-18
32. Cream, Inc.s taxable income for 2008 before any deduction for an NOL carryforward of $30,000 is $70,000. Creams qualified production activities income (QPAI) is $60,000. What is the amount of Creams domestic production activities deduction (DPAD) for 2008? a. $1,200. b. $1,800. c. $2,400. d. $3,600. e. None of the above. ANS: C Taxable income for purposes of calculating the DPAD is reduced by any NOL carryforward. Thus, the amount of the DPAD is $2,400 [($70,000 $30,000) 6%]. PTS: 1 REF: p. 7-17 | p. 7-18
33. In the computation of a net operating loss, which of the following items is not added to the negative taxable income? a. Losses incurred in a transaction entered into for profit. b. Personal casualty loss. c. Alimony payments. d. All of the above. e. None of the above. ANS: D PTS: 1 REF: p. 7-21 | p. 7-22
34. If a taxpayer incurs a farming NOL in 2008, the taxpayer may: a. Carry the NOL back 5 years. b. Carry the NOL back 3 years. c. Carry the NOL forward for 15 years instead of back. d. All of the above. e. None of the above. ANS: A PTS: 1 REF: p. 7-20
35. Wu, who is single, has the following items for 2008: Salary Itemized deductions ($27,000 attributable to casualty loss) What is Wus NOL for 2008? a. $0. b. $2,000. c. $15,000. d. $25,000. e. None of the above. $25,000 (32,000)
Deductions and Losses: Certain Business Expenses and Losses
ANS: B Salary Itemized deductions Personal exemption Taxable income Taxable income Personal exemption Excess of nonbusiness deductions ($32,000 $27,000 = $5,000) over nonbusiness income ($0) NOL PTS: 1 REF: p. 7-21 | p. 7-22
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$25,000 (32,000) (3,500) ($10,500) ($10,500) 3,500 5,000 ($ 2,000)
36. Khalid, who is single, had the following items for 2008: Salary Interest income Loss on theft of securities What is Khalids NOL for 2008? a. $10,000. b. $12,000. c. $15,000. d. $25,100. e. None of the above. ANS: A Salary Interest income AGI Less: Itemized deductions Personal exemption Taxable income Taxable income Personal exemption Net operating loss $40,000 10,000 $50,000 (60,000) (3,500) ($13,500) ($13,500) 3,500 ($10,000) $40,000 10,000 (60,000)
The loss on theft of securities is treated as attributable to a trade or business. Therefore, it can create an NOL. PTS: 1 REF: p. 7-21 | p. 7-22
37. Janice, single with one dependent child, had the following items for the year 2008: Salary Dividend income Loss on 1244 small business stock held for three years Total itemized deductions $30,000 10,000 (45,000) (5,000)
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2009 Annual Edition/Test Bank
Determine Janices net operating loss for the year 2008. a. $0. b. $5,000. c. $13,000. d. $20,000. e. None of the above. ANS: C Salary Dividend income Small business stock ordinary loss Adjusted gross income Less: Standard deduction (head of household) Personal and dependency exemptions (2 $3,500) Taxable income Taxable income Excess of nonbusiness deductions over nonbusiness income ($8,000 $10,000) Personal and dependency exemption Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22 $30,000 10,000 (45,000) ($ 5,000) (8,000) (7,000) ($20,000) ($20,000) -07,000 ($13,000)
38. Bill, age 40, is married with two dependents. Bill had the following items for the year 2008: Bills business loss Bills salary Personal casualty gains Personal casualty loss (after $100 floor) Other itemized deductions ($40,000) 50,000 5,000 (23,000) (15,000)
Based on the above information, what is the net operating loss for Bill and his spouse for the year 2008? a. $0. b. $5,000. c. $7,000. d. $12,000. e. None of the above.
Deductions and Losses: Certain Business Expenses and Losses
ANS: C Business loss Salary Personal casualty gains in excess of casualty losses ($5,000 $5,000) Adjusted gross income Less: Itemized deductions $17,000 Casualty loss [$18,000 (10% $10,000)] Other itemized deductions 15,000 Total itemized deductions Personal and dependency exemptions (4 $3,500) Taxable income Taxable income Nonbusiness deductions in excess of nonbusiness income ($32,000 $17,000) Personal and dependency exemptions Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22
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($40,000) 50,000 -0$10,000
(32,000) (14,000) ($36,000) ($36,000) 15,000 14,000 ($ 7,000)
39. Jack, age 30 and married with no dependents, is a self-employed individual. For 2008, his selfemployed business sustained a net loss from operations of $10,000. The following additional information was obtained from his personal records for the year: Nonbusiness long-term capital gain Interest income Itemized deductionsconsisting of taxes and interest $ 2,000 6,000 (12,000)
Based on the above information, what is Jacks net operating loss for the current year if he and his spouse file a joint return? a. $2,000. b. $8,000. c. $10,000. d. $11,000. e. $16,400. ANS: C Operating loss Nonbusiness long-term capital gain Interest income Adjusted gross income Less: Itemized deductions Personal exemptions (2 $3,500) Taxable income ($10,000) 2,000 6,000 ($ 2,000) (12,000) (7,000) ($21,000)
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2009 Annual Edition/Test Bank
Taxable income Personal exemptions Excess of nonbusiness deductions over nonbusiness income Itemized deductions Nonbusiness long-term capital gain Interest income Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22 ($21,000) 7,000 $12,000 (2,000) (6,000)
4,000 ($10,000)
40. Mavis, age 70, is single with no dependents. The following information was obtained from her personal records for the current year: Interest income Loss on sale of 1244 stock Itemized deductions $ 7,000 20,000 4,000
Based on the above information, what is Maviss net operating loss for the current year? a. $18,000. b. $19,800. c. $20,000. d. $23,300. e. None of the above. ANS: B Ordinary loss Interest income AGI Less: Standard deduction Additional standard deduction Personal exemption Taxable income Taxable income Add: Personal exemption Excess of nonbusiness deductions over nonbusiness income ($6,800 $7,000) Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22 ($20,000) 7,000 ($13,000) (5,450) (1,350) (3,500) ($23,300) ($23,300) 3,500 -0($19,800)
Deductions and Losses: Certain Business Expenses and Losses
41. Ralph is single and has the following items for the current year: Nonbusiness capital gains Nonbusiness capital losses Interest income Itemized deductions (none of the amount resulted from a casualty loss)
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$ 9,000 (3,000) 6,000 (10,000)
In calculating Ralphs net operating loss, and with respect to the above amounts only, what amount must be added back to taxable income (loss)? a. $0. b. $2,000. c. $3,000. d. $4,000. e. None of the above. ANS: A $10,000 [$6,000 + ($9,000 $3,000)] = ($2,000). Therefore, nothing is added back. PTS: 1 REF: p. 7-21 | p. 7-22
42. Elizabeth has the following items for the current year: Nonbusiness capital gains Nonbusiness capital losses Interest income Itemized deductions (including a $20,000 casualty loss) $ 5,000 (3,000) 3,000 (27,000)
In calculating Elizabeths net operating loss, and with respect to the above amounts only, what amount must be added back to taxable income (loss)? a. $0. b. $1,000. c. $2,000. d. $20,000. e. None of the above. ANS: C ($27,000 $20,000) [$3,000 + ($5,000 $3,000)] = $2,000. PTS: 1 REF: p. 7-21 | p. 7-22
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2009 Annual Edition/Test Bank
43. Steve and Holly have the following items for 2008: Dividend income Interest income Itemized deductions (none of the amount resulted from a casualty loss) Business capital gains Business capital losses $5,000 6,000 (9,000) 1,000 (3,000)
In calculating their net operating loss, and with respect to the above amounts only, what amount must be added back to taxable income (loss)? a. $0. b. $1,300. c. $1,900. d. $3,000. e. None of the above. ANS: C $3,000 [$1,000 + ($11,000 $10,900*)] = $1,900. *Standard deduction would be used. PTS: 1 PROBLEM 1. Teresa had the following items for last year: Salary Short-term capital gain Nonbusiness bad debt For the current year, Teresa had the following items: Salary Nonbusiness bad debt Collection of last years bad debt Determine Teresas adjusted gross income for the current year. ANS: Salary Income under tax benefit rule Short-term capital loss (nonbusiness bad debt) AGI Income on collection of nonbusiness bad debt (classified as STCL) to the extent of tax benefit in the prior year ($3,000 offset against short-term capital gain and $3,000 offset against ordinary income) PTS: 1 REF: p. 7-4 | p. 7-5 $45,000 6,000 (1,000) $50,000 $ 6,000 $45,000 (1,000) 10,000 $40,000 3,000 (10,000) REF: p. 7-21 | p. 7-22
Deductions and Losses: Certain Business Expenses and Losses
2. Maria, who is single, had the following items for 2008: Salary Loss on sale of 1244 small business stock acquired 3 years ago Stock acquired 2 years ago became worthless during the year Long-term capital gain Nonbusiness bad debt Casualty gain on property held 4 years Determine Marias adjusted gross income for 2008. ANS: Salary Ordinary loss from 1244 stock Capital gains and losses Long-term capital gain ($17,000 + $4,000) Less: Long-term capital loss [($60,000 $50,000) + $5,000] Net long-term capital gain Less: Short-term capital loss Net short-term capital loss Adjusted gross income PTS: 1 REF: p. 7-4 to 7-7
7-33
$80,000 (60,000) (5,000) 17,000 (8,000) 4,000
$80,000 (50,000) $21,000 (15,000) $ 6,000 (8,000) (2,000) $28,000
3. Mike, single, age 31, had the following items for 2008: Salary Nonbusiness bad debt Casualtiesindependent events Asset A (personal use property held for two years)gain Securities (stolen)loss Dividends Interest expense on personal residence Compute Mikes taxable income for 2008. ANS: Salary Dividends Casualty gain (long-term capital gain) Nonbusiness bad debt (short-term capital loss) Net short-term capital loss Adjusted gross income Less: Interest expense on personal residence Miscellaneous itemized deduction: casualty loss Personal exemption Taxable income PTS: 1 REF: p. 7-4 | p. 7-5 | p. 7-11 | p. 7-14 $42,000 1,000 $2,000 (4,500) (2,500) $40,500 (10,000) (5,000) (3,500) $22,000 $42,000 (4,500) 2,000 (5,000) 1,000 10,000
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2009 Annual Edition/Test Bank
4. Julie, who is single, has the following items for the current year: Salary $140,000. A hurricane completely destroyed Julies duplex during the current year. Julie lived in one-half of the duplex and rented out the other half. Julie paid $400,000 for the duplex and has taken $80,000 of cost recovery on the rental portion of the duplex. The duplex was worth $420,000 at the time of the destruction. Julies insurance policy paid her 90% of the fair market value of the duplex. Household items destroyed in the hurricane had a basis of $15,000 and a fair market value of $8,500. There was no insurance recovery on the household items. Julie purchased a painting three years ago for $4,000. At the time of the hurricane, the painting was worth $10,000. Julie purchased the painting as an investment with the intent that she would sell it when its value exceeded $12,000. There was no insurance recovery on the painting. Home mortgage interest $10,000. Determine the amount of Julies taxable income for the current year. ANS: Salary Plus: Gain on rental duplex Recovery [($420,000 90%) 50%] $200,000 Cost (50% 400,000) Less: cost recovery (80,000) Adjusted basis Casualty gain AGI Less: Itemized deductions Casualty loss Dwelling $200,000 Basis ($400,000 50%) Recovery (189,000) Loss $ 11,000 Household items 8,500 Total loss $ 19,500 Less: $100 floor (100) (20,900) 10% $209,000 Deductible loss Home mortgage interest Other miscellaneous itemized deductionpainting Total itemized deductions Personal exemption Taxable income PTS: 1 REF: p. 7-10 to 7-14 $140,000 $189,000
(120,000) 69,000 $209,000
$ -010,000 4,000 (14,000) (3,500) $191,500
Deductions and Losses: Certain Business Expenses and Losses
5. Juanita, single and age 43, had the following items for 2008: Salary Interest income Casualty loss on long-term business property Casualty loss on rental property Loss on theft of securities Personal casualty gains Personal casualty loss (after $100 floor) Other itemized deductions Compute Juanitas taxable income for 2008. ANS: Salary Interest income Casualty loss on business property Casualty loss on rental property Personal casualty gains $6,000 Personal casualty loss (6,000) AGI Less: Itemized deductions Casualty loss [($13,000 $6,000) (10% $46,000)] Theft of securities Other itemized deductions Personal exemption Taxable income PTS: 1 REF: p. 7-10 to 7-14
7-35
$60,000 6,000 (15,000) (5,000) (8,000) 6,000 (13,000) (9,000)
$60,000 6,000 (15,000) (5,000) -0$46,000 (2,400) (8,000) (9,000) (3,500) $23,100
6. While Susan was on vacation during the current year, someone broke into her home and stole the following items: A computer used 60% in connection with Susans rental property and 40% for her personal use. The cost of the computer was $8,000. Depreciation of $1,000 had been taken on the computer and it had a fair market value of $4,000 at the time of the theft. A painting, which Susan purchased as an investment for $10,000, had a fair market value of $17,000. Silverware purchased for $3,000 had a fair market value of $5,000. Cash of $30,000.
Susans adjusted gross income, before considering any of the above items, is $60,000. Determine the total amount of Susans itemized deductions resulting from the theft.
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2009 Annual Edition/Test Bank
ANS: AGI before theft loss Less: loss on rental computer Cost ($8,000 60%) Depreciation Adjusted basis AGI Painting loss (investment property) Casualty loss Computer ($4,000 40%) Silverware Cash Total Less: $100 floor 10% $56,200 (AGI) Total itemized deductions PTS: 1 REF: p. 7-10 to 7-14
$60,000 $4,800 (1,000) (3,800) $56,200 $10,000 $ 1,600 3,000 30,000 $34,600 (100) (5,620)
28,880 $38,880
7. Neal, single and age 37, has the following items for 2008: Salary Casualty loss on business property Casualty loss on rental property Personal casualty gains Personal casualty losses (after $100 floor) Interest expense on personal residence Determine Neals taxable income for 2008. ANS: Salary Casualty loss on business property Casualty loss on rental property Personal casualty gains Personal casualty losses AGI Less: Itemized deductions Casualty loss ($12,000 $3,000) Less (10% $37,000) Casualty loss deduction Interest expense Personal exemption Taxable income PTS: 1 REF: p. 7-10 to 7-14 $50,000 (8,000) (5,000) $3,000 (3,000) -0$37,000 $50,000 (8,000) (5,000) 3,000 (12,000) (7,000)
$9,000 (3,700) $5,300 7,000 (12,300) (3,500) $21,200
Deductions and Losses: Certain Business Expenses and Losses
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8. In 2007, Robin Corporation incurred the following expenditures in connection with the development of a new product: Salaries Supplies Market survey Depreciation $50,000 20,000 10,000 15,000
In 2008, Robin incurred the following additional expenditures in connection with the development of the product: Salaries Supplies Depreciation Advertising $75,000 15,000 17,000 8,000
In October 2008, Robin began receiving benefits from the project. If Robin elects to expense research and experimental expenditures, determine the amount and year of the deduction. ANS: Deductibility of research and experimental expenditures is permitted in the year of incurrence. 2007 Salaries Supplies Depreciation Deductible expenses The market survey is not a research and experimental expenditure. 2008 Salaries Supplies Depreciation Deductible expenses The advertising is not a research and experimental expenditure PTS: 1 REF: p. 7-15 | p. 7-16 $50,000 20,000 15,000 $85,000
$ 75,000 15,000 17,000 $107,000
9. Green, Inc., manufactures and sells widgets. During 2008, an examination of the company records showed the following items: Domestic production gross receipts Cost of goods sold for domestic products Expenses directly related to domestic production gross receipts (other than wages) W-2 wages paid to employees engaged in qualified domestic production activities Ratable portion of other expenses Total W-2 wages Taxable income $3,000,000 750,000 300,000 150,000 100,000 250,000 1,600,000
Determine Greens domestic production activities deduction for 2008.
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ANS: Domestic production gross receipts Less: Cost of goods sold Direct expenses W-2 wages directly related Allocated expenses Qualified production activities income (QPAI) Domestic production activities deduction Lessor of: QPAI 6% ($1,700,000 6%) Taxable income 6% ($1,600,000 6%) Limited to 50% of related W-2 wages (50% $150,000) PTS: 1 REF: p. 7-17 to 7-19
$3,000,000 (750,000) (300,000) (150,000) (100,000) $1,700,000
$ $
96,000 75,000
10. Nora, married with no children, had the following income and deductions for 2008: Sales $100,000 Business expenses (150,000) Interest 6,000 Dividends 1,000 Nonbusiness capital gains 4,000 Itemized deductions (2,000) Business capital loss (2,000) Business capital gain 1,000 If Nora and her spouse file a joint return, compute the net operating loss of 2008. ANS: Sales Business expenses Interest Dividends Capital gains ($4,000 + $1,000) Less: Capital losses Net capital gains Adjusted gross income Standard deduction Personal exemptions (2 $3,500) Taxable income $100,000 (150,000) 6,000 1,000 $5,000 (2,000) 3,000 ($ 40,000) (10,900) (7,000) ($ 57,900)
Deductions and Losses: Certain Business Expenses and Losses
Taxable income Personal exemptions Excess of nonbusiness capital losses over nonbusiness capital gains Excess of nonbusiness deductions over sum of nonbusiness income and net nonbusiness capital gains Standard deduction Interest income Dividend income Nonbusiness capital gains Excess of business capital losses over the sum of business capital gains and the excess of nonbusiness income and net nonbusiness capital gains over nonbusiness deductions $2,000 [$1,000 + (no excess)] Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22 ($ 57,900) 7,000 -0-
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$10,900 (6,000) (1,000) (4,000)
-0-
1,000 ($ 49,900)
11. Juan, married and filing jointly, had the following income and deductions for 2008: Sales Business expenses Interest income Dividends Personal casualty loss (after deducting the $100 floor) Personal casualty gain Taxes paid on personal residence Interest paid on personal residence Juan has three dependent children. Calculate the net operating loss for 2008. ANS: Sales Business expense Interest income Dividends Personal casualty gains Personal casualty losses Adjusted gross income Less: Itemized deductions Casualty loss [$25,000 $8,000 (10% $0)] Taxes on personal residence Interest on personal residence Personal and dependency exemptions (5 $3,500) Taxable income $600,000 (650,000) 3,000 4,000 8,000 (8,000) ($ 43,000) $17,000 7,000 9,000 $600,000 (650,000) 3,000 4,000 (25,000) 8,000 (7,000) (9,000)
(33,000) (17,500) ($ 93,500)
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Taxable income Personal and dependency exemptions Excess of nonbusiness deductions over nonbusiness income: Itemized deductions ($33,000 $17,000) Interest income Dividends Net operating loss PTS: 1 REF: p. 7-14 | p. 7-21 | p. 7-22 ($ 93,500) 17,500 $16,000 (3,000) (4,000)
9,000 ($ 67,000)
12. Jason, married and filing jointly, had the following income for 2008: Salary Loss on the sale of 1244 stock held for 5 years Dividends Interest income Itemized deductions (no casualty losses) Jason has four dependent children. Calculate the net operating loss for 2008. ANS: Salary Ordinary loss ( 1244 stock) Long-term capital loss [($110,000 $100,000) = $10,000] limited to Dividends Interest income AGI Itemized deductions Personal exemptions (6 $3,500) Taxable income Taxable income Excess of nonbusiness deductions over nonbusiness income [$12,000 ($25,000 + $10,000 $3,000)] Personal exemptions (6 $3,500) Net operating loss PTS: 1 REF: p. 7-21 | p. 7-22 $ 70,000 (100,000) (3,000) 25,000 10,000 $ 2,000 (12,000) (21,000) ($ 31,000) ($ 31,000) -021,000 ($ 10,000) $ 70,000 (110,000) 25,000 10,000 (12,000)
Deductions and Losses: Certain Business Expenses and Losses
ESSAY
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1. Identify the factors that should be considered in determining whether a transaction is a bona fide loan or a gift. ANS: Factors to be considered in determining whether a transaction is a bona fide loan or gift are as follows: Was a note properly executed? Was there a reasonable rate of interest? Was collateral provided? What collection efforts were made? What was the intent of the parties? REF: p. 7-5 | p. 7-6
PTS: 1
2. A taxpayer who sustains a casualty loss in an area designated by the President of the United States as a disaster area may take the loss in the year in which the loss occurred or elect to take the loss in the previous year. Identify factors that should be considered in deciding in which year to take the loss. ANS: Factors that should be considered include: The marginal tax rates of the two different years. The adjusted gross incomes of the two different years. Other casualty losses in the two different years. The benefits of a faster refund (or reduction of tax). REF: p. 7-27
PTS: 1
3. Discuss the treatment of casualty and theft losses incurred with property in a transaction entered into for profit. ANS: These losses are not subject to the $100 per event floor and the 10% of AGI limitations. If these losses are attributable to rents or royalties, the deduction is for AGI. However, if the losses are not connected with property held for the production of rents or royalties, they are deductions from AGI. These losses are itemized deductions which are not subject to the 2%-of-AGI floor. PTS: 1 REF: p. 7-13
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4. What are the three methods of handling research and experimental expenditures incurred in a trade or business? Under what circumstances would you choose each? ANS: The following methods are permitted: The expense method, where the expenditures are written off immediately, is attractive where the taxpayer is currently in a high tax bracket and has sufficient other income to offset the deductions. Deferral and amortization of expenditures over a period of not less than 60 months is generally chosen when the total deduction is not wanted immediately because future income is expected to be available to offset the deduction. The capitalization method allows no deduction until the project is abandoned or becomes worthless. Usually taxpayers do not choose this method, since the tax benefit is deferred for an indefinite period. REF: p. 7-15 | p. 7-16
PTS: 1
5. Why was the domestic production activities deduction (DPAD) enacted by Congress? ANS: The American Jobs Creation Act of 2004 provision creating DPADs was enacted to replace certain tax provisions that our world trading partners regarded as allowing unfair advantage to U.S. exports. Note, however, in no way is the DPAD limited to exports. PTS: 1 REF: p. 7-17
6. How is qualified production activities income (QPAI) calculated? ANS: QPAI is calculated as follows: The excess of domestic production gross receipts (DPGR) over the sum of: Cost of goods sold allocated to such receipts. Other deductions, expenses, or losses directly allocated to such receipts. The ratable portion of deductions, expenses, and losses not directly allocable to such receipts or another class of income. REF: p. 7-18
PTS: 1
7. Discuss the farm NOL limits and the carryback period. ANS: The farm loss is the amount of the total NOL attributable to the farming business. The farm loss cannot exceed the total NOL for the year. The farm loss is allowed a 5-year carryback period. PTS: 1 REF: p. 7-20
Deductions and Losses: Certain Business Expenses and Losses
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8. Discuss the calculation of nonbusiness deductions for purposes of determining an individuals NOL. ANS: The amount of nonbusiness deductions is equal to the total itemized deductions less personal casualty and theft losses and losses associated with a transaction entered into for profit which are deducted as other itemized deductions not subject to the 2%-of-AGI reduction. If a taxpayer does not itemize deductions, the amount of nonbusiness deductions is the amount of the standard deduction. PTS: 1 REF: p. 7-21 | p. 7-22
9. Discuss the computation of NOL remaining to be carried forward after the NOL has been applied in a carryback year. ANS: The NOL amount to be carried forward is the excess of the NOL over the taxable income of the year to which the NOL is being applied. However, the taxable income of the year to which the NOL is being applied must be computed with the following modifications: No deduction is allowed for the excess of capital losses over capital gains. No deduction is allowed for the NOL that is being carried back. However, deductions are allowed for NOLs occurring before the loss year. Any deductions claimed that are based on or limited by AGI must be determined after making the preceding adjustments. However, charitable contributions do not take into account any NOL carryback. No deduction is allowed for personal or dependency exemptions. REF: p. 7-24
PTS: 1
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