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Question 1:
Parker, whose spouse died during the preceding year, has not remarried. Parker maintains a home for a dependent child. What is Parker\’s most advantageous filing status?
A. Single.
B. Head of household.
C. Married filing separately.
D. Qualifying widow(er) with dependent child.
Correct Answer: D
Choice “d” is correct. A qualifying widow (er) is a taxpayer who may use the joint tax return standard deduction and rates (but not the exemption for the deceased spouse) for each of two taxable years following the year of death of his or her spouse, unless he or she remarries. The surviving spouse must maintain a household that, for the whole entire taxable year, was the principal place of abode of a son, stepson, daughter, or stepdaughter (whether by blood or adoption). The surviving spouse must also be entitled to a dependency exemption for such individual. Parker may file as a qualifying widow (er) since her spouse died in the previous tax year, she did not remarry and she maintained a home for a dependent child. Since, qualifying widow (er) is the most advantageous status and Parker qualifies, Parker would file as a qualifying widow (er). Choice “a” is incorrect. Even though Parker would qualify as single, filing single would give Parker a high tax liability than the qualifying widow (er) status and therefore is not most advantageous. Choice “b” is incorrect. Parker would not qualify as head of household for the first two years after the death of Parker\’s spouse because one of the requirements for Head of Household status is that the taxpayer is NOT a surviving spouse. (Also, note that the likely reason for this requirement is that filing as Head of Household status would give the qualifying surviving spouse taxpayer a higher tax liability than the Qualifying Widow(er) status, which would be less advantageous.) Choice “c” is incorrect. Parker would not qualify to file married filing separately.
Question 2:
In which of the following situations may taxpayers file as married filing jointly?
A. Taxpayers who were married but lived apart during the year.
B. Taxpayers who were married but lived under a legal separation agreement at the end of the year.
C. Taxpayers who were divorced during the year.
D. Taxpayers who were legally separated but lived together for the entire year.
Correct Answer: A
RULE: In order to file a joint return, the parties must be MARRIED at the end of the year. Exception: If the parties are married but are LEGALLY SEPARATED under the laws of the state in which they reside, they cannot file a joint return (they
will file either under the single or head of household filing status).
Choice “a” is correct. Per the above rule, taxpayers who are married but lived apart during the year are allowed to file a joint return for the year. The fact that they did not live together during the year has no bearing on the issue. Choice “b” is
incorrect. Per the above rule, taxpayers who are married but lived under a legal separation agreement at the end of the year may not file a joint return. They will generally file either under the single or head of household filing status.
Choice “c” is incorrect. Per the above rule, taxpayers who were divorced during the year may not file a joint return together, as they are not married at the end of the year. [Note, however, that they may become married again in the year and
file a joint return with the new spouse.]
Choice “d” is incorrect. Per the above rule, taxpayers who were legally separated but lived together for the entire year may not file a joint return. They will generally file either under the single or head of household filing status.
Question 3:
In evaluating the hierarchy of authority in tax law, which of the following carries the greatest authoritative value for tax planning of transactions?
A. Internal Revenue Code.
B. IRS regulations.
C. Tax court decisions.
D. IRS agents\’ reports.
Correct Answer: A
Note: This question is addressed in your Appendix D text materials. We are confident that our students would be able to respond correctly over 85% of the time without any guidance on this topic. The answer is rather obvious. Just by looking
at the answer options, you will immediately notice that Option A is presented in title case. This would be a quick sign that it may be the correct response. Further, we suspect that most students would narrow the options down to “a” or “b” by
simply using common sense.
While we are confident that our students would fare well on this question if it appeared on their exams, we present the following detailed of the answer options.
Choice “a” is correct. According to the IRS\’s website under Tax Code, Regulations and Official Guidance, the “federal tax law begins with the Internal Revenue Code (IRC), [which was] enacted by Congress in Title 26 of the United States
Code (26 U.S.C.).” The IRC holds the most authoritative value.
Choice “b” is incorrect. According to the IRS\’s website under Tax Code, Regulations and Official Guidance, the IRS regulations or “Treasury regulations (26 C.F.R.)-commonly referred to as Federal tax regulations-pick up where the Internal
Revenue Code (IRC) leaves off by providing the official interpretation of the IRS by the U.S. Department of Treasury.” Regulations give directions on how to apply the law outlined in the Internal Revenue Code. Regulations have the second
most force and effect, second only to the IRC.
Choice “c” is incorrect. Tax court decisions interpret the Internal Revenue Code. They do not have the authority of the IRC.
Choice “d” is incorrect. The reports of IRS agents are used to report on specific taxpayer situations. IRS agents\’ reports apply the Internal Revenue Code, IRS regulations, and other forms of authoritative literature, but they do not hold the
value that the IRC, the IRS regulations, or even tax court decisions have.
Question 4:
Adams owns a second residence that is used for both personal and rental purposes. During 2001,
Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct?
A. Depreciation may not be deducted on the property under any circumstances.
B. A rental loss may be deducted if rental-related expenses exceed rental income.
C. Utilities and maintenance on the property must be divided between personal and rental use.
D. All mortgage interest and taxes on the property will be deducted to determine the property\’s net income or loss.
Correct Answer: C
Choice “c” is correct. Because the second property was personally used more than 14 days, any net loss from the rental of the property will be disallowed.
All related expenses must be prorated between the personal use portion and the rental activity portion.
Prorated depreciation is permitted for the rental activity.
Question 5:
Baum, an unmarried optometrist and sole proprietor of Optics, buys and maintains a supply of eyeglasses and frames to sell in the ordinary course of business. In 1999, Optics had $350,000 in gross business receipts and its year-end
inventory was not subject to the uniform capitalization rules. Baum\’s 1999 adjusted gross income was $90,000 and Baum qualified to itemize deductions. During 1999, Baum recorded the following information:
Business expenses:
What amount should Baum report as 1999 net earnings from self-employment?
A. $243,250
B. $252,000
C. $273,000
D. $281,750
Correct Answer: D
Choice “d” is correct. Baum should report $281,750 as 1999 net earnings from self-employment (line 12 of the Form 1040), calculated as follows:
Choices “a”, “b”, and “c” are incorrect. Self-employment tax and self-employment health insurance expenses are adjustments from total gross income. They are not deducted from self-employment earnings (i.e., not reported net on line 12 of
the Form 1040).
Note: There are many distracters in this question, all relating to items that are either deductible as part of itemized deductions or not deductible. Be careful to read the requirement of the question before spending unnecessary time on the
Question 6:
On December 1, 1997, Krest, a self-employed cash basis taxpayer, borrowed $200,000 to use in her business. The loan was to be repaid on November 30, 1998. Krest paid the entire interest amount of $24,000 on December 1, 1997. What amount of interest was deductible on Krest\’s 1997 income tax return?
A. $0
B. $2,000
C. $22,000
D. $24,000
Correct Answer: B
Choice “b” is correct. Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on December 1, 1997, only the interest relating to
December 1997 can be deducted in 1997. The question does not give an interest rate, but because the loan is to be repaid in a lump sum at maturity, 1/12 of the interest, or $2,000 applies to each month.
Choice “a” is incorrect. Because $2,000 of the interest relates to 1997, this amount is deductible in 1997.
Choice “c” is incorrect. This is the amount that cannot be deducted until 1998, the year to which the interest relates. Be sure to read questions like this very carefully, because if you had simply misread the question as seeking the amount
deductible in 1998, you would get the question wrong despite understanding the rule.
Choice “d” is incorrect. Cash basis taxpayers can deduct interest in the year paid or the year to which the interest relates, whichever is later, thus 11 months of the interest will not be deductible until 1998.
Question 7:
Which payment(s) is(are) included in a recipient\’s gross income?
I. Payment to a graduate assistant for a part-time teaching assignment at a university. Teaching is not a requirement toward obtaining the degree.
II.
A grant to a Ph.D. candidate for his participation in a university-sponsored research project for the benefit of the university.
A.
I only.
B.
II only.
C.
Both I and II.
D.
Neither I nor II.
Correct Answer: C
Choice “c” is correct.
I. A payment to a student for a part-time teaching assignment is taxable income just as a payment for any other campus job would be. This is not a scholarship or fellowship. II. There is no exclusion in the tax law for amounts paid to a degree candidate for participation in university-sponsored research.
Question 8:
In a tax year where the taxpayer pays qualified education expenses, interest income on the redemption of qualified U.S. Series EE Bonds may be excluded from gross income. The exclusion is subject to a modified gross income limitation and a limit of aggregate bond proceeds in excess of qualified higher education expenses. Which of the following is (are) true?
I. The exclusion applies for education expenses incurred by the taxpayer, the taxpayer\’s spouse, or any person whom the taxpayer may claim as a dependent for the year.
II.
“Otherwise qualified higher education expenses” must be reduced by qualified scholarships not includible in gross income.
A.
I only.
B.
II only.
C.
Both I and II.
D.
Neither I nor II.
Correct Answer: C
Choice “c” is correct. Interest earned on Series EE bonds issued after 1989 may qualify for exclusion. One requirement is that the interest is used to pay tuition and fees for the taxpayer, spouse, or dependent enrolled in higher education. The interest exclusion is reduced by qualified scholarships that are exempt from tax and other nontaxable payments received for educational expenses (other than gifts and inheritances).
Question 9:
During 1993 Kay received interest income as follows:
On U.S. Treasury certificates $4,000 On refund of 1991 federal income tax 500
The total amount of interest subject to tax in Kay\’s 1993 tax return is:
A. $4,500
B. $4,000
C. $500
D. $0
Correct Answer: A
Choice “a” is correct. Interest income from U.S. obligations is generally taxable. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed.
Choice “b” is incorrect. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed.
Choice “c” is incorrect. Interest income from U.S. obligations is generally taxable.
Choice “d” is incorrect. Interest income from U.S. obligations is generally taxable. Interest income on a federal tax refund is taxable, even though the refund itself is not taxed.
Question 10:
Freeman, a single individual, reported the following income in the current year:
Guaranteed payment from services rendered to a partnership $50,000 Ordinary income from a S corporation $20,000
What amount of Freeman\’s income is subject to self-employment tax?
A. $0
B. $20,000
C. $50,000
D. $70,000
Correct Answer: C
Choice “c” is correct. Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to selfemployment tax. Payments not guaranteed are merely another way to distribute partnership profits. The ordinary income reported from an S corporation are taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).
Question 11:
During 2001, Adler had the following cash receipts:
What is the total amount that must be included in gross income on Adler\’s 2001 income tax return?
A. $18,000
B. $18,400
C. $19,500
D. $19,900
Correct Answer: C
Choice “c” is correct. The wages of $18,000 and unemployment compensation are both includable in gross income on Adler\’s 2001 income tax return.
Choice “a” is incorrect. The unemployment compensation must be included in gross income.
Choice “b” is incorrect. Municipal bond interest income is excluded from gross income and the unemployment compensation must be included in gross income.
Choice “d” is incorrect. Municipal bond interest income is excluded from gross income.
Question 12:
DAC Foundation awarded Kent $75,000 in recognition of lifelong literary achievement. Kent was not required to render future services as a condition to receive the $75,000. What condition(s) must have been met for the award to be excluded from Kent\’s gross income?
I. Kent was selected for the award by DAC without any action on Kent\’s part.
II.
Pursuant to Kent\’s designation, DAC paid the amount of the award either to a governmental unit or to a charitable organization.
A.
I only.
B.
II only.
C.
Both I and II.
D.
Neither I nor II.
Correct Answer: C
Choice “c” is correct. Generally, the fair market value of prizes and awards is taxable income. However, an exclusion from income for certain prizes and awards applies where the winner is selected for the award without entering into a contest
(i.e., without any action on their part) and then assigns the award directly to a governmental unit or charitable organization. Therefore, conditions “I” and “II” must be met in order for Ken to exclude the award from his gross income.
Choice “a” is incorrect. “II” is a necessary condition as well. See above.
Choice “b” is incorrect. “I” is a necessary condition as well. See above.
Choice “d” is incorrect. “I” and “II” are both necessary conditions. See above.
Question 13:
Mosh, a sole proprietor, uses the cash basis of accounting. At the beginning of the current year, accounts receivable were $25,000. During the year, Mosh collected $100,000 from customers. At the end of the year, accounts receivable were $15,000. What was Mosh\’s gross taxable income for the current year?
A. $75,000
B. $90,000
C. $100,000
D. $110,000
Correct Answer: C
Choice “c” is correct. The facts state that cash collections from customers were $100,000 and as a cash basis taxpayer this is the amount of Mosh\’s gross taxable income for the year. Note that according to the formula BASE – we can determine the amount of sales = $90,000, but that would give us accrual, not cash basis, income.
Choice “a” is incorrect. See above.
Choice “b” is incorrect. $90,000 is the amount of sales that would be Mosh\’s taxable income if Mosh were an accrual basis taxpayer.
Choice “d” is incorrect. See above.
Question 14:
Porter was unemployed for part of the year. Porter received $35,000 of wages, $4,000 from a state unemployment compensation plan, and $2,000 from his former employer\’s company-paid supplemental unemployment benefit plan. What is the amount of Porter\’s gross income?
A. $35,000
B. $37,000
C. $39,000
D. $41,000
Correct Answer: D
RULE: Gross income includes all income unless it is specifically excluded in the tax code.
Choice “d” is correct. Wages and all unemployment compensation are not excluded from being taxable; therefore, there are included in the taxpayer\’s gross income for tax purposes.
Choice “a” is incorrect. All forms of unemployment compensation are included as part of gross income. Choice “b” is incorrect. The $4,000 of state unemployment compensation received is included as part of gross income. Choice “c” is incorrect. The $2,000 of his former employer\’s company-paid supplemental unemployment benefit plan is included as part of gross income.
Question 15:
In the current year Jensen had the following items:
What is Jensen\’s AGI for the current year?
A. $44,000
B. $59,000
C. $62,000
D. $84,000
Correct Answer: B
Choice “b” is correct. The question asks for AGI, but all of the items in the list are items of potential gross income. There are no adjustments included in the list; therefore, in this case, AGI is the same as gross income. The calculation is as follows:
Choices “a”, “c”, and “d” are incorrect, per the above calculation.