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of University Wisconsin Parkside School of Business and Technology Dr. R. Zameeruddin INDIVIDUAL TAXATION, ACCT 305 PRACTICE EXAMINATION II Name _______________________ MULTIPLE CHOICE 1. The taxpayer's marginal tax bracket is 40% (combined Federal and state rates). Which would the taxpayer prefer? a. $1.41 taxable income rather than $1.00 tax-exempt income. b. $.59 tax-exempt income rather than $1.00 taxable income. c. $1.75 taxable income rather than $1.00 tax-exempt income. d. $1.60 taxable income rather than $1.00 tax-exempt income. e. None of the above. Register to View AnswerThe $1.75 of taxable income is worth $1.05 [(1 .40)($1.75)] after taxes. PTS: 1 REF: p. 5-2 3. Sharon's automobile slid into a ditch. A stranger pulled her out. Sharon offered to pay $25, but the stranger refused. Sharon slipped the $25 in the stranger's truck when he was not looking. a. The $25 is a nontaxable gift received by the stranger because Sharon was not legally required to pay him. b. The $25 is a nontaxable gift because the stranger did not ask to receive it. c. The $25 is taxable compensation for services rendered. d. The $25 is a nontaxable service award. e. None of the above. Register to View AnswerThe $25 Sharon paid the stranger compensated the stranger for services rendered. The fact that Sharon was not legally obligated to make the payment does not affect the outcome in this case. PTS: 1 REF: p. 5-5 4. Carin, a widow, elected to receive the proceeds of a $100,000 life insurance policy on the life of her deceased husband in 10 installments of $15,000 each. Her husband had paid premiums of $75,000 on the policy. Over the life of the installment contract, Carin must include in gross income: a. $0. b. $50,000. c. $75,000. d. $100,000. e. None of the above. Register to View AnswerThe interest element of $50,000 ($150,000 $100,000) is included in Carin's gross income. PTS: 1 REF: p. 5-6 to 5-9 5. Iris collected $100,000 on her deceased husband's life insurance policy. The policy was purchased by the husband's employer under a group policy. Iris's husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $12,500 each. a. None of the payments must be included in Iris's gross income. b. The first 8 payments are a return of her capital and thus Iris is not required to recognize any income from the policy until she receives the ninth payment. c. For each $12,500 payment that Iris receives, she can exclude $10,000 ($100,000/$125,000 $12,500) from gross income. d. For each $12,500 that Iris receives, she can exclude from gross income $500 ($5,000/$125,000 $12,500). e. None of the above. Register to View AnswerThe life insurance proceeds of $100,000 are excluded from Iris's gross income. The income portion of each annuity payment is $2,500 ($12,500 $10,000 recovery of capital). The recovery of capital is ($100,000/$125,000) $12,500 = $10,000. PTS: 1 REF: p. 5-6 to 5-9 | Chapter 4 6. Green Company purchased a $1 million life insurance policy on the company's chief executive officer, Howard. After the company had paid $300,000 in premiums, Howard died and the company collected the $1 million face amount of the policy. The company also purchased group-term life insurance on all its employees. Howard's widow, Agnes, received the $150,000 proceeds from the group-term life insurance policy. a. Green Company must include $700,000 ($1,000,000 $300,000) in gross income and Agnes must include $150,000 in gross income. b. Green Company can exclude $700,000 ($1,000,000 $300,000) from gross income, but Agnes must include $150,000 in gross income. c. Agnes can exclude the life insurance proceeds of $150,000, but Green Company must include $700,000 ($1,000,000 $300,000) in gross income. d. Green Company and Agnes can exclude the life insurance proceeds of $1,000,000 and $150,000 respectively from gross income. e. None of the above. Register to View AnswerAll of the proceeds qualify for the life insurance exclusion because the payments were received as a result of the death of the insured. PTS: 1 REF: p. 5-6 | p. 5-7 7. Swan Finance Company, an accrual method taxpayer, requires all of its customers to carry credit life insurance. If a customer dies, the company receives from the insurance company the balance due on the customer's loan. Ali, a customer, died owing the company $1,000. The balance due included $100 accrued interest that Swan had included in income. When Swan collects $1,000 from the insurance company, Swan: a. Does not recognize income because life insurance proceeds are tax-exempt. b. Must recognize $900 income from the life insurance proceeds. c. Must recognize $1,000 income from the life insurance proceeds. d. Does not recognize income from the life insurance because the entire amount is a recovery of capital. e. None of the above. Register to View AnswerSwan has a basis in the receivable of $1,000, since it is an accrual method taxpayer. PTS: 1 REF: p. 5-7 8. In 2007, Ted was diagnosed with a terminal illness. His physician estimated that Ted would live no more than 18 months. Ted cashed in his life insurance policy to pay some medical bills, after he received the doctor's diagnosis. Ted has paid $12,000 in premiums and he collected $25,000, the cash surrender value of the policy. George enjoys excellent health, but he cashed in his life insurance policy to purchase a new home. He had paid premiums of $12,000 and collected $25,000 from the insurance company. a. Neither Ted nor George is required to recognize gross income. b. Both Ted and George must recognize $13,000 ($25,000 $12,000) gross income. c. Ted must recognize $13,000 ($25,000 $12,000) of gross income, but George does not recognize any gross income. d. George must recognize $13,000 ($25,000 $12,000) of gross income, but Ted does not recognize any gross income. e. None of the above. Register to View AnswerThe redemption of the policy by Ted qualifies as an accelerated death benefit. Thus, the realized gain is excluded from his gross income. PTS: 1 REF: p. 5-6 | p. 5-7 | Chapter 4 9. Albert has a terminal illness and will require almost constant nursing care for the remaining two years of his estimated life, according to his doctor. Albert has $25,000 in unpaid medical expenses and a life insurance policy with a face amount of $100,000. Albert has paid $10,000 of premiums on the policy. The insurance company has offered to pay him $75,000 to cancel the policy, although its cash surrender value is only $60,000. Assume Albert takes the $75,000, cancels the policy, and pays the $25,000 in medical expenses. Albert lives another seven years. a. Albert must recognize $40,000 ($75,000 $25,000 $10,000) of gross income. b. Albert must recognize $65,000 ($75,000 $10,000) of gross income. c. Albert is not required to recognize any gross income because of his terminal illness. d. Albert must recognize $100,000 of gross income, but he has $25,000 of deductible medical expenses. e. None of the above. Register to View AnswerAlbert is chronically ill and, therefore, can qualify for the accelerated death benefit exclusion for his life insurance policy. PTS: 1 REF: p. 5-7 10. A scholarship recipient at City University must include in gross income the scholarship proceeds used to pay for: a. Only tuition. b. Tuition, books, and supplies, but not meals and lodging. c. Books, supplies, meals, and lodging. d. Meals and lodging. e. None of the above. Register to View AnswerREF: p. 5-9 12. Barney, a full-time graduate student, receives a full tuition waiver ($5,500 during the year) and a monthly stipend for 9 months of $500 from State University for performing research for the university as a graduate assistant ($4,500 during the year). In addition, he receives a $2,000 research grant to pursue his own research and studies. Barney's gross income from the above is: a. $0. b. $4,500. c. $10,000. d. $12,000. e. None of the above. Register to View AnswerThe tuition waiver of $5,500 and the monthly stipend of $500 (for 9 months = $4,500) for research are taxable compensation. The research grant of $2,000 is to assist him in his education and is not in exchange for services; therefore, the grant is a nontaxable scholarship. PTS: 1 REF: p. 5-9 13. Jena is a full-time student at State University and is claimed by her parents as a dependent. Her only source of income is an $8,000 scholarship ($800 for books, $3,800 tuition, $200 student activity fee, and $3,200 room and board). Jena's gross income for the year is: a. $0. b. $200. c. $3,200. d. $3,400. e. None of the above. Register to View AnswerThe portion included in gross income is $3,200 for room and board. The books ($800), tuition ($3,800), and student activity fee ($200) qualify for exclusion. PTS: 1 REF: p. 5-9 14. As an executive of Cherry, Inc., Ollie receives a fringe benefit in the form of annual tuition scholarships of $10,000 to each of his three children. The scholarships are paid by the company directly to each child's educational institution and are payable only if the student maintains a B average. a. The tuition payments of $30,000 may be excluded from Ollie's gross income as a scholarship. b. The tuition payments of $10,000 each must be included in the child's gross income. c. The tuition payments of $30,000 may be excluded from Ollie's gross income because the payments are for the academic achievements of the children. d. The tuition payments of $30,000 must be included in Ollie's gross income. e. None of the above. Register to View AnswerThe tuition payments of $30,000 are compensation to Ollie since the awards are only to children of key employees. PTS: 1 REF: p. 5-10 15. The taxpayer is a Ph.D. student in accounting at State University. The student is paid $1,000 per month for teaching two classes. a. The $1,000 is excludible if all Ph.D. students are required to teach. b. The $1,000 is excludible because it is a gift. c. The $1,000 is considered a scholarship and, therefore, is excluded. d. Only $500 is included in income. e. None of the above. Register to View AnswerThe $1,000 per month represents compensation for services rendered and must be included in the student's gross income. PTS: 1 REF: p. 5-9 17. Sally sued her former employer for a back injury she suffered on the job in 2006. As a result of the injury, she was partially disabled. In 2007, she received $250,000 for her loss of future income, $150,000 in punitive damages because of the employer's flagrant disregard for the employee's safety, and $10,000 for medical expenses. Sally had deducted $6,000 (the amount in excess of 7.5% of adjusted gross income) in medical expenses in 2006. Sally's 2007 gross income from the above is: a. $410,000. b. $404,000. c. $160,000. d. $150,000. e. None of the above. Register to View AnswerSally must include in gross income the $150,000 of punitive damages received and the $6,000 recovery of medical expenses that were deducted in 2006. PTS: 1 REF: p. 5-11 | p. 5-12 18. Early in the year, Mike was in an automobile accident during the course of his employment. As a result of the injuries he sustained, he received the following payments during the year: Worker's compensation benefit Reimbursement of medical expenses from the company's group medical insurance plan Regular salary under the company's sick pay plan What is the amount that Mike must include in gross income for the current year? a. $15,000. b. $11,000. c. $9,000. d. $5,000. e. None of the above. Register to View AnswerThe $5,000 Mike received under the company's sick pay plan must be included in his gross income. Note that if the $5,000 had been received in a damage settlement, it could be excluded from gross income. PTS: 1 REF: p. 5-11 to 5-14 19. Theresa sued her former employer for age, race, and gender discrimination. She claimed $250,000 in damages for loss of income and $500,000 in punitive damages. She settled the claim for $600,000. As a result of the settlement, Theresa must include in gross income: a. $0. b. $400,000 [$500,000/($250,000 + $500,000) $600,000]. c. $500,000. d. $600,000. e. None of the above. Register to View AnswerThe damages did not arise out of a physical personal injury; therefore, none of the amount received can be excluded from gross income. PTS: 1 REF: p. 5-11 | p. 5-12 | Concept Summary 5-1 $4,000 6,000 5,000 20. Jack received a court award for $100,000 for damages to his personal reputation by the National Gossip. He also received $50,000 in punitive damages. Jack must include in his gross income as a damage award: a. $0. b. $50,000. c. $100,000. d. $150,000. e. None of the above. Register to View AnswerThe punitive damages of $50,000 must be included in his gross income. In addition, since the compensatory damages of $100,000 are not for physical personal injury or physical sickness, they must be included in his gross income. PTS: 1 REF: p. 5-11 | p. 5-12 21. Olaf was injured in an automobile accident and received $25,000 for his physical injury, $10,000 for his loss of income, and $50,000 punitive damages. As a result of the award, the amount Olaf must include in gross income is: a. $10,000. b. $50,000. c. $60,000. d. $85,000. e. None of the above. Register to View AnswerPunitive damages are never excluded from gross income. PTS: 1 REF: p. 5-11 | p. 5-12 23. Julie was suffering from a viral infection that caused her to miss work for 90 days. During the first 30 days of her absence, she received her regular salary of $5,000 from her employer. For the next 60 days, she received $10,000 under an accident and health insurance policy that she had purchased for premium payments totaling $6,000. Of the $15,000 she received, Julie must include in gross income: a. $0. b. $4,000. c. $5,000 d. $9,000. e. None of the above. Register to View AnswerThe $10,000 received under the accident and health insurance policy Julie purchased is excluded from her gross income. PTS: 1 REF: p. 5-13 | p. 5-14 24. Matilda works for a company with 1,000 employees. The company has a hospitalization insurance plan that covers all employees. However, the employee must pay the first $3,000 of his or her medical expenses each year. Each year the employer contributes $1,500 to each employee's health savings account (HSA). Matilda's employer made the contributions in 2006 and 2007, and the account earned $100 interest in 2007. At the end of 2007, Matilda withdrew $2,100 from the account to pay the deductible portion of her medical expenses for the year. As a result, Matilda must include in her 2007 gross income: a. $0. b. $100. c. $1,600. d. $2,100. e. None of the above. Register to View AnswerWith the health savings account (HSA), the employee is not taxed when the money is contributed, as income is earned in the account, nor when amounts are withdrawn to pay medical expenses. PTS: 1 REF: p. 5-14 25. All employees of Mauve Company are covered by a group hospitalization insurance policy, but the employees must pay the premiums (which are withheld from the employee's wages). None of the employees have sufficient medical expenses to deduct them as an itemized deduction. If the employer reduced each employee's pay by the cost of the insurance and the employer paid the premiums: a. All of the employees' income after tax and insurance cost would increase. b. Only the high income (35% marginal tax bracket) employees would benefit. c. Only the low income (10% and 15% marginal tax bracket) employees would benefit. d. All of the employees' income after tax and insurance cost would remain the same. e. None of the above. Register to View AnswerEach employee's income, less taxes and insurance, would increase by the cost of insurance times the employee's marginal tax rate. PTS: 1 REF: p. 5-13 to 5-15 26. The plant union is negotiating with the Eagle Company, which is on the verge of bankruptcy. Eagle has offered to pay for the employees' hospitalization insurance in exchange for a wage reduction. The employees each currently pay premiums of $4,000 a year for their insurance. a. If an employee's wages are reduced by $5,000 and the employee is in the 28% marginal tax bracket, the employee would benefit from the offer. b. If an employee's wages are reduced by $4,000 and the employee is in the 15% marginal tax bracket, the employee would benefit from the offer. c. If an employee's wages are reduced by $6,000 and the employee is in the 35% marginal tax bracket, the employee would benefit from the offer. d. a., b., and c. e. None of the above. Register to View AnswerIn all three cases, the reduction in after-tax pay of the employee will be less than the $4,000 value of the nontaxable insurance premiums to be paid by the employer. Reduction in Pay $5,000 $4,000 $6,000 Marginal Tax Rate 0.28 0.15 0.35 Reduction in Tax $1,400 $ 600 $2,100 Reduction in After-tax Income $3,600 $3,400 $3,900 a. b. c. PTS: 1 REF: p. 5-13 | p. 5-33 | p. 5-34 27. James, a cash basis taxpayer, received the following compensation and fringe benefits in 2007: Salary Disability income protection premiums Long-term care insurance premiums $66,000 3,000 4,000 James did not receive in 2007 $6,000 of his $72,000 salary because in December 2006 his employer advanced him $6,000 on his 2007 salary. The employer made the salary advance so that James could pay his son's college tuition that was due in December 2006. The wage continuation insurance is available to all employees and pays the employee three-fourths of the regular salary if the employee is sick or disabled. The long-term care insurance is available to all employees and pays $150 per day towards a nursing home or similar facility. What is James's gross income from the above? a. $66,000. b. $72,000. c. $75,000. d. $76,000. e. None of the above. Register to View AnswerThe $6,000 salary advance was taxed in 2006 when the cash basis taxpayer received it. The disability income protection and long-term care insurance premiums are excluded from gross income. PTS: 1 REF: Exhibit 5-1 | p. 5-13 | p. 5-15 28. The First Chance Casino has gambling facilities, a bar, a restaurant, and a hotel. All employees are allowed to obtain food from the restaurant at no charge during working hours. In the case of the employees who operate the gambling facilities, bar, and restaurant, 60% of all of Casino's employees, the meals are provided for the convenience of the Casino. However, the hotel workers, demanded equal treatment and therefore were also allowed to eat in the restaurant at no charge while they are at work. Which of the following is correct? a. All the employees are required to include the value of the meals in their gross income. b. Only the restaurant employees may exclude the value of their meals from gross income. c. Only the employees who work in gambling, the bar, and the restaurant may exclude the meals from gross income. d. All of the employees may exclude the value of the meals from gross income. e. None of the above. Register to View AnswerFor more than 50% of the employees, the meals are furnished for the convenience of the employer; therefore, all of the meals are excludible. PTS: 1 REF: p. 5-15 to 5-17 29. Section 119 excludes the value of meals from the employee's gross income: a. Whenever the employer pays for the meal and for the convenience of the employee. b. When the meals are provided for the employee on the employer's premises as a convenience to the employee. c. When the meals are provided for the employee on the employer's premises for the convenience of the employer. d. All of the above. e. None of the above. Register to View AnswerREF: p. 5-15 to 5-17 31. Adam repairs power lines for the Egret Utilities Company. He is generally working on a power line during the lunch hour. He must eat when and where he can and still get his work done. He usually purchases something at a convenience store and eats in his truck. Egret reimburses Adam for the cost of his meals. a. Adam must include the reimbursement in his gross income. b. Adam can exclude the reimbursement from his gross income since the meals are provided for the convenience of the employer. c. Adam can exclude the reimbursement from his gross income because he eats the meals on the employer's business premises (the truck). d. Adam may exclude from his gross income the difference between what he paid for the meals and what it would have cost him to eat at home. e. None of the above. Register to View AnswerThe meals do not qualify for the meals and lodging exclusion because the meals are not furnished by the employer. PTS: 1 REF: p. 5-15 to 5-17 32. Robin, a senior at State University, receives free room and board as full compensation for working as a resident advisor at the university dormitory. The regular housing contract is $1,400 a year in total, $800 for lodging and $600 for meals in the dormitory. Robin had the option of receiving the meals or $600 in cash. Robin accepted the meals. What is Robin's gross income from working as a resident advisor? a. $0, the entire value of the contract is excluded from gross income. b. $600, the meal contract must be included in gross income. c. $800, the lodging contract must be included in gross income. d. $1,400, the entire value of the contract is compensation. e. None of the above. Register to View AnswerBecause Robin had the option to receive meals or the cash, the meals were not provided for the convenience of the employer and therefore the value of the meals must be included in gross income. PTS: 1 REF: p. 5-15 to 5-17 33. Under the Swan Company's cafeteria plan, all full-time employees are allowed to select any combination of the benefits below, but the total received by the employee cannot exceed $8,000 a year. I. II. III. IV. Group medical and hospitalization insurance for the employee, $3,600 a year. Group medical and hospitalization insurance for the employee's spouse and children, $1,200 a year. Child-care payments, actual cost but not more than $4,800 a year. Cash required to bring the total of benefits and cash to $8,000. Which of the following statements is true? a. Sam, a full-time employee, selects choices II and III and $2,000 cash. His gross income must include the $2,000. b. Paul, a full-time employee, elects to receive $8,000 cash because his wife's employer provided these same insurance benefits for him. Paul is required to include the $8,000 in gross income. c. Sue, a full-time employee, elects to receive choices I, II and $3,200 for III. Sue is not required to include any of the above in gross income. d. All of the above. e. None of the above. Register to View AnswerREF: p. 5-18 | p. 5-19 | Example 23 34. Carol is a full-time employee of the Drake Company and participates in the company's flexible spending plan that is available to all employees. Which of the following is correct? a. Carol reduces her salary by $1,200, but receives only $1,000 as reimbursement for her medical expenses. Carol can get a refund of the remaining $200, which is nontaxable. b. Carol reduces her salary by $1,200, but receives only $900 as reimbursement for her medical expenses. She can receive her $300 remaining balance and only that amount is taxable. c. Carol reduces her salary by $1,200, but receives only $800 as reimbursement for her medical expenses. She is not refunded the $400. Her gross income is reduced by $1,200. d. Carol reduces her salary by $1,200, but receives only $900 as reimbursement for her medical expenses. She forfeits the $300. Her gross income is reduced by $900. e. None of the above. Register to View AnswerAnswers a. and b are incorrect because to qualify for exclusion treatment, the employee must either use the funds for the designated purpose or forfeit any unused portion of the salary reduction. Answer d. is incorrect because Carol's gross income is reduced by the full $1,200 salary reduction. PTS: 1 REF: p. 5-19 35. Employers of the Family Bowling Alley allow their employees to bowl without charge after the employee's working hours and when there are adequate idle bowling lanes. Tom bowled 12 games during the month at no charge when the non-employee charge was $3.00 per game. a. Tom must include $36 in gross income. b. Tom must include in gross income the employer's marginal cost of providing the bowling lanes and equipment. c. Tom is not required to include anything in gross income because this is a noadditional-cost service fringe benefit. d. Tom is not required to include the $36 in gross income if the arrangement is for the convenience of the employer. e. None of the above. Register to View AnswerThe free bowling qualifies as a no-additional-cost service. PTS: 1 REF: p. 5-20 | p. 5-21 36. The Royal Motor Company manufactures automobiles. Employees of the company can buy a new automobile for Royal's cost plus 2%. The automobiles are sold to dealers at cost plus 20%. Generally, employees of Local Dealer, Inc., are allowed to buy a new automobile from the company at the dealer's cost. Officers of Local Dealer are allowed to use a company vehicle (for personal use) at no cost. a. None of the employees who take advantage of the fringe benefits described above are required to recognize income. b. Employees of Royal are required to recognize as gross income 18% (20% 2%) of the cost of the automobile purchased. c. Employees of Local Dealer are required to recognize as gross income the gross profit Local Dealer loses as a result of the sale to the employees. d. Local Dealer officers must recognize gross income from the personal use of the company vehicles. e. None of the above. Register to View AnswerThe discounts for the employees of Royal Motor Company and those of Local Dealer both qualify for exclusion treatment as a qualified employee discount. The personal use of company vehicles is discriminatory and must be included in the officers' gross income. PTS: 1 REF: p. 5-19 to 5-24 37. Peggy is an executive for the Tan Furniture Manufacturing Company. Peggy purchased furniture from the company for $7,000. The price Tan ordinarily charges a wholesaler is $8,500. The retail price of the furniture was $12,000, and Tan's cost was $8,000. The company also paid for Peggy's parking space in a garage near the office. The parking fee was $1,200 for the year. All employees are allowed to buy furniture at a discounted price comparable to that charged to Peggy. However, the company does not pay other employees' parking fees. Peggy's gross income from the above is: a. $0. b. $1,000. c. $5,000. d. $6,200. e. None of the above. Register to View AnswerThe furniture purchases were under a qualified employee discount plan, but the exclusion is limited to the employer's gross profit. Because Peggy purchased the furniture for $7,000 when the employer's cost was $8,000, she must include $1,000 of the discount in gross income. The parking space is a qualified transportation fringe and is not required to be available to all employees (i.e., can be provided on a discriminatory basis). PTS: 1 REF: p. 5-19 to 5-24 38. The employees of the Daily Newspaper are given a free newspaper each day. The annual subscription fee for a newspaper is $270. a. The employees can exclude the value of the newspaper from their gross income as a noadditional cost fringe benefit. b. The employees can exclude the value of the newspaper from their gross income because the employees were not given an option of receiving cash. c. An employee is required to include the value of the newspaper in gross income only if the employee would otherwise have bought a newspaper. d. The employees are not required to include the value of the newspaper in their gross income because the employer would have otherwise thrown away the newspapers. e. None of the above. Register to View AnswerOption a. is incorrect because the newspaper is property and the no-additional-cost exclusion applies only to services. Based on the facts provided, options b., c., and d. do not fit within any of the 132 exclusion provisions either. Thus, the employees must each include the value of the newspapers in their gross income. PTS: 1 REF: p. 5-19 to 5-24 39. The Perfection Tax Service gives employees $10 as supper money when they are required to work overtime, approximately 20 days each year. The supper money received: a. Must be included in the employee's gross income. b. Must be included in the employee's gross income if the employee does not spend it for supper. c. May be excluded from the employee's gross income as a no-additional cost fringe benefit. d. May be excluded from the employee's gross income as a de minimis fringe benefit. e. None of the above. Register to View AnswerThe House Ways and Means Committee specifically cited occasional supper money because of overtime work as a de minimis fringe. PTS: 1 REF: p. 5-22 40. The president of Silver Corporation is assigned a secretary. When the secretary has completed work on company matters, the secretary is available to do the president's personal matters (pick up laundry, buy groceries) so long as the privilege is not abused. No other employee has a personal secretary. a. The value of the secretary's services provided to the president may be excluded as noadditional-cost services. b. The value of the secretary's services provided to the president may be excluded because the president did not receive cash. c. The value of the secretary's services provided to the president may be excluded as noadditional-cost services because the services are not available to all employees. d. If the value of secretary's services are considered de minimis, the president may exclude the benefit from gross income even through other employees are not provided the same benefit. e. None of the above. Register to View AnswerAnswers a. and c. are incorrect because the no-additional-cost services must be provided to all employees to qualify for the exclusion. Answer b. is incorrect because the receipt of noncash items (e.g., services, other property) can produce gross income. PTS: 1 REF: p. 5-19 to 5-24 41. Evaluate the following statements: I. II. a. b. c. d. e. De minimis fringe benefits are those that are so immaterial that accounting for them is impractical. De minimis fringe benefits are subject to strict anti-discrimination requirements. I and II are true. I is true, but II is false. I and II are false. I is false, but II is true. None of the above. Register to View AnswerThe de minimis exemption is not subject to a nondiscrimination requirement because the amount is too small to make it worthwhile to account for the items. It follows that it would not be worthwhile to apply additional rules. PTS: 1 REF: p. 5-22 42. Veneia's employer pays for her automobile parking space that she uses while she is at work ($100 per month). a. Veneia can exclude the cost of the parking from income even though not all employees receive a free parking space (that is, even though the plan is discriminatory). b. Veneia is allowed to exclude the cost of the parking space from income because if the employer did not pay for the space, Veneia could deduct her cost. c. Veneia must include the cost of the parking space in gross income. d. All of the above. e. None of the above. Register to View AnswerAs a qualified transportation fringe, the benefit can be granted on a discriminatory basis and still qualify for the exclusion. PTS: 1 REF: p. 5-22 | p. 5-23 43. In the case of a fringe benefit plan that is discriminatory (e.g., the plan favors officers over other employees), a. All employees must include all benefits received in gross income. b. De minimis fringes may be excluded from gross income. c. The value of a parking space provided (value of $100 per month) must be included in gross income. d. Those who are being discriminated against can exclude a certain portion of their cash compensation from gross income to achieve parity. e. None of the above. Register to View AnswerDe minimis fringe benefits can be excluded, even if discriminatory, because the potential amount of income at issue is small relative to the cost of accounting for those benefits. PTS: 1 REF: p. 5-23 | p. 5-24 | Concept Summary 5-2 44. A U.S. citizen worked in a foreign country for the period November 1, 2006, through December 31, 2007. Her salary was $10,000 per month. Also, in 2007 she received $5,000 in dividends from foreign corporations (not qualified dividends). a. The taxpayer can exclude $20,000 from U.S. gross income for 2006 because the salary was less than the annual foreign earned income exclusion. b. The taxpayer can exclude all of the income from U.S. gross income in 2006 and 2007 because the income was earned in a foreign country. c. The taxpayer can exclude from U.S. gross income a portion of the salary in 2006 and 2007, but none of the dividends can be excluded. d. The taxpayer can exclude a portion of the salary from U.S. gross income in 2006 and 2007, and can exclude all of the dividends received in 2007. e. None of the above. Register to View AnswerAnswer a. is incorrect because the available exclusion for 2006 is less than $20,000. Answer b. is incorrect because the annual statutory limit on the foreign earned income exclusion is $82,400 in 2006 and $85,700 in 2007. Answer d. is incorrect because the dividends received cannot be excluded from gross income. PTS: 1 REF: p. 5-24 | p. 5-26 | p. 5-27 45. Louise works in a foreign branch of her employer's business. She earned $5,000 per month throughout the relevant period. a. If Louise worked in the foreign branch from May 1, 2007 until October 31, 2008, she may exclude $40,000 from gross income in 2007 and exclude $50,000 in 2008. b. If Louise worked in the foreign branch from May 1, 2007 until October 31, 2008, she cannot exclude anything from gross income because she was not present in the country for 330 days in either year. c. If Louise began work in the foreign country on May 1, 2007, she must work through November 30, 2008 in order to exclude $55,000 from gross income in 2008 but none in 2007. d. Louise will not be allowed to exclude any foreign earned income because she made less than $85,700. e. None of the above. Register to View AnswerLouise was in the foreign country for the requisite number of days, at least 330 days out of 365 days. Therefore, the foreign earned income exclusion applies for all of the time she worked in the foreign country. The amount earned is less than the statutory annual ceiling. Answer d. is incorrect because the annual limit is the amount, if earned, that can be excluded. PTS: 1 REF: p. 5-24 | p. 5-26 | p. 5-27 46. In the case of interest income from state and Federal bonds: I. Interest on United States Government bonds received by a state resident cannot be subject to that state's income tax. II. Interest on United States Government bonds are not subject to Federal income tax. III. Interest received on bonds issued by State A received by a resident of State B cannot be subject to income tax in State B. a. b. c. d. e. I is true, II and III are false. I and II are true, and III is false. II and III are true, and I is false. I, II, and III are true. None of the above. Register to View AnswerFederal statute prohibits the states from taxing interest United States Government bonds (just as state bond interest is not subject to Federal income tax) [I]. The Federal government does tax its own bonds (II), and there is no statutory or Constitutional limitation on the states taxing each other's obligations (III). PTS: 1 REF: p. 5-27 | p. 5-28 48. Emily is in the 35% marginal tax bracket. She can purchase a York County school bond yielding 5% interest, but she is interested in earning a higher return for comparable risk. a. If she buys a corporate bond that pays 8% interest, her after-tax rate of return will be greater than if she purchased the York County school bond. b. If she buys a U.S. government bond paying 6%, her after-tax rate of return will be less than if she purchased the York County school bond. c. If she buys a common stock paying 6% dividend, her after-tax rate of return will be higher than if she purchased the York County school bond. d. All of the above are correct. e. None of the above are correct. Register to View AnswerSee the table below: Tax @ 0.35; .15* 2.800% 2.100% .900% York County Bond 5.0% 5.0% 5.0% a. b. c. Before Tax 8.00% 6.00% 6.00% After-tax 5.200% 3.900% 5.100% *The dividend is taxed at 15%. PTS: 1 REF: p. 5-2 | p. 5-27 | p. 5-28 49. Harry and Wanda received the following interest income in the current year: Savings account United States Treasury bonds Interest on Federal tax refund Interest on State income tax refund $3,000 300 100 50 The bank gave Harry and Wanda a cellular phone (worth $70) for opening their savings account. What amount of interest income should they report on their joint income tax return? a. $3,520. b. $3,220. c. $3,170. d. $3,100. e. None of the above. Register to View AnswerAll of the amounts ($3,520) represent interest payments and are included in Harry and Wanda's gross income. PTS: 1 REF: p. 5-27 | p. 5-28 | Exhibit 5-1 50. George, an unmarried cash basis taxpayer, received the following amounts during 2007: Interest on savings accounts Original issue discount on a certificate of deposit purchased on July 1, 2006, and matured on June 30, 2007 Dividends on USG common stock Interest on United States Government bonds Interest on City of Radford school bonds $2,400 1,200 200 300 600 What amount should George report as gross income from dividends and interest for 2007? a. $4,700. b. $4,100. c. $3,800. d. $3,600. e. None of the above. Register to View AnswerThe interest on the Radford school bonds of $600 is tax-exempt, but the interest on the United States Government bonds of $300 is taxable. Since the life of the certificate of deposit is only 1 year, the $1,200 is included in gross income in 2006. Thus, the gross income is $4,100 ($2,400 + $1,200 + $200 + $300). PTS: 1 REF: p. 5-27 to 5-29 | Chapter 4 52. Assuming a taxpayer qualifies for the exclusion treatment, the interest income on educational savings bonds: a. Is gross income to the person who purchased the bond in the year the interest is earned. b. Is gross income to the student in the year the interest is earned. c. Is included in the student's gross income in the year the savings bonds are sold or redeemed to pay educational expenses. d. Is not included in anyone's gross income if the proceeds are used to pay college tuition. e. None of the above. Register to View AnswerREF: p. 5-29 | p. 5-30 53. The exclusion of interest on educational savings bonds: a. Applies only to savings bonds owned by the child. b. Applies to parents who purchase bonds for which the proceeds are used for their child's education. c. Means that the child must include the interest in income is the bond is owned by the parent. d. Is phased out once the taxpayer's adjusted gross income exceeds $50,000. e. None of the above. Register to View AnswerREF: p. 5-29 | p. 5-30 54. Martha participated in a qualified tuition program for the benefit of her son. She invested $5,000 in the fund. Four years later her son withdrew $7,500, the entire balance in the program, to pay his college tuition. a. Martha must include the $2,500 ($7,500 $5,000) in her gross income when the funds are used to pay the tuition. b. Martha must include the portion of the $2,500 accumulated each year in her gross income (i.e., interest). c. Martha's son must include the $2,500 ($7,500 $5,000) in his gross income when the funds are used to pay the tuition. d. Martha's son must include the portion of the $2,500 accumulated each year in his gross income (i.e., interest). e. None of the above. Register to View AnswerUnder a qualified tuition program, neither the beneficiary of the income (the son) nor the owner (Martha) of the property includes the earnings in gross income as long as the funds are used to pay qualified tuition. PTS: 1 REF: p. 5-30 | p. 5-31 55. In December 2007, Todd, a cash basis taxpayer, paid $1,200 fire insurance for the calendar year 2008 on a building he held for rental income. Todd deducted the $1,200 insurance premiums on his 2007 tax return. He had $150,000 of taxable income that year. On June 30, 2008, he sold the building and, as a result, received a $500 refund on his fire insurance premiums. As a result of the above: a. Todd should amend his 2007 return and claim $500 less insurance expense. b. Todd should add the $500 to his sales proceeds from the building. c. Todd should include the $500 in 2008 gross income in accordance with the tax benefit rule. d. Todd should include the $500 in 2008 gross income in accordance with the claim of right doctrine. e. None of the above. Register to View AnswerAs a cash basis taxpayer, Todd can deduct the one-year prepayment for insurance in the year it was paid, 2007. Because he deducted $1,200 and his net cost was only $700 ($1,200 $500), Todd should include the $500 refund in gross income for 2008 under the tax benefit rule. PTS: 1 REF: p. 5-29 57. Harold bought land from Jewel for $100,000. Harold paid $20,000 cash and gave Jewel an 8% note for $80,000. The note was to be paid over a five-year period. When the balance on the note was $40,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $30,000 cash from Harold in final payment of the note principal. a. Harold must recognize $10,000 income. b. Harold is not required to recognize income, but must reduce his cost basis in the land to $90,000. c. Harold is not required to recognize income, since he made a gift to Jewel when he paid the debt before it was due. d. Jewel must recognize income from discharge of the debt. e. None of the above. Register to View AnswerThe debt reduction of $10,000 is treated as an adjustment to the basis of the land. PTS: 1 REF: p. 5-32 58. Hazel, a solvent individual but a recovering alcoholic, embezzled $5,000 from her employer. In the same year that she embezzled the funds, her employer discovered the theft. Her employer did not fire her and told her she did not have to repay the $5,000 if she would attend Alcoholics Anonymous. Hazel met the conditions and her employer cancelled the debt. a. Hazel did not realize any income because she obtained the funds illegally. b. Hazel is not required to include the $5,000 in gross income because her employer made a gift to her. c. Hazel must include $5,000 in gross income from discharge of indebtedness. d. Hazel may exclude the $5,000 from gross income because the debt never existed. e. None of the above. Register to View AnswerEven if the employer had intended that a gift be made, 102(c) prohibits exclusion treatment. Hazel realized a $5,000 increase in her net worth as a result of the theft and the subsequent cancellation of the debt. PTS: 1 REF: p. 5-32 | p. 5-33 On January 1, 1997, Yellow corporation issued 6% 25-year bonds at par and used the $10,000,000 proceeds to finance the construction of a new plant. On January 1, 2007, the company acquired the bonds on the open market for $9,500,000. Assuming that Yellow Corporation is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following: a. The company must recognize a $500,000 gain. b. The company can make an election to recognize a $500,000 gain or reduce the company's basis in the plant by $500,000. c. The company must recognize a $500,000 gain and increase the company's basis in the plant by $500,000. d. The company can amortize the $500,000 gain, recognizing income over the remaining life of the bonds. e. None of the above. Register to View AnswerREF: p. 5-32 61. In the case of income from discharge of indebtedness: I. II. III. If the debt is secured by property sold to the debtor by the creditor, the debtor reduces the basis in the property instead of recognizing income. If the debtor is a business, the discharge usually is considered a gift. If a corporation's debt is forgiven by a shareholder in the corporation, the corporation increases paid-in capital and is not required to recognize income. I, II and III are true. I and II are true, III is false. I and III are true, II is false. II and III are true, I is false. I, II, and III are false. a. b. c. d. e. Register to View AnswerII is false. Business persons do not ordinarily forgive indebtedness out of unattached generosity. PTS: 1 REF: p. 5-32 | p. 5-33 62. Flora Company owed $100,000 to the National Bank. Flora borrowed the funds to purchase land, which secures the loan. a. If the bank accepts $90,000 in full payment of the debt, and Flora is solvent after the payment, Flora must recognize a $10,000 gain. b. If the bank forecloses on the property (takes the property and cancels the debt) with a basis and fair market value of $100,000, when Flora is solvent, Flora must recognize a $100,000 gain. c. If Flora transfers to the bank other property, with a basis of $40,000 and a fair market value of $100,000, in full payment of the debt, Flora must reduce its basis in the land by $60,000. d. If Flora sells the property for $125,000, when its basis is $100,000 and uses the proceeds to retire the debt, Flora is not required to recognize the gain on the sale. e. None of the above. Register to View AnswerFlora must recognize income from discharge of indebtedness under the facts of answer a. Answer b. is incorrect because Flora is deemed to realize $100,000 from the transfer of an asset whose basis is also $100,000. Answer c. is incorrect because the transfer is treated as a sale of the property for $100,000 when its basis is $60,000. Answer d. is incorrect because the sale and the repayment are two separate events, and the sale resulted in a gain. PTS: 1 REF: p. 5-31 to 5-33 1. In preparing his 2007 Federal income tax return, Sam, who is not married, incorrectly claimed alimony payments of $12,000 as an itemized deduction (rather than as a deduction for AGI). Sam's AGI is $60,000 and itemized deductions (which consist of the alimony, property taxes, and mortgage interest) are $20,000. Which of the following statements is correct? a. The error will result in taxable income being overstated. b. The error will result in taxable income being understated. c. The error could result in either taxable income being overstated or understated. d. The error will have no effect on taxable income. e. None of the above. Register to View AnswerIf the correction is made, the amount of the deductions for AGI increases by $12,000 and the amount of the itemized deductions decreases by $12,000. Thus, taxable income does not change. Note that none of the itemized deductions are based on AGI (i.e., there are no medical expenses, charitable contributions, or miscellaneous itemized deductions). Even with the alimony properly classified as a deduction for AGI, Sam still itemizes because the $8,000 exceeds the amount of the standard deduction for an unmarried taxpayer. PTS: 1 REF: p. 6-3 | Example 2 2. Which of the following are deductions for AGI? a. Qualified moving expenses. b. Unreimbursed employee business expenses. c. Alimony. d. Only a. and c. e. a., b., and c. REF: p. 6-4 Register to View Answer 4. Janice is single, had gross income of $38,000, and incurred the following expenses: Charitable contribution Taxes and interest on home Legal fees incurred in a tax dispute Medical expenses Penalty on early withdrawal of savings Her AGI is: a. $21,300. b. $28,800. c. $32,800. d. $35,500. e. $37,800. $2,500 9,000 1,000 4,000 200 Register to View AnswerJanice's AGI is calculated as follows: Gross income Deductions for AGI: Penalty on early withdrawal of savings AGI PTS: 1 5. REF: p. 6-4 $38,000 (200) $37,800 Which of the following expenses can be claimed as a deduction for AGI? a. Legal fees incurred in a trade or business. b. Alimony. c. Expenses incurred on rental property. d. Tax preparation fees related to rental income. e. All of the above. REF: p. 6-3 | p. 6-4 Register to View Answer6. Which of the following is a deduction from AGI (itemized deduction)? a. Contribution to a traditional IRA. b. Roof repairs to a rental home. c. Personal casualty loss. d. Alimony payment. e. None of the above. Register to View Answera., b., and d. are deductions for AGI. PTS: 1 REF: p. 6-4 | Concept Summary 6-3 7. Which of the following is correct? a. A charitable contribution is classified as a deduction from AGI. b. Real estate taxes on a taxpayer's personal residence are classified as deductions from AGI. c. An expense associated with rental property is classified as a deduction from AGI. d. Only a. and b. are correct. e. a., b., and c., are correct. REF: p. 6-4 | p. 6-5 Register to View Answer8. Which of the following are deductions for AGI? a. Alimony payments. b. Property taxes on a personal residence. c. Charitable contributions. d. Fines and penalties incurred in a trade or business. e. None of the above. REF: p. 6-4 | p. 6-5 Register to View Answer9. Which of the following is incorrect? a. Alimony is a deduction for AGI. b. The expenses associated with royalty property are a deduction for AGI. c. Contributions to a traditional IRA are a deduction from AGI. d. Medical expenses are a deduction from AGI e. All of the above are correct. REF: p. 6-4 | p. 6-5 Register to View Answer 11. Which of the following is a required test for the deduction of a business expense? a. Ordinary. b. Necessary. c. Reasonable. d. All of the above. e. None of the above. Register to View AnswerREF: p. 6-5 | p. 6-6 12. Agnes is the sole shareholder of Violet, Inc. For 2007, she receives from Violet a salary of $200,000 and dividends of $100,000. Violet's taxable income for 2007 is $500,000. On audit, the IRS treats $50,000 of Agnes's salary as unreasonable. Which of the following statements is correct? a. Agnes's gross income will increase by $50,000 as a result of the IRS adjustment. b. Violet's taxable income will not be affected by the IRS adjustment. c. Agnes's gross income will decrease by $50,000 as a result of the IRS adjustment. d. Violet's taxable income will increase by $50,000 as a result of the IRS adjustment. e. None of the above is correct. Register to View AnswerThe $50,000 of salary is reclassified as a dividend. Thus, Violet's taxable income increases by $50,000 because dividends are not deductible. Agnes's gross income remains the same. Her salary income decreases by $50,000, but her dividend income increases by $50,000. PTS: 1 REF: p. 6-6 | p. 6-7 | Example 6 14. Benita incurred a business expense on December 10, 2007, which she charged on her bank credit card. She paid the credit card statement which included the charge on January 5, 2008. Which of the following is correct? a. If Benita is a cash method taxpayer, she cannot deduct the expense until 2008. b. If Benita is an accrual method taxpayer, she can deduct the expense in 2007. c. If Benita uses the accrual method, she can choose to deduct the expense in either 2007 or 2008. d. Only b. and c. are correct. e. a., b., and c. are correct. Register to View AnswerChoice a. is incorrect because charging the expense on a bank credit card is treated as a constructive payment. Thus, as a cash method taxpayer, she can deduct the expense in 2007. If Benita uses the accrual method, she deducts the expense in 2007. In any event, she does not merely choose the year in which to deduct the expense (item c.). PTS: 1 REF: p. 6-9 | p. 6-10 15. During the first year of operations, Al's fast food restaurant had cash sales of $200,000. Other relevant information is as follows: Purchases Salaries Other expenses Ending inventory a. b. c. d. e. If Al's business uses the accrual method, the net profit is $50,000. If Al's business uses the accrual method, the net profit is $30,000. Al's business is not eligible to use the cash method. Only a. and c. Only b. and c. $70,000 90,000 10,000 20,000 Register to View AnswerThe net profit of Al's business is calculated as follows: Sales Less: Expenses Salaries Other expenses Purchases net of ending inventory ($70,000 $20,000) Net profit $200,000 $90,000 10,000 50,000 (150,000) $ 50,000 Since the business has inventory, the accrual method must be used to calculate cost of goods sold. PTS: 1 REF: p. 6-9 | p. 6-10 16. Swan, Inc. is an accrual basis taxpayer. Swan uses the aging approach to calculate the reserve for bad debts. During 2007, the following occur associated with bad debts. Credit sales Collections on credit sales Amount added to the reserve Beginning balance in the reserve Identifiable bad debts during 2007 The amount of the deduction for bad debt expense for Swan for 2007 is: a. $18,000. b. $25,000. c. $40,000. d. $43,000. e. None of the above. Register to View AnswerOnly the specific charge-off method can be used. Reserves for estimated expenses are not allowed for tax purposes because the economic performance test cannot be satisfied. PTS: 1 REF: p. 6-10 $300,000 260,000 25,000 -018,000 17. Which of the following legal expenses are deductible for AGI? a. Incurred in connection with a trade or business. b. Incurred in connection with or rental royalty property held for the production of income. c. Incurred for tax advice relative to the preparation of an individual's income tax return. d. Only a. and b. qualify. e. a., b., and c. qualify. Register to View AnswerExpenses incurred for tax advice relative to the preparation of an individual's income tax return are classified as itemized deductions. PTS: 1 REF: p. 6-12 18. Rex, a cash basis calendar year taxpayer, runs a bingo operation which is illegal under state law. During 2007, a bill designated H.R. 9 is introduced into the state legislature which, if enacted, would legitimize bingo games. In 2007, Rex had the following expenses: Operating expenses in conducting bingo games Payoff money to state and local police Newspaper ads supporting H.R. 9 Political contributions to legislators who support H.R. 9 Of these expenditures, Rex may deduct: a. $247,000. b. $249,000. c. $257,000. d. $281,000. e. None of the above. Register to View AnswerRex can deduct only the $247,000 of operating expenses. PTS: 1 REF: Example 16 $247,000 24,000 2,000 8,000 19. Angela, a real estate broker, had the following income and expenses in her business: Commissions income Expenses: Commissions paid to non-brokers for referrals (illegal under state law and subject to criminal penalties) Commissions paid to other real estate brokers for referrals (not illegal under state law) Travel and transportation Supplies Office and phone Parking tickets How much net income must Angela report from this business? a. $48,500. b. $49,000. c. $60,000. d. $68,500. e. $69,000. Register to View AnswerThe illegal commissions and the parking tickets are in violation of public policy and are not deductible. Income Expenses: Commissions to other brokers Travel and transportation Supplies Office and phone Net income PTS: 1 REF: Example 14 | Example 16 $100,000 $10,000 12,000 4,000 5,000 $100,000 20,000 10,000 12,000 4,000 5,000 500 (31,000) $ 69,000 21. Terry and Jim are both involved in operating illegal businesses. Terry operates a gambling business and Jim operates a drug running business. Both businesses have gross revenues of $500,000. The businesses incur the following expenses. Terry $200,000 25,000 50,000 -0Jim $200,000 25,000 50,000 125,000 Employee salaries Bribes to police Rent and utilities Cost of goods sold Which of the following statements is correct? a. Neither Terry nor Jim can deduct any of the above items in calculating the business profit. b. Terry should report profit from his business of $250,000. c. Jim should report profit from his business of $500,000. d. Jim should report profit from his business of $250,000. e. None of the above. Register to View AnswerTerry and Jim should report net profit from their businesses as follows: Terry $500,000 (-0-) $500,000 (200,000) (50,000) -0$250,000 Jim $500,000 (125,000) $375,000 -0-0-0$375,000 Gross revenues Less: Cost of goods sold Gross income Less: Expenses Employee salaries Rent and utilities Bribes to police Net profit For Terry, the bribes to the police of $25,000 cannot be deducted. None of Jim's expenses can be deducted. However, the cost of goods sold is viewed as a negative item in calculating gross income (i.e., gross income = gross profit) rather than as a deduction. PTS: 1 REF: p. 6-12 | p. 6-13 22. Tom operates an illegal drug-running operation and incurred the following expenses: Salaries Illegal kickbacks Bribes to border guards Cost of goods sold Rent Interest Insurance on furniture and fixtures Utilities and telephone Which of the above amounts reduces his taxable income? a. $0. b. $160,000. c. $279,000. d. $324,000. e. None of the above. Register to View AnswerCost of goods sold of $160,000 is treated as a negative item in calculating gross income rather than as a deduction. For a drug dealer, all deductions are disallowed. PTS: 1 REF: p. 6-13 24. Which of the following is not a variable in the determination of whether the expenses in investigating a business can be deducted? a. The amount of reasonable expenditures. b. The nature of the business being investigated. c. Whether or not the acquisition actually takes place. d. The current business of the taxpayer. e. None of the above. Register to View AnswerREF: p. 6-14 $ 75,000 20,000 25,000 160,000 8,000 10,000 6,000 20,000 25. Iris, a calendar year cash basis taxpayer, owns and operates several TV rental outlets in Florida, and wants to expand to other states. During 2007, she spends $14,000 to investigate TV rental stores in South Carolina and $9,000 to investigate TV rental stores in Georgia. She acquires the South Carolina operations, but not the outlets in Georgia. As to these expenses, Iris should: a. Capitalize $14,000 and not deduct $9,000. b. Expense $23,000 for 2007. c. Expense $9,000 for 2007 and capitalize $14,000. d. Capitalize $23,000. e. None of the above. Register to View AnswerSince Iris owns and operates TV rental outlets, all of the investigation expenses can be deducted. PTS: 1 REF: Example 18 26. Which of the following statements is correct in connection with the investigation of a business? a. If the taxpayer is not already engaged in the trade or business, the expenses incurred are deductible if the project is abandoned. b. If the business is acquired, the expenses may be deducted immediately by a taxpayer engaged in a similar trade or business. c. That business must be related to the taxpayer's present business for any expense ever to be deductible. d. Regardless of whether the taxpayer is already engaged in the trade or business, the expenses must be capitalized and amortized. e. None of the above. Register to View AnswerREF: Concept Summary 6-1 27. Which of the following is not relevant in determining whether an activity is profit-seeking or a hobby? a. Whether the activity is enjoyed by the taxpayer. b. The expertise of the taxpayers or their advisers. c. The time and effort expended. d. The relationship of profits earned to losses incurred. e. All of the above are relevant factors. Register to View AnswerAll of these items are relevant factors in determining whether an activity is profit-seeking or a hobby. PTS: 1 REF: p. 6-16 29. Priscella pursued a hobby of making bedspreads in her spare time. Her AGI before considering the hobby is $40,000. During the year she sold the bedspreads for $10,000. She incurred expenses as follows: Supplies Interest on loan to get business started Advertising $4,000 500 6,500 Assuming that the activity is deemed a hobby, how should she report these items on her tax return? a. Include $10,000 in income and deduct $11,000 for AGI. b. Ignore both income and expenses since hobby losses are disallowed. c. Include $10,000 in income, deduct nothing for AGI, and claim $10,000 of the expenses as itemized deductions. d. Include $10,000 in income and deduct interest of $500 for AGI. e. None of the above. Register to View AnswerThe itemized deductions of $10,000 must be reduced by 2% of $50,000 or $1,000. PTS: 1 REF: Example 22 30. Cory incurred and paid the following expenses: Tax return preparation fee Moving expenses Investment expenses Expenses associated with rental property Interest expense associated with loan to finance tax-exempt bonds Calculate the amount that Cory can deduct (before any percentage limitations). a. $5,000. b. $4,600. c. $3,000. d. $1,500. e. None of the above. Register to View AnswerAll of the expenses are deductible either as deductions for ($2,000 + $1,500) or as deductions from ($600 + $500) except for the expenses associated with the tax-exempt bonds ($400). PTS: 1 REF: p. 6-27 | Concept Summary 6-3 31. Which of the following is not deductible? a. Moving expenses. b. Tax return preparation fees. c. Expenses incurred for the production of income. d. Allowable hobby expenses in excess of hobby income. e. None of the above. Register to View AnswerMoving expenses ( 217); tax return preparation fee ( 212); and expenses incurred for the production of income ( 212) are deductible. The hobby expenses in excess of the hobby income cannot be deducted. PTS: 1 REF: Concept Summary 6-3 $ 600 2,000 500 1,500 400 33. Robyn rents her beach house for 60 days and uses it for personal use for 30 days during the year. The rental income is $6,000 and the expenses are as follows: Mortgage interest Real estate taxes Utilities Maintenance Insurance Depreciation (rental part) $9,000 3,000 2,000 1,000 500 4,000 Using the IRS approach, total expenses that Robyn can deduct on her tax return associated with the beach house are: a. $0. b. $6,000. c. $8,000. d. $12,000. e. None of the above. Register to View AnswerSince the property is classified as personal/rental use, the general rule is that the deductible expenses cannot exceed the gross income. Thus, under the general rule, the deductible expenses would be limited to $6,000. However, this ceiling does not apply to expenses that otherwise would be deductible as itemized deductions. Consequently, all of the mortgage interest and real estate taxes can be deducted ($9,000 + $3,000 = $12,000). PTS: 1 REF: p. 6-20 34. If a vacation home is determined to be a personal/rental use residence, which of the following statements is false? a. All rental income is included in gross income. b. All rental related expenses are deductible for gross income. c. Expenses must be allocated between rental and personal use. d. Some expenses are deductible from AGI. e. None of the above. Register to View AnswerREF: Example 28 35. Bob and April own a house at the beach. The house was rented to unrelated parties for 8 weeks during the year. April and the children used the house 12 days for their vacation during the year. After properly dividing the expenses between rental and personal use, it was determined that a loss was incurred as follows: Gross rental income Less: Mortgage interest and property taxes Other allocated expenses Net rental loss $4,000 $3,500 2,000 (5,500) ($1,500) What is the correct treatment of the rental income and expenses on Bob and April's joint income tax return for the current year assuming the IRS approach is used if applicable? a. A $1,500 loss should be reported. b. Only the mortgage interest and property taxes should be deducted. c. Since the house was used more than 10 days personally by Bob and April, the rental expenses (other than mortgage interest and property taxes) are limited to the gross rental income in excess of deductions for interest and taxes allocated to the rental use. d. Since the house was used less than 50% personally by Bob and April, all expenses allocated to personal use may be deducted. e. Bob and April should include none of the income or expenses related to the beach house in their current year income tax return. Register to View AnswerREF: p. 6-19 36. Which of the following is correct? a. A taxpayer generally can claim a deduction for payment of an obligation of a dependent. b. Expenses paid for medical care of a dependent are deductible by the payor. c. Charitable contributions paid on behalf of a dependent are deductible by the payor. d. Only b. and c. are correct. e. a., b., and c. are correct. Register to View AnswerREF: p. 6-22 38. Harry divorced Wanda during the year. He incurred the following legal expenses as itemized on the bill from his attorney: Fees related to property division Fees related to the determination of dependency exemption General legal fees incident to divorce How much can Harry deduct? a. $0. b. $150. c. $650. d. $1,550. e. None of the above. Register to View AnswerOnly those separately stated fees that relate solely to tax advice ($150) are deductible. PTS: 1 REF: p. 6-12 | p. 6-24 $500 150 900 39. Which of the following must be capitalized by a business? a. Replacement of an alternator on a truck used in business. b. Replacement of a windshield of a business truck which was broken in an accident. c. Repair of a roof. d. Amount paid for a covenant not to compete. e. None of the above. Register to View AnswerAll of these expenses, except for the covenant, can be deducted in the current tax year. The amortization period for the covenant is 15 years. PTS: 1 REF: p. 6-24 41. In January, Lance sold stock with a cost basis of $26,000 to his brother, James, for $24,000, the fair market value of the stock on the date of sale. Five months later, James sold the same stock through his broker for $27,000. What is the tax effect of these transactions? a. Disallowed loss to James of $2,000; gain to Lance of $1,000. b. Disallowed loss to Lance of $2,000; gain to James of $3,000. c. Deductible loss to Lance of $2,000; gain to James of $3,000. d. Disallowed loss to Lance of $2,000; gain to James of $1,000. e. None of the above. Register to View AnswerLance's realized loss of $2,000 ($24,000 $26,000) is disallowed. James may reduce his realized gain of $3,000 ($27,000 $24,000) by Lance's disallowed loss of $2,000. So James' recognized gain is $1,000. PTS: 1 REF: Example 35 43. For constructive ownership purposes, which of the following are related parties under 267? I. II. III. IV. a. b. c. d. e. Taxpayer's cousin. Taxpayer's uncle. Taxpayer's 65% owned corporation. Taxpayer's sister. I IV. II IV. III and IV. IV only. None of the above are related parties. Register to View AnswerTaxpayer's cousin and uncle are not related parties under 267. PTS: 1 REF: p. 6-26 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. Register to View AnswerMable's 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 2. Ace Corporation, an accrual basis taxpayer, sells widgets. Ace sold on account a deluxe widget to Alan, Inc., for $22,000. Ace had a basis in the widget of $12,000. During the current year, after receiving $3,000 from Alan, Ace was notified that Alan was bankrupt and no further payments would be received. What amount of loss may Ace deduct in the current year? a. $0. b. $7,000. c. $9,000. d. $10,000. e. None of the above. Register to View AnswerThe loss is limited to the amount Ace included in gross income ($10,000) less any recovery ($3,000). This results in a $7,000 loss. PTS: 1 REF: p. 7-3 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. Register to View AnswerThe entire $10,000 loss on the bad debt is classified as an ordinary loss. PTS: 1 REF: p. 7-5 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. Register to View AnswerThe amount collected is $5,000 ($85,000 $80,000) in excess of Lucy's basis in the receivable. PTS: 1 REF: p. 7-3 6. Two years ago, Green Corporation, an accrual basis taxpayer, sold merchandise on credit to John, an individual. Green's account receivable from John was $20,000. Last year, John filed for bankruptcy, and Green was notified that it could expect to receive 20 cents on the dollar. Accordingly, Green took a $16,000 bad debt deduction on last year's tax return. In June of the current year, Green received a $6,000 payment from John in final settlement of the debt. How should Green 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 $2,000 of income for the current year. d. Report $4,000 of income for the current year. e. Report $6,000 of income for the current year. Register to View AnswerGreen should report $2,000 ($6,000 $4,000) of income in the current year. PTS: 1 REF: p. 7-4 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, Hank's Auto. As partial payment for the car, the dealer accepted the note from Sharon's sister. At the time Sharon purchased the car, the note had a balance of $18,000. During the current year, Sharon's sister died. Hank's 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 Hank's 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. Register to View AnswerThis is a business bad debt for Hank's Auto and therefore, the loss is $15,500. PTS: 1 REF: p. 7-3 to 7-5 9. On September 3, 2006, Able purchased stock in Red Corporation (the stock is not small business stock) for $6,000. On December 31, 2006, the stock was worth $8,500. On August 15, 2007, Able was notified that the stock was worthless. How should Able report this item on his 2006 and 2007 tax returns? a. 2006--$0; 2007--$6,000 short-term capital loss. b. 2006--$0; 2007--$6,000 long-term capital loss. c. 2006--$2,500 short-term capital loss; 2007--$8,500 short-term capital loss. d. 2006--$2,500 short-term capital gain; 2007--$3,800 long-term capital loss. e. None of the above. Register to View AnswerThe loss cannot be recognized until the year the stock is completely worthless. That year is 2007 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 2007. PTS: 1 REF: p. 7-6 | p. 7-7 10. On February 20, 2006, Bill purchased stock in Pink Corporation (the stock is not small business stock) for $1,000. On May 1, 2007, the stock became worthless. During 2007, 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 2007 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. Register to View AnswerOrdinary 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) ($8,000) 11. John files a return as a single taxpayer. In 2007, 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 John's AGI for 2007. a. $13,000. b. $25,000. c. $28,000. d. $75,000. e. None of the above. Register to View AnswerSalary 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 13. On January 10, 2006, Margie, who is single, purchased stock in Orange Corporation (the stock is 1244 small business stock) for $140,000. On October 15, 2007, Margie sold the stock for $20,000. How should Margie treat the loss on the sale of the stock? a. $120,000 ordinary loss. b. $20,000 short-term capital loss; $100,000 ordinary loss. c. $20,000 long-term capital loss; $100,000 ordinary loss. d. $50,000 ordinary loss and $70,000 long-term capital loss. e. None of the above. Register to View AnswerSection 1244 ordinary loss treatment applies. Therefore, the $120,000 loss is $50,000 ordinary loss and $70,000 long-term capital loss. PTS: 1 REF: p. 7-6 | p. 7-7 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 taxpayer's willful negligence. d. A stolen diamond ring. e. None of the above. Register to View AnswerA loss may be taken for the theft of personal use property (the diamond ring). PTS: 1 REF: p. 7-7 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. Fair Market Value Before After $ 700 $300 2,000 -0900 -0Insurance Recovery $100 500 200 Asset A B C Adjusted Basis $ 500 3,000 700 Rick's casualty loss deduction is: a. $400. b. $600. c. $1,000. d. $1,400. e. None of the above. Register to View AnswerAsset 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 in connection with his management of apartment buildings. Jim received an insurance recovery of 80% of the value of the car at the time of the accident. If Jim's AGI for the year is $50,000, determine his deductible loss on the car. a. $900. b. $6,000. c. $10,900. d. $30,000. e. None of the above. Register to View AnswerThe car is used for business or a transaction entered into for profit and hence, the amount of the loss is $40,000 (basis) reduced by the insurance recovery ($24,000). The $16,000 loss is not subject to the $100 floor per event or the 10%-of-AGI limitations. PTS: 1 REF: p. 7-11 | p. 7-13 17. Norm's car, which he uses 100% for personal purposes, was completely destroyed in an accident. The car's 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 Norm's deductible loss? a. $0. b. $2,000. c. $9,500. d. $8,000. e. None of the above. Register to View AnswerAmount (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 However no deduction is permitted because a timely insurance claim was not filed. PTS: 1 REF: p. 7-10 to 7-13 $11,500 (9,500) (100) (1,400) $ 500 19. John had adjusted gross income of $40,000. 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 $110,000 160,000 20,000 90,000 John had an accident with his personal use car. As a result of the accident, the other driver 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 John's deductible casualty loss? a. $22,500. b. $20,500. c. $35,800. d. $36,000. e. None of the above. Register to View AnswerLoss on home ($110,000 $90,000 $100) Loss on car ($4,000 $100) Total loss Less: (10% $40,000 AGI) Deductible casualty loss PTS: 1 REF: p. 7-7 to 7-14 $19,900 3,900 $23,800 (4,000) $19,800 $20,000 12,000 8,000 -0- 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 Assuming that Ned and Mary file a joint return, determine their taxable income for the current year. a. $22,500. b. $26,500. c. $27,200. d. $30,200. e. None of the above. Register to View AnswerSalary 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 ($3,300 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 (10,700) (6,800) $22,500 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 Theo's itemized deduction from these losses. a. $0. b. $2,800. c. $2,900. d. $4,580. e. None of the above. Register to View AnswerSalary 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%-ofAGI floor. Loss on theft of securities PTS: 1 REF: p. 7-13 | p. 7-14 $5,000 24. Last year Billy had silverware worth $25,000 (basis of $20,000) stolen from his home. Billy's insurance company told him that his policy did not cover the theft. Therefore, Billy took a casualty loss on his return last year. His AGI for last year was $40,000. His other itemized deductions last year were $13,000. In July of the current year, Billy's insurance company decided that Billy's policy did cover the theft of the silverware and they paid Billy $25,000. Determine the tax treatment of the $25,000 received by Billy during the current year. a. $25,000 should be included in gross income. b. $15,900 should be included in gross income. c. Last year's return should be amended to include the effect of the $25,000 payment by the insurance company. d. $20,900 should be included in gross income. e. None of the above. Register to View AnswerThe $25,000 should be included in the current year's gross income only to the extent that it provided a tax benefit in the prior year. This benefit was $20,900, computed as follows: The casualty transaction was reported last year as follows: Casualty loss (lesser of $20,000 basis and $25,000 FMV). Less: $100 floor 10% of AGI (10% $40,000) Itemized deduction in prior year $20,000 (100) (4,000) $15,900 The transaction would have been reported as follows if the $25,000 had been received last year. Insurance proceeds Adjusted basis Casualty gain $25,000 (20,000) $ 5,000 Therefore, $20,900 should be included in gross income this year ($15,900 + $5,000). PTS: 1 REF: p. 7-10 to 7-14 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. Register to View AnswerAmount 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 26. During the current year, Juan's 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. Juan's homeowner's policy had a $50,000 deductible clause for thefts. If Juan's 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. Register to View AnswerSalary Less: Loss on theft of tools AGI Personal use property theft loss Less: $100 floor 10% of AGI (10% $54,000) Deductile 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 $90,000 (71,250) $18,750 28. Swan Corporation incurred the following expenditures in connection with the development of a new product: Salaries Materials Advertising Market survey $40,000 8,000 3,000 2,000 If Swan Corporation elects to expense research and experimental expenditures, determine the amount of the deduction for research and experimental expenditures. a. $40,000. b. $48,000. c. $50,000. d. $51,000. e. $53,000. Register to View Answer$48,000 ($40,000 salaries + $8,000 materials). 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 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. Register to View AnswerSalary Materials Utilities Depreciation Research and experimental costs Current deduction $50,833 [($305,000 60) 10 months] $200,000 80,000 10,000 15,000 $305,000 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 30. Ivory, Inc., has taxable income of $300,000 and qualified production activities income (QPAI) of $200,000 in 2007. Ivory's domestic production activities deduction is: a. $6,000. b. $9,000. c. $12,000. d. $18,000. e. None of the above. Register to View AnswerDPAD is calculated for Ivory for 2007 as the lesser of the following: $200,000 $300,000 6% = $12,000 6% = $18,000 So the DPAD is $12,000. PTS: 1 REF: p. 7-17 1. Grape Corporation purchased a machine in December of the current year. This was the only asset purchased during the current year. The machine was placed in service in February of the following year. No assets were purchased in the following year. Grape Corporation's cost recovery would begin: a. In the current year using a mid-quarter convention. b. In the current year using a half-year convention. c. In the following year using a mid-quarter convention. d. In the following year using a half-year convention. e. None of the above. REF: p. 8-3 | p. 8-7 Register to View Answer3. On June 1 of the current year, Tab converted a machine to rental property. At the time of the conversion, the machine was worth $90,000. Five years ago Tab purchased the machine for $120,000. The machine is still encumbered by a $50,000 mortgage. What is the basis of the machine for cost recovery? a. $70,000. b. $90,000. c. $120,000. d. $140,000. e. None of the above. Register to View AnswerThe basis is $90,000, the lower of the adjusted basis ($120,000) or fair market value ($90,000) at the date of conversion. PTS: 1 REF: p. 8-4 | Example 3 4. Tara purchased a machine for $40,000 to be used in her business. The cost recovery allowed and allowable for the three years the machine was used are as follows: Cost Recovery Allowed $16,000 9,600 5,760 Cost Recovery Allowable $ 8,000 12,800 7,680 Year 1 Year 2 Year 3 If Tara sells the machine after three years for $15,000, how much gain should she recognize? a. $3,480. b. $6,360. c. $9,240. d. $11,480. e. None of the above. Register to View AnswerCost Less the greater of cost recovery allowed or allowable ($16,000 + $12,800 + $7,680) Adjusted basis The recognized gain is $11,480 ($15,000 $3,520). PTS: 1 REF: Example 2 $40,000 (36,480) $ 3,520 5. Hazel purchased a new business asset (five-year property) on November 30, 2007, at a cost of $100,000. This was the only asset acquired by Hazel during 2007. On January 7, 2008, Hazel placed the asset in service. She did not elect to expense any of the asset cost under 179, nor did she elect straight-line cost recovery. On October 25, 2009, Hazel sold the asset. Determine the cost recovery for 2009. a. $9,600. b. $16,000. c. $26,000. d. $38,000. e. None of the above. Register to View AnswerThe asset was placed in service in 2008; so 2009 is the second year in the cost recovery period. $100,000 .32 1/2 = $16,000. PTS: 1 REF: p. 8-7 | Table 8-1 6. Tan Company acquires a new machine (ten-year property) on January 15, 2007, at a cost of $200,000. Tan also acquires another new machine (seven-year property) on November 5, 2007, at a cost of $40,000. No election is made to use the straight-line method. The company does not make the 179 election. Determine the total deductions in calculating taxable income related to the machines for 2007. a. $24,000. b. $25,716. c. $102,000. d. $132,858. e. None of the above. Register to View AnswerThe Regular MACRS is calculated as follows: 10-year property ($200,000 .10) 7-year property ($40,000 .1429) Total regular MACRS PTS: 1 7. REF: p. 8-4 to 8-7 | Table 8-1 $20,000 5,716 $25,716 James purchased a new business asset (three-year property) on July 23, 2007, at a cost of $50,000. He did not elect to expense any of the asset under 179, nor did he elect straightline cost recovery. Determine the cost recovery deduction for 2007. a. $8,333. b. $16,665. c. $26,666. d. $33,333. e. None of the above. .3333) $16,665 Register to View AnswerRegular MACRS ($50,000 PTS: 1 REF: p. 8-4 to 8-7 | Table 8-1 9. Barry purchased a used business asset (seven-year property) on November 30, 2007, at a cost of $60,000. This is the only asset he purchased during the year. Barry did not elect to expense any of the asset under 179, nor did he elect straight-line cost recovery. Barry sold the asset on July 17, 2008. Determine the cost recovery deduction for 2008. a. $9,566. b. $9,975. c. $10,331. d. $16,530. e. None of the above. .2755 2.5/4 = $10,331. Register to View AnswerThe mid-quarter convention applies in this case. $60,000 PTS: 1 REF: p. 8-4 to 8-8 | Table 8-2 10. Bonnie purchased a new business asset (five-year property) on March 10, 2007, at a cost of $20,000. She also purchased a new business asset (seven-year property) on November 20, 2007, at a cost of $13,000. Bonnie did not elect to expense either of the assets under 179, nor did she elect straight-line cost recovery. Determine the cost recovery deduction for 2007 for these assets. a. $5,858. b. $7,464. c. $9,586. d. $12,333. e. None of the above. Register to View AnswerThe half-year convention applies in this case. Five-year property: Regular MACRS ($20,000 Seven-year property: Regular MACRS ($13,000 Total cost recovery PTS: 1 .20) $4,000 .1429) 1,858 $5,858 REF: p. 8-4 to 8-7 | Table 8-1 11. Doug purchased a new factory building on January 15, 1987, for $4,000,000. On March 1, 2007, the building was sold. Determine the cost recovery deduction for the year of the sale assuming he did not use the ACRS straight-line method. a. $0. b. $15,870. c. $26,450. d. $126,960. e. None of the above. Register to View Answer.03174 PTS: 1 $4,000,000 2.5/12 = $26,450. REF: p. 8-9 | Table 8-6 12. Cora purchased a hotel building on May 17, 2007, for $3,000,000. Determine the cost recovery deduction for 2008. a. $48,150. b. $59,520. c. $69,000. d. $109,080. e. None of the above. Register to View AnswerThe hotel building is nonresidential realty. .02564 PTS: 1 REF: p. 8-9 | Table 8-6 $3,000,000 = $76,920. 13. Carlos purchased an apartment building on November 16, 1989, for $1,000,000. Determine the cost recovery for 2007. a. $36,360. b. $32,100. c. $45,500. d. $331,850. e. None of the above. Register to View Answer$1,000,000 PTS: 1 .03637 = $36,370. REF: p. 8-8 | Table 8-6 15. Howard's business is raising and harvesting peaches. On March 10, 2007, Howard purchased 10,000 new peach trees at a cost of $50,000. Howard does not elect to expense assets under 179. Determine the cost recovery deduction for 2007. a. $0. b. $1,250. c. $2,500. d. $10,000. e. None of the above. Register to View Answer.05 $50,000 = $2,500. PTS: 1 REF: p. 8-10 | Table 8-3 16. On May 15, 2007, Brent purchased a truck for $40,000. The truck weighed less than 13,000 lbs. Brent used the truck in connection with his farming business. Brent does not elect to expense assets under 179. Determine the cost recovery deduction for 2007. a. $4,000. b. $6,000. c. $8,000. d. $10,000. e. None of the above. Register to View Answer.15 $40,000 = $6,000. PTS: 1 REF: p. 8-10 | Table 8-4 19. On February 20, 2007, Susan paid $200,000 for a unique improvement to a building that she is going to lease to John. The lease will begin on June 1, 2007, and terminate on May 31, 2027. At the termination of the lease, the improvement will be worthless. Determine Susan's deductible loss as a result of the termination of the lease. a. $0. b. $97,863. c. $99,786. d. $102,991. e. None of the above. Register to View AnswerCost Less: Cost recovery 2007 (.01391 $200,000) 2008 - 2026 (.02564 $200,000 19 years) 2027 [.02564 $200,000 (4.5/12)] Loss (unrecovered cost) PTS: 1 REF: p. 8-11 | Table 8-6 $200,000 (2,782) (97,432) (1,923) $ 97,863 20. White Company acquires a new machine (seven-year property) on January 10, 2007, at a cost of $204,000. White makes the election to expense the maximum amount under 179. No election is made to use the straight-line method. Determine the total deductions in calculating taxable income related to the machine for 2007 assuming White has taxable income of $500,000. a. $46,294. b. $51,151. c. $119,147. d. $125,147. e. None of the above. Register to View Answer 179 deduction Regular MACRS [($204,000 $112,000) Total deduction PTS: 1 $112,000 13,147 $125,147 .1429] REF: p. 8-12 | p. 8-13 | Table 8-1 22. In 2006, Gail had a 179 deduction carryover of $15,000. In 2007, she elected 179 for an asset acquired at a cost of $95,000. Gail's 179 business income limitation for 2007 is $120,000. Determine Gail's 179 deduction for 2007. a. $95,000. b. $105,000. c. $108,000. d. $110,000. e. None of the above. Register to View Answer$110,000 ($15,000 + $95,000), limited to $112,000. PTS: 1 REF: p. 8-12 | p. 8-13 23. The only asset Bill purchased during 2007 was a new seven-year class asset. The asset, which was listed property, was acquired on June 17 at a cost of $50,000. The asset was used 40% for business, 30% for the production of income, and the rest of the time for personal use. Bill always elects to expense the maximum amount under 179 whenever it is applicable. The net income from the business before the 179 deduction is $100,000. Determine Bill's maximum deduction with respect to the property for 2007. a. $1,428. b. $2,499. c. $26,749. d. $33,375. e. None of the above. Register to View AnswerThe listed property does not pass the predominantly business usage test. Therefore, 179 expensing cannot be taken. In addition, only straight-line cost recovery can be used. Maximum deduction ($50,000 PTS: 1 .0714 70%) $2,499 REF: p. 8-4 to 8-17 | Table 8-3 24. Mary purchased a new five-year class asset on March 7, 2007. The asset was listed property (not an automobile). It was used 60% for business and the rest of the time for personal use. The asset cost $120,000. Mary made the 179 election. The income from the business before the 179 deduction was $200,000. Determine the total deductions with respect to the asset for 2007. a. $18,000. b. $24,000. c. $72,000. d. $102,000. e. None of the above. Register to View AnswerCost 179 expense Basis for cost recovery PTS: 1 REF: p. 8-12 | p. 8-13 Business Use (60%) $72,000 (72,000) $ -0Personal Use (40%) $48,000 26. On June 1, 2007, Irene places in service a new automobile that cost $21,000. The car is used 70% for business and 30% for personal use. (Assume this percentage is maintained for the life of the car.) Determine the cost recovery deduction for 2008. a. $2,960. b. $3,290. c. $3,360. d. $6,720. e. None of the above. Register to View Answer$21,000 $4,800 32% = $6,720 (limited to $4,800*). 70% = $3,360. *These depreciation limits are indexed annually. PTS: 1 REF: Example 21 | Table 8-1 27. On June 1, 2007, James places in service a new automobile that cost $40,000. The car is used 60% for business and 40% for personal use. (Assume this percentage is maintained for the life of the car.) Determine the cost recovery deduction for 2007. a. $1,776. b. $2,960. c. $3,360. d. $4,700. e. None of the above. Register to View Answer$40,000 $2,960 .20 = $8,000 (limited to $2,960*). 60% = $1,776. *These depreciation limits are indexed annually. PTS: 1 REF: Example 21 | Table 8-1 28. On May 2, 2007, Karen places in service a new sports utility vehicle that cost $70,000 and has a gross vehicle weight of 6,300 lbs. The vehicle is used 40% for business and 60% for personal use. Determine the cost recovery deduction for 2007. a. $1,224. b. $2,800. c. $7,000. d. $10,003. e. None of the above. Register to View AnswerThe vehicle is not a passenger automobile because the gross vehicle weight exceeds 6,000 lbs. Therefore, it is not subject to the statutory dollar cost recovery limits under 280F. However, the vehicle is listed property. Because it does not pass the more-than-50% business use test, Karen must use straight-line cost recovery and also cannot elect 179 expensing. $70,000 PTS: 1 .10 40% = $2,800. REF: p. 8-13 to 8-16 | Table 8-3 29. On July 17, 2007, Kevin places in service a new automobile that cost $50,000. The car is used 80% for business and 20% for personal use. In 2008, he used the automobile 40% for business and 60% for personal use. Determine the cost recovery recapture for 2008. a. $0. b. $3,060. c. $3,680. d. $6,120. e. None of the above. Register to View AnswerCost recovery in 2007: MACRS ($50,000 .20) = $10,000 (limited to $2,960*) $2,960 80% Straight-line ($50,000 .10) = $5,000 (limited to $2,960*) $2,960 80% Cost recovery recapture in 2008 *These depreciation limits are indexed annually. PTS: 1 REF: Example 27 | Table 8-1 | Table 8-3 $2,368 (2,368) $ -0- 30. Janet purchased a new car on June 5, 2007, at a cost of $18,000. She used the car 80% for business and 20% for personal use in 2007. She used the automobile 40% for business and 60% for personal use in 2008. Determine Janet's cost recovery recapture for 2008. a. $0. b. $928. c. $1,440. d. $4,668. e. None of the above. Register to View AnswerCost recovery in 2007: MACRS ($18,000 .20) = $3,600 (limited to $2,960*) $2,960 80% Straight-line ($18,000 .10) = $1,800 (limited to $2,960*) $1,800 80% Cost recovery recapture in 2008 *These depreciation limits are indexed annually. PTS: 1 REF: Example 27 | Table 8-1 | Table 8-3 31. On July 10, 2007, Ariff places in service a new sports utility vehicle that cost $60,000 and weighed 6,300 pounds. The SUV is used 100% for business. Determine Ariff's maximum deduction for 2007, assuming Ariff's 179 business income is $110,000. a. $7,660. b. $26,400. c. $35,500. d. $40,400. e. None of the above. Register to View AnswerSince the SUV weighs over 6,000 pounds, it is not subject to the statutory dollar limits on luxury automobiles. 179 expensing (limited to $25,000 for such SUVs) Regular MACRS [($60,000 $25,000) .20] Total PTS: 1 REF: p. 8-13 to 8-16 $25,000 7,000 $32,000 $2,368 (1,440) $ 928 32. On March 1, 2007, Lana leases and places in service a passenger automobile. The lease will run for five years and the payments are $900 per month. During 2007, she uses her car 20% for business and 80% for personal activities. Assuming the dollar amount from the IRS table is $233, determine Lana's deduction for the lease payments. a. $0. b. $1,800. c. $2,000. d. $2,330. e. None of the above. Register to View Answer$900 PTS: 1 10 months 20% = $1,800. REF: p. 8-17 | p. 8-18 33. On June 1, 2007, Norm leases a taxi and places it in service. The lease payments are $1,000 per month. Assuming the dollar amount from the IRS table is $233, determine Norm's inclusion amount. a. $0. b. $130. c. $907. d. $1,554. e. None of the above. Register to View AnswerA taxi is not a passenger automobile. Thus, it is not subject to the lease inclusion amount provision. PTS: 1 REF: p. 8-16 34. Bhaskar purchased a new factory building on September 2, 2006, for $4,000,000. He elected the alternative depreciation system (ADS). Determine the cost recovery deduction for 2008. a. $30,000. b. $36,000. c. $44,000. d. $100,000. e. None of the above. Register to View Answer.025 PTS: 1 $4,000,000 = $100,000. REF: Example 31 | Table 8-7 35. Pat purchased a used five-year class asset on March 15, 2007, for $60,000. He did not elect 179 expensing. Determine the cost recovery deduction for 2007 for earnings and profits purposes. a. $2,000. b. $3,000. c. $6,000. d. $12,000. e. None of the above. Register to View Answer.10 $60,000 = $6,000. PTS: 1 REF: p. 8-19 | Table 8-5 37. During the past two years, through extensive advertising and improved customer relations, Orange Corporation estimated that it had developed customer goodwill worth $500,000. For the current year, determine the amount of goodwill Orange Corporation may amortize. a. $16,667. b. $26,667. c. $33,333. d. $100,000. e. None of the above. Register to View AnswerSelf-created goodwill is not a 197 intangible and thus cannot be amortized. PTS: 1 REF: p. 8-20 39. Orange Corporation begins business on April 2, 2007. The corporation has start-up expenditures of $54,000. If Orange Corporation elects 195, determine the total amount that Orange may deduct in 2007. a. $1,000. b. $2,650. c. $3,650. d. $5,000. e. None of the above. Register to View AnswerDeductible amount [$5,000 ($54,000 $50,000)] Amortizable amount {[($54,000 $1,000)/180] 9 months} Total deduction PTS: 1 1. REF: p. 8-21 | Example 34 $1,000 2,650 $3,650 Joshua performs services for Abigail. Which, if any, of the following factors would indicate that Joshua is an independent contractor (rather than an employee)? a. Abigail sets the work schedule. b. Joshua furnishes his own tools. c. Abigail provides the workplace. d. Joshua is paid by the hour. e. None of the above. Register to View AnswerChoices a., c., and d. reflect employee status. PTS: 1 REF: p. 9-3 3. Statutory employees: a. Report their expenses on Form 2106. b. Include common law employees. c. Are subject to income tax withholdings. d. Claim their expenses as deductions for AGI. e. None of the above. Register to View AnswerTheir expenses are reported on Schedule C, not on Form 2106 (choice a.). Although subject to Social Security tax, they are not subject to income tax withholdings (choice c.). PTS: 1 REF: p. 9-4 7. Under the actual expense method, which, if any, of the following expenses will not be allowed? a. Parking fines incurred during business use. b. Interest expense on a car loan (taxpayer is self-employed). c. Auto insurance. d. Dues to auto clubs. e. None of the above. Register to View AnswerFines and penalties are not deductible (choice a.). PTS: 1 REF: p. 9-7 | p. 9-31 8. Bill is the regional manager for a national chain of auto-parts stores and is based in Salt Lake City. When the company opens new stores in Boise, Bill is given the task of supervising their initial operation. For three months, he works weekdays in Boise and returns home on weekends. He spends $410 returning to Salt Lake City but would have spent $390 had he stayed in Boise for the weekend. As to the weekend trips, how much, if any, qualifies as a deduction? a. $0, since the trips are personal and not work related. b. $0, since Bill's tax home has changed from Salt Lake City to Boise. c. $390. d. $410. e. None of the above. Register to View AnswerBill's assignment in Boise is temporary, so his tax home has not changed (choice b.). Bill's deduction is limited to the lesser of what he actually spent and what he would have spent had he not returned home (choice c.). PTS: 1 REF: Example 10 9. Allowing for the cutback adjustment (50% reduction for meals and entertainment), which of the following trips, if any, will qualify for the travel expense deduction? a. Dr. Jones, a general dentist, attends a two-day seminar on developing a dental practice. b. Dr. Brown, a surgeon, attends a two-day seminar on financial planning. c. Paul, a romance language high school teacher, spends summer break in France, Portugal, and Spain improving his language skills. d. Myrna went on a two-week vacation in Boston. While there, she visited her employer's home office to have lunch with former co-workers. e. None of the above. Register to View AnswerPTS: 1 REF: Example 13 | Example 14 | Example 18 | Example 21 10. During the year, Hugh went from Cleveland to Fairbanks on business. Preceding a five-day business meeting, he spent four days vacationing at a dude ranch. Excluding the dude ranch costs, his expenses for the trip are: Air fare Lodging Meals Entertainment $1,800 600 500 300 Presuming no reimbursement, deductible expenses are: a. $3,200. b. $3,050. c. $2,800. d. $1,900. e. None of the above. Register to View Answer$1,800 + $600 + $400 [50%($500 + $300)] = $2,800. No allocation is required for domestic transportation costs (i.e., the airfare). PTS: 1 REF: Example 20 12. During the year, Kirk travels from Trenton to Oslo (Norway) on business. His time was spent as follows: 2 days travel (one day each way), 2 days business, and 2 days personal. His expenses for the trip were as follows (meals and lodging reflect only the business portion): Air fare Lodging Meals and entertainment $3,300 900 1,500 Presuming no reimbursement, Kirk's deductible expenses are: a. $5,700. b. $4,950. c. $3,850. d. $2,750. e. None of the above. Register to View Answer$3,300 + $900 + (50% $1,500) = $4,950. Since the 7-days-or-less exception applies, the full airfare ($3,300) is allowed. PTS: 1 REF: p. 9-10 | Footnote 18 14. Carolyn is single and has a college degree in finance. She is employed as a loan officer at a bank; her yearly AGI approximates $50,000. During 2006, she enrolled in a weekend MBA program and incurred the following nonreimbursed expenses: $3,900 (tuition), $300 (books), $200 (other school supplies), and $200 (transportation to and from campus). Disregarding the 2%-of-AGI limitation, as to the MBA program, Carolyn has a: a. Deduction for and deduction from AGI of $0. b. Deduction for AGI of $3,900 and deduction from AGI of $700. c. Deduction for AGI of $4,000 and deduction from AGI of $600. d. Deduction for AGI of $4,100 and deduction from AGI of $500. e. None of the above. Register to View AnswerSection 222 allows up to $4,000 for qualified tuition and related expenses. As Carolyn spent only $3,900, this is the amount she can claim as a deduction for AGI. The remaining expenses of $700 ($300 + $200 + $200) can be claimed as deductions from AGI. PTS: 1 REF: Example 28 16. Which, if any, of the following is subject to the cutback adjustment? a. An airline pilot for an executive jet rental company who pays his own travel expenses. b. Meals provided at cost to employees by a cafeteria funded by the employer. c. Fourth of July company picnic for employees. d. Business gifts of $25 (or less). e. None of the above. Register to View AnswerAlthough a reduced rate is in effect, the cutback adjustment still applies to persons subject to regulation by the U.S. Department of Transportation. PTS: 1 REF: p. 9-18 17. Dan entertains several of his clients on January 1 of the current year. Expenses paid by Dan are as follows: Cab fare Cover charge at supper club Dinner at club Tips to waiter Presuming proper substantiation, Dan's deduction is: a. $230. b. $260. c. $305. d. $335. e. None of the above. Register to View Answer$60 + [50% PTS: 1 ($150 + $330 + $70)] = $335. REF: Example 30 $ 60 150 330 70 19. Bill made the following gifts during the year: To Carl, a key client To Rowena (Carl's wife and a homemaker) To Jean, Bill's secretary, on her birthday ($3 was for gift wrapping) To Irv, Bill's boss, at Christmas Presuming proper substantiation, Bill's deduction is: a. $52. b. $53. c. $73. d. $78. e. None of the above. Register to View Answer$25 (Carl) + $28 (Jean) = $53 (choice b.). Gift wrapping ($3) can be included with the $25 maximum allowed. Double dipping on the $25 limit is not allowed by including a client's spouse or other family members (choice c.). A gift to a superior (choice d.) is not deductible. PTS: 1 REF: p. 9-21 $25 20 30 40 ... View Full Document

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