Multiple-Choice Answers and Explanations

Answers

Explanations

1. (c) The requirement is to determine the pension (annuity) amounts excluded from income for 2012, 2013, and 2014. Brown’s contribution of $12,000 will be recovered pro rata over the life of the annuity. Under this rule, $100 per month (12,000 ÷ 120 months) is excluded from income.

2. (b) The requirement is to determine the amount of life insurance proceeds that must be included in gross income by Decker, on the death of Fuller’s parent. Life insurance proceeds paid because of the insured person’s death are generally excluded from gross income. However, the exclusion generally does not apply if the insurance policy was obtained by the beneficiary in exchange for valuable consideration from a person other than the insurance company. Here, Decker purchased the policy from Fuller for $25,000 and paid an additional $40,000 in premiums, so Decker must include in gross income the excess of insurance proceeds over his investment in the policy [$200,000 − ($25,000 + $40,000) = $135,000.

3. (b) The requirement is to determine the amount of life insurance payments to be included in a widow’s gross income. Life insurance proceeds paid by reason of death are excluded from income if paid in a lump sum or in installments. If the payments are received in installments, the principal amount of the policy divided by the number of annual payments is excluded each year. Therefore, $1,200 of the $5,200 insurance payment is included in Penelope’s gross income.

Annual installment	$ 5,200
Principal amount ($100,000 ÷ 25)	– 4,000
Gross income	$ 1,200

4. (c) The requirement is to determine the correct statement regarding a “cafeteria plan” maintained by an employer. Cafeteria plans are employer-sponsored benefit packages that offer employees a choice between taking cash and receiving qualified benefits (e.g., accident and health insurance, group-term life insurance, coverage under a dependent care or group legal services program). Thus, employees “may select their own menu of benefits.” If an employee chooses qualified benefits, they are excluded from the employee’s gross income to the extent allowed by law. If an employee chooses cash, it is includible in the employee’s gross income as compensation. Answer (a) is incorrect because participation is restricted to employees only. Answer (b) is incorrect because there is no minimum service requirement that must be met before an employee can participate in a plan. Answer (d) is incorrect because deferred compensation plans other than 401(k) plans are not included in the definition of a cafeteria plan.

5. (a) The requirement is to determine the amount of group-term life insurance proceeds that must be included in gross income by Autrey’s widow. Life insurance proceeds paid by reason of death are generally excluded from gross income. Note that although only the cost of the first $50,000 of group-term insurance coverage can be excluded from gross income during the employee’s life, the entire amount of insurance proceeds paid by reason of death will be excluded from the beneficiary’s income.

6. (d) The requirement is to determine the amount of employee death payments to be included in gross income by the widow and the son. The $5,000 employee death benefit exclusion was repealed for decedents dying after August 20, 1996.

7. (b) The requirement is to determine the maximum amount of tax-free group-term life insurance coverage that can be provided to an employee by an employer. The cost of the first $50,000 of group-term life insurance coverage provided by an employer will be excluded from an employee’s income.

8. (d) The requirement is to determine the amount to be included in Hal’s gross income for the current year. All three amounts that Hal received as a result of his injury are excluded from gross income. Benefits received as workers’ compensation and compensation for damages for physical injuries are always excluded from gross income. Amounts received from an employer’s accident and health plan as reimbursement for medical expenses are excluded so long as the medical expenses are not deducted as itemized deductions.

9. (a) James Martin’s gross income consists of

Salary	$50,000
Bonus	10,000
	$60,000

Medical insurance premiums paid by an employer are excluded from an employee’s gross income. Additionally, qualified moving expense reimbursements are an employee fringe benefit and can be excluded from gross income. This means that an employee can exclude an amount paid by an employer as payment for (or reimbursement of) expenses that would be deductible as moving expenses if directly paid or incurred by the employee.

10. (d) The requirement is to determine how much income Hall should include in his 2013 tax return for the inheritance of stock which he received from his father’s estate. Since the definition of gross income excludes property received as a gift, bequest, devise, or inheritance, Hall recognizes no income upon receipt of the stock. Since the executor of his father’s estate elected the alternate valuation date (August 1), and the stock was distributed to Hall before that date (June 1), Hall’s basis for the stock would be its $4,500 FMV on June 1. Since Hall also sold the stock on June 1 for $4,500, Hall would have no gain or loss resulting from the sale.

11. (b) The requirement is to determine the amount of dividend income that should be reported by Gail Judd. The $100 dividend on Gail’s life insurance policy is treated as a reduction of the cost of insurance (because total dividends have not yet exceeded accumulated premiums paid) and is excluded from gross income. Thus, Gail will report the $300 dividend on common stock and the $500 dividend on preferred stock, a total of $800 as dividend income.

12. (b) The requirement is to determine the amount of dividend income to be reported on Amy’s 2013 return. Dividends are included in income at earlier of actual or constructive receipt. When corporate dividends are paid by mail, they are included in income for the year in which received. Thus, the $875 dividend received 1/2/13 is included in income for 2013. The $500 dividend on a life insurance policy from a mutual insurance company is treated as a reduction of the cost of insurance and is excluded from gross income.

13. (c) The requirement is to determine the amount of dividends to be reported by the Mitchells on a joint return. The amount of dividends would be ($400 + $50 + $300) = $750. The $200 dividend on the life insurance policy is not gross income, but is considered a reduction of the cost of the policy.

14. (d) The requirement is to determine Karen’s basis in the 10 shares of preferred stock received as a stock dividend. Generally, stock dividends are nontaxable, and a taxpayer’s basis for original stock is allocated to the dividend stock in proportion to fair market values. However, any stock that is distributed on preferred stock results in a taxable stock dividend. The amount to be included in the shareholder’s income is the stock’s fair market value on date of distribution. Similarly, the shareholder’s basis for the dividend shares will be equal to their fair market value on date of distribution (10 × $60 = $600).

15. (c) The requirement is to determine the correct statement(s) regarding the amortization of bond premium on a taxable bond. The amount of premium amortization on taxable bonds acquired by the taxpayer after 1987 is treated as an offset to the amount of interest income reported on the bond. The method of calculating the annual amortization is determined by the date the bond was issued, as opposed to the acquisition date. If the bond was issued after September 27, 1985, the amortization must be calculated under the constant yield to maturity method. Otherwise, the amortization must be made ratably over the life of the bond. Under the constant yield to maturity method, the amortizable bond premium is computed on the basis of the taxpayer’s yield to maturity, using the taxpayer’s basis for the bond, and compounding at the close of each accrual period.

16. (c) The requirement is to determine whether two statements are true concerning the exclusion of interest income on US Series EE Bonds that are redeemed to pay for higher education. The accrued interest on US Series EE savings bonds that are redeemed by a taxpayer is excluded from gross income to the extent that the aggregate redemption proceeds (principal plus interest) are used to finance the higher education of the taxpayer, taxpayer’s spouse, or dependents. Qualified higher educational expenses include tuition and fees, but not room and board or the cost of courses involving sports, games, or hobbies that are not part of a degree program. In determining the amount of available exclusion, qualified educational expenses must be reduced by qualified scholarships that are exempt from tax, and any other nontaxable payments such as veteran’s educational assistance and employer-provided educational assistance.

17. (a) The requirement is to determine the amount of interest subject to tax in Kay’s 2013 tax return. Interest must generally be included in gross income, unless a specific statutory provision provides for its exclusion (e.g., interest on municipal bonds). Interest on US Treasury certificates and on a refund of federal income tax would be subject to tax on Kay’s 2013 tax return.

18. (c) The requirement is to determine the amount of interest income taxable on Charles and Marcia’s joint income tax return. A taxpayer’s income includes interest on state and federal income tax refunds and interest on federal obligations, but excludes interest on state obligations. Here, their joint taxable income must include the $500 interest on federal income tax refund, $600 interest on state income tax refund, and $800 interest on federal government obligations, but will exclude the $1,000 tax-exempt interest on state government obligations. Although a refund of federal income tax would be excluded from gross income, any interest on a refund must be included in gross income.

19. (a) The requirement is to determine the condition that must be met for tax exemption of accumulated interest on Series EE US Savings Bonds. An individual may be able to exclude from income all or a part of the interest received on the redemption of Series EE US Savings Bonds. To qualify, the bonds must be issued after December 31, 1989, the purchaser of the bonds must be the sole owner of the bonds (or joint owner with his or her spouse), and the owner(s) must be at least twenty-four years old before the bond’s issue date. To exclude the interest the redemption proceeds must be used to pay the tuition and fees incurred by the taxpayer, spouse, or dependents to attend a college or university or certain vocational schools.

20. (d) The requirement is to determine the amount of tax-exempt interest. Interest on obligations of a state or one of its political subdivisions (e.g., New York Port Authority bonds), or a possession of the US (e.g., Puerto Rico Commonwealth bonds) is tax-exempt.

21. (c) Stone will report $1,700 of interest income. Interest on FIT refunds, personal injury awards, US savings bonds, and most other sources is fully taxable. However, interest on state or municipal bonds is generally not taxable.

22. (d) The requirement is to determine how Don Raff’s $500 interest forfeiture penalty should be reported. An interest forfeiture penalty for making a premature withdrawal from a certificate of deposit should be deducted from gross income in arriving at adjusted gross income in the year in which the penalty is incurred, which in this case is 2013.

23. (c) The requirement is to determine which payment(s) must be included in a recipient’s gross income. A candidate for a degree can exclude amounts received as a scholarship or fellowship if, according to the conditions of the grant, the amounts are used for the payment of tuition and fees, books, supplies, and equipment required for courses at an educational institution. All payments received for services must be included in income, even if the services are a condition of receiving the grant or are required of all candidates for the degree. Here, the payment to a graduate assistant for a part-time teaching assignment and the grant to a Ph.D. candidate for participation in research are payments for services and must be included in income.

24. (c) The requirement is to determine the amount of scholarship awards that Majors should include as taxable income in 2013. Only a candidate for a degree can exclude amounts received as a scholarship award. The exclusion available to degree candidates is limited to amounts received for the payment of tuition and fees, books, supplies, and equipment required for courses at the educational institution. Since Majors is a candidate for a graduate degree, Majors can exclude the $10,000 received for tuition, fees, books, and supplies required for courses. However, the $2,000 stipend for research services required by the scholarship must be included in taxable income for 2013.

25. (a) The requirement is to determine a lessor’s 2013 gross income. A lessor excludes from income any increase in the value of property caused by improvements made by the lessee, unless the improvements were made in lieu of rent. In this case, there is no indication that the improvements were made in lieu of rent. Therefore, for 2013, Farley should only include the six rent payments in income: 6 × $1,000 = $6,000.

26. (d) The requirement is to determine the amount of alimony recapture that must be included in Bob’s gross income for 2013. Alimony recapture may occur if alimony payments sharply decline in the second and third years that payments are made. The payor must report the recaptured alimony as gross income in the third year, and the payee is allowed a deduction for the same amount. Recapture for the second year (2012) occurs to the extent that the alimony paid in the second year ($20,000) exceeds the alimony paid in the third year ($0) by more than $15,000 [i.e., $20,000 − ($0 + $15,000) = $5,000 of recapture].

Recapture for the first year (2011) occurs to the extent that the alimony paid in the first year ($50,000) exceeds the average alimony paid in the second and third years by more than $15,000. For this purpose, the alimony paid in the second year ($20,000) must be reduced by the amount of recapture for that year ($5,000).

First year (2011) payment		$500
Second year (2012) payment ($20,000 − $5,000)	$15,000
Third year (2013) payment	+0
Total	$15,000
	÷2	(7,500)
		(15,000)
Recapture for first year (2011)		$27,500

Thus, the total recapture to be included in Bob’s gross income for 2013 is $5,000 + $27,500 = $32,500.

27. (c) The requirement is to determine which conditions must be present in a divorce agreement for a payment to qualify as deductible alimony. In order for a payment to be deductible by the payor as alimony, the payment must be made in cash or its equivalent, the payment must be received by or on behalf of a spouse under a divorce or separation instrument, the payments must terminate at the recipient’s death, and must not be designated as other than alimony (e.g., child support).

28. (d) The requirement is to determine which of the following would be included in gross income by Darr who is an employee of Sorce C corporation. The definition of gross income includes income from whatever source derived and would include the dividend income on shares of stock that Darr received for services rendered. However, items specifically excluded from gross income include amounts received as a gift or inheritance, as well as employer-provided medical insurance coverage under a health plan.

29. (c) The requirement is to determine the correct statement regarding the inclusion of social security benefits in gross income for 2013. A maximum of 85% of social security benefits may be included in gross income for high-income taxpayers. Thus, no matter how high a taxpayer’s income, 85% of the social security benefits is the maximum amount of benefits to be included in gross income.

30. (c) The requirement is to determine the amount that Perle should include in taxable income as a result of performing dental services for Wood. An exchange of services for property or services is sometimes called bartering. A taxpayer must include in income the amount of cash and the fair market value of property or services received in exchange for the performance of services. Here, Perle’s taxable income should include the $200 cash and the bookcase with a comparable value of $350, a total of $550.

31. (b) The requirement is to determine the amount of payments to be included in Mary’s income tax return for 2013. Alimony must be included in gross income by the payee and is deductible by the payor. In order to be treated as alimony, a payment must be made in cash and be received by or paid on behalf of the former spouse. Amounts treated as child support are not alimony; they are neither deductible by the payor, nor taxable to the payee. Payments will be treated as child support to the extent that payments will be reduced upon the happening of a contingency relating to a child (e.g., the child attaining a specified age, marrying, becoming employed). Here, since future payments will be reduced by 20% on their child’s 18th birthday, the total cash payments of $10,000 ($7,000 paid directly to Mary plus the $3,000 of tuition paid on Mary’s behalf) must be reduced by 20% and result in $8,000 of alimony income for Mary. The remaining $2,000 is treated as child support and is not taxable.

32. (b) The requirement is to determine the amount of interest for overpayment of 2012 state income tax and state income tax refund that is taxable in Clark’s 2013 federal income tax return. The $10 of interest income on the tax refund is taxable and must be included in gross income. On the other hand, a state income tax refund is included in gross income under the “tax benefit rule” only if the refunded amount was deducted in a prior year and the deduction provided a benefit because it reduced the taxpayer’s federal income tax. The payment of state income taxes will not result in a “benefit” if an individual does not itemize deductions, or is subject to the alternative minimum tax for the year the taxes are paid. Individuals who file Form 1040EZ are not allowed to itemize deductions and must use the standard deduction. Since state income taxes are only allowed as an itemized deduction and Clark did not itemize for 2012 (he used Form 1040EZ), his $900 state income tax refund is nontaxable and is excluded from gross income.

33. (d) The requirement is to determine the amount to be reported in Hall’s 2013 return as alimony income. If a divorce agreement specifies both alimony and child support, but less is paid than required, then payments are first allocated to child support, with only the remainder in excess of required child support to be treated as alimony. Pursuant to Hall’s divorce agreement, $3,000 was to be paid each month, of which $600 was designated as child support, leaving a balance of $2,400 per month to be treated as alimony. However, during 2013, only $5,000 was paid to Hall by her former husband which was less than the $36,000 required by the divorce agreement. Since required child support payments totaled $600 × 12 = $7,200 for 2013, all $5,000 of the payments actually received by Hall during 2013 is treated as child support, with nothing remaining to be reported as alimony.

34. (b) The requirement is to determine the amount of income to be reported by Lee in connection with the receipt of stock for services rendered. Compensation for services rendered that is received by a cash method taxpayer must be included in income at its fair market value on the date of receipt.

35. (c) The requirement is to determine when Ross was subject to “regular tax” with regard to stock that was acquired through the exercise of an incentive stock option. There are no tax consequences when an incentive stock option is granted to an employee. When the option is exercised, any excess of the stock’s FMV over the option price is a tax preference item for purposes of the employee’s alternative minimum tax. However, an employee is not subject to regular tax until the stock acquired through exercise of the option is sold.

If the employee holds the stock acquired through exercise of the option at least two years from the date the option was granted (and holds the stock itself at least one year), the employee’s realized gain is treated as long-term capital gain in the year of sale, and the employer receives no compensation deduction. If the preceding holding period rules are not met at the time the stock is sold, the employee must report ordinary income to the extent that the stock’s FMV at date of exercise exceeded the option price, with any remaining gain reported as long-term or short-term capital gain. As a result, the employer receives a compensation deduction equal to the amount of ordinary income reported by the employee.

36. (a) The requirement is to determine the amount that is taxable as alimony in Ann’s return. In order to be treated as alimony, a payment must be made in cash and be received by or on behalf of the payee spouse. Furthermore, cash payments must be required to terminate upon the death of the payee spouse to be treated as alimony. In this case, the transfer of title in the home to Ann is not a cash payment and cannot be treated as alimony. Although the mortgage payments are cash payments made on behalf of Ann, the payments are not treated as alimony because they will be made throughout the full twenty-year mortgage period and will not terminate in the event of Ann’s death.

37. (c) The requirement is to determine the correct statement with regard to income in respect of a cash basis decedent. Income in respect of a decedent is income earned by a decedent before death that was not includible in the decedent’s final income tax return because of the decedent’s method of accounting (e.g., receivables of a cash basis decedent). Such income must be included in gross income by the person who receives it and has the same character (e.g., ordinary or capital) as it would have had if the decedent had lived.

38. (d) The requirement is to determine the amount of gross income. Drury’s gross income includes the $36,000 salary, the $500 of premiums paid by her employer for group-term life insurance coverage in excess of $50,000, and the $5,000 proceeds received from a state lottery.

39. (b) The requirement is to determine the amount of foster child payments to be included in income by the Charaks. Foster child payments are excluded from income to the extent they represent reimbursement for expenses incurred for care of the foster child. Since the payments ($3,900) exceeded the expenses ($3,000), the $900 excess used for the Charaks’ personal expenses must be included in their gross income.

40. (b) The requirement is to determine the amount and the year in which the tip income should be included in Pierre’s gross income. If an individual receives less than $20 in tips during one month while working for one employer, the tips do not have to be reported to the employer and the tips are included in the individual’s gross income when received. However, if an individual receives $20 or more in tips during one month while working for one employer, the individual must report the total amount of tips to that employer by the tenth day of the next month. Then the tips are included in gross income for the month in which they are reported to the employer. Here, Pierre received $2,000 in tips during December 2013 that he reported to his employer in January 2014. Thus, the $2,000 of tips will be included in Pierre’s gross income for 2014.

41. (c) The requirement is to determine the correct statement regarding the alimony deduction in connection with a divorce. To be considered alimony, cash payments must terminate on the death of the payee spouse. Answer (a) is incorrect because alimony payments cannot be contingent on the status of the divorced couple’s children. Answer (b) is incorrect because the divorced couple cannot be members of the same household at the time the alimony is paid. Answer (d) is incorrect because only cash payments can be considered alimony.

42. (d) The requirement is to determine the amount of a $10,000 award for outstanding civic achievement that Joan should include in her 2013 adjusted gross income. An award for civic achievement can be excluded from gross income only if the recipient was selected without any action on his/her part, is not required to render substantial future services as a condition of receiving the award, and designates that the award is to be directly transferred by the payor to a governmental unit or a tax-exempt charitable, educational, or religious organization. Here, since Joan accepted and actually received the award, the $10,000 must be included in her adjusted gross income.

43. (d) The requirement is to determine the amount of lottery winnings that should be included in Gow’s taxable income. Lottery winnings are gambling winnings and must be included in gross income. Gambling losses are deductible from AGI as a miscellaneous deduction (to the extent of winnings) not subject to the 2% of AGI floor if a taxpayer itemizes deductions. Since Gow elected the standard deduction for 2013, the $400 spent on lottery tickets is not deductible. Thus, all $5,000 of Gow’s lottery winnings are included in his taxable income.

44. (d) The requirement is to determine the amount of advance rents and lease cancellation payments that should be reported on Lake Corp.’s 2013 tax return. Advance rental payments must be included in gross income when received, regardless of the period covered or whether the taxpayer uses the cash or accrual method. Similarly, lease cancellation payments are treated as rent and must be included in income when received, regardless of the taxpayer’s method of accounting.

45. (c) The requirement is to determine the amount to be reported as gross income. Gross income includes the $50,000 of recurring rents plus the $2,000 lease cancellation payment. The $1,000 of lease improvements are excluded from income since they were not required in lieu of rent.

46. (c) The requirement is to determine the amount of net rental income that Gow should include in his adjusted gross income. Since Gow lives in one of two identical apartments, only 50% of the expenses relating to both apartments can be allocated to the rental unit.

Rent	$7,200
Less:
Real estate taxes (50% × $6,400)	(3,200)
Painting of rental apartment	(800)
Fire insurance (50% × $600)	(300)
Depreciation (50% × $5,000)	(2,500)
Net rental income	$400

47. (a) The requirement is to determine the amount of rent income to be reported on Amy’s 2013 return. Both the $6,000 of rent received for 2013, as well as the $1,000 of advance rent received in 2013 for the last two months of the lease must be included in income for 2013. Advance rent must be included in income in the year received regardless of the period covered or the accounting method used.

48. (a) The requirement is to determine the amount to be reported as rent revenue in an accrual-basis taxpayer’s tax return for 2013. An accrual-basis taxpayer’s rent revenue would consist of the amount of rent earned during the taxable year plus any advance rent received. Advance rents must be included in gross income when received under both the cash and accrual methods, even though they have not yet been earned. In this case, Royce’s rent revenue would be determined as follows:

Rent receivable 12/31/12	$35,000
Rent receivable 12/31/13	25,000
Decrease in receivables	(10,000)
Rent collections during 2013	50,000
Rent deposits	5,000
Rent revenue for 2013	$45,000

The rent deposits must be included in gross income for 2013 because they are nonrefundable deposits.

49. (a) The requirement is to determine the amount of state unemployment benefits that should be included in adjusted gross income for 2013. Unemployment compensation benefits received must generally be included in gross income.

50. (d) The requirement is to determine the correct statement regarding the reporting of income by a cash-basis taxpayer. A cash-basis taxpayer should report gross income for the year in which income is either actually or constructively received, whether in cash or in property. Constructive receipt means that an item of income is unqualifiedly avail-able to the taxpayer without restriction (e.g., interest on bank deposit is income when credited to account).

51. (b) The requirement is to determine which taxpayer may use the cash method of accounting. The cash method cannot generally be used if inventories are necessary to clearly reflect income, and cannot generally be used by C corporations, partnerships that have a C corporation as a partner, tax shelters, and certain tax-exempt trusts. Taxpayers permitted to use the cash method include a qualified personal service corporation, an entity (other than a tax shelter) if for every year it has average gross receipts of $5 million or less for any prior three-year period (and provided it does not have inventories), and a small taxpayer with average annual gross receipts of $1 million or less for any prior three-year period may use the cash method and is excepted from the requirement to account for inventories.

52. (b) The requirement is to select the correct statement regarding the $1,000 of additional income determined by Stewart, an accrual method corporation. Under the accrual method, income generally is reported in the year earned. If an amount is included in gross income on the basis of a reasonable estimate, and it is later determined that the exact amount is more, then the additional amount is included in income in the tax year in which the determination of the exact amount is made. Here, Stewart properly accrued $5,000 of income for 2012 on the basis of a reasonable estimate and discovered that the exact amount was $6,000 in 2013. Therefore, the additional $1,000 of income is properly includible in Stewart’s 2013 income tax return.

53. (b) The requirement is to determine the correct statement regarding Axis Corp.’s deduction for its employees bonus expense. An accrual-method taxpayer can deduct compensation (including a bonus) when there is an obligation to make payment, the services have been performed, and the amount can be determined with reasonable accuracy. It is not required that the exact amount of compensation be determined during the taxable year. As long as the computation is known and the liability is fixed, accrual is proper even though the profits upon which the compensation are based are not determined until after the end of the year.

Although compensation is generally deductible only for the year in which the compensation is paid, an exception is made for accrual method taxpayers so long as payment is made within 2 1/2 months after the end of the year. Here, since the services were performed, the method of computation was known, the amount was reasonable, and payment was made by March 15, 2013, the bonus expense may be deducted on Axis Corp.’s 2012 tax return. Note that the bonus could not be a disguised dividend because none of the employees were shareholders.

54. (b) The requirement is to determine the amount of the 2012 interest payment of $12,000 that was deductible on Michaels’ 2013 income tax return. Generally, there is no deduction for prepaid interest. When a taxpayer pays interest for a period that extends beyond the end of the tax year, the interest paid in advance must be spread over the period to which it applies. Michaels paid $12,000 of interest during 2012 that relates to the period beginning December 1, 2012, and ending November 30, 2013. Therefore, 1/12 × $12,000 = $1,000 of interest was deductible for 2012, and 11/12 × $12,000 = $11,000 is deductible for 2013.

55. (c) The requirement is to determine the amount of income to be reported in Blair’s 2013 return for the stock received in satisfaction of a client fee owed to Blair. Since Blair is a cash method taxpayer, the amount of income to be recognized equals the $4,000 fair market value of the stock on date of receipt. Note that the $4,000 of income is reported by Blair in 2013 when the stock is received; not in 2014 when the stock is sold.

56. (d) The requirement is to determine whether the accrual method of tax reporting is mandatory for a sole proprietor when there are accounts receivable for services rendered, or year-end merchandise inventories. A taxpayer’s taxable income should be computed using the method of accounting by which the taxpayer regularly computes income in keeping the taxpayer’s books. Either the cash or the accrual method generally can be used so long as the method is consistently applied and clearly reflects income. However, when the production, purchase, or sale of merchandise is an income producing factor, inventories must be maintained to clearly reflect income. If merchandise inventories are necessary to clearly determine income, only the accrual method of tax reporting can be used for purchases and sales.

57. (d) The requirement is to determine the amount of salary taxable to Burg in 2013. Since Burg is a cash-basis taxpayer, salary is taxable to Burg when actually or constructively received, whichever is earlier. Since the $30,000 of unpaid salary was unqualifiedly available to Burg during 2013, Burg is considered to have constructively received it. Thus, Burg must report a total of $80,000 of salary for 2013; the $50,000 actually received plus $30,000 constructively received.

58. (d) The requirement is to determine the 2013 medical practice net income for a cash basis physician. Dr. Berger’s income consists of the $200,000 received from patients and the $30,000 received from third-party reimbursers during 2013. His 2013 deductions include the $20,000 of salaries and $24,000 of other expenses paid in 2013. The year-end bonuses will be deductible for 2014.

59. (c) The requirement is to determine which taxpayer may use the cash method of accounting for tax purposes. The cash method generally cannot be used (and the accrual method must be used to measure sales and cost of goods sold) if inventories are necessary to clearly determine income. Additionally, the cash method generally cannot generally be used by (1) a corporation (other than an S corporation), (2) a partnership with a corporation as a partner, and (3) a tax shelter. However, this prohibition against the use of the cash method in the preceding sentence does not apply to a farming business, a qualified personal service corporation (e.g., a corporation performing services in health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting), and a corporation or partnership (that is not a tax shelter) that does not have inventories and whose average annual gross receipts for the most recent three-year period do not exceed $5 million.

60. (a) Uniform capitalization rules generally require that all costs incurred (both direct and indirect) in manufacturing or constructing real or personal property, or in purchasing or holding property for sale, must be capitalized as part of the cost of the property. However, these rules do not apply to a “small retailer or wholesaler” who acquires personal property for resale if the retailer’s or wholesaler’s average annual gross receipts for the three preceding taxable years do not exceed $10 million.

61. (a) The requirement is to determine whether the cost of merchandise, and business expenses other than the cost of merchandise, can be deducted in calculating Mock’s business income from a retail business selling illegal narcotic substances. Generally, business expenses that are incurred in an illegal activity are deductible if they are ordinary and necessary, and reasonable in amount. Under a special exception, no deduction or credit is allowed for any amount that is paid or incurred in carrying on a trade or business which consists of trafficking in controlled substances. However, this limitation that applies to expenditures in connection with the illegal sale of drugs does not alter the normal definition of gross income (i.e., sales minus cost of goods sold). As a result, in arriving at gross income from the business, Mock may reduce total sales by the cost of goods sold, and thus is allowed to deduct the cost of merchandise in calculating business income.

62. (b) The requirement is to determine the percentage of business meals expense that Banks Corp. can deduct for 2013. Generally, only 50% of business meals and entertainment is deductible. When an employer reimburses its employees’ substantiated qualifying business meal expenses, the 50% limitation on deductibility applies to the employer.

63. (a) The requirement is to determine which of the costs is not included in inventory under the Uniform Capitalization (UNICAP) rules for goods manufactured by a taxpayer. UNICAP rules require that specified overhead items must be included in inventory including factory repairs and maintenance, factory administration and officers’ salaries related to production, taxes (other than income taxes), the costs of quality control and inspection, current and past service costs of pension and profit-sharing plans, and service support such as purchasing, payroll, and warehousing costs. Nonmanufacturing costs such as selling, advertising, and research and experimental costs are not required to be included in inventory.

64. (d) If no exceptions are met, the uniform capitalization rules generally require that all costs incurred in purchasing or holding inventory for resale must be capitalized as part of the cost of the inventory. Costs that must be capitalized with respect to inventory include the costs of purchasing, handling, processing, repackaging and assembly, and off-site storage. An off-site storage facility is one that is not physically attached to, and an integral part of, a retail sales facility. Service costs such as marketing, selling, advertising, and general management are immediately deductible and need not be capitalized as part of the cost of inventory.

65. (d) The requirement is to determine the correct statement regarding the deduction for bad debts in the case of a corporation that is not a financial institution. Except for certain small banks that can use the experience method of accounting for bad debts, all taxpayers (including those that previously used the reserve method) are required to use the direct charge-off method of accounting for bad debts.

66. (d) The requirement is to determine the amount of life insurance premium that can be deducted in Ram Corp.’s income tax return. Generally, no deduction is allowed for expenditures that produce tax-exempt income. Here, no deduction is allowed for the $6,000 life insurance premium because Ram is the beneficiary of the policy, and the proceeds of the policy will be excluded from Ram’s income when the officer dies.

67. (a) The requirement is to determine the amount of bad debt deduction for a cash-basis taxpayer. Accounts receivable resulting from services rendered by a cash-basis taxpayer have a zero tax basis, because the income has not yet been reported. Thus, failure to collect the receivable results in a nondeductible loss.

68. (c) The requirement is to determine the loss that Cook can claim as a result of the worthless note receivable in 2013. Cook’s $1,000 loss will be treated as a nonbusiness bad debt, deductible as a short-term capital loss. The loss is not a business bad debt because Cook was not in the business of lending money, nor was the loan required as a condition of Cook’s employment. Since Cook owned no stock in Precision, the loss could not be deemed to be a loss from worthless stock, deductible as a long-term capital loss.

69. (b) The requirement is to determine the amount of gifts deductible as a business expense. The deduction for business gifts is limited to $25 per recipient each year. Thus, Palo Corporation’s deduction for business gifts would be [(4 × $10) + (13 × $25)] = $365.

70. (b) The requirement is to determine Jennifer’s net operating loss (NOL) for 2013. Jennifer’s personal casualty loss of $45,000 incurred as a result of the destruction of her personal residence is allowed as a deduction in the computation of her NOL and is subtracted from her salary income of $30,000, to arrive at a NOL of $15,000. No deduction is allowed for personal and dependency exemptions in the computation of a NOL.

71. (c) The requirement is to determine the amount of net operating loss (NOL) for a self-employed taxpayer for 2013. A NOL generally represents a loss from the conduct of a trade or business and can generally be carried back two years and forward twenty years to offset income in the carryback and carry forward years. Since a NOL generally represents a business loss, an individual taxpayer’s personal and dependency exemptions and an excess of nonbusiness deductions over nonbusiness income cannot be subtracted in computing the NOL. Nonbusiness deductions generally include itemized deductions as well as the standard deduction if the taxpayer does not itemize. In this case, the $6,100 standard deduction offsets the $1,500 of nonbusiness income received in the form of dividends and short-term capital gain, but the excess ($4,600) cannot be included in the NOL computation. Thus, the taxpayer’s NOL simply consists of the $6,000 business loss.

72. (a) The requirement is to determine Destry’s net operating loss (NOL). A net operating loss generally represents a loss from the conduct of a trade or business and can generally be carried back two years and forward twenty years to offset income in the carryback and carry forward years. Since a NOL generally represents a business loss, an individual taxpayer’s personal and dependency exemptions and an excess of nonbusiness deductions (e.g., standard deduction) over nonbusiness income (e.g., interest from savings account) cannot be subtracted in computing the NOL. Similarly, no deduction is allowed for a net capital loss. As a result, Destry’s NOL consists of his net business loss of $16,000 reduced by his business income of $5,000 from wages and $4,000 of net rental income, resulting in a NOL of $7,000.

73. (a) The requirement is to determine the amount of Cobb’s rental real estate loss that can be used as an offset against income from non passive sources. Losses from passive activities may generally only be used to offset income from other passive activities. Although a rental activity is defined as a passive activity regardless of the owner’s participation in the operation of the rental property, a special rule permits an individual to offset up to $25,000 of income that is not from passive activities by losses from a rental real estate activity if the individual actively participates in the rental real estate activity. However, this special $25,000 allowance is reduced by 50% of the taxpayer’s AGI in excess of $100,000, and is fully phased out when AGI exceeds $150,000. Since Cobb’s AGI is $200,000, the special $25,000 allowance is fully phased out and no rental loss can be offset against income from non passive sources.

74. (c) The requirement is to determine the entity to which the rules limiting the deductibility of passive activity losses and credits applies. The passive activity limitations apply to individuals, estates, trusts, closely held C corporations, and personal service corporations. Application of the passive activity loss limitations to personal service corporations is intended to prevent taxpayers from sheltering personal service income by creating personal service corporations and acquiring passive activity losses at the corporate level. A personal service corporation is a corporation (1) whose principal activity is the performance of personal services, and (2) such services are substantially performed by owner-employees. Since passive activity income, losses, and credits from partnerships and S corporations flow through to be reported on the tax returns of the owners of such entities, the passive activity limitations are applied at the partner and shareholder level, rather than to partnerships and S corporations themselves.

75. (c) The requirement is to determine Wolf’s passive loss resulting from his 5% general partnership interest in Gata Associates. A partnership is a pass-through entity and its items of income and loss pass through to partners to be included on their tax returns. Since Wolf does not materially participate in the partnership’s auto parts business, Wolf’s distributable share of the loss from the partnership’s auto parts business is classified as a passive activity loss. Portfolio income or loss must be excluded from the computation of the income or loss resulting from a passive activity, and must be separately passed through to partners.

Portfolio income includes all interest income, other than interest income derived in the ordinary course of a trade or business. Interest income derived in the ordinary course of a trade or business includes only interest income on loans and investments made in the ordinary course of a trade or business of lending money, and interest income on accounts receivable arising in the ordinary course of a trade or business. Since the $20,000 of interest income derived by the partnership resulted from a temporary investment, the interest income must be classified as portfolio income and cannot be netted against the $100,000 operating loss from the auto parts business. Thus, Wolf will report a passive activity loss of $100,000 × 5% = $5,000; and will report portfolio income of $20,000 × 5% = $1,000.

76. (a) The requirement is to determine the correct statement regarding the passive loss rules involving rental real estate activities. By definition, any rental activity is a passive activity without regard as to whether or not the taxpayer materially participates in the activity. Answer (b) is incorrect because interest and dividend income not derived in the ordinary course of business is treated as portfolio income, and cannot be offset by passive rental activity losses when the “active participation” requirement is not met. Answer (c) is incorrect because passive rental activity credits cannot be used to offset the tax attributable to non passive activities. Answer (d) is incorrect because the passive activity rules contain no provision that excludes taxpayers below a certain income level from the limitations imposed by the passive activity rules.

77. (d) The requirement is to determine the correct statement regarding an individual taxpayer’s passive losses relating to rental real estate activities that cannot be currently deducted. Generally, losses from passive activities can only be used to offset income from passive activities. If there is insufficient passive activity income to absorb passive activity losses, the unused losses are carried forward indefinitely or until the property is disposed of in a taxable transaction. Answers (a) and (c) are incorrect because unused passive losses are never carried back to prior taxable years. Answer (b) is incorrect because there is no maximum carry forward period.

78. (b) The requirement is to determine the maximum amount of Sec. 179 expense election that Aviation Corp. will be allowed to deduct for 2013, and the maximum amount of expense election that it can carry over to 2014. Sec. 179 permits a taxpayer to elect to treat up to $500,000 (for 2012 and 2013) of the cost of qualifying depreciable personal property as an expense rather than as a capital expenditure. The $500,000 maximum is reduced dollar-for-dollar by the cost of qualifying property placed in service during the taxable year that exceeds $2 million. Here, since the production machinery cost $570,000, the maximum amount that can be expensed is $500,000. However, this amount is further limited as a deduction for 2013 to Aviation’s taxable income of $405,000 before the Sec. 179 expense deduction. The remainder ($500,000 − $405,000 = $95,000) that is not currently deductible because of the taxable income limitation can be carried over and will be deductible subject to the taxable income limitation in 2014.

79. (c) The requirement is to determine which conditions must be satisfied to enable a taxpayer to expense the cost of new or used tangible depreciable personal property under Sec. 179. For 2012 and 2013, a taxpayer may elect to expense up to $500,000 of the cost of new or used tangible depreciable personal property placed in service during the taxable year. To qualify, the property must be acquired by purchase from an unrelated party for use in the taxpayer’s active trade or business. The maximum cost that can be expensed of $500,000 is reduced dollar-for-dollar by the cost of qualifying property that is placed in service during the year that exceeds $2 million. Additionally, the amount that can be expensed is further limited to the aggregate taxable income derived from the active conduct of any trade or business of the taxpayer.

80. (a) The requirement is to determine the MACRS deduction for the used furniture and fixtures placed in service during 2013. The furniture and fixtures qualify as seven-year property and under MACRS will be depreciated using the 200% declining balance method. Normally, a half-year convention applies to the year of acquisition. However, the mid-quarter convention must be used if more than 40% of all personal property is placed in service during the last quarter of the taxpayer’s taxable year. Since this was Krol’s only acquisition of personal property and the property was placed in service during the last quarter of Krol’s calendar year, the mid-quarter convention must be used. Under this convention, property is treated as placed in service during the middle of the quarter in which placed in service. Since the furniture and fixtures were placed in service in November, the amount of allowable MACRS depreciation is limited to $56,000 × 2/7 × 1/8 = $2,000.

81. (b) The requirement is to determine Sullivan’s MACRS deduction for the apartment building in 2013. The MACRS deduction for residential real property placed in service during 2013 must be determined using the mid-month convention (i.e., property is treated as placed in service at the midpoint of the month placed in service) and the straight-line method of depreciation over a 27.5-year recovery period. Here, the $360,000 cost must first be reduced by the $30,000 allocated to the land, to arrive at a basis for depreciation of $330,000. Since the building was placed in service on June 29, the mid-month convention results in 6.5 months of depreciation for 2013. The MACRS deduction for 2013 is [$330,000 × (6.5 months)/(27.5 × 12 months)] = $6,500.

82. (c) The requirement is to determine the depreciation convention that must be used when a calendar-year taxpayer’s only acquisition of equipment during the year occurs during November. Generally, a half-year convention applies to depreciable personal property, and a mid-month convention applies to depreciable real property. Under the half-year convention, a half-year of depreciation is allowed for the year in which property is placed in service, regardless of when the property is placed in service during the year, and a half-year of depreciation is allowed for the year in which the property is disposed of. However, a taxpayer must instead use a mid-quarter convention if more than 40% of all depreciable personal property acquired during the year is placed in service during the last quarter of the taxable year. Under this convention, property is treated as placed in service (or disposed of) in the middle of the quarter in which placed in service (or disposed of). Since Data Corp. is a calendar-year taxpayer and its only acquisition of depreciable personal property was placed in service during October (i.e., the last quarter of its taxable year), it must use the mid-quarter convention, and will only be allowed a half-quarter of depreciation of its office equipment for 2013.

83. (b) The requirement is to determine the correct statement regarding the modified accelerated cost recovery system (MACRS) of depreciation for property placed in service after 1986. Under MACRS, salvage value is completely ignored for purposes of computing the depreciation deduction, which results in the recovery of the entire cost of depreciable property. Answer (a) is incorrect because used tangible depreciable property is depreciated under MACRS. Answer (c) is incorrect because the cost of some depreciable realty must be depreciated using the straight-line method. Answer (d) is incorrect because the cost of some depreciable realty is included in the ten-year (e.g., single purpose agricultural and horticultural structures) and twenty-year (e.g., farm buildings) classes.

84. (a) The requirement is to determine the correct statement regarding the half-year convention under the general MACRS method. Under the half-year convention that generally applies to depreciable personal property, one-half of the first year’s depreciation is allowed in the year in which the property is placed in service, regardless of when the property is placed in service during the year, and a half-year’s depreciation is allowed for the year in which the property is disposed of, regardless of when the property is disposed of during the year. Answer (b) is incorrect because allowing one-half month’s depreciation for the month that property is placed in service or disposed of is known as the “midmonth convention.”

85. (c) The requirement is to determine the portion of the $600,000 cost of the machine that can be treated as a Sec. 179 expense deduction for 2013. Sec. 179 permits a taxpayer to elect to treat up to $500,000 (for 2012 and 2013) of the cost of qualifying depreciable personal property as an expense rather than as a capital expenditure. However, the $500,000 maximum is reduced dollar-for-dollar by the cost of qualifying property placed in service during the taxable year that exceeds $2 million.

86. (d) The requirement is to determine the amount to be reported in Mel’s gross income for the $400 per month received for business automobile expenses under a nonaccountable plan from Easel Co. Reimbursements and expense allowances paid to an employee under a nonaccountable plan must be included in the employee’s gross income and are reported on the employee’s W-2. The employee must then complete Form 2106 and itemize to deduct business-related expenses such as the use of an automobile.

87. (c) The requirement is to determine the correct statement regarding a second residence that is rented for 200 days and used 50 days for personal use. Deductions for expenses related to a dwelling that is also used as a residence by the taxpayer may be limited. If the taxpayer’s personal use exceeds the greater of 14 days, or 10% of the number of days rented, deductions allocable to rental use are limited to rental income. Here, since Adams used the second residence for 50 days and rented the residence for 200 days, no rental loss can be deducted. All expenses related to the property, including utilities and maintenance, must be allocated between personal use and rental use. Answer (d) is incorrect because only the mortgage interest and taxes allocable to rental use would be deducted in determining the property’s net rental income or loss. Answer (a) is incorrect, since depreciation on the property could be deducted if Adams’ gross rental income exceeds allocable out-of-pocket rental expenses.

88. (a) The requirement is to determine the amount of unreimbursed employee expenses that can be deducted by Gilbert if he does not itemize deductions. Gilbert cannot deduct any of the expenses listed if he does not itemize deductions. The unreimbursed employee business expenses are deductible only as itemized deductions, subsequent to the 2% of AGI floor.

89. (c) The requirement is to determine the amount of moving expense that James can deduct for 2013. Direct moving expenses are deductible if closely related to the start of work at a new location and a distance test (i.e., distance from new job to former residence is at least fifty miles further than distance from old job to former residence) and a time test (i.e., employed at least thirty-nine weeks out of twelve months following move) are met. Since both tests are met, James’ unreimbursed lodging and travel expenses ($1,000), cost of insuring household goods and personal effects during move ($200), cost of shipping household pets ($100), and cost of moving household furnishings and personal effects ($3,000) are deductible. Indirect moving expenses such as pre-move house-hunting, temporary living expenses, and meals while moving are not deductible.

90. (c) The requirement is to determine Martin’s deductible moving expenses. Moving expenses are deductible if closely related to the start of work at a new location and a distance (i.e., new job must be at least fifty miles from former residence) and time (i.e., employed at least thirty-nine weeks out of twelve months following move) tests are met. Here, both tests are met and Martin’s $800 cost of moving his personal belongings is deductible. However, the $300 penalty for breaking his lease is not deductible.

91. (a) Only the direct costs incurred for transporting a taxpayer, his or her family, and their household goods and personal effects from their former residence to their new residence can qualify as deductible moving expenses. The indirect moving expense costs incurred for meals while in transit, house hunting, temporary lodging, to sell or purchase a home, and to break or acquire a lease are not deductible.

92. (d) The requirement is to determine the incorrect statement concerning a Roth IRA. The maximum annual contribution to a Roth IRA is subject to reduction if the taxpayer’s adjusted gross income exceeds certain thresholds. Unlike a traditional IRA, contributions are not deductible and can be made even after the taxpayer reaches age 70¹/₂. The contribution must be made by the due date of the taxpayer’s tax return (not including extensions).

93. (d) The requirement is to determine the maximum amount of adjusted gross income that a taxpayer may have and still qualify to roll over a traditional IRA into a Roth IRA for 2013. For tax years beginning before 2010, a conversion or rollover of a traditional IRA to a Roth IRA could occur if the taxpayer’s AGI did not exceed $100,000 and the taxpayer was not married filing a separate return. The IRA conversion or rollover amount was not taken into account in determining the $100,000 AGI ceiling. However, both the AGI limit and the joint filing requirement have been eliminated for tax years beginning after 2009.

94. (d) The requirement is to determine which statement concerning an education IRA is not correct. Contributions to an education IRA are not deductible, but withdrawals of earnings will be tax-free if used to pay the qualified higher education expenses of the designated beneficiary. The maximum amount that can be contributed to an education IRA is limited to $2,000, but the annual contribution is phased out by adjusted gross income in excess of certain thresholds. Contributions generally cannot be made to an education IRA if the designated beneficiary is age eighteen or older.

95. (a) The requirement is to determine the Whites’ allowable IRA deduction on their 2013 joint return. For married taxpayers filing a joint return for 2013, up to $5,500 can be deducted for contributions to the IRA of each spouse (even if one spouse is not working), provided that the combined earned income of both spouses is at least equal to the amounts contributed to the IRAs. Even though Val is covered by his employer’s qualified pension plan, the Whites are eligible for the maximum deduction because their gross income of $55,000 + $4,000 = $59,000 does not exceed the base amount ($95,000) at which the maximum $5,500 deduction would be reduced. Also note that Pat’s $4,000 of taxable alimony payments is treated as compensation for purposes of qualifying for an IRA deduction. Since they each contributed $5,500 to an IRA account, the allowable deduction on their joint return is $11,000.

96. (d) The requirement is to determine the definition of “earned income” for purposes of computing the annual contribution to a Keogh profit-sharing plan by Davis, a sole proprietor. A self-employed individual may contribute to a qualified retirement plan called a Keogh plan. For 2013, the maximum contribution to a Keogh profit-sharing plan is the lesser of $51,000 or 25% of earned income. For this purpose, “earned income” is defined as net earnings from self-employment (i.e., business gross income minus allowable business deductions) reduced by the deduction for one-half of the self-employment tax, and the deductible Keogh contribution itself.

97. (d) A single individual with AGI over $69,000 for 2013 would only be entitled to an IRA deduction if the taxpayer is not covered by a qualified employee pension plan.

98. (c) The requirement is to determine the allowable IRA deduction on the Cranes’ 2013 joint return. Since Sol is covered by his employer’s pension plan, Sol’s contribution of $5,500 is proportionately phased out as a deduction by AGI between $95,000 and $115,000. Since the Cranes’ AGI exceeded $115,000, no deduction is allowed for Sol’s contribution. Although Julia is not employed, $5,500 can be contributed to her IRA because the combined earned income on the Cranes’ return is at least $11,000. The maximum IRA deduction for an individual who is not covered by an employer plan, but whose spouse is, is proportionately phased out for AGI between $178,000 and $188,000 for 2013. Since Julia is not covered by an employer plan and the Cranes’ AGI is below $178,000, the $5,500 contribution to Julia’s IRA is fully deductible for 2013.

99. (d) The requirement is to determine the Lees’ maximum IRA contribution and deduction on a joint return for 2013. Since neither taxpayer is covered by an employer-sponsored pension plan, there is no phase-out of the maximum deduction due to the level of their adjusted gross income. For married taxpayers filing a joint return, up to $5,500 can be deducted for contributions to the IRA of each spouse (even if one spouse is not working), provided that the combined earned income of both spouses is at least equal to the amounts contributed to the IRAs. Additionally, an individual at least age 50 can make a special catch-up contribution of $1,000 for 2013, resulting in an increased maximum contribution and deduction of $6,500 for 2013. Thus, the Lees may contribute and deduct a maximum of $13,000 to their individual retirement accounts for 2013, with a maximum of $6,500 placed into each account.

100. (c) The maximum amount of contributions to a defined contribution self-employed retirement plan is limited to the lesser of $51,000, or 100% of self-employment income for 2013.

101. (d) The requirement is to determine which allowable deduction can be claimed in arriving at an individual’s adjusted gross income. One hundred percent of a self-employed individual’s health insurance premiums are deductible in arriving at an individual’s adjusted gross income for 2013. Charitable contributions, foreign income taxes (if not used as a credit), and tax return preparation fees can be deducted only from adjusted gross income if an individual itemizes deductions.

102. (b) The requirement is to determine the incorrect statement concerning the deduction for interest on qualified education loans. For 2013, an individual is allowed to deduct up to $2,500 for interest on qualified education loans in arriving at AGI. The deduction is subject to an income phase-out and the loan proceeds must have been used to pay for the qualified higher education expenses (e.g., tuition, fees, room, board) of the taxpayer, spouse, or a dependent (at the time the debt was incurred). The education expenses must relate to a period when the student was enrolled on at least a half-time basis. The sixty-month limitation was repealed for tax years beginning after 2002.

103. (c) The requirement is to determine how Dale should treat her $1,000 jury duty fee that she remitted to her employer. Fees received for serving on a jury must be included in gross income. If the recipient is required to remit the jury duty fees to an employer in exchange for regular compensation, the remitted jury duty fees are allowed as a deduction from gross income in arriving at adjusted gross income.

104. (b) The requirement is to determine George’s taxable income. George’s adjusted gross income consists of $3,700 of dividends and $1,700 of wages. Since George is eligible to be claimed as a dependency exemption by his parents, there will be no personal exemption on George’s return and his basic standard deduction is limited to the greater of $1,000, or George’s earned income of $1,700, plus $350. Thus, George’s taxable income would be computed as follows:

Dividends	$ 3,700
Wages	1,700
AGI	$ 5,400
Exemption	0
Std. deduction	(2,050)
Taxable income	$3,350

105. (c) The item asks you to determine the requirements that must be met in order for a single individual to qualify for the additional standard deduction. A single individual who is age sixty-five or older or blind is eligible for an additional standard deduction ($1,500 for 2013). Two additional standard deductions are allowed for an individual who is age sixty-five or older and blind. It is not required that an individual support a dependent child or aged parent in order to qualify for an additional standard deduction.

106. (b) The requirement is to determine Carroll’s maximum medical expense deduction after the applicable threshold limitation 2013. An individual taxpayer’s unreimbursed medical expenses are deductible to the extent in excess of 10% of the taxpayer’s adjusted gross income. Although the cost of cosmetic surgery is generally not deductible, the cost is deductible if the cosmetic surgery or procedure is necessary to ameliorate a deformity related to a congenital abnormality or personal injury resulting from an accident, trauma, or disfiguring disease. Here, Carroll’s deduction is ($5,000 + $15,000) − ($100,000 × 10%) = $10,000.

107. (b) The requirement is to determine the Blairs’ itemized deduction for medical expenses for 2013. A taxpayer can deduct the amounts paid for the medical care of himself, spouse, or dependents. The Blairs’ qualifying medical expenses include the $800 of medical insurance premiums, $450 of prescribed medicines, $1,000 of unreimbursed doctor’s fees, and $150 of transportation related to medical care. These expenses, which total $3,150, are deductible to the extent they exceed 10% (for 2013) of adjusted gross income, and result in a deduction of $150. Note that nonprescription medicines, including aspirin and over-the-counter cold capsules, are not deductible. Additionally, the Blairs cannot deduct the emergency room fee they paid for their son because they did not provide more than half of his support and he therefore does not qualify as their dependent.

108. (a) The requirement is to determine the amount the Whites may deduct as qualifying medical expenses without regard to the adjusted gross income percentage threshold. The Whites’ deductible medical expenses include the $600 spent on repair and maintenance of the motorized wheelchair and the $8,000 spent for tuition, meals, and lodging at the special school for their physically handicapped dependent child. Payment for meals and lodging provided by an institution as a necessary part of medical care is deductible as a medical expense if the main reason for being in the institution is to receive medical care. Here, the item indicates that the Whites’ physically handicapped dependent child was in the institution primarily for the availability of medical care, and that meals and lodging were furnished as necessary incidents to that care.

109. (c) The requirement is to determine the amount Wells can deduct as qualifying medical expenses without regard to the adjusted gross income percentage threshold. Wells’ deductible medical expenses include the $500 premium on the prescription drug insurance policy and the $500 unreimbursed payment for physical therapy. The earnings protection policy is not considered medical insurance because payments are not based on the amount of medical expenses incurred. As a result, the $3,000 premium is a nondeductible personal expense.

110. (d) The requirement is to determine the amount of expenses incurred in connection with the adoption of a child that can be deducted by the Sloans on their 2013 joint return. A taxpayer can deduct the medical expenses paid for a child at the time of adoption if the child qualifies as the taxpayer’s dependent when the medical expenses are paid. Additionally, if a taxpayer pays an adoption agency for medical expenses the adoption agency already paid, the taxpayer is treated as having paid those expenses. Here, the Sloans can deduct the child’s medical expenses of $5,000 that they paid. On the other hand, the legal expenses of $9,000 and agency fee of $4,000 incurred in connection with the adoption are treated as nondeductible personal expenses. However, the Sloans will qualify to claim a nonrefundable tax credit of up to $12,970 (for 2013) for these qualified adoption expenses.

111. (a) The requirement is to determine the amount that can be claimed by the Clines in their 2013 return as qualifying medical expenses. No medical expense deduction is allowed for cosmetic surgery or similar procedures, unless the surgery or procedure is necessary to ameliorate a deformity related to a congenital abnormality or personal injury resulting from an accident, trauma, or disfiguring disease. Cosmetic surgery is defined as any procedure that is directed at improving a patient’s appearance and does not meaningfully promote the proper function of the body or prevent or treat illness or disease. Thus, Ruth’s face-lift and Mark’s hair transplant do not qualify as deductible medical expenses in 2013.

112. (d) The requirement is to determine the amount that Scott can claim as deductible medical expenses. The medical expenses incurred by a taxpayer for himself, spouse, or a dependent are deductible when paid or charged to a credit card. The $4,000 of medical expenses for his dependent son are deductible by Scott in 2013 when charged on Scott’s credit card. It does not matter that payment to the credit card issuer had not been made when Scott filed his return. Expenses paid for the medical care of a decedent by the decedent’s spouse are deductible as medical expenses in the year they are paid, whether the expenses are paid before or after the decedent’s death. Thus, the $2,800 of medical expenses for his deceased spouse are deductible by Scott when paid in 2013, even though his spouse died in 2012.

113. (d) The requirement is to determine which expenditure qualifies as a deductible medical expense. Premiums paid for Medicare B supplemental medical insurance qualify as a deductible expense. Diaper service, funeral expenses, and nursing care for a healthy baby are not deductible as medical expenses.

114. (b) The requirement is to determine Stenger’s net medical expense deduction for 2013. It would be computed as follows:

Prescription drugs	$ 300
Medical insurance premiums	1,750
Doctors ($2,550 − $900)	1,650
Eyeglasses	75
	$3,775
Less 10% of AGI ($35,000)	3,500
Medical expense deduction for 2013	$275

115. (d) The requirement is to determine the total amount of deductible medical expenses for the Bensons before the application of any limitation rules. Deductible medical expenses include those incurred by a taxpayer, taxpayer’s spouse, dependents of the taxpayer, or any person for whom the taxpayer could claim a dependency exemption except that the person had gross income of $3,900 or more, or filed a joint return. Thus, the Bensons may deduct medical expenses incurred for themselves, for John (i.e., no dependency exemption only because his gross income is $3,900 or more), and for Nancy (i.e., a dependent of the Bensons).

116. (d) The requirement is to determine the tax that is not deductible as an itemized deduction. One-half of a self-employed taxpayer’s self-employment tax is deductible from gross income in arriving at adjusted gross income. Foreign real estate taxes, foreign income taxes, and personal property taxes can be deducted as itemized deductions from adjusted gross income.

117. (c) The requirement is to determine the amount that Matthews can deduct as taxes on her 2013 Schedule A of Form 1040. An individual’s state and local income taxes are deductible as an itemized deduction, while federal income taxes are not deductible. For a cash-basis taxpayer, state and local taxes are deductible for the year in which paid or withheld. As a result, Matthew’s deduction for 2013 consists of her state and local taxes withheld of $1,500 and the December 30 estimated payment of $400. The state and local income taxes that Matthews paid in April 2014 will be deductible for 2014.

118. (a) The requirement is to determine the correct statement regarding Farb, a cash-basis individual taxpayer who paid an $8,000 invoice for personal property taxes under protest in 2012, and received a $5,000 refund of the taxes in 2013. If a taxpayer receives a refund or rebate of taxes deducted in an earlier year, the taxpayer must generally include the refund or rebate in income for the year in which received. Here, Farb should deduct $8,000 in his 2012 income tax return and should report the $5,000 refund as income in his 2013 income tax return.

119. (d) The requirement is to determine the amount of itemized deduction for realty taxes that can be deducted by Burg. Generally, an individual’s payment of state, local, or foreign real estate taxes is deductible as an itemized deduction if the individual is the owner of the property on which the taxes are imposed. Because the property is jointly owned by Burg, he is individually liable for the entire amount of realty taxes and may deduct the entire payment on his return. Even back taxes can be deducted by Burg as long as he was the owner of the property during the period of time to which the back taxes are related.

120. (b) The requirement is to determine Sara’s deduction for state income taxes in 2013. Sara’s deduction would consist of the $2,000 withheld by her employer in 2013, plus the three estimated payments (3 × $300 = $900) actually paid during 2013, a total of $2,900. Note that the 1/15/14 estimated payment would be deductible for 2014.

121. (b) The requirement is to determine the amount of taxes deductible as an itemized deduction. The $360 vehicle tax based on value is deductible as a personal property tax. The real property tax of $2,700 must be apportioned between the Bronsons and the buyer for tax purposes according to the number of days in the real property tax year that each owns the property even though they did not actually make an apportionment. Taxes are apportioned to the seller up to, but not including, the date of the sale, and apportioned to the buyer beginning with the date of sale. Since the house was sold June 30, the Bronson’s deduction for real estate taxes would be $2,700 × 180/365 = $1,332. The buyer would deduct the remaining $1,368.

122. (a) The requirement is to determine what portion of the $1,300 of realty taxes is deductible by King in 2013. The $600 of delinquent taxes charged to the seller and paid by King are not deductible, but are added to the cost of the property. The $700 of taxes for 2013 are apportioned between the seller and King according to the number of days that each held the property during the year. King’s deduction would be

123. (b) The requirement is to determine the amount of property taxes deductible as itemized deductions. The property taxes on the residence and the land held for appreciation, together with the personal property taxes on the auto are deductible. The special assessment is not deductible, but would be added to the basis of the residence.

124. (a) The requirement is to determine the amount the Burgs should deduct for taxes in their itemized deductions. The $1,200 of state income tax paid by the Burgs is deductible as an itemized deduction. However, the $7,650 of self-employment tax is not deductible as an itemized deduction. Instead, a portion of the self-employment tax is deductible from gross income in arriving at the Burgs’ adjusted gross income.

125. (c) The requirement is to determine the correct statement regarding an individual taxpayer’s deduction for interest on investment indebtedness. The deduction for interest expense on investment indebtedness is limited to the taxpayer’s net investment income. Net investment income includes such income as interest, dividends, and short-term capital gains, less any related expenses.

126. (b) The requirement is to determine the correct statement regarding the interest on the Browns’ $20,000 loan that was secured by their home and used to purchase an automobile. Qualified residence interest consists of interest on acquisition indebtedness and home equity indebtedness. Interest on home equity indebtedness loans of up to $100,000 is deductible as qualified residence interest if the loans are secured by a taxpayer’s principal or second residence regardless of how the loan proceeds are used. The amount of home equity indebtedness cannot exceed the fair market value of a home as reduced by any acquisition indebtedness. Since the Browns’ home had an FMV of $400,000 and was unencumbered by other debt, the interest on the $20,000 home equity loan is deductible as qualified residence interest.

127. (c) The requirement is to determine how much interest is deductible by the Philips for 2013. Qualified residence interest includes the interest on acquisition indebtedness. Such interest is deductible on up to $1 million of loans secured by a principal or second residence if the loans were used to purchase, construct, or substantially improve a home. Here, the Philips’ original mortgage of $200,000 as well as the additional loan of $15,000 qualify as acquisition indebtedness, and the resulting $17,000 + $1,500 = $18,500 of interest is deductible. On the other hand, the $500 of interest on the auto loan is considered personal interest and not deductible.

128. (c) The requirement is to determine the maximum amount allowable as a deduction for Jackson’s second residence. Qualified residence interest includes acquisition indebtedness and home equity indebtedness on the taxpayer’s principal residence and a second residence. Here, the $5,000 of mortgage interest on the second residence is qualified residence interest and is deductible as an itemized deduction. In contrast, the $1,200 of utilities expense and $6,000 of insurance expense are nondeductible personal expenses.

129. (c) The requirement is to determine the amount of interest expense deductible as an itemized deduction. The $3,600 of home mortgage interest, and the $900 mortgage prepayment penalty are fully deductible as interest expense in computing itemized deductions. The $1,200 interest on the life insurance policy is not deductible since it is classified as personal interest.

130. (a) The requirement is to determine the amount of interest deductible as an itemized deduction. Since 2/3 of the loan proceeds were used to purchase tax-exempt bonds, 2/3 of the bank interest is nondeductible. The remaining 1/3 of the bank interest ($1,200) is related to the purchase of the Arrow debentures and is classified as investment interest deductible to the extent of net investment income ($0). The $3,000 of home mortgage interest is fully deductible as qualified residence interest. The interest on credit card charges is personal interest and is not deductible.

131. (a) None of the items listed relating to the tax deficiency for 2011 are deductible. The interest on the tax deficiency is considered personal interest and is not deductible. The additional federal income tax, the late filing penalty, and the negligence penalty are also not deductible.

132. (b) The requirement is to determine the amount that Smith should deduct as a charitable contribution. If appreciated property is contributed, the amount of contribution is generally the property’s FMV if a sale of the property would result in a long-term capital gain. Here, the art object worth $3,000 was purchased for $2,000 just four months earlier. Since its holding period did not exceed twelve months, a sale of the art object would result in only a short-term capital gain, and the amount of allowable contribution deduction is limited to its $2,000 cost basis. Additionally, the donation of $5,000 cash to Smith’s church is deductible but no deduction is available for the $1,000 contribution to a needy family. To be deductible, a contribution must be made to a qualifying organization.

133. (c) The requirement is to determine the amount of charitable contributions deductible on Stein’s current year income tax return. The donation of appreciated stock held more than twelve months is a contribution of intangible, long-term capital gain appreciated property. The amount of contribution is the stock’s FMV of $25,000, but is limited in deductibility for the current year to 30% of AGI. Thus, the current year deduction is limited to 30% × $80,000 = $24,000. The remaining $1,000 of contributions can be carried forward for up to five years, subject to the 30% limitation in the carry forward years.

134. (c) The requirement is to determine the maximum amount of properly substantiated charitable contributions that Moore could claim as an itemized deduction for 2013. Moore gave $18,000 to her church during 2013 and had a $10,000 charitable contribution carryover from 2012, resulting in a total of $28,000 of contributions. Since an individual’s deduction for charitable contributions cannot exceed an overall limitation of 50% of adjusted gross income, Moore’s charitable contribution deduction for 2013 is limited to ($50,000 AGI × 50%) = $25,000. Since Moore’s 2013 contributions will be deducted before her carry forward from 2012, Moore will carry over $3,000 of her 2012 contributions to 2014.

135. (c) The requirement is to determine the maximum amount that Spencer can claim as a deduction for charitable contributions in 2013. The cash contribution of $4,000 to church and the $600 fair market value of the used clothing donated to Salvation Army are fully deductible. However, the deduction for the art object is limited to the $400 excess of its cost ($1,200) over its fair market value ($800).

136. (b) The requirement is to determine Lewis’ charitable contribution deduction. The donation of appreciated stock held more than twelve months is a contribution of intangible, long-term capital gain appreciated property. The amount of contribution is the stock’s FMV of $70,000, but is limited in deductibility for 2013 to 30% of AGI. Thus, the 2013 deduction is $100,000 × 30% = $30,000. The amount of contribution in excess of the 30% limitation ($70,000 − $30,000 = $40,000) can be carried forward for up to five years, subject to the 30% limitation in the carry forward years.

137. (b) The requirement is to determine the amount of contributions deductible in 2013. Charitable contributions are generally deductible in the year actually paid. The $500 charge to his bank credit card made on December 15, 2013, is considered a payment, and is deductible for 2013. The $1,000 promissory note delivered on November 1, 2013, is not considered a contribution until payment of the note upon maturity in 2014.

138. (b) The requirement is to determine the amount of student expenses deductible as a charitable contribution. A taxpayer may deduct as a charitable contribution up to $50 per school month of unreimbursed expenses incurred to maintain a student (in the 12th or lower grade) in the taxpayer’s home pursuant to a written agreement with a qualified organization. Since the student started school in September, the amount deductible as a charitable contribution is $50 × 4 = $200.

139. (a) Vincent Tally is not entitled to a deduction for contributions in 2013 because he did not give up his entire interest in the book collection. By reserving the right to use and possess the book collection for his lifetime, Vincent Tally has not made a completed gift. Therefore, no deduction is available. The contribution will be deductible when his entire interest in the books is transferred to the art museum.

140. (b) The requirement is to determine the maximum amount of charitable contribution allowable as an itemized deduction on Jimet’s 2013 income tax return. If appreciated property is contributed, the amount of contribution is generally the property’s FMV if the property would result in a long-term capital gain if sold. If not, the amount of contribution for appreciated property is generally limited to the property’s basis. Here, the stock worth $3,000 was purchased for $1,500 just four months earlier. Since its holding period did not exceed twelve months, a sale of the stock would result in a short-term capital gain, and the amount of allowable contribution deduction is limited to the stock’s basis of $1,500. Additionally, to be deductible, a contribution must be made to a qualifying organization. As a result, the $2,000 cash given directly to a needy family is not deductible.

141. (a) The requirement is to determine the maximum amount of charitable contribution deductible as an itemized deduction on Taylor’s tax return for 2013. The donation of appreciated land purchased for investment and held for more than twelve months is a contribution of real capital gain property (property that would result in long-term capital gain if sold). The amount of contribution is the land’s FMV of $25,000, limited in deductibility for the current year to 30% of AGI. In this case, since 30% of AGI would be 30% × $90,000 = $27,000, the full amount of the land contribution ($25,000) is deductible for 2013.

142. (a) The requirement is to determine the amount of the fire loss to her personal residence that Frazer can claim as an itemized deduction. The amount of a personal casualty loss is computed as the lesser of (1) the adjusted basis of the property ($130,000), or (2) the decline in the property’s fair market value resulting from the casualty ($130,000 − $0 = $130,000); reduced by any insurance recovery ($120,000), and a $100 floor. Since Frazer had no casualty gains during the year, the net casualty loss is then deductible as an itemized deduction to the extent that it exceeds 10% of adjusted gross income.

Fire loss	$ 130,000
Insurance proceeds	(120,000)
$100 floor	(100)
10% of $70,000 AGI	(7,000)
Casualty loss itemized deduction	$2,900

143. (a) The requirement is to determine the amount the Burgs should deduct for the casualty loss (repair of glass vase accidentally broken by their dog) in their itemized deductions. A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Deductible casualty losses may result from earthquakes, tornadoes, floods, fires, vandalism, auto accidents, etc. However, a loss due to the accidental breakage of household articles such as glassware or china under normal conditions is not a casualty loss. Neither is a loss due to damage caused by a family pet.

144. (d) The requirement is to determine the proper treatment of the $490 casualty insurance premium. Casualty insurance premiums on an individual’s personal residence are considered nondeductible personal expenses. Even though a casualty is actually incurred during the year, no deduction is available for personal casualty insurance premiums.

145. (d) The requirement is to determine the amount of the fire loss damage to their personal residence that the Hoyts can deduct as an itemized deduction. The amount of a nonbusiness casualty loss is computed as the lesser of (1) the adjusted basis of the property, or (2) the property’s decline in FMV; reduced by any insurance recovery, and a $100 floor. If an individual has a net casualty loss for the year, it is then deductible as an itemized deduction to the extent that it exceeds 10% of adjusted gross income.

Lesser of:
Adjusted basis	= $50,000
Decline in FMV ($60,000 − $55,000)	= $ 5,000	$ 5,000
Reduce by:
Insurance recovery		(0)
$100 floor		(100)
10% of $34,000 AGI		(3,400)
Casualty loss itemized deduction		$1,500

Note that the $2,500 spent for repairs is not included in the computation of the loss.

146. (b) The requirement is to determine the proper treatment for the $800 appraisal fee that was incurred to determine the amount of the Hoyts’ fire loss. The appraisal fee is considered an expense of determining the Hoyts’ tax liability; it is not a part of the casualty loss itself. Thus, the appraisal fee is deductible as a miscellaneous itemized deduction subject to a 2% of adjusted gross income floor.

147. (d) The requirement is to determine which item is not a miscellaneous itemized deduction. A legal fee for tax advice related to a divorce, IRA trustee’s fees that are separately billed and paid, and an appraisal fee for valuing a charitable contribution qualify as miscellaneous itemized deductions subject to the 2% of AGI floor. On the other hand, the check writing fees for a personal checking account are a personal expense and not deductible.

148. (b) The requirement is to determine the proper treatment of the $2,000 legal fee that was incurred by Hall in a suit to collect the alimony owed her. The $2,000 legal fee is considered an expenditure incurred in the production of income. Expenses incurred in the production of income are deductible as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor.

149. (b) The requirement is to determine the proper reporting of Hall’s lottery transactions. Hall’s lottery winnings of $200 must be reported as other income on page 1 of Hall’s Form 1040. Hall’s $1,000 expenditure for state lottery tickets is deductible as a miscellaneous itemized deduction not subject to the 2% of AGI floor, but is limited in amount to the $200 of lottery winnings included in Hall’s gross income.

150. (d) The requirement is to determine how expenses pertaining to business activities should be deducted by an outside salesman. An outside salesman is an employee who principally solicits business for his employer while away from the employer’s place of business. All unreimbursed business expenses of an outside salesman are deducted as miscellaneous itemized deductions, subject to a 2% of AGI floor. Deductible expenses include business travel, secretarial help, and telephone expenses.

151. (a) The requirement is to determine the amount that can be claimed as miscellaneous itemized deductions. Both the initiation fee and the union dues are fully deductible. The voluntary benefit fund contribution is not deductible. Miscellaneous itemized deductions are generally deductible only to the extent they exceed 2% of AGI. In this case the deductible amount is $80 [$280 − (.02 × $10,000)].

152. (b) The requirement is to compute the amount of miscellaneous itemized deductions. The cost of uniforms not adaptable to general use (specialized work clothes), union dues, unreimbursed auto expenses, and the cost of income tax preparation are all miscellaneous itemized deductions. The preparation of a will is personal in nature, and is not deductible. Thus, the computation of Brodsky’s miscellaneous itemized deductions in excess of the 2% of AGI floor is as follows:

Unreimbursed auto expenses	$ 100
Specialized work clothes	550
Union dues	600
Cost of income tax preparation	150
	$1,400
Less (2% × $25,000)	(500)
Deduction allowed	$900

153. (d) The requirement is to determine which item is not included in determining the total support of a dependent. Support includes food, clothing, FMV of lodging, medical, recreational, educational, and certain capital expenditures made on behalf of a dependent. Excluded from support is life insurance premiums, funeral expenses, nontaxable scholarships, and income and social security taxes paid from a dependent’s own income.

154. (c) The requirement is to determine the number of exemptions that Smith was entitled to claim on his 2013 tax return. Smith will be allowed one exemption for himself and one exemption for his dependent mother. Smith is entitled to an exemption for his mother because he provided over half of her support, and her gross income ($0) was less than $3,900. Note that her $9,000 of social security benefits is excluded from her gross income, and that she did not have to live with Smith because she is related to him. No exemption is available to Smith for his son, Clay, because his son filed a joint return on which there was a tax liability.

155. (b) The requirement is to determine how many exemptions Jim and Kay can claim on their 2013 joint income tax return. Jim and Kay are entitled to one personal exemption each on their joint return. They also are entitled to one exemption for their son, Dale, since he is a qualifying child (i.e., Dale did not provide more than half of his own support, and Dale is a full-time student under age twenty-four). However, no dependency exemptions are available for Kim and Grant. Kim is not a qualifying child because she is at least age 19 and not a full-time student, and she is not a qualifying relative because her gross income was at least $3,900. Similarly, Grant is not a qualifying relative because his gross income was at least $3,900.

156. (d) The requirement is to determine the requirements which must be satisfied in order for Joe to claim an exemption for his spouse on Joe’s separate return for 2013. An exemption can be claimed for Joe’s spouse on Joe’s separate 2013 return only if the spouse had no gross income and was not claimed as another person’s dependent in 2013.

157. (a) The requirement is to determine the amount of personal exemption on a dependent’s tax return. No personal exemption is allowed on an individual’s tax return if the individual can be claimed as a dependency exemption by another taxpayer.

158. (d) The requirement is to determine Robert’s filing status and the number of exemptions that he should claim. Robert’s father does not qualify as Robert’s dependent because his father’s gross income (interest income of $4,700) was not less than $3,900. Social security is not included in the gross income test. Since his father does not qualify as his dependent, Robert does not qualify for head-of-household filing status. Thus, Robert will file as single with one exemption.

159. (a) The requirement is to determine the filing status of the Arnolds. Since they were legally separated under a decree of separate maintenance on the last day of the taxable year and do not qualify for head-of-household status, they must each file as single.

160. (a) Mr. and Mrs. Stoner are entitled to one exemption each. They are entitled to one exemption for their daughter since she is a qualifying child (i.e., she did not provide more than half of her own support, and she is a full-time student under age twenty-four). An exemption can be claimed for their son because he is a qualifying relative (i.e., they provided more than half of his support, and his gross income was less than $3,900). No exemption is allowable for Mrs. Stoner’s father since he was neither a US citizen nor resident of the US, Canada, or Mexico. There is no additional exemption for being age sixty-five or older.

161. (c) The requirement is to determine the number of exemptions the Planters may claim on their joint tax return. There is one exemption for Mr. Planter, and one exemption for his spouse. In addition there is one dependency exemption for their daughter who is a qualifying child (i.e., she did not provide more than half of her own support, and she is a full-time student under age twenty-four). There is also one dependency exemption for their niece who is a qualifying relative (i.e., they provided more than half of her support, and her gross income was less than $3,900). However, there is no additional exemption for being age sixty-five or older.

162. (b) The requirement is to determine which of the relatives can be claimed as a dependent (or dependents) on Sam’s 2013 return. A taxpayer’s own spouse is never a dependent of the taxpayer. Although a personal exemption is generally available for a taxpayer’s spouse on the taxpayer’s return, it is not a “dependency exemption.” Generally, a dependency exemption is available for a qualifying relative if (1) the taxpayer furnishes more than 50% of the dependent’s support, (2) the dependent’s gross income is less than $3,900, (3) the dependent is of specified relationship to the taxpayer or lives in the taxpayer’s household for the entire year, (4) the dependent is a US citizen or resident of the US, Canada, or Mexico, and (5) the dependent does not file a joint return. Here, the support, gross income, US citizen, and joint return tests are met with respect to both Sam’s cousin and his father’s brother (i.e., Sam’s uncle). However, Sam’s cousin is not of specified relationship to Sam as defined in the IRC, and could only be claimed as a dependent if the cousin lived in Sam’s household for the entire year. Since Sam’s cousin did not live in Sam’s household, Sam cannot claim a dependency exemption for his cousin. On the other hand, Sam’s uncle is of specified relationship to Sam as defined in the IRC and can be claimed as a dependency exemption by Sam.

163. (b) The requirement is to determine which relative could be claimed as a dependent. One of the requirements that must be satisfied to claim a dependency exemption for a person as a qualifying relative is that the person must be (1) of specified relationship to the taxpayer, or (2) a member of the taxpayer’s household. Cousins and foster parents are not of specified relationship and only qualify if a member of the taxpayer’s household. Since Alan’s cousin and foster parent do not qualify as members of Alan’s household, only Alan’s niece can be claimed as a dependent.

164. (c) The requirement is to determine who can claim Sara’s dependency exemption under a multiple support agreement. A multiple support agreement can be used if (1) no single taxpayer furnishes more than 50% of a dependent’s support, and (2) two or more persons, each of whom would be able to take the exemption but for the support test, together provide more than 50% of the dependent’s support. Then, any taxpayer who provides more than 10% of the dependent’s support can claim the dependent if (1) the other persons furnishing more than 10% agree not to claim the dependent as an exemption, and (2) the other requirements for a dependency exemption are met. One of the other requirements that must be met is that the dependent be related to the taxpayer or live in the taxpayer’s household. Alma is not eligible for the exemption because Sara is unrelated to Alma and did not live in Alma’s household. Carl is not eligible for the exemption because he provided only 9% of Sara’s support. Ben is eligible to claim the exemption for Sara under a multiple support agreement because Ben is related to Sara and has provided more than 10% of her support.

165. (b) The requirement is to determine the number of exemptions allowable in 2013. Mr. and Mrs. Vonce are entitled to one exemption each. They are also entitled to one exemption for their dependent daughter since they provided over one half of her support and she had less than $3,900 of gross income. An exemption is not available for their son because he provided over one-half of his own support.

166. (d) The requirement is to determine which statements (if any) are among the requirements to enable a taxpayer to be classified as a “qualifying widow(er).” Qualifying widow(er) filing status is available for the two years following the year of a spouse’s death if (1) the surviving spouse was eligible to file a joint return in the year of the spouse’s death, (2) does not remarry before the end of the current year, and (3) the surviving spouse pays over 50% of the cost of maintaining a household that is the principal home for the entire year of the surviving spouse’s dependent child.

167. (c) The requirement is to determine which items are considered in determining whether an individual has contributed more than one half the cost of maintaining the household for purposes of head of household filing status. The cost of maintaining a household includes such costs as rent, mortgage interest, taxes, insurance on the home, repairs, utilities, and food eaten in the home. The cost of maintaining a household does not include the cost of clothing, education, medical treatment, vacations, life insurance, transportation, the rental value of a home an individual owns, or the value of an individual’s services or those of any member of the household.

168. (b) The requirement is to determine the correct statement regarding the filing of a joint tax return. A husband and wife can file a joint return even if they have different accounting methods. Answer (a) is incorrect because spouses must have the same tax year to file a joint return. Answer (c) is incorrect because if either spouse was a nonresident alien at any time during the tax year, both spouses must elect to be taxed as US citizens or residents for the entire tax year. Answer (d) is incorrect because taxpayers cannot file a joint return if divorced before the end of the year.

169. (c) The requirement is to determine Emil Gow’s filing status for 2013. Emil should file as a “Qualifying widower with dependent child” (i.e., surviving spouse) which will entitle him to use the joint return tax rates. This filing status is available for the two taxable years following the year of a spouse’s death if (1) the surviving spouse was eligible to file a joint return in the year of the spouse’s death, (2) does not remarry before the end of the current tax year, and (3) the surviving spouse pays over 50% of the cost of maintaining a household that is the principal home for the entire year of the surviving spouse’s dependent child.

170. (c) The requirement is to determine Nell’s filing status for 2013. Nell qualifies as a head of household because she is unmarried and maintains a household for her infant child. Answer (a) is incorrect because although Nell is single, head of household filing status provides for lower tax rates. Answer (b) is incorrect because Nell is unmarried at the end of 2013. Since Nell’s spouse died in 2010, answer (d) is incorrect because the filing status of a “qualifying widow” is only available for the two years following the year of the spouse’s death.

171. (a) Mrs. Felton must file as a single taxpayer. Even though she is unmarried, Mrs. Felton does not qualify as a head of household because her son is neither a qualifying child (because of his age) nor a qualifying relative (because he is not her dependent). Answer (b) is incorrect because in order for Mrs. Felton to qualify, her son must qualify as a dependent, which he does not. Although Mrs. Felton would have qualified as married filing jointly, answer (d), in 2012 (the year of her husband’s death), the problem requirement is her 2013 filing status.

172. (c) The requirement is to determine the 2013 income tax for Poole, an unmarried taxpayer in the 15% bracket with $20,000 of adjusted gross income. To determine Poole’s taxable income, his adjusted gross income must be reduced by the greater of his itemized deductions or a standard deduction, and a personal exemption. Since Poole’s medical expenses of $7,500 are subject to a 10% of AGI limitation, his itemized deductions of $5,500 are less than his available standard deduction of $6,100. Poole’s tax computation is as follows:

Adjusted gross income		$20,000
Less:
Standard deduction	$6,100
Personal exemption	3,900	10,000
Taxable income		$10,000
Tax rate		× 15%
Income tax		1,500

173. (d) The requirement is to determine the itemized deduction that is deductible when computing an individual’s alternative minimum tax (AMT). For purposes of computing an individual’s AMT, no deduction is allowed for personal, state, and local income taxes, and miscellaneous itemized deductions subject to the 2% of adjusted gross income threshold. Similarly, no deduction is allowed for home mortgage interest if the loan proceeds were not used to buy, build, or substantially improve the home.

174. (a) The requirement is to determine the amount of tax preferences and adjustments that must be included in the computation of Randy’s 2013 alternative minimum tax. Tax preferences include the $1,000 of tax-exempt interest on private activity bonds. It must be added to regular taxable income in arriving at alternative minimum taxable income (AMTI). The adjustments include the $3,900 personal exemption and $1,500 of state income taxes that are deductible in computing regular taxable income but are not deductible in computing AMTI. Note that tax-exempt interest on private activity bonds issued in 2009 and 2010 is not an item of tax preference.

175. (d) The requirement is to determine the amount of Karen’s unused alternative minimum tax credit that will carry over to 2014. The amount of alternative minimum tax paid by an individual that is attributable to timing preferences and adjustments is allowed as a tax credit (i.e., mini-mum tax credit) that can be applied against regular tax liability in future years. The minimum tax credit is computed as the excess of the AMT actually paid over the AMT that would have been paid if AMTI included only exclusion preferences and adjustments (e.g., disallowed itemized deductions, excess percentage depletion, tax-exempt private activity bond interest). Since the minimum tax credit can only be used to reduce future regular tax liability, the credit can only reduce regular tax liability to the point at which it equals the taxpayer’s tentative minimum tax. In this case, Karen’s payment of $20,000 of alternative minimum tax in 2012 generates a minimum tax credit of $20,000 − $9,000 = $11,000 which is carried forward to 2013. Since Karen’s 2013 regular tax liability of $50,000 exceeded her tentative minimum tax of $45,000, $5,000 of Karen’s minimum tax credit would be used to reduce her 2013 tax liability to $45,000. Therefore, $11,000 − $5,000 = $6,000 of unused minimum tax credit would carry over to 2014.

176. (c) The requirement is to determine the amount that Mills should report as alternative minimum taxable income (AMTI) before the AMT exemption. Certain itemized deductions, although allowed for regular tax purposes, are not deductible in computing an individual’s AMTI. As a result, no AMT deduction is allowed for state, local, and foreign income taxes, real and personal property taxes, and miscellaneous itemized deductions subject to the 2% of AGI floor. Also, no deduction is allowed for qualified residence interest if the mortgage proceeds were not used to buy, build, or substantially improve the taxpayer’s principal residence or a second home. Additionally, no AMT deduction is allowed for personal exemptions and the standard deduction.

Here, Mills’ $5,000 of state and local income taxes and $2,000 of miscellaneous itemized deductions that were deducted for regular tax purposes must be added back to his $70,000 of regular taxable income before personal exemption to arrive at Mills’ AMTI before AMT exemption of ($70,000 + $5,000 + $2,000)= $77,000. Note that no adjustment was necessary for the mortgage interest because the mortgage loan was used to acquire his residence.

177. (c) The requirement is to determine whether a net capital gain and home equity interest expense are adjustments for purposes of computing the alternative minimum tax. Although an excess of net long-term capital gain over net short-term capital loss may be subject to a reduced maximum tax rate, the excess is neither a tax preference nor an adjustment in computing the alternative minimum tax. On the other hand, home equity interest expense where the home equity loan proceeds were not used to buy, build, or improve the home is an adjustment because the interest expense, although deductible for regular tax purposes, is not deductible for purposes of computing an individual’s alternative minimum tax.

178. (d) The requirement is to determine the proper treatment for the credit for prior year alternative minimum tax (AMT). The amount of AMT paid by an individual taxpayer that is attributable to timing differences can be carried forward indefinitely as a minimum tax credit to offset the individual’s future regular tax liability (not future AMT liability). The amount of AMT credit to be carried forward is the excess of the AMT actually paid over the AMT that would have been paid if AMTI included only exclusion preferences (e.g., disallowed itemized deductions, preferences for excess percentage depletion, and tax-exempt private activity bond interest).

179. (b) The requirement is to determine the correct statement regarding the computation of the alternative minimum tax (AMT). A taxpayer is subject to the AMT only if the taxpayer’s tentative AMT exceeds the taxpayer’s regular tax. Thus, the alternative minimum tax is computed as the excess of the tentative AMT over the regular tax.

180. (b) The requirement is to determine the amount of net earnings from self-employment that would be multiplied by the self-employment tax rate to compute Diamond’s self-employment tax for 2013. Since self-employment earnings generally represent earnings derived from a trade or business carried on as a sole proprietor, the $10,000 of interest income from personal investments would be excluded from the computation. On the other hand, a self-employed taxpayer is allowed a deemed deduction equal to 7.65% of self-employment earnings in computing the amount of net earnings upon which the tax is based. The purpose of this deemed deduction is to reflect the fact that employees do not pay FICA tax on the corresponding 7.65% FICA tax paid by their employers.

Gross receipts from business	$150,000
Cost of goods sold	(80,000)
Operating expenses	(40,000)
Operating expenses	(40,000)
Self-employment earnings	$ 30,000
Less deemed deduction (100% − 7.65%)	× 92.35%
Net earnings to be multiplied by self-employment tax rate	$27,705

181. (c) The requirement is to determine the amount of Freeman’s income that is subject to self-employment tax. The self-employment tax is imposed on self-employment income to provide Social Security and Medicare benefits for self-employed individuals. Self-employment income includes an individual’s net earnings from a trade or business carried on as sole proprietor or as an independent contractor. The term also includes a partner’s distributive share of partnership ordinary income or loss from trade or business activities, as well as guaranteed payments received by a partner for services rendered to a partnership. Self-employment income excludes gains and losses from the disposition of property used in a trade or business, as well as a shareholder’s share of ordinary income from an S corporation.

182. (a) The requirement is to determine the amount of Rich’s net self-employment income. Income from self-employment generally includes all items of business income less business deductions. Excluded from the computation would be estimated income taxes on self-employment income, charitable contributions, investment income, and gains and losses on the disposition of property used in a trade or business. An individual’s charitable contributions can only be deducted as an itemized deduction. Rich’s net self-employment income would be

Business receipts	$20,000
Air conditioning parts	(2,500)
Yellow Pages listing	(2,000)
Business telephone calls	(400)
Business telephone calls	$15,100

183. (c) The requirement is to determine the correct statement regarding the self-employment tax. The self-employment tax is imposed at a rate of 15.3% on individuals who work for themselves (e.g., sole proprietor, independent contractor, partner). Generally, one-half of an individual’s self-employment tax is deductible from gross income in arriving at adjusted gross income.

184. (c) The requirement is to determine the correct statement with regard to social security tax (FICA) withheld in an amount greater than the maximum for a particular year. If an individual works for more than one employer, and combined wages exceed the maximum used for FICA purposes, too much FICA tax will be withheld. In such case, since the excess results from correct withholding by two or more employers, the excess should be claimed as a credit against income tax. Answer (a) is incorrect because the excess cannot be used as an itemized deduction. Answer (b) is incorrect because if employers withhold correctly, no reimbursement can be obtained from the employers. Answer (d) is incorrect because if the excess FICA tax withheld results from incorrect withholding by any one employer, the employer must reimburse the excess and it cannot be claimed as a credit against tax.

185. (b) The requirement is to determine Berger’s gross income from self-employment for the current year. Self-employment income represents the net earnings of an individual from a trade or business carried on as a proprietor or partner, or from rendering services as an independent contractor. The director’s fee is self-employment income since it is related to a trade or business, and Berger is not an employee. Fees received by a fiduciary (e.g., executor) are generally not related to a trade or business and not self-employment income. However, executor’s fees may constitute self-employment income if the executor is a professional fiduciary or carries on a trade or business in the administration of an estate.

186. (d) The requirement is to determine Smith’s gross income from self-employment. Self-employment income represents the net earnings of an individual from a trade or business carried on as a sole proprietor or partner, or from rendering services as an independent contractor (i.e., not an employee). The $8,000 consulting fee and the $2,000 of director’s fees are self-employment income because they are related to a trade or business and Smith is not an employee.

187. (c) The requirement is to determine which credit is not a component of the general business credit. The general business credit is a combination of several credits that provide uniform rules for current and carryback-carryover years. The general business credit is composed of the investment credit, work opportunity credit, alcohol fuels credit, research credit, low-income housing credit, enhanced oil recovery credit, disabled access credit, renewable electricity production credit, empowerment zone employment credit, Indian employment credit, employer social security credit, orphan drug credit, the new markets credit, the small employer pension plan start-up costs credit, and the employer-provided child care facilities credit. A general business credit in excess of the limitation amount is carried back one year and forward twenty years to offset tax liability in those years.

188. (a) The requirement is to determine which tax credit is a combination of credits to provide for uniform rules for the current and carryback-carryover years. The general business credit is composed of the investment credit, work opportunity credit, welfare-to-work credit, alcohol fuels credit, research credit, low-income housing credit, enhanced oil recovery credit, disabled access credit, renewable electricity production credit, empowerment zone employment credit, Indian employment credit, employer social security credit, orphan drug credit, the new markets credit, the small employer pension plan start-up costs credit, and the employer-provided child care facilities credit. A general business credit in excess of the limitation amount is carried back one year and forward twenty years to offset tax liability in those years.

189. (a) The requirement is to determine the amount that can be claimed as a credit for the elderly. The amount of credit (limited to tax liability) is 15% of an initial amount reduced by social security and 50% of AGI in excess of $10,000. Here, the credit is the lesser of (1) the taxpayers’ tax liability of $61, or (2) 15% [$7,500 − $3,000 − (.50)($22,200 − $10,000)] = $0.

190. (c) The requirement is to compute Nora’s child care credit for 2013. Since she has two dependent preschool children, all $6,000 paid for child care qualifies for the credit. The credit is 35% of qualified expenses, but is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI over $15,000 down to a minimum of 20%. Since Nora’s AGI is $44,000, her credit is 20% × $6,000 = $1,200.

191. (b) The requirement is to determine the amount of the child care credit allowable to the Jasons. The credit is from 20% to 35% of certain dependent care expenses limited to the lesser of (1) $3,000 for one qualifying individual, $6,000 for two or more; (2) taxpayer’s earned income, or spouse’s if smaller; or (3) actual expenses. The $2,500 paid to the Union Day Care Center qualifies, as does the $1,000 paid to Wilma Jason. Payments to relatives qualify if the relative is not a dependent of the taxpayer. Since Robert and Mary Jason only claimed three exemptions, Wilma was not their dependent. The $500 paid to Acme Home Cleaning Service does not qualify since it is completely unrelated to the care of their child. To qualify, expenses must be at least partly for the care of a qualifying individual. Since qualifying expenses exceed $3,000, the Jasons’ credit is 20% × $3,000 = $600.

192. (b) The requirement is to determine the qualifications for the child care credit that at least one spouse must satisfy on a joint return. The child care credit is a percentage of the amount paid for qualifying household and dependent care expenses incurred to enable an individual to be gainfully employed or look for work. To qualify for the child care credit on a joint return, at least one spouse must be gainfully employed or be looking for work when the related expenses are incurred. Note that it is not required that at least one spouse be gainfully employed, but only needs to be looking for work when the expenses are incurred. Additionally, at least one spouse must have earned income during the year. However, there is no limit as to the maximum amount of earned income or adjusted gross income reported on the joint return.

193. (a) The requirement is to determine which factor(s) may affect the amount of Sunex’s foreign tax credit available in its current year corporate income tax return. Since US taxpayers are subject to US income tax on their worldwide income, they are allowed a credit for the income taxes paid to foreign countries. The applicable foreign tax rate will affect the amount of foreign taxes paid, and thereby affect the amount available as a foreign tax credit. Additionally, since the amount of credit that can be currently used cannot exceed the amount of US tax attributable to the foreign-source income, the income source will affect the amount of available foreign tax credit for the current year if the limitation based on the amount of US tax is applicable.

194. (b) The requirement is to determine the amount of foreign tax credit that Wald Corp. may claim for 2013. Since US taxpayers are subject to US income tax on their worldwide income, they are allowed a credit for the income taxes paid to foreign countries. However, the amount of credit that can be currently used cannot exceed the amount of US tax that is attributable to the foreign income. This foreign tax credit limitation can be expressed as follows:

One limitation must be computed for foreign source passive income (e.g., interest, dividends, royalties, rents, annuities), with a separate limitation computed for all other foreign source taxable income.

In this case, the foreign income taxes paid on other foreign source taxable income of $27,000 is fully usable as a credit in 2013 because it is less than the applicable limitation amount (i.e., the amount of US tax attributable to the income).

On the other hand, the credit for the $12,000 of foreign income taxes paid on non-business-related interest is limited to the amount of US tax attributable to the foreign interest income, $9,600.

Thus, Wald Corp.’s foreign tax credit for 2013 totals $27,000 + $9,600 = $36,600. The $12,000 − $9,600 = $2,400 of unused foreign tax credit resulting from the application of the limitation on foreign taxes attributable to foreign source interest income can be carried back one year and forward ten years to offset US income tax in those years.

195. (a) The requirement is to determine the correct statement regarding a corporation’s foreign income taxes. Foreign income taxes paid by a corporation may be claimed either as a credit or as a deduction, at the option of the corporation.

196. (c) The requirement is to determine the credit that can result in a refund even if an individual had no income tax liability. The earned income credit is a refundable credit and can result in a refund even if the individual had no tax withheld from wages.

197. (a) The requirement is to choose the correct statement regarding Kent’s earned income credit. The earned income credit could result in a refund even if Kent had no tax withheld from wages. Since the credit is refundable, answer (c) is incorrect because there will never be any unused credit to carry back or forward. Answer (d) is incorrect because the credit is a direct subtraction from the computed tax.

198. (c) The requirement is to determine the correct statement regarding the earned income credit. The earned income credit is a refundable credit and can result in a refund even if the individual had no tax withheld from wages. To qualify, an individual must have earned income, but the amount of earned income does not have to equal adjusted gross income. For purposes of the credit, earned income excludes workers’ compensation benefits. Additionally, the credit is available only if the tax return covers a full twelve-month period.

199. (b) The requirement is to determine the tax credit that cannot be claimed by a corporation. The foreign tax credit, alternative fuel production credit, and general business credit may be claimed by a corporation. The earned income credit cannot be claimed by a corporation; it is available only to individuals.

200. (a) The requirement is to determine the correct statement regarding the credit for adoption expenses. The adoption expenses credit is a nonrefundable credit for up to $12,970 (for 2013) of expenses (including special needs children) incurred to adopt an eligible child. An eligible child is one who is under eighteen years of age at time of adoption, or physically or mentally incapable of self-care. Generally, adoption expenses incurred or paid during a tax year prior to the year in which the adoption is finalized may be claimed as a credit in the tax year following the year the expense was incurred. Adoption expenses incurred during the year the adoption becomes final or in the year following the finalization of the adoption are claimed in the year they were incurred.

201. (c) The requirement is to determine the incorrect statement concerning the child tax credit. Individual taxpayers are permitted to take a tax credit based solely on the number of their dependent children under age seventeen. The amount of the credit is $1,000 per qualifying child, but is subject to reduction if adjusted gross income exceeds certain income levels. A qualifying child must be a US citizen or resident.

202. (c) The requirement is to determine the incorrect statement concerning the 2013 American Opportunity credit. The American Opportunity credit provides for a maximum credit of $2,500 per year (100% of the first $2,000, plus 25% of the next $2,000 of tuition, fees, and course materials) for the first four years of postsecondary education. The credit is available on a per student basis and covers tuition paid for the taxpayer, spouse, and dependents. To be eligible, the student must be enrolled on at least a half-time basis for one academic period during the year. If a parent claims a child as a dependent, only the parent can claim the credit and any qualified expenses paid by the child are deemed paid by the parent.

203. (d) The requirement is to determine the incorrect statement concerning the lifetime learning credit. The lifetime learning credit provides a credit of 20% of up to $10,000 of tuition and fees paid by a taxpayer for one or more students for graduate and undergraduate courses at an eligible educational institution. The credit may be claimed for an unlimited number of years, is available on a per taxpayer basis, and covers tuition paid for the taxpayer, spouse, and dependents.

204. (a) The requirement is to determine which statement(s) describe how Baker may avoid the penalty for the underpayment of estimated tax for the 2014 tax year. An individual whose regular and alternative minimum tax liability is not sufficiently covered by withholding from wages must pay estimated tax in quarterly installments or be subject to penalty. Individuals will incur no underpayment penalty for 2014 if the amount of tax withheld plus estimated payments are at least equal to the lesser of (1) 90% of the current year’s tax; (2) 100% of the prior year’s tax; or (3) 90% of the tax determined by annualizing current year taxable income through each quarter. However, note that high-income individuals (i.e., individuals whose adjusted gross income for the preceding year exceeds $150,000) must use 110% (instead of 100%) if they wish to base their estimated tax payments on their prior year’s tax liability.

205. (a) The requirement is to determine what amount would be subject to penalty for the underpayment of estimated taxes. A taxpayer will be subject to an underpayment of estimated tax penalty if the taxpayer did not pay enough tax either through withholding or by estimated tax payments. For 2012, there will be no penalty if the total tax shown on the return less the amount paid through withholding (including excess social security tax withholding) is less than $1,000. Additionally, individuals will incur no penalty if the amount of tax withheld plus estimated payments are at least equal to the lesser of (1) 90% of the current year’s tax (determined on the basis of actual income or annualized income), or (2) 100% of the prior year’s tax. In this case, since the tax shown on Krete’s return ($16,500) less the tax paid through withholding ($16,000) was less than $1,000, there will be no penalty for the underpayment of estimated taxes.

206. (d) The requirement is to determine the original due date for a decedent’s federal income tax return. The final return of a decedent is due on the same date the decedent’s return would have been due had death not occurred. An individual’s federal income tax return is due on the 15th day of the fourth calendar month following the close of the tax year (e.g., April 15 for a calendar-year taxpayer).

207. (a) The requirement is to determine Birch’s filing requirement. A self-employed individual must file an income tax return if net earnings from self-employment are $400 or more.

208. (c) The requirement is to determine the date on which the statute of limitations begins for Jackson Corp.’s 2012 tax return. Generally, any tax that is imposed must be assessed within three years of the filing of the return, or if later, the due date of the return. Since Jackson Corp.’s 2012 return was filed on March 8, 2013, and the return was due on March 15, 2013, the statute of limitations expires on March 15, 2016. This means that the statute of limitations begins on March 16, 2013.

209. (c) The requirement is to determine the latest date that the IRS can assert a notice of deficiency for a 2012 calendar-year return if the taxpayer neither committed fraud nor omitted amounts in excess of 25% of gross income. The normal period for assessment is the later of three years after a return is filed, or three years after the due date of the return. Since the 2012 calendar-year return was filed on March 20, 2013, and was due on April 15, 2013, the IRS must assert a deficiency no later than April 15, 2016.

210. (d) A six-year statute of limitations applies if gross income omitted from the return exceeds 25% of the gross income reported on the return. For this purpose, gross income of a business includes total gross receipts before subtracting cost of goods sold and deductions. Thus, a six-year statute of limitations will apply to Thompson if he omitted from gross income an amount in excess of ($400,000 + $36,000) × 25% = $109,000.

211. (d) The requirement is to determine the maximum period during which the IRS can issue a notice of deficiency if the gross income omitted from a taxpayer’s return exceeds 25% of the gross income reported on the return. A six-year statute of limitations applies if gross income omitted from the return exceeds 25% of the gross income reported on the return. Additionally, a tax return filed before its due date is treated as filed on its due date. Thus, if a return is filed before its due date, and the gross income omitted from the return exceeds 25% of the gross income reported on the return, the IRS has six years from the due date of the return to issue a notice of deficiency.

212. (c) The requirement is to determine the form that must be filed by an individual to claim a refund of erroneously paid income taxes. Form 1040X, Amended US Individual Income Tax Return, should be used to claim a refund of erroneously paid income taxes. Form 843 should be used to file a refund claim for taxes other than income taxes. Form 1139 may be used by a corporation to file for a tentative adjustment or refund of taxes when an overpayment of taxes for a prior year results from the carryback of a current year’s net operating loss or net capital loss. Form 1045 may be used by taxpayers other than corporations to apply for similar adjustments.

213. (a) The requirement is to determine the date by which a refund claim must be filed if an individual paid income tax during 2013 but did not file a tax return. An individual must file a claim for refund within three years from the date a return was filed, or two years from the date of payment of tax, whichever is later. If no return was filed, the claim for refund must be filed within two years from the date that the tax was paid.

214. (c) The requirement is to determine the date by which a taxpayer must file an amended return to claim a refund of tax paid on a calendar-year 2012 return. A taxpayer must file an amended return to claim a refund within three years from the date a return was filed, or two years from the date of payment of tax, whichever is later. If a return is filed before its due date, it is treated as filed on its due date. Thus, the taxpayer’s 2012 calendar-year return that was filed on March 15, 2013, is treated as filed on April 15, 2013. Therefore, an amended return to claim a refund must be filed not later than April 15, 2016.

215. (d) The requirement is to determine the date by which a refund claim due to worthless security must be filed. The normal three-year statute of limitations is extended to seven years for refund claims resulting from bad debts or worthless securities. Since the securities became worthless during 2012, and Baker’s 2012 return was filed on April 15, 2013, Baker’s refund claim must be filed no later than April 15, 2020.

216. (b) The requirement is to determine the amount on which the penalties for late filing and late payment would be computed. The late filing and late payment penalties are based on the amount of net tax due. If a taxpayer’s tax return indicated a tax liability of $50,000, and $45,000 of taxes were withheld, the late filing and late payment penalties would be based on the $5,000 of tax that is owed.

217. (c) An accuracy-related penalty equal to 20% of the underpayment of tax may be imposed if the underpayment of tax is attributable to one or more of the following: (1) negligence or disregard of the tax rules and regulations; (2) any substantial understatement of income tax; (3) any substantial valuation overstatement; (4) any substantial overstatement of pension liabilities; or (5) any substantial gift or estate tax valuation understatement. The penalty for gift or estate tax valuation understatement may apply if the value of property on a gift or estate tax return is 50% or less of the amount determined to be correct. The penalty for a substantial income tax valuation overstatement may apply if the value (or adjusted basis) of property is 200% or more of the amount determined to be correct.

Simulations

Task-Based Simulation 1

Cole, a newly licensed CPA, opened an office in 2013 as a sole practitioner engaged in the practice of public accountancy. Cole reports on the cash basis for income tax purposes.

Listed below are Cole’s 2013 business and nonbusiness transactions, as well as possible tax treatments. For each of Cole’s transactions (Items 1 through 20), select the appropriate tax treatment. A tax treatment may be selected once, more than once, or not at all.

Tax treatments

Task-Based Simulation 2

Mr. Cole is considering purchasing a new principal residence for $1,500,000, and intends to finance the purchase with a mortgage in the amount of $1,150,000. Which code section, subsection, and paragraph provide the maximum amount of mortgage indebtedness on which the interest expense will be deductible? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 3

Green is self-employed as a human resources consultant and reports on the cash basis for income tax purposes. Green is an unmarried custodial parent with one dependent child.

Listed below are Green’s 2013 business and nonbusiness transactions, as well as possible tax treatments. For each of Green’s transactions (Items 1 through 25), select the appropriate tax treatment. A tax treatment may be selected once, more than once, or not at all.

Tax treatments

Task-Based Simulation 4

For 2013, Green, who had adjusted gross income of $40,000, qualified to itemize deductions and was subject to federal income tax liability. For items 1 through 9, select from the following list of tax treatments the appropriate tax treatment. A tax treatment may be selected once, more than once, or not at all.

Selections

Task-Based Simulation 5

Mr. Green paid $5,000 to an unrelated babysitter for the care of his child while he worked. Which code section and subsection provide the maximum amount of employment-related child care expenses that qualify for a tax credit? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 6

Mark Smith is an employee of Patton Corporation. Additionally, Smith operates a consulting business as a sole proprietor and owns an apartment building. Smith made the expenditures listed below during 2013.

For each of the following items, indicate whether each expenditure is deductible for AGI, from AGI (not subject to 2% limitation), from AGI (subject to 2% limitation), or not deductible. Assume Smith plans to itemize deductions for 2013.

Task-Based Simulation 7

In January of 2013, Mark Smith had to have heart surgery. The total cost of the surgery was $100,000, and his insurance covered a total of $82,000. Smith paid the remaining $18,000 in February of 2013. Which code section and subsection determine the extent to which Smith’s unreimbursed medical expenses will be deductible? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 8

Situation

Frank and Dale Cumack are married and filing a joint 2013 income tax return. During 2013, Frank, age sixty-three, was retired from government service and Dale, fifty-five, was employed as a university instructor. In 2013, the Cumacks contributed all of the support to Dale’s father, Jacques, an unmarried French citizen and French resident who had no gross income.

For items 1 through 10, select the correct amount of income, loss, or adjustment to income that should be reported on page 1 of the Cumacks’ 2013 Form 1040—Individual Income Tax Return to arrive at the adjusted gross income for each separate transaction. A tax treatment may be selected once, more than once, or not at all.

Any information contained in an item is unique to that item and is not to be incorporated in your calculations when answering other items.

Task-Based Simulation 9

Frank and Dale Cumack are married and filing a joint 2013 income tax return. During 2013, Frank, age sixty-three, was retired from government service and Dale, fifty-five, was employed as a university instructor. In 2013, the Cumacks contributed all of the support to Dale’s father, Jacques, an unmarried French citizen and French resident who had no gross income.

Determine whether the Cumacks overstated, understated, or correctly determined the number of both personal and dependency exemptions.

Selections

O. Overstated the number of both personal and dependency exemptions.

U. Understated the number of both personal and dependency exemptions.

C. Correctly determined the number of both personal and dependency exemptions.

Task-Based Simulation 10

Assume that the Cumacks’ automobile was stolen during 2013. The automobile was uninsured for theft and had a fair market value of $7,000, and an adjusted basis of $10,000. Which code section and subsection provide the limitations that apply to the deductibility of the Cumacks’ uninsured theft loss? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 11

Situation

Mrs. Vick, a forty-year-old cash-basis taxpayer, earned $45,000 as a teacher and $5,000 as a part-time real estate agent in 2012. Mr. Vick, who died on July 1, 2012, had been permanently disabled on his job and collected state disability benefits until his death. For all of 2012 and 2013, the Vicks’ residence was the principal home of both their eleven-year-old daughter Joan and Mrs. Vick’s unmarried cousin, Fran Phillips, who had no income in either year. During 2012 Joan received $200 a month in survivor social security benefits that began on August 1, 2012, and will continue at least until her eighteenth birthday. In 2012 and 2013, Mrs. Vick provided over one-half the support for Joan and Fran, both of whom were US citizens. Mrs. Vick did not remarry. Mr. and Mrs. Vick received the following in 2012:

Earned income	$50,000
State disability benefits	1,500
Interest on:
Refund from amended tax return	50
Savings account and certificates of deposit	350
Municipal bonds	100
Gift	3000
Pension benefits	900
Jury duty pay	200
Gambling winnings	450
Life insurance proceeds	5,000

Additional information:

• Mrs. Vick received the $3,000 cash gift from her uncle.
• Mrs. Vick received the pension distributions from a qualified pension plan, paid for exclusively by her husband’s employer.
• Mrs. Vick had $100 in gambling losses in 2012.
• Mrs. Vick was the beneficiary of the life insurance policy on her husband’s life. She received a lump-sum distribution. The Vicks had paid $500 in premiums.
• Mrs. Vick received Mr. Vick’s accrued vacation pay of $500 in 2013.

Foritems 1 and 2, determine and select from the choices below, BOTH the filing status and the number of exemptions for each item.

	Filing Status	Exemptions
S.	Single	1
M.	Married filing joint	2
H.	Head of household	3
Q.	Qualifying widow with dependent child	4

For items 3 through 9, determine the amount, if any, that is taxable and should be included in Adjusted Gross Income (AGI) on the 2012 federal income tax return filed by Mrs. Vick.

3. State disability benefits

4. Interest income

5. Pension benefits

6. Gift

7. Life insurance proceeds

8. Jury duty pay

9. Gambling winnings

Task-Based Simulation 12

During 2012 the following payments were made or losses were incurred. For items 1 through 14, select the appropriate tax treatment. A tax treatment may be selected once, more than once, or not at all.

Tax treatment

Task-Based Simulation 13

Mrs. Vick is considering making contributions to a qualified tuition program to provide savings for her daughter’s college education. However, Mrs. Vick is concerned that the contributions will be considered a gift of a future interest and result in a taxable gift. Which code section and subsection provide the gift tax treatment for contributions to a qualified tuition program? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 14

Tom and Joan Moore, both CPAs filed a joint 2013 federal income tax return showing $70,000 in taxable income. During 2013, Tom’s daughter Laura, age 16, resided with Tom’s former spouse. Laura had no income of her own and was not Tom’s dependent. For items 1 through 10, determine the amount of income or loss, if any, that should be included on page one of the Moore’s 2013 Form 1040.

Task-Based Simulation 15

Tom and Joan Moore are married filing a joint return. During 2013, the following events took place. For items 1 through 12, select the appropriate tax treatment. A tax treatment may be selected once, more than once, or not at all.

Tax treatment

Task-Based Simulation 16

Adjustments must be made to regular taxable income in order to compute an individual’s alternative minimum taxable income (AMTI). Which code section and subsection provide the adjustments that only apply to individuals when computing the alternative minimum tax? Indicate the reference to that citation in the shaded boxes below.

Task-Based Simulation 17

Situation

Fred (social security number 123-67-5489) and Laura Shaw provided you with the following tax return data. The amount from Form 1040, line 38 is $80,000.

Medical and dental expenses
Medical insurance premiums	$3,600
Disability income insurance premiums	800
Prescription drugs	825
Nonprescription medicine	280
Dr. Jones—neurologist	280
Dr. Jones—neurologist	2,250
Dentist	750
Dr. Smith—LASIK surgery	900
Insurance reimbursement for medical bills	2,000
Transportation to and from doctors	80
Taxes
Balance of state income taxes due for 2011 paid on April 15, 2012	$ 225
State income taxes withheld for 2012	975
Real estate taxes on principal residence	7,000
Real estate taxes on summer residence	3,000
County personal property tax	410
Registration fee for automobiles	160
Interest
Mortgage interest on principal residence	$5,500
Mortgage interest on summer residence	2,200
Interest paid on automobile loan	800
Interest paid on personal use credit cards	500
Contributions
Cash donated to church	$2,500
Stock donated to church. (The Shaws purchased it for $3,000 18 months ago)	4,000
Miscellaneous payments
Legal fee for preparation of a will	$ 350
Rent for safety-deposit box containing stocks and bonds	120
Union dues	600
Subscriptions to investment publications	300
Life insurance premiums	2,800
Transportation to and from work	2,400
Fee paid for tax return preparation	2,400
Transportation to and from work	400
Unreimbursed business travel away from home overnight	900
Contribution to a national political party	200
Repairs to principal residence	2,000

Complete the following 2012 Form 1040 Schedule A-Itemized Deductions for Fred and Laura Shaw.

Task-Based Simulation 18

The Shaws are considering donating a painting to a state university for display in the university’s library. The Shaws acquired the painting six months ago for $90,000 and believe that the painting is now worth $105,000. Which code section and subsection determine the amount of charitable contribution to which the Shaws will be entitled if they donate the painting at the present time? Indicate the reference to that citation in the shaded boxes below.

Simulation Solutions

Task-Based Simulation 1

Explanations

1. (B) Fees received for jury duty represent compensation for services and must be included in gross income. Since there is no separate line for jury duty fees, they are taxable as other income on page 1 of Form 1040.

2. (A) Interest income on a mortgage loan receivable must be included in gross income and is taxable as interest income in Schedule B—Interest and Dividend Income.

3. (D) An interest forfeiture penalty for making an early withdrawal from a certificate of deposit is deductible on page 1 of Form 1040 to arrive at adjusted gross income.

4. (P) The problem indicates that Cole is a CPA reporting on the cash basis. Accounts receivable resulting from services rendered by a cash-basis taxpayer have a zero tax basis, because the income has not yet been reported. Therefore, the write-offs of zero basis uncollectible accounts receivable from Cole’s accounting practice are not deductible.

5. (P) An educational expense that is part of a program of study that can qualify an individual for a new trade or business is not deductible. This is true even if the individual is not seeking a new job. In this case, the cost of attending a review course in preparation for the CPA examination is a nondeductible personal expense since it qualifies Cole for a new profession.

6. (I) Licensing and regulatory fees paid to state or local governments are an ordinary and necessary trade or business expense and are deductible by a sole proprietor on Schedule C—Profit or Loss from Business. Since Cole is a cash method tax payor, he can deduct the fee for the biennial permit to practice when paid in 2013.

7. (I) All trade or business expenses of a self-employed individual are deductible on Schedule C—Profit or Loss from Business. Education must meet certain requirements before the related expenses can be deducted. Generally, deductible education expenses must not be a part of a program that will qualify the individual for a new trade or business and must (1) be required by an employer or by law to keep the individual’s present position, or (2) maintain or improve skills required in the individual’s present work. In this case, Cole already is a CPA and is fulfilling state CPE requirements, so his education costs of attending CPE courses are deductible in Schedule C—Profit or Loss from Business.

8. (D) Contributions to a self-employed individual’s qualified Keogh retirement plan are deductible on page 1 of Form 1040 to arrive at adjusted gross income. The maximum deduction for contributions to a defined contribution Keogh retirement plan is limited to the lesser of $51,000 (for 2013), or 25% of self-employment income.

9. (J) A loss sustained from a nonbusiness bad debt is always classified as a short-term capital loss. Therefore, Cole’s nonbusiness bad debt is deductible in Schedule D—Capital Gains or Losses.

10. (L) A loss sustained on the sale of Sec. 1244 stock is generally deductible as an ordinary loss, with the amount of ordinary loss deduction limited to $50,000. On a joint return, the limit is increased to $100,000, even if the stock was owned by only one spouse. The ordinary loss resulting from the sale of Sec. 1244 stock is deductible in Form 4797—Sales of Business Property. To the extent that a loss on Sec. 1244 stock exceeds the applicable $50,000 or $100,000 limit, the loss is deductible as a capital loss in Schedule D—Capital Gains or Losses. Similarly, if Sec. 1244 stock is sold at a gain, the gain would be reported as a capital gain in Schedule D if the stock is a capital asset.

11. (K) Rental income and expenses related to rental property are generally reported in Schedule E. Here, the taxes paid on land owned by Cole and rented out as a parking lot are deductible in Schedule E—Supplemental Income and Loss. Schedule E also is used to report the income or loss from royalties, partnerships, S corporations, estates, and trusts.

12. (P) The interest paid on installment purchases of household furniture is considered personal interest and is not deductible. Personal interest is any interest that is not qualified residence interest, investment interest, passive activity interest, or business interest. Personal interest generally includes interest on car loans, interest on income tax, underpayments, installment plan interest, credit card finance charges, and late payment charges by a utility.

13. (D) Alimony paid to a former spouse who reports the alimony as taxable income is deductible on page 1 of Form 1040 to arrive at adjusted gross income.

14. (E) Personal medical expenses are generally deductible as an itemized deduction subject to a 10% (7.5% prior to 2013) of AGI threshold for the year in which they are paid. Additionally, an individual can deduct medical expenses charged to a credit card in the year the charge is made. It makes no difference when the amount charged is actually paid. Here, Cole’s personal medical expenses charged on a credit card in December 2013 but not paid until January 2014 are deductible for 2013 in Schedule A—Itemized Deductions, subject to a threshold of 10% of adjusted gross income.

15. (F) If an individual sustains a personal casualty loss, it is deductible in Schedule A—Itemized Deductions subject to a threshold of $100 and an additional threshold of 10% of adjusted gross income.

16. (P) State inheritance taxes paid on a bequest that was received are not deductible. Other taxes not deductible in computing an individual’s federal income tax include federal estate and gift taxes, federal income taxes, and social security and other employment taxes paid by an employee.

17. (M) An individual can deduct foreign income taxes as an itemized deduction or can deduct foreign income taxes as a tax credit. Cole’s foreign income tax withheld at source on foreign dividends received can be claimed in Form 1116—Foreign Tax Credit, or in Schedule A—Itemized Deductions, at Cole’s option.

18. (O) A self-employed individual is subject to a self-employment tax if the individual’s net earnings from self-employment are at least $400.

19. (D) An individual’s self-employment tax is computed in Schedule SE and is added as an additional tax in arriving at the individual’s total tax. A portion of the computed self-employment tax is allowed as a deduction in arriving at adjusted gross income. Here, one-half of Cole’s self-employment tax for 2013 is deductible for 2013 on page 1 of Form 1040 to arrive at adjusted gross income, even though the tax was not paid until the return was filed in April 2014.

20. (P) Insurance premiums paid on Cole’s life are classified as a personal expense and are not deductible.

Task-Based Simulation 2

Internal Revenue Code Section 163, subsection (h), paragraph (3) provides that interest is deductible on up to $1,000,000 of acquisition indebtedness, and also is deductible on up to $100,000 of home equity indebtedness.

Task-Based Simulation 3

Explanations

1. (C) All trade or business income and deductions of a self-employed individual are reported on Schedule C—Profit or Loss from Business. Retainer fees received from clients is reported in Schedule C as trade or business income.

2. (D) Income derived from royalties is reported in Schedule E—Supplemental Income and Loss. Schedule E also is used to report the income or loss from rental real estate, partnerships, S corporations, estates, and trusts.

3. (E) Interest from general obligation state and local government bonds is tax-exempt and is excluded from gross income.

4. (B) The interest income on a refund of federal income taxes must be included in gross income and is reported in Schedule B—Interest and Dividend Income. The actual refund of federal income taxes itself is excluded from gross income.

5. (E) Life insurance proceeds paid by reason of death are generally excluded from gross income. Here, the death benefits received by Green from a term life insurance policy on the life of Green’s parent are not taxable.

6. (B) Interest income from US Treasury bonds and treasury bills must be included in gross income and is reported in Schedule B—Interest and Dividend Income.

7. (D) A partner’s share of a partnership’s ordinary income that is reported to the partner on Form 1065, Schedule K-1 must be included in the partner’s gross income and is reported in Schedule E—Supplemental Income and Loss.

8. (D) The taxable income from the rental of a townhouse owned by Green must be included in gross income and is reported in Schedule E—Supplemental Income and Loss.

9. (A) A prize won as a contestant on a TV quiz show must be included in gross income. Since there is no separate line on Form 1040 for prizes, they are taxable as other income on Form 1040.

10. (A) Fees received for jury duty represent compensation for services and must be included in gross income. Since there is no separate line for jury duty fees, they are taxable as other income on Form 1040.

11. (E) An investor in a mutual fund may receive several different kinds of distributions including ordinary dividends, capital gain distributions, tax-exempt interest dividends, and return of capital distributions. A mutual fund may pay tax-exempt interest dividends to its shareholders if it meets certain requirements. These dividends are paid from the tax-exempt state and local obligation interest earned by the fund and retain their tax-exempt character when reported by the shareholder. Thus, Green’s dividends received from mutual funds that invest in tax-free government obligations are not taxable.

12. (H) Qualifying medical expenses not reimbursed by insurance are deductible in Schedule A as an itemized deduction to the extent in excess of 10% of adjusted gross income.

13. (O) Personal life insurance premiums paid on Green’s life are classified as a personal expense and not deductible.

14. (M) All trade or business expenses of a self-employed individual are deductible on Schedule C—Profit or Loss from Business. However, only 50% of the cost of business meals and entertainment is deductible. Therefore, Green’s expenses for business-related meals where clients were present are partially deductible in Schedule C.

15. (K) The deduction for depreciation on listed property (e.g., automobiles, computers, and property used for entertainment etc.) is computed on Form 4562—Depreciation and Amortization. Since Green’s personal computer was used in his business as a self-employed consultant, the amount of depreciation computed on Form 4562 is then deductible in Schedule C—Profit or Loss from Business.

16. (L) Lodging expenses while out of town on business are an ordinary and necessary business expense and are fully deductible by a self-employed individual in Schedule C—Profit or Loss from Business.

17. (L) The cost of subscriptions to professional journals used for business are an ordinary and necessary business expense and are fully deductible by a self-employed individual in Schedule C—Profit or Loss from Business.

18. (G) An individual’s self-employment tax is computed in Schedule SE and is added as an additional tax in arriving at the individual’s total tax liability. A portion of the computed self-employment tax is then allowed as a deduction on Form 1040 in arriving at adjusted gross income.

19. (F) Qualifying contributions to a self-employed individual’s simplified employee pension plan are deductible on page 1 of Form 1040 to arrive at adjusted gross income.

20. (K) For 2013, Sec. 179 permits a taxpayer to elect to treat up to $500,000 of the cost of qualifying depreciable personal business property as an expense rather than as a capital expenditure. In this case, Green’s election to expense business equipment would be computed on Form 4562—Depreciation and Amortization, and then would be deductible in Schedule C—Profit or Loss from Business.

21. (F) Qualifying alimony payments made by Green to a former spouse are fully deductible on Form 1040 to arrive at adjusted gross income.

22. (I) The costs of subscriptions for investment publications are not related to Green’s trade or business, but instead are considered expenses incurred in the production of portfolio income and are reported as miscellaneous itemized deductions in Schedule A—Itemized Deductions. These investment expenses are deductible to the extent that the aggregate of expenses in this category exceed 2% of adjusted gross income.

23. (L) The nature of interest expense is determined by using a tracing approach (i.e., the nature depends upon how the loan proceeds were used). Since the interest expense on Green’s home-equity line of credit was for a loan to finance Green’s business, the best answer is to treat the interest as a business expense fully deductible in Schedule C—Profit or Loss from Business.

24. (M) The interest expense on a loan for an auto used by a self-employed individual in a trade or business is deductible as a business expense. Since Green’s auto was used 75% for business, only 75% of the interest expense is deductible in Schedule C—Profit or Loss from Business. The remaining 25% is considered personal interest expense and is not deductible.

25. (O) The loss resulting from the sale of Green’s personal residence is not deductible because the property was held for personal use. Only losses due to casualty or theft are deductible for personal use property.

Task-Based Simulation 4

Explanations

1. (B) Interest expense on home equity indebtedness is deductible on up to $100,000 of home equity loans secured by a first or second residence regardless of how the loan proceeds were used.

2. (C) Contributions in excess of applicable percentage limitations can be carried forward for up to five tax years. Here, the $30,000 of charitable contribution carryover from 2012 is deductible as an itemized deduction for 2013 subject to a limitation of 50% of AGI.

3. (B) Investment interest expense is deductible as an itemized deduction to the extent of net investment income. Since Green’s investment interest expense did not exceed his net investment income, it is deductible in full.

4. (A) Gambling losses (including lottery ticket losses) are deductible as an itemized deduction to the extent of the gambling winnings included in gross income. Since Green had no gambling winnings, the losses are not deductible.

5. (B) State, local, or foreign real estate taxes imposed on the taxpayer for property held for personal use are fully deductible as an itemized deduction.

6. (A) A premium for a homeowner’s insurance policy on a principal residence is a nondeductible personal expense.

7. (G) Payments to an unrelated babysitter to care for his child while Green worked would qualify for the child and depen-dent care credit. For 2013, the credit may vary from 20% to 35% of up to $3,000 ($6,000 for two or more qualifying individuals) of qualifying household and dependent care expenses incurred to enable the taxpayer to be gainfully employed or look for work.

8. (B) Interest expense on acquisition indebtedness is deductible on up to $1 million of loans secured by the residence if such loans were used to acquire, construct, or substantially improve a principal residence or a second residence.

9. (F) Expenses incurred in the production of rental income (e.g., interest, taxes, depreciation, insurance, utilities) are deductible on Schedule E and are included in the computation of net rental income or loss.

Task-Based Simulation 5

Internal Revenue Code Section 21, subsection (c) provides that the maximum amount of employment-related expenses that qualify for a credit is limited to $3,000 for one qualifying individual.

Task-Based Simulation 6

Explanations

1. (B) Deductible medical expenses include amounts paid for the diagnosis, cure, relief, treatment or prevention of disease of the taxpayer, spouse, and dependents. The term dependent includes any person who qualifies as a dependency exemption, or would otherwise qualify as a dependency exemption except that the gross income and joint return tests are not met. Therefore, the medical expenses of Smith’s mother-in-law are properly deductible from Smith’s AGI and are not subject to the 2% limitation.

2. (A) Expenses attributable to property held for the production of rents or royalties are properly deductible “above the line.” “Above the line” deductions are subtracted from gross income to determine adjusted gross income. Therefore, expenses incurred from a passive activity such as Smith’s rental apartment building are deductible for AGI.

3. (B) For 2013, an individual may elect to deduct state and local general sales taxes in lieu of state and local income taxes. The amount that can be deducted is either the total of actual general sales taxes paid as substantiated by receipts, or an amount from IRS-provided tables, plus the amount of general sales taxes paid with regard to the purchase of a motor vehicle, boat, and specified other items.

4. (D) Real estate (real property) taxes are deductible only if imposed on property owned by the taxpayer. Since Smith’s mother-in-law is the legal owner of the house, Smith cannot deduct his payment of those real estate taxes.

5. (D) No deduction is allowed for personal interest.

6. (D) Personal legal expenses are not a deductible expense. Only legal counsel obtained for advice concerning tax matters or incurred in the production of income are deductible. Therefore, Smith cannot deduct the $500 incurred to prepare his will.

7. (C) Unreimbursed employee expenses including business meals and entertainment (subject to the 50% rule) are deductible to the extent they exceed 2% of AGI. Therefore, $375 ($750 × 50%) is deductible from AGI, subject to the 2% floor.

8. (A) An individual is allowed to deduct a portion of the self-employment tax paid for the taxable year in the computation of AGI. Normally, 50% of the self-employment tax paid is deductible for AGI.

9. (A) Contributions by self-employed individuals to a qualified retirement plan (Keogh Plan) are a deduction for AGI.

10. (B) Gambling losses to the extent of gambling winnings are categorized as miscellaneous deductions not subject to the 2% floor. Therefore, the $2,500 of Smith’s gambling losses would be deductible in full since he properly included his $5,000 winnings in his gross income for 2013.

Task-Based Simulation 7

Internal Revenue Code Section 213, subsection (a) provides that the unreimbursed medical expenses of a taxpayer, spouse, and dependents are deductible to the extent in excess of 10% of adjusted gross income.

Task-Based Simulation 8

Explanations

1. ($0) Amounts received as a gift are fully excluded from gross income.

2. ($3,500) The maximum deduction for contributions to a traditional IRA by an individual at least age 50 is the lesser of $6,500, or 100% of compensation for 2013. Since the Cumacks were not active participants in an employer’s qualified pension or annuity plan, there is no phaseout of the deduction based on AGI.

3. ($0) Since federal income taxes are not deductible in computing a taxpayer’s federal income tax liability, a refund of federal income taxes is excluded from gross income.

4. ($4,000) Guaranteed payments are partnership payments to partners for services rendered or for the use of capital without regard to partnership income. A guaranteed payment is deductible by the partnership, and the receipt of a guaranteed payment must be included in the partner’s gross income, and is reported as self-employment income in the computation of the partner’s self-employment tax.

5. ($0) The proceeds of life insurance policies paid by reason of death of the insured are generally excluded from the beneficiary’s gross income.

6. ($2,000) An employer’s payment of the cost of the first $50,000 of coverage for group-term life insurance can be excluded from an employee’s gross income. Since Dale’s employer provided group-term insurance of $450,000, and the cost of coverage was $5 per $1,000 of coverage, $5 × 400 = $2,000, must be included in Dale’s gross income.

7. ($5,000) Gambling winnings must be included in gross income. Gambling losses cannot be offset against gambling winnings, but instead are deducted from AGI as a miscellaneous itemized deduction limited in amount to the gambling winnings included in gross income.

8. ($1,000) Although a federal income tax refund can be excluded from gross income, interest on the refund must be included in gross income.

9. ($0) Up to $250,000 of gain can be excluded from gross income if an individual owned and occupied a residence as a principal residence for an aggregate of at least two of the five years preceding sale. The excludable gain is increased to $500,000 for married individuals filing jointly if either spouse meets the ownership requirement, and both spouses meet the use requirement.

10. ($0) Stock dividends are generally excluded from gross income because a shareholder’s relative interest in earnings and assets is unaffected.

Task-Based Simulation 9

Explanation

(O) To qualify as a dependency exemption, a dependent must be a US citizen or resident of the US, Canada, or Mexico. Since Dale’s father, Jacques, is both a French citizen and French resident, he does not qualify as a dependency exemption even though the Cumacks provided all of his support.

Task-Based Simulation 10

Internal Revenue Code Section 165, subsection (h) provides that an individual’s personal casualty loss is allowable to the extent that it exceeds $100 and that a net personal casualty loss is deductible to the extent that it exceeds 10% of adjusted gross income.

Task-Based Simulation 11

For items 1 and 2, candidates were asked to determine the filing status and number of exemptions for Mrs. Vick.

1. (M, 4) Since Mr. Vick died during the year, Mrs. Vick is considered married for the entire year for filing status purposes. There would be four exemptions on the Vicks’ joint return—one each for Mr. and Mrs. Vick, one for their 11-year-old daughter Joan, and one for Mrs. Vick’s unmarried cousin Fran Phillips. Although Fran is treated as unrelated to the Vicks for dependency exemption purposes, Fran qualifies as a dependency exemption because the Vicks’ residence was Fran’s principal home for 2012.

2. (Q, 3) Mrs. Vick will file as a “qualifying widow with dependent child” which will entitle her to use the joint return rates for 2013. This filing status is available for the two years following the year of the spouse’s death if (1) the surviving spouse was eligible to file a joint return in the year of the spouse’s death, (2) does not remarry before the end of the taxable year, and (3) the surviving spouse pays over 50% of the cost of maintaining a household that is the principal home for the entire year of the surviving spouse’s dependent child. There will be three exemptions on the return—one for Mrs. Vick, a dependency exemption for her daughter Joan, and a dependency exemption for her cousin Fran.

For items 3 through 9, candidates were asked to determine the amount that is taxable and should be included in Adjusted Gross Income (AGI) on the 2012 federal income tax return filed by Mrs. Vick.

3. ($0) State disability benefits are excluded from gross income.

4. ($400) The $50 interest on the tax refund and $350 interest from a savings account and certificates of deposit are taxable; the $100 interest on municipal bonds is excluded from gross income.

5. ($900) The pension benefits are fully taxable because they were paid for exclusively by Mr. Vick’s employer.

6. ($0) Property received as a gift is always excluded from gross income.

7. ($0) The proceeds of life insurance paid because of Mr. Vick’s death are excluded from gross income, without regard to the amount of premiums paid.

8. ($200) Jury duty pay represents compensation for services and must be included in gross income.

9. ($450) The $450 of gambling winnings must be included in gross income. Mrs. Vick’s $100 of gambling losses are deductible only from AGI as a miscellaneous itemized deduction.

Task-Based Simulation 12

For items 1 through 14, candidates were asked to select the appropriate tax treatment for the payments made or losses incurred by Mrs. Vick for 2012.

Explanations

1. (A) Life insurance premiums are considered a personal expense and are not deductible.

2. (D) An interest forfeiture penalty for making an early withdrawal from a certificate of deposit is deductible on page 1 of Form 1040 to arrive at adjusted gross income.

3. (F) Charitable contributions are generally deductible as an itemized deduction up to a maximum of 50% of AGI.

4. (E) Estimated state income tax payments are deductible in full as an itemized deduction on Schedule A.

5. (E) Real estate taxes on a principal residence are deductible in full as an itemized deduction on Schedule A.

6. (A) A family car is a personal use asset and a loss from its sale is not deductible. The only type of loss that can be deducted on a personal use asset is a casualty or theft loss.

7. (B) A capital expenditure made for medical reasons that improves a residence is deductible as a medical expense to the extent that the expenditure exceeds the increase in value of the residence. As a medical expense, the excess expenditure is deductible as an itemized deduction on Schedule A subject to a 7.5% of AGI threshold.

8. (B) Health insurance premiums qualify as a medical expense and are deductible as an itemized deduction on Schedule A subject to a 7.5% of AGI threshold.

9. (C) Tax return preparation fees are deductible as an itemized deduction on Schedule A subject to a 2% of AGI threshold.

10. (E) Points paid to refinance a mortgage are deductible as interest expense over the term of the loan. Interest expense on a personal residence is deductible as an itemized deduction on Schedule A.

11. (D) Normally, one-half of a self-employed taxpayer’s self-employment tax is deductible on page 1 of Form 1040 to arrive at AGI.

12. (E) Gambling losses are deductible as a miscellaneous itemized deduction on Schedule A to the extent that the taxpayer’s gambling winnings are included in gross income. Since Mrs. Vick reported $450 of gambling winnings, her $100 of gambling losses are deductible.

13. (C) Unreimbursed employee expenses (including union dues) are generally deductible as miscellaneous itemized deductions on Schedule A subject to a 2% of AGI threshold.

14. (A) A payment of federal income tax is not deductible in computing a taxpayer’s taxable income.

Task-Based Simulation 13

Internal Revenue Code Section 529, subsection (c) provides that any contribution to a qualified tuition program on behalf of a beneficiary shall be treated as a completed gift and not a gift of a future interest in property.

Task-Based Simulation 14

1. ($3,000) The Moores have a net capital loss of $6,000, of which $3,000 can be currently deducted, with the remaining $3,000 carried forward as a STCL.

2. ($0) Joan received the land as a gift, and her basis for gain is the land’s adjusted basis of $60,000, while her basis for loss is the land’s $50,000 fair market value on date of gift. Joan recognizes no gain or loss on the sale because she sold the land for $56,000 and the use of her basis for gain ($60,000) does not result in a gain, and the use of her basis for loss ($50,000) does not result in a loss.

3. ($0) The security deposit is not treated as rent and only will be included in gross income when not returned to the tenant.

4. ($55,000) Tom’s compensation consists of the wages of $53,000 plus the $2,000 value of group-term life insurance coverage in excess of $50,000.

5. ($1,250) Since the Moores’ itemized deductions exceeded their available standard deduction by $1,450, all $1,250 of the state income tax refund must be included in gross income for 2013 because its deduction in 2012 reduced the Moores’ federal income tax.

6. ($1,300) Unemployment compensation is generally taxable.

7. ($2,500) The net rental income is computed on Schedule E and reported on page 1 of Form 1040.

8. ($900) Although generally nontaxable, a stock dividend will be taxable if any shareholder can elect to receive the distribution in either stock or in property. The amount of dividend is equal to the stock’s $900 fair market value on date of distribution.

9. ($3,500) The $5,000 employee death benefit exclusion was repealed for decedents dying after August 20, 1996.

10. ($5,000) The accrued interest on redeemed Series EE US savings bonds can be excluded from gross income to the extent that the aggregate redemption proceeds (principal plus interest) are used to finance the higher education expenses (tuition and fees) of the taxpayer, taxpayer’s spouse, or dependents. Here, there is no interest exclusion available for Tom because the proceeds were used to pay for Laura’s tuition, and Laura does not qualify as Tom’s dependent.

Task-Based Simulation 15

Explanations

1. (A) No loss is deductible if stock is sold at a loss and within thirty days before or after the sale, substantially identical stock in the same corporation is purchased. Here, the loss on the March 23 sale of 50 shares of Zip stock cannot be recognized because Tom repurchased fifty shares of Zip stock on April 15. The $1,200 loss not recognized is added to the basis of the newly acquired stock.

2. (B) Personal property taxes based on value are fully deductible as an itemized deduction.

3. (D) The fair market value of used clothing donated to a qualified charitable organization is deductible as an itemized deduction subject to a 50% of AGI limitation.

4. (A) Premiums on insurance against the loss of earnings in the event of disability are a nondeductible personal expense.

5. (F) Since Tom is a CPA working as an employee, the unreimbursed cost of subscriptions to accounting journals is deductible as an itemized deduction subject to a threshold of 2% of AGI.

6. (B) Interest on home-equity indebtedness of up to $100,000 is fully deductible as an itemized deduction regardless of how the proceeds of the loan were used.

7. (C) The unreimbursed cost of prescriptions qualify as a medical expense deductible as an itemized deduction subject to a threshold of 10% of AGI.

8. (A) Funeral expenses are a nondeductible personal expense.

9. (E) A theft loss on personal use property is deductible as an itemized deduction subject to a $100 floor and a threshold of 10% of AGI.

10. (A) A loss resulting from the sale of personal use property is not deductible.

11. (B) Interest on acquisition indebtedness of up to $1 million is fully deductible as an itemized deduction if the mortgage is secured by the taxpayer’s principal or second residence.

12. (A) No charitable deduction is allowable for the value of a taxpayer’s services performed for a charitable organization.

Task-Based Simulation 16

Internal Revenue Code Section 56, subsection (b) provides the adjustments to regular taxable income that are applicable only to individuals when computing the alternative minimum tax.

Task-Based Simulation 17

(See Schedule A on the next page)

Medical and Dental Expenses

The disability income insurance premiums do not represent medical insurance and are not deductible. Similarly, although prescription drugs are deductible, nonprescription medicine is not deductible.

Taxes

The automobile registration fee is not deductible.

Interest

Only home mortgage interest and investment interest expense can be deducted as an itemized deduction. The interest on the automobile loan and the credit card interest are considered personal interest and are not deductible.

Contributions

The stock was appreciated and held for more than one year so it qualifies as capital gain property. As a result, the amount of contribution is the stock’s fair market value of $4,000.

Miscellaneous

The legal fee for preparation of a will and life insurance premiums are nondeductible personal expenses. Similarly, no deduction is available for transportation to and from work (commuting), political contributions, and repairs to a principal residence.

Task-Based Simulation 18

Internal Revenue Code Section 170, subsection (e) provides that the amount of the Shaws’ charitable contribution will be limited to the painting’s cost of $90,000, since the painting would not result in long-term capital gain if sold (i.e., it has not been held for more than 12 months).