chapter i7

Prentice Hall's Federal Taxation 2015 Comprehensive, 28e (Pope)Chapter I7 Itemized Deductions

1) For individuals, all deductible expenses must be classified as deductions for AGI or deductions from AGI.Answer: TRUEPage Ref.: I:7-2Objective: 1

2) In 2014, medical expenses are deductible as a from AGI deduction to the extent that they exceed 7.5 percent of the taxpayer's AGI.Answer: FALSEExplanation: Starting in 2014, the floor for medical expenses has increased to 10% of AGI (unless the taxpayer is 65 or older).Page Ref.: I:7-2Objective: 1

3) Medical expenses paid on behalf of an individual who could be the taxpayer's dependent except for the gross income or joint return tests are deductible as itemized deductions.Answer: TRUEExplanation: Generally an expense must be paid on behalf of oneself (or spouse) in order to deduct the expense, but an exception is allowed for medical expenses paid on behalf of a dependent.Page Ref.: I:7-2Objective: 1

4) Medical expenses incurred on behalf of children of divorced parents are deductible by the parent who pays the expenses but only if that parent also is entitled to the dependency exemption.Answer: FALSEExplanation: As long as one divorced parent qualifies to claim the dependency exemption under Sec. 152(e), the parent who pays medical expenses on behalf of the children may deduct the expenses.Page Ref.: I:7-2Objective: 1

5) The definition of medical care includes preventative measures such as routine physical examinations.Answer: TRUEExplanation: The definition of medical care does include preventative medical care.Page Ref.: I:7-3Objective: 1

6) Due to stress on the job, taxpayer Charlie began to experience chest pains. In order to relax and relieve the pains, he and his spouse went on an ocean cruise. The cost of the cruise to alleviate this medical condition is tax deductible.Answer: FALSEExplanation: Unless expenditures are for routine preventative care, expenditures must be incurred to treat a specific ailment, rather than for general health. Page Ref.: I:7-3; Example I:7-2Objective: 1

7) Expenditures for a weight reduction program are deductible if recommended by a physician to treat a specific medical condition such as hypertension caused by excess weight.Answer: TRUE

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Explanation: Unless expenditures are for routine preventative care, expenditures must be incurred to treat a specific ailment, rather than for general health. A weight loss program must be prescribed by a doctor to treat a specific condition.Page Ref.: I:7-3; Example I:7-3Objective: 1

8) In order for a taxpayer to deduct a medical expense, the amount must be paid to a certified medical doctor (M.D.).Answer: FALSEExplanation: Taxpayers may deduct payments to a wide range of medical, dental, and other diagnostic and healing services.Page Ref.: I:7-3 and I:7-4Objective: 1

9) Jeffrey, a T.V. news anchor, is concerned about the wrinkles around his eyes. Because it is job-related, the cost of a face lift to eliminate these wrinkles is a deductible medical expense.Answer: FALSEExplanation: Cosmetic surgery is not deductible unless such surgery is necessary to correct a deformity arising from a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease.Page Ref.: I:7-4Objective: 1

10) Expenditures for long-term care insurance premiums qualify as a medical expense deduction subject to an annual limit based upon the age of an individual.Answer: TRUEExplanation: Premiums for long-term care will qualify for medical expense treatment, but the deduction amounts are limited by the taxpayer's age.Page Ref.: I:7-5Objective: 1

11) Capital expenditures for medical care which permanently improve or better the taxpayer's property are deductible to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.Answer: TRUEExplanation: Capital improvements needed for medical care are only allowed to the extent they exceed the increase in the FMV of the property.Page Ref.: I:7-5Objective: 1


12) Expenditures incurred in removing structural barriers in the home of a physically handicapped individual are deductible only to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.Answer: FALSEExplanation: Such expenses are fully deductible subject to the 10% (7.5% for those 65 and older) limitation on all medical expenses.Page Ref.: I:7-5Objective: 1

13) If the principal reason for a taxpayer's presence in an institution is the need and availability of medical care, the entire cost of lodging and meals is considered qualified medical expenditures.Answer: TRUEPage Ref.: I:7-6Objective: 1

14) A medical expense is generally deductible only in the year in which the expense is actually paid.Answer: TRUEPage Ref.: I:7-6Objective: 1

15) If a prepayment is a requirement for the receipt of the medical care, the payment is deductible in the year paid rather than the year in which the care is rendered.Answer: TRUEPage Ref.: I:7-7Objective: 1

16) If a medical expense reimbursement is received in a year after a deduction has been taken on a previous year's return, the previous year's return must be amended to eliminate the reimbursed expense.Answer: FALSEExplanation: The reimbursement should be included in gross income in the year received to the extent the taxpayer received a tax benefit in the year of payment.Page Ref.: I:7-7Objective: 1

17) Assessments or fees imposed for specific privileges or services are not deductible as taxes.Answer: TRUEExplanation: Assessments or fees for specific privileges or services do not meet the definition of a tax.Page Ref.: I:7-9Objective: 2

18) Foreign real property taxes and foreign income taxes are not deductible as itemized deductions.Answer: FALSEExplanation: Both are deductible as itemized deductions.Page Ref.: I:7-9Objective: 2


19) A personal property tax based on the weight of the property is deductible.Answer: FALSEExplanation: In order to be deductible, a personal property tax must be ad valorem (based on value).Page Ref.: I:7-10Objective: 2

20) Assessments made against real estate for the purpose of funding local improvements are not deductible in the year paid but rather should be added to the cost basis of the property.Answer: TRUEExplanation: Such assessments are not taxes; they are improvements.Page Ref.: I:7-11Objective: 2

21) Self-employed individuals may deduct the full self-employment taxes paid as a for AGI deduction.Answer: FALSEExplanation: One-half of the self-employment tax is a deduction for AGI. Page Ref.: I:7-12Objective: 2

22) Finance charges on personal credit cards are considered interest and are, therefore, deductible. Answer: FALSEExplanation: The charge is a nondeductible personal expense.Page Ref.: I:7-12Objective: 3

23) In general, the deductibility of interest depends on the purpose for which the indebtedness is incurred.Answer: TRUEExplanation: Treasury Regulations require that taxpayers allocate interest expense to the different interest expense categories based on the use of the borrowed funds.Page Ref.: I:7-13Objective: 3

24) Interest expense incurred in the taxpayer's trade or business is deductible as a for AGI deduction without limitation if the taxpayer materially participates in the business.Answer: TRUEExplanation: If the taxpayer does not materially participate, the interest is subject to the passive loss limitations.Page Ref.: I:7-14Objective: 3

25) Investment interest expense which is disallowed because it exceeds the taxpayer's net investment income may be carried over and treated as incurred in subsequent years.Answer: TRUEExplanation: There is no time limit on investment interest expense carryovers.Page Ref.: I:7-14Objective: 3


26) Investment interest includes interest expense incurred to purchase tax-exempt securities.Answer: FALSEExplanation: Interest expense related to tax-exempt securities is not deductible.Page Ref.: I:7-15Objective: 3

27) Taxpayers may elect to include net capital gain as part of investment income.Answer: TRUEExplanation: Net capital gain and qualifying dividend income are not normally included in the net investment income ceiling, but an election is available to the taxpayer to include them if the taxpayer is willing to forego the applicable favorable tax rates.Page Ref.: I:7-15Objective: 3

28) Taxpayers may not deduct interest expense on most personal debt, including credit card debt, car loans, and other consumer debt.Answer: TRUEExplanation: Except for interest expense on debt to acquire a personal residence and on certain student loans, interest expense on personal loans is not deductible.Page Ref.: I:7-16Objective: 3

29) Qualified residence interest consists of both acquisition indebtedness and home equity interest.Answer: TRUEPage Ref.: I:7-16Objective: 3

30) Acquisition indebtedness for a personal residence includes debt incurred to substantially improve the residence.Answer: TRUEExplanation: Acquisition indebtedness is any debt secured by the residence and incurred in acquiring, constructing or substantially improving the qualified residence.Page Ref.: I:7-16Objective: 3

31) A taxpayer is allowed to deduct interest expense incurred on home equity indebtedness limited to the lesser of $100,000 or the home equity (FMV of the residence less the acquisition indebtedness).Answer: TRUEExplanation: Home equity indebtedness is any indebtedness, other than acquisition indebtedness, that is secured by a qualified residence.Page Ref.: I:7-17Objective: 3

32) While points paid to purchase a residence are deductible as interest in the period paid, points associated with the refinancing of a residence must be amortized and deducted over the life of the loan.Answer: TRUEExplanation: Prepaid interest must generally be capitalized and amortized, but an exception allows immediate deduction only in the case of points paid for a loan to purchase a primary residence.Page Ref.: I:7-17 and I:7-18Objective: 3

33) Christopher, a cash basis taxpayer, borrows $1,000 from ABC Bank by issuing a 3-month note on December 1, 2014. Christopher receives $940 but must repay $1,000 on the


due date. The amount of interest expense deductible in 2014 is $20.Answer: FALSEExplanation: He is cash basis and does not pay the interest until the following year.Page Ref.: I:7-20; Example I:7-22Objective: 3

34) Charitable contributions made to individuals are deductible if the individuals can show extreme financial need.Answer: FALSEExplanation: Charitable contributions made directly to individuals are generally not deductible.Page Ref.: I:7-21 and I:7-22Objective: 4

35) For charitable contribution purposes, capital gain property includes property which, if sold, would produce a long-term capital gain.Answer: TRUEExplanation: In general, the treatment of property contributions is determined by the character of the property if it had been sold.Page Ref.: I:7-23Objective: 4

36) A charitable contribution deduction is allowed for the FMV of services rendered to a qualified charitable organization.Answer: FALSEExplanation: The taxpayer may deduct only the unreimbursed expenses incurred incident to rendering the services.Page Ref.: I:7-24Objective: 4

37) A charitable contribution in excess of the deduction limit for one taxable year can be carried forward five years.Answer: TRUEExplanation: The tax law does allow a five-year carryover of charitable contributions that exceed the contribution ceiling.Page Ref.: I:7-25Objective: 4

38) If a taxpayer makes a charitable contribution to a university and in return receives the right to purchase tickets to athletic events, the taxpayer may deduct only 80% of the payment.Answer: TRUEPage Ref.: I:7-25Objective: 4


39) An accrual-basis corporation can only deduct contributions made by year-end.Answer: FALSEExplanation: An accrual-basis corporation which pledges a contribution can deduct the contribution in the year of the pledge if it fulfills the pledge by the fifteenth day of the third month following year-end.Page Ref.: I:7-26Objective: 4

40) Corporate charitable deductions are limited to 10% of the corporation's taxable income for the year.Answer: TRUEPage Ref.: I:7-26Objective: 4

41) Legal fees for drafting a will are generally deductible.Answer: FALSEExplanation: To be deductible, such fees must deal with tax-related items.Page Ref.: I:7-29Objective: 6

42) A taxpayer can deduct a reasonable amount for small out-of-pocket (i.e. cash) donations.Answer: FALSEExplanation: All charitable contributions must be supported by qualifying documentation such as receipts.Page Ref.: I:7-32Objective: 8

43) Van pays the following medical expenses this year:• $1,500 for doctor bills for Van's son who is claimed as a dependent by Van's former spouse.• $300 for Van's eyeglasses.• $900 for Van's dental work.• $3,800 for Van's face lift. Van, a newscaster, is worried about the wrinkles around his eyes.

How much can Van include on his return as qualified medical expenses before limitation?A) $1,200B) $2,400C) $2,700D) $6,500Answer: CExplanation: C) ($1,500 + $300 + $900) = $2,700Page Ref.: I:7-2 through I:7-4Objective: 1

44) All of the following are deductible as medical expenses exceptA) vitamins and health foods that improve a taxpayer's general health.B) payments for a vision exam and contact lenses.C) payments to a hospital for laboratory fees and X-rays for diagnosis of a medical problem.D) cosmetic surgery necessary to correct a deformity arising from a congenital abnormality.Answer: AExplanation: A) Nonprescription drugs, except for insulin, are not deductible as medical expenses.Page Ref.: I:7-3 and I:7-4Objective: 1


45) All of the following payments for medical items are deductible with the exception of the payment forA) insulin.B) general appointment for teeth cleaning.C) acupuncture for specific medical purposes.D) nonprescription medicine for treatment of a specific medical condition.Answer: DExplanation: D) Only prescription drugs and insulin are deductible.Page Ref.: I:7-3 and I:7-4Objective: 1

46) In 2014 Sela traveled from her home in Flagstaff to San Francisco to seek medical care. Because she was unable to travel alone, her mother accompanied her. Total expenses included:

Hotel room en route ($150 × 2 rooms × 3 nights) $900Mileage, 1,000 milesDoctors bills in San Francisco 1,600

The total medical expenses deductible before the 10% limitation areA) $1,600.B) $2,135.C) $2,500.D) $2,460.Answer: BExplanation: B) $300 [($50 maximum × 2) for 3 nights ] + $235 mileage (1,000 × 23.5 cents per mile) + $1,600 doctors = $2,135.Page Ref.: I:7-4Objective: 1

47) Leo spent $6,600 to construct an entrance ramp and to widen doorways in his personal residence to make the home accessible for his wife, who is disabled and confined to a wheelchair. The $6,600 expenditure increased the value of the residence by $2,000. How much of the $6,600 is a deductible medical expense (before considering limits based on AGI)?A) $0B) $2,000C) $4,600D) $6,600Answer: DExplanation: D) Expenditures to remove structural barriers in the home of a physically handicapped individual such as costs of constructing entrance ramps, widening doorways and halls, etc. are deductible in full.Page Ref.: I:7-5Objective: 1


48) Linda had a swimming pool constructed at her house. Her physician advised and prescribed to her that the pool would slow the effects of her degenerative disease. The pool was not suitable for recreational use. Prior to the construction of the pool, the fair market value of her house was $172,000. After the construction of the pool, the appraised fair market value of the house was $181,000. The cost of the pool was $13,000. What is the amount of Linda's qualified medical expense (before considering limits based on AGI)?A) $0B) $4,000C) $9,000D) $13,000Answer: BExplanation: B) The deduction is limited to the portion of the cost which exceeds the increase in the house's FMV or $13,000 - ($181,000 - $172,000) = $4,000.Page Ref.: I:7-5; Example I:7-4Objective: 1

49) Alan, who is a security officer, is shot while on the job. As a result, Alan suffers from a chronic leg injury and must use a wheelchair and undergo therapy to regain and retain strength. Alan's physician recommends that he install a whirlpool bath in his home for therapy. During the year, Alan makes the following expenditures:

Wheelchair $ 1,200Whirlpool bath 2,000Maintenance of the whirlpool 250Increased utility bills associated with whirlpool 450Entrance ramp, various home modifications 7,200

A professional appraiser tells Alan that the whirlpool has increased the value of his home by $1,000. Alan's deductible medical expenses (before considering limitations based on AGI) will beA) $6,000.B) $10,100.C) $7,000.D) $7,700.Answer: BExplanation: B) Wheelchair $ 1,200Whirlpool bath - increase in home value 1,000Maintenance of the whirlpool 250Increased utility bills associated with whirlpool 450Entrance ramp, various home modifications 7,200Total qualifying expenses $10,100Page Ref.: I:7-5; Example I:7-4Objective: 1


50) Mitzi's medical expenses include the following:

Medical premiums $10,850Doctors fees 2,000Hospital fees 3,350Prescription drugs 600Eyeglasses 350General purpose vitamins 100

Mitzi's AGI for the year is $33,000. She is single and age 49. None of the medical costs are reimbursed by insurance. After considering the AGI floor, Mitzi's medical expense deduction isA) $12,900.B) $13,850.C) $14,675.D) $16,325.Answer: BExplanation: B) [$10,850 + $2,000 + $3,350 + $600 + $350] = $17,150 total expenses - ($33,000 × 0.10) = $13,850. The general purpose vitamins do not qualify.Page Ref.: I:7-2 through I:7-7; Example I:7-6Objective: 1

51) Caleb's medical expenses before reimbursement for the year include the following:

Medical premiums $11,000Doctors, hospitals 3,500Prescriptions 600

Caleb's AGI for the year is $50,000. He is single and age 58. Caleb also receives a reimbursement for medical expenses of $1,000. Caleb's deductible medical expenses that will be added to the other itemized deduction will beA) $10,350.B) $9,100.C) $14,500.D) $15,100.Answer: BExplanation: B) ($11,000 + $3,500 + $600 - $1,000) - 5,000 ($50,000 × 0.10) = $9,100Page Ref.: I:7-2 through I:7-7; Example I:7-6Objective: 1


52) A review of the 2014 tax file of Gregory, a single taxpayer who is age 40, provides the following information regarding Gregory's 2014 tax status:

Adjusted gross income $40,000Medical expenses (before percentage limit) 5,000Itemized deductions other than medical 5,4002014 potential standard deduction 6,200

In 2015, Gregory receives a reimbursement for last year's medical expenses of $1,200. As a result, Gregory mustA) include $200 in gross income for 2015.B) include $1,200 in gross income for 2015.C) reduce 2015's medical expenses by $1,200.D) amend the 2014 return.Answer: AExplanation: A) Include in 2015's income the lesser of the reimbursement or to the extent the tax benefit received in 2014.

Medical Expenses $5,000 Limit (10% × $40,000) ($4,000)

$1,000 Other itemized $5,400 Total 2014 Itemized Deduction Allowed $6,400 2014 Standard Deduction ( 6,200)Tax Benefit included on the 2015 return $ 200 Page Ref.: I:7-7; Example I:7-7Objective: 1


53) Mr. and Mrs. Thibodeaux, who are filing a joint return, have adjusted gross income of $75,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Thibodeaux's mother, Mrs. Watson (age 63). Mrs. Watson provided over one-half of her own support.

Prescription drugs for Mr. Thibodeaux $3,600General vitamins for Mrs. Thibodeaux $ 100Doctor bill for Mr. Thibodeaux $1,800Doctor bill for Mrs. Thibodeaux $4,000Hospital bill for Mrs. Watson $2,200

Mr. and Mrs. Thibodeaux received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?A) $1,900B) $2,000C) $4,100D) $9,400Answer: AExplanation: A) Prescription drugs for Mr. Thibodeaux $3,600 Doctor bill for Mrs. Thibodeaux 4,000 Doctor bill for Mr. Thibodeaux 1,800 Total expenses $9,400 Minus: 10% of AGI ($75,000 × 0.10) ( 7,500)Deduction $ 1,900

No deduction is allowed for the mother's expenses because she provided more than half of her own support. Mrs. Thibodeaux' vitamins are not a prescription drug and do not qualify.Page Ref.: I:7-2 through I:7-7Objective: 1


54) Mr. and Mrs. Gere, who are filing a joint return, have adjusted gross income of $50,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Gere's mother, Mrs. Williams. The Gere's could claim Mrs. Williams as their dependent, but she has too much gross income.

Insulin for Mr. Gere $1,000Health insurance premiums for Mrs. Gere $3,100Hospital bill for Mrs. Williams $5,200Doctor bill for Mrs. Gere $4,000

Mr. and Mrs. Gere received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?A) $5,200B) $8,300C) $4,300D) $13,300Answer: BExplanation: B) Insulin for Mr. Gere $1,000 Health insurance premiums for Mrs. Gere 3,100 Hospital bill for Mrs. Williams 5,200 Doctor bill for Mrs. Gere 4,000 Total expenses $13,300 Minus: 10% of AGI ($50,000 × 0.10) ( 5,000)Deduction $8,300 Page Ref.: I:7-2 through I:7-7; Example I:7-6Objective: 1

55) The following taxes are deductible as itemized deductions with the exception ofA) state income taxes.B) federal income taxes.C) foreign real property taxes.D) local personal property taxes.Answer: BExplanation: B) Federal income taxes are not deductible.Page Ref.: I:7-9Objective: 2


56) Matt paid the following taxes in 2014:

Real estate taxes on rental property he owns $4,000Real estate taxes on his own residence 3,600Federal income taxes 8,000State income taxes 3,400Local city income taxes 500State sales taxes 700

What amount can Matt deduct as an itemized deduction on his tax return?A) $7,500B) $11,500C) $15,500D) $19,500Answer: AExplanation: A) Real estate taxes on his own residence $3,600State income taxes 3,400Local city income taxes 500 Total itemized deduction $7,500

Sales taxes are not deductible in 2014.Page Ref.: I:7-9, I:7-10 and I:7-12Objective: 2

57) In 2014, Carlos filed his 2013 state income tax return and paid taxes of $800. Also in 2014, Carlos's employer withheld state income tax of $750 from Carlos's salary. In 2015, Carlos filed his 2014 state income tax return and paid an additional $600 of state income tax due for 2014. How much state income tax can Carlos deduct on his 2014 federal income tax return for state income tax?A) $1,350B) $1,400C) $1,550D) $2,150Answer: CExplanation: C) State income tax withheld in 2014 $ 7502012 state income tax paid in 2014 800 Total Deduction $1,550Page Ref.: I:7-10; Example I:7-8Objective: 2


58) Doug pays a county personal property tax on his automobile of $1,500. The $1,500 includes $800 based on the weight of the car and $700 based on the value of the car. How much of the tax can Doug deduct on his tax return?A) $0B) $700C) $800D) $1,500Answer: BExplanation: B) Personal property taxes are deductible to the extent that they are ad valorem or based on value.Page Ref.: I:7-10; Example I:7-9Objective: 2

59) During the year Jason and Kristi, cash basis taxpayers, paid the following taxes:

State gift tax $1,000Property tax on home in the United States 4,100State income tax (withholdings) 3,000Estimated federal income tax 4,500Estimated state income tax (paid by check) 800Special assessment by city for sidewalks and street lighting on their street 2,000

What amount can Kristi and Jason claim as an itemized deduction for taxes on their federal income tax return in the current year?A) $7,900B) $8,900C) $10,900D) $15,400Answer: AExplanation: A) $4,100 + 3,000 + 800 = 7,900Page Ref.: I:7-9 through I:7-12Objective: 2

60) In February of the current year (assume a non-leap year), Ken and Kelsey received their property tax statement for last calendar-year taxes of $1,600, which they paid to the taxing authority on March 1 of the current year. They had purchased their home on May 1 last year. What amount of property tax on this statement may they claim as an itemized deduction this year?A) $0B) $1,069C) $1,074D) $1,600Answer: CExplanation: C) (245/365 × $1,600 = $1,074)Page Ref.: I:7-11; Example I:7-10Objective: 2


61) On September 1, of the current year, James, a cash-basis taxpayer, sells his farm to Bill, also a cash-basis taxpayer, for $100,000. James' basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable in November of the current year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Bill pays all of the real estate taxes in the current year. The effects of this sales structure will be:

A) Taxes allocated to James Taxes allocated to BillEffect on James' Gain $0 $3,650 no effect on gain

B) Taxes allocated to James Taxes allocated to BillEffect on James' Gain $3,650 $0 decrease gain by $1,220

C) Taxes allocated to James Taxes allocated to BillEffect on James' Gain $2,430 $1,220 increase gain by $2,430

D) Taxes allocated to James Taxes allocated to BillEffect on James' Gain $1,220 $2,430 increase gain by $1,220

Answer: CExplanation: C) Taxes allocated to Bill:(122/365 days) × $3,650 = $1,220.Taxes allocated to James = $3,650 - $1,220 = $2,430.Increase James' gain by $2,430.Page Ref.: I:7-11; Example I:7-10Objective: 2


62) On September 1, of the current year, Samuel, a cash-basis taxpayer, sells his farm to Edward, also a cash-basis taxpayer for $100,000. Samuel's basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable on April 1 of the following year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Samuel pays all of the real estate taxes prior to the sale. The effects of this sales structure will be:

A) Taxes allocated to Samuel

Taxes allocated to Edward

Effect on Samuel's Gain

$1,220 $2,430 increase gain by $1,220

B) Taxes allocated to Samuel



$2,430 $1,220 increase gain by $2,430

C) Taxes allocated to Samuel



$2,430 $1,220 decrease gain by $1,220

D) Taxes allocated to Samuel



$1,220 $2,430 decrease gain by $1,220

Answer: CExplanation: C) Taxes allocated to Edward:(122/365 days) × $3,650 = $1,220 rounded.Decrease Samuel's gain by $1,220.Taxes allocated to Samuel = $3,650 - $1,220 = $2,430.Page Ref.: I:7-11; Example I:7-10Objective: 2

63) Peter is assessed $630 for street improvements in front of his house. Which of the following statements is correct?A) Peter must deduct the assessment as a tax.B) Peter must reduce the property basis by $630.C) Peter must increase the property basis by $630.D) Peter can elect to deduct the $630 currently or increase the basis in the property.Answer: CExplanation: C) Tax law requires capitalization of assessments as part of the property's adjusted basis.Page Ref.: I:7-11Objective: 2


64) Hui pays self-employment tax on her sole proprietorship income, supplemental Medicare surtaxes on excess wages and self-employment income (the .09% tax) and supplemental Medicare taxes on investment income (the 3.8% tax). Which of the following statements is correct regarding the deductibility of these taxes?A) All three of the taxes are deductible as itemized deductions.B) One-half of the self-employment tax is deductible for AGI, and the .09% and 3.8% taxes are itemized deductions.C) None of the taxes are allowed as a deduction.D) One-half of the self-employment tax is deductible for AGI, but the .09% and 3.8% taxes are not allowed as deductions.Answer: DExplanation: D) The two supplemental Medicare taxes are not deductible at all, but one-half of the self-employment tax is allowed as a deduction for AGI.Page Ref.: I:7-11 and I:7-12Objective: 2

65) Which of the following is deductible as interest expense?A) personal credit card interestB) interest to purchase tax-exempt bondsC) bank service charges on personal accountD) interest on a home equity loan to purchase a carAnswer: DExplanation: D) Interest on home equity loans is deductible.Page Ref.: I:7-12, I:7-15 through I:7-17Objective: 3

66) Riva borrows $10,000 that she intends to use for purchasing supplies for her business. She temporarily deposits the funds in her personal checking account. Prior to the deposit, the checking account held $40,000 of personal funds. Riva books a vacation for $6,000 and writes a check to the travel agency from her personal account. Later in the month, the business supplies bill arrives and Riva writes a check for $10,000 from the personal account. With respect to the interest expense on the $10,000 loan, A) it will all be treated trade or business expense.B) 60 percent will be treated as personal interest expense and 40 percent as trade or business expense.C) it will all be treated as personal expense.D) 20 percent will be treated trade or business expense.Answer: BExplanation: B) If borrowed and personal funds are mingled in the same account, expenditures from that account are treated as coming first from borrowed funds. Therefore, the $6,000 vacation payment is considered as coming from borrowed funds, and only $4,000 of the business supply bill is treated as coming from borrowed funds. Accordingly, the interest expense will be allocated 60% to personal use and 40% to business use.Page Ref.: I:7-13 and I:7-14; Example I:7-13Objective: 3


67) When both borrowed and owned funds are mingled in the same account, for purposes of categorizing interest expense, a repayment of the debt is allocated first toA) personal expenditures.B) trade or business expenditures.C) investment expenditures.D) passive activity expenditures in real estate.Answer: AExplanation: A) When the taxpayer repays the debt, the tax law requires that the allocation of the repayment to the expenditures made with the borrowed funds occur in the following order: (1) personal expenditures, (2) investment expenditures and passive activity expenditures other than rental real estate, (3) passive activity expenditures in rental real estate, and (4) trade or business expenditures.Page Ref.: I:7-13 and I:7-14Objective: 3

68) All of the following statements are true exceptA) investment interest expense is deductible to the extent of a taxpayer's net investment income.B) short-term capital gains meet the definition of net investment income.C) investment interest expense includes interest expense to purchase or carry tax-exempt securities.D) net investment income is the taxpayer's investment income in excess of investment expenses.Answer: CExplanation: C) Investment interest does not include interest expense incurred to purchase or carry tax-exempt securities.Page Ref.: I:7-14 through I:7-16Objective: 3

69) In the current year, Julia earns $9,000 in net investment income and incurs $14,000 of investment interest expense. What is the maximum amount of investment interest expense she is allowed to deduct this year?A) $0B) $3,000 deductible this year; $11,000 carried forward to next yearC) $9,000 deductible this year; $5,000 carried forward to next yearD) $14,000 deductible this year; nothing to be carried forward to next yearAnswer: CExplanation: C) Investment interest expense is deductible to the extent of net investment income. The remainder is carried over to the next tax year.Page Ref.: I:7-14; Example I:7-14Objective: 3


70) Ted pays $2,100 interest on his automobile loan, $120 interest on a loan to purchase a computer for personal use, $630 interest on credit cards, and $1,100 investment interest expense. Ted has net investment income of $850. Ted's deductible interest isA) $850.B) $1,100.C) $2,950.D) $3,200.Answer: AExplanation: A) Only the investment interest expense, to the extent of net investment income of $850 is deductible.Page Ref.: I:7-14 through I:7-16Objective: 3

71) Takesha paid $13,000 of investment interest expense in a year in which she earned $4,500 in dividends, $5,400 in interest income, and had a short-term capital gain of $1,000 and a long-term capital gain of $2,200. The capital gains resulted from the sale of stock held as an investment. She has no other investment-related expenses. What is her maximum deduction for investment interest expense, assuming Takesha does not make any elections?A) $5,400B) $6,400C) $13,100D) $13,000Answer: BExplanation: B) Her investment income ceiling will only include the interest income and the short-term capital gain so the deduction for investment interest expense is limited to $6,400. The dividend income and long-term capital gain will not be included in her investment income ceiling without a special election.Page Ref.: I:7-15; Example I:7-15Objective: 3

72) Dana paid $13,000 of investment interest expense in a year in which she earned $4,500 in dividends, $5,400 in interest income, and had a short-term capital gain of $1,000 and a long-term capital gain of $2,200. The capital gains resulted from the sale of stock held as an investment. She has no other investment-related expenses. What is her maximum deduction for investment interest expense if Dana makes the proper elections to raise her ceiling as high as possible?A) $5,400B) $9,900C) $13,100D) $13,000Answer: DExplanation: D) If she makes the appropriate election on her return to include the dividends and long-term capital gain in her ceiling, she can deduct the investment interest expense to the extent of net investment income including the dividends and long-term capital gain. $4,500 + $5,400 + 1,000 + $2,200 = $13,100 limited to $13,000 of investment interest expense.Page Ref.: I:7-15; Example I:7-15Objective: 3


73) Faye earns $100,000 of AGI, including $90,000 of salary and $10,000 of interest income. Faye does itemize her deductions. The miscellaneous category of her itemized deductions consists of $1,500 of unreimbursed employee business expenses and a $900 fee paid for investment advice. Faye has paid $11,000 of interest expense on a loan used to purchase stocks. How much of the $11,000 interest expense can be deducted this year?A) $11,000B) $10,000C) $9,100D) $9,600Answer: DExplanation: D) Deduction of investment interest expense is limited to net investment income. Net investment income includes the $10,000 interest income, but is reduced by investment-related expenses remaining after the 2% of AGI floor is applied to the miscellaneous deduction category.

Investment expense $900 Disallowed by 2% limitation:2% of $100,000 $2,000 Unreimbursed employee expense (1,500)Remaining disallowance (500)Deductible investment expense $400 Net investment income $10,000 - 400 $9,600

$9,600 of the $11,000 interest expense is currently deductible, and the balance carries over.Page Ref.: I:7-15 and I:7-16; Example I:7-16Objective: 3


74) Teri pays the following interest expenses during the year:

Home mortgage interest on personal residence $8,500Credit card interest on personal purchases 550Interest on loans used to purchase investments (Net investmentincome is $2,000) 2,400Interest on loans used for a business conducted as a sole proprietorship 3,800Interest on a credit card used exclusively in the business 470

What is the amount of interest expense that can be deducted as an itemized deduction?A) $10,500B) $10,900C) $14,300D) $14,700Answer: AExplanation: A) Home mortgage interest $ 8,500Investment interest limited to net investment income 2,000 Total as itemized deduction $ 10,500

Personal interest is not deductible. Interest for the business is deducted as a for AGI deduction on the Schedule C.Page Ref.: I:7-14 through I:7-16Objective: 3

75) On July 31 of the current year, Marjorie borrows $120,000 to purchase a new fishing boat. The loan is secured by her personal residence. On the date of the loan, the outstanding balance on the original debt incurred to purchase the residence is $300,000 and the FMV of the home is $450,000. What is the total amount of debt on which Marjorie can deduct interest in the current year?A) $300,000B) $400,000C) $420,000D) $450,000Answer: BExplanation: B) The loan for the boat is home equity indebtedness. Interest on $300,000 of acquisition indebtedness and $100,000 of home equity indebtedness. The home equity indebtedness is the lesser of home equity of $150,000 or $100,000.Page Ref.: I:7-17; Example I:7-18Objective: 3


76) Wayne and Maria purchase a home on April 1 of the current year. In order to obtain a thirty-year mortgage, they are required to pay $7,200 in points at closing. Charging points is a customary business practice in the area. In addition, they pay $4,400 of interest during the year. What is their current year deduction related to their home?A) $4,400B) $4,580C) $7,200D) $11,600Answer: DExplanation: D) Points on the purchase of a home are deductible in the year paid, provided certain requirements are met.Page Ref.: I:7-18; Example I:7-19Objective: 3

77) Claudia refinances her home mortgage on June 1 of the current year. She obtains a 30 year mortgage at 5%. As part of the refinancing, she pays points of $3,600 (a customary practice in her location). What amount, if any, of the points are deductible?A) $0B) $70C) $120D) $3,600Answer: BExplanation: B) $3,600/(30 × 12) = $10 monthly amortization. $10 × 7 months = $70Page Ref.: I:7-18Objective: 3

78) Leslie, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses. She has not received any type of educational assistance or scholarships. The amount of interest paid during the year amounted to $3,800. What is the amount and classification of her student loan interest education deduction if her modified AGI is $40,000?A) $2,500 for AGIB) $2,500 from AGIC) $3,800 for AGID) $3,800 from AGIAnswer: AExplanation: A) The limit for the student loan interest deduction is $2,500, and it is a deduction for AGI.Page Ref.: I:7-19Objective: 3


79) Marcia, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses. She has not received any type of educational assistance or scholarships. The amount of interest paid during the year amounted to $3,000. What is the amount and classification of her student loan interest deduction if her AGI is $68,000?A) $500 for AGIB) $2,000 for AGIC) $2,500 for AGID) $3,000 for AGIAnswer: BExplanation: B) The limit for student loan interest deduction is $2,500, and it is a deduction for AGI. The limit is phased-out ratably between $65,000 and $80,000 of AGI for a single person. [($68,000 - $65,000)/($80,000 - $65,000)] = 20% phase-out. $2,500 limit × (100% - 20%)= $2,000 maximum due to excess AGI.Page Ref.: I:7-19; Example I:7-21Objective: 3

80) Don's records contain the following information:1. Donated stock having a fair market value of $3,600 to a qualified charitable organization. He acquired the stock five months previously at a cost of $2,400.2. Paid $700 to a church school as a requirement for the enrollment of his daughter.3. Paid $200 for annual homeowner's association dues.4. Drove 400 miles in his personal auto at 14 cents per mile. The travel was directly related to volunteer services he performed for his church (actual costs were not available).

What is Don's charitable contribution deduction?A) $2,456B) $3,156C) $3,356D) $3,656Answer: AExplanation: A) [$2,400 + (400 × $.14/Mile)] = $2,456. School tuition and homeowner association dues do not qualify, and the stock was held short-term so it is deducted at basis.Page Ref.: I:7-22 through I:7-25Objective: 4


81) Erin's records reflect the following information:

1. Paid $200 dues to a fraternal organization (such as the Elks Club)2. Donated stock having a fair market value of $3,500 to a qualified charitable organization. She purchased the stock 2 years earlier for $3,000.3. Paid $1,600 cash to qualified public charitable organizations

Erin's adjusted gross income for this year was $50,000. What is the amount of her charitable contribution deduction for the year?A) $4,600B) $4,800C) $5,100D) $5,300Answer: CExplanation: C) Cash $1,600FMV Stock (held long-term) 3,500Total Charitable Contributions $5,100Page Ref.: I:7-22 through I:7-25Objective: 4

82) Sacha purchased land in 2010 for $35,000 that she held as a capital asset. This year, she contributed the land to the Boy Scouts of America (a charitable organization) for use as a site for a summer camp. The market value of the land at the date of contribution is $40,000. Sacha's adjusted gross income is $90,000. Assuming no special elections, Sacha's maximum deductible contribution this year isA) $13,000.B) $27,000.C) $35,000.D) $40,000.Answer: BExplanation: B) The potential deduction is the $40,000 FMV. Ceiling on current year contribution:$90,000 AGI× .30 Limit on capital gain property$ 27,000 Maximum current year deduction$ 13,000 CarryoverPage Ref.: I:7-23 and I:7-25; Examples I:7-24 and I:7-30Objective: 4


83) Doris donated a diamond brooch recently appraised at $25,000 to her local church. Doris had purchased it many years ago for $10,000. The church sold the brooch to provide funding for church programming. Doris' AGI is $40,000. Doris will be able to take a charitable deduction of A) $10,000.B) $25,000.C) $12,000.D) $20,000.Answer: AExplanation: A) The brooch is capital gain property, but the church puts it to an unrelated use (sells it) so the deduction is taken at the $10,000 adjusted basis.Page Ref.: I:7-23; Example I:7-25Objective: 4

84) Clayton contributes land to the American Red Cross for use as a future site for a new building. His AGI is $50,000. Clayton paid $20,000 for the land eight months ago but its market value at the date of contribution is $25,000. With no special elections, Clayton's deductible contribution this year isA) $7,000.B) $18,000.C) $20,000.D) $25,000.Answer: CExplanation: C) Since the property was held by Clayton for less than one year, the contribution amount is the adjusted basis of $20,000. The $20,000 does not exceed the 50% of AGI ceiling.Page Ref.: I:7-24 and I:7-25; Example I:7-26Objective: 4

85) Carl purchased a machine for use in his trade or business two years ago for $30,000. During the current year, Carl donates the machine to the local community college. At the time of the contribution, the machine's adjusted basis is $10,000 and its FMV is $15,000. Carl's AGI for the year is $48,000. What is the amount of his charitable contribution deduction?A) $10,000B) $14,000C) $15,000D) $25,000Answer: AExplanation: A) Because the machine is ordinary income property (if sold the machine would have resulted in section 1245 ordinary income), the amount of the contribution is adjusted basis of $10,000.Page Ref.: I:7-24; Example I:7-27Objective: 4


86) During the current year, Jane spends approximately 90 hours of her time in developing computer software for a church. As a programmer and data analyst, Jane normally bills her clients at $130 per hour for her time. Jane also drives her car a total of 800 miles in performing her voluntary work. Jane's deductible contribution isA) $0.B) $112.C) $11,700.D) $11,812.Answer: BExplanation: B) (800 miles × $.14/mile) = $112. The value of service provided is not deductible.Page Ref.: I:7-24 and I:7-25; Example I:7-29Objective: 4

87) Carol contributes a painting to a local museum for display. Her AGI is $60,000. Carol paid $22,000 for the painting in 2006, but its market value at the date of the contribution is $25,000. With no special elections, Carol's deductible contribution this year isA) $ 7,000.B) $18,000.C) $22,000.D) $25,000.Answer: BExplanation: B) The potential deduction is $25,000, the FMV as of the contribution, but it is limited by the percentage of AGI ceiling.$60,000 AGI× .30 Limitation on capital gain property to public charities$18,000 Charitable Contribution allowed for this year$ 7,000 CarryoverPage Ref.: I:7-25; Example I:7-30Objective: 4

88) Hugh contributes a painting to a local museum for display. His AGI is $35,000. Hugh paid $16,000 for the painting in 2000, but its market value at the date of the contribution is $22,000. If Hugh makes the election to maximize the current year deduction, his deductible contribution for this year will beA) $10,500.B) $16,000.C) $17,500.D) $22,000.Answer: BExplanation: B) To avoid the 30% of AGI ceiling ($10,500), he can elect to use the adjusted basis rather than FMV and instead apply the 50% of AGI ceiling.Page Ref.: I:7-25; Example I:7-30Objective: 4


89) Patrick's records for the current year contain the following information. He donated stock having a fair market value of $5,000 to a qualified charitable organization. Patrick acquired the stock two years ago at a cost of $3,000. He paid $1,000 for membership in an athletic scholarship program maintained by the university. The only benefit of the membership is that Patrick is entitled to purchase a season ticket to the university's home football games. He also donated $7,500 cash to a qualified charitable organization. Patrick's adjusted gross income for the year is $100,000. What is the amount of his charitable contribution deduction?A) $11,300B) $11,500C) $13,300D) $13,500Answer: CExplanation: C) FMV Stock $5,000Athletic Program ($1,000 × 0.80) 800Cash 7,500 Total $13,300Page Ref.: I:7-25Objective: 4

90) Grace has AGI of $60,000 in 2013 and 2014. She makes cash contributions to public charities of $34,000 in 2013 and $31,000 in 2014. Grace's charitable contribution carryover to 2015 isA) $0.B) $1,000.C) $4,000.D) $5,000.Answer: DExplanation: D) $60,000 AGI × 50% = $30,000 limit each year. Thus, from last year to this year, $4,000 was carried over. This year the total contributions were $31,000 + $4,000 carryover = $35,000. $30,000 is deductible with $5,000 carried over to next year.Page Ref.: I:7-25 and I:7-26; Example I:7-32Objective: 4


91) Daniel had adjusted gross income of $60,000, which consisted of $55,000 in wages and $5,000 in dividend income from taxable domestic corporations. His expenses include:

Investment counseling fee $800Attorney fee for preparing a will 200Union dues 350Tax return preparation fee 450

What is the net amount deductible by Daniel for the above items?A) $400B) $600C) $1,000D) $1,600Answer: AExplanation: A) Investment counseling fee $ 800 Will preparation—personal expense 0Union dues 350 Tax return preparation fee 450 Total 1,600 Minus: 2% of AGI (60,000 × 2%) ( 1,200)Net Deduction $ 400 Page Ref.: I:7-28 and I:7-29Objective: 6

92) Wang, a licensed architect employed by Skye Architects, incurred the following unreimbursed expenses this year:

Subscription to architectural journals $800Dues to Professional Architecture Society 400Tax return preparation 600Investment advice 500

Wang's AGI is $75,000. What is his net deduction for miscellaneous itemized deductions?A) $0B) $1,900C) $800D) $1,500Answer: CExplanation: C) ($800 + 400 + 600 + 500) - (.02 × 75,000) = $800Page Ref.: I:7-28 and I:7-29Objective: 6


93) Tasneem, a single taxpayer has paid the following amounts in 2014:

State income taxes $10,000Property taxes on home 4,000Mortgage interest on home 12,000Charitable contributions 14,000

Tasneem's AGI is $360,000. What is her net itemized deduction allowed?A) $40,000B) $38,352C) $36,826D) None of the above.Answer: CExplanation: C) $40,000 gross itemized deductions before phaseout - [($360,000 - $254,200) × .03] = $36,826 itemized deductions allowed.Page Ref.: I:7-29Objective: 6

94) Christa has made a $25,000 pledge to the American Red Cross (a public charity). Christa expects AGI of $200,000 this year. Which of the following assets should she donate? A) $25,000 of cashB) stock purchased three years ago for $18,000 with a current FMV of $25,000C) stock purchased six months ago for $28,000 with a current FMV of $25,000D) Christa should be indifferent among the three choices.Answer: BExplanation: B) All of the options will provide a deduction of $25,000, but the appreciated stock will provide the $25,000 deduction without recognizing the gain. Christa will never get the tax savings on the loss stock if she donates it.Page Ref.: I:7-31 to I:7-32; Example I:7-36Objective: 7

95) Which of the following is not required substantiation for a noncash charitable contribution?A) name and address of charitable organizationB) method used to determine the donated property's fair market valueC) date and location of property donatedD) use of donation by charitable organizationAnswer: DExplanation: D) Use of donation by charity is not required in the substantiation.Page Ref.: I:7-33Objective: 8


96) During the current year, Deborah Baronne, a single individual, paid the following amounts:

Federal income tax $10,000State income tax $4,000Real estate taxes on land in France $1,500Real estate taxes on land in U.S. $1,700State sales taxes $2,000State occupational license fee $ 600

How much can Deborah deduct in taxes as itemized deductions?Answer: $4,000 + 1,500 + 1,700 = $7,200. Page Ref.: I:7-9 through I:7-12Objective: 2

97) Phoebe's AGI for the current year is $120,000. Included in this AGI is $100,000 salary and $20,000 of interest income. In earning the investment income, Phoebe paid investment interest expense of $30,000. She also incurred the following expenditures subject to the 2% of AGI limitation:

Investment expenses:Subscriptions to investment journals $ 500Investment counseling 1,500Safe-deposit box rental for stock certificates 100

Noninvestment expenses:Unreimbursed employee business expenses $1,800

Tax return preparation fees (non-business-related) 500

What is Phoebe's investment interest expense deduction for the year?Answer: Investment expenses:

Subscriptions to investment journals $ 500 Investment counseling 1,500 Safe-deposit box rental 100

Total $2,100 Disallowed by the 2% limitation:

.02 × $120,000 $2,400 Unreimbursed employee expenses (1,800)Tax return preparation fees ( 500)

Investment expenses (remainder of 2% limit allocated to investment exp) ( 100)Deductible investment expenses $ 2,000

Net investment income ($20,000 - 2,000) $18,000

$18,000 is currently deductible; $12,000 is carried over and deducted in a subsequent year.Page Ref.: I:7-15 and I:7-16; Example I:7-16Objective: 3


98) On December 1, 2014, Delilah borrows $2,000 from her credit union to use in her business. Under the terms of the contract, Delilah actually receives $1,940 but is required to repay $2,000 in three months.a. What amount may Delilah deduct as interest expense in 2014 and in 2015 if she is a cash basis taxpayer?b. What amount may Delilah deduct as interest expense in 2014 and in 2015 if she is an accrual basis taxpayer?Answer: a. A cash basis taxpayer may deduct the full amount, $60, when the loan is repaid in 2015 but cannot deduct any in 2014.b. An accrual basis taxpayer may deduct 1/3 × $60 or $20 in 2014 and $40 in 2015.Page Ref.: I:7-20; Example I:7-22Objective: 3


99) During 2014 Richard and Denisa, who are married and have two dependent children, have the following income and losses:

Total salaries $150,000Bank account interest 25,000Short-term capital gains 4,000Short-term capital losses ( 1,500)

They also incurred the following expenses:Qualified medical expenses $ 8,000State income taxes paid 12,000Property taxes on home 2,300Qualified residence interest 9,000Investment interest expense 7,500Cash charitable contributions 15,000Tax return preparation fees 3,600Unreimbursed employee business expenses 4,000

Compute Richard and Denisa's taxable income for the year. (Show all calculations in good form.)Answer: Salaries $150,000 Interest income 25,000 Net STCG 2,500

AGI $177,500

Itemized deductions (49,850)Exemptions ($3,950 × 4) ( 15,800)Taxable income $ 111,850

Itemized deductions:Medical expenses [$8,000 - ($177,500 × 10%)] = $ 0 State income taxes 12,000 Property taxes 2,300 Interest on residence 9,000 Investment interest deduction - limited to net investment income

($27,500 interest income. No need to make elections) 7,500 Contributions - limited to 50% × AGI of $177,500 15,000 Misc. 2% deductions:

Unreimbursed employee business expenses$ 4,000 Tax return preparation fee 3,600

Subtotal 7,600Less: 2% × $177,500 AGI = ( 3,550)

Allowable 2% deductions 4,050 Itemized deductions $49,850 Page Ref.: This is a comprehensive problem. See text and examples throughout chapter.Objective: 7


100) Hope is a marketing manager at a local company. Information about her 2014 income and expenses is as follows:

Income receivedSalary $150,000Taxes withheld from salary:Federal income tax $30,000State income tax 8,000Social Security tax 7,254Medicare tax 2,175Interest income from bank 6,000Dividend income from U.S. stocks 4,000Short-term capital gain 2,000Long-term capital gain 3,000State income tax refund from last year 500Expenses paid:Unreimbursed dental and eyecare costs $1,800Property taxes on her home 3,900Fees paid to town for garbage pick-up 400Stock donated to American Red Cross; FMV $5,000; purchased three years ago for $3,100Dues paid to American Marketing Association 600Subscription to professional marketing journals 300Fee for preparation of 2013 tax return and IRS audit assistance 2,000Investment advisor fee 1,000Home mortgage interest 10,000Interest on borrowing to purchase investment assets 11,000Interest on car loan 1,100

Compute Hope's taxable income for the year in good form. Show all supporting computations. Hope is single, and she elects to itemize her deductions each year. Assume she does not make any elections regarding the investment interest expense. Also assume that her tax profile was similar in the preceding year.


Answer: Salary $150,000Interest income 6,000Dividends 4,000STCG 2,000LTCG 3,000State tax refund (tax benefit rule) 500AGI $165,500Itemized Deductions:Medical-Eyecare and dental costs $1,800- 10% AGI -16,550 $ 0Taxes-State income tax withheld $8,000Property tax 3,900Garbage fee and Social Security/Medicare tax 0 11,900Charitable contribution 5,000Miscellaneous-Unreimbursed employee business 600 + 300 900Tax advisor fees 2,000Investment advisor fee 1,000- 2% AGI -3,310 590Interest-Home mortgage interest $10,000Investment interest (see below) 7,410Car loan interest 0 17,410Total itemized deductions $34,900Personal exemption 3,950 Taxable income $126,650

Investment interest expense calculation:Interest income 6,000STCG 2,000 $8,000Deducted investment expense-Investment advisor fee $1,0002% floor offset- 3,310Employee business expense -900Tax advisor fee -2,000 -410 -590Net investment income ceiling $7,410Allowable deduction--lesser of $11,000 Interest paid or $7,410 ceiling $7,410$3,590 is carried forwardPage Ref.: This is a comprehensive problem. See text and examples throughout chapter.Objective: 7


101) Explain under what circumstances meals and lodging en route to a medical facility may be deductible.Answer: Certain courts have held that the cost of meals is deductible while enroute if the trip to the medical facility is long enough to warrant a meal. The lodging is only deductible if the following three criteria are met: (1) the travel to the medical facility was primarily for and essential to the medical care, (2) there was no significant personal pleasure or recreation in the travel, and (3) the individual receives treatment in a licensed hospital or its equivalent.Page Ref.: I:7-4Objective: 1

102) Explain when the cost of living in an institution other than a hospital may be deductible.Answer: If an individual is living in an institution other than a hospital, such as a nursing home, the deductibility of the related costs depends on the individual facts and circumstances. If the principal reason the taxpayer is in the institution is the need for and availability of medical care furnished by the institution, all costs of meals, lodging, and other services necessary for furnishing the medical care are qualified medical expenditures and may be deductible. However, if the individual is in the institution primarily for considerations other than the furnishing of medical care, only costs directly associated with the furnishing of medical care are deductible. The costs of meals, lodging, and other services are not qualified medical expenditures.Page Ref.: I:7-6Objective: 1

103) Discuss the timing of the allowable medical expense deduction.Answer: Generally, a deduction for medical expenses is allowed only in the year in which the expenses are actually paid, regardless of the taxpayer's method of accounting or when the event that caused the expenditure occurs. For example, if medical care is received during the year but remains unpaid as of the end of the year, the deduction for that care is deferred until the year in which payment occurs. If medical care is prepaid, no deduction is allowed until the year the care is actually rendered unless there is a legal obligation to pay or unless the prepayment is a prerequisite to receipt of the medical care. If the obligation is charged on a credit card, payment is deemed to have been made on the date of the charge, not on the later date when the credit card balance is paid.Page Ref.: I:7-6 and I:7-7Objective: 1

104) Patrick and Belinda have a twelve year old son, Aidan, who is autistic. Patrick and Belinda pay tuition of $20,000 annually for Aidan to attend a school for autistic children. What tax issues should be considered? What additional information would you need?Answer: Will the tuition qualify as a deductible medical expense?Other information needed is:Does the school provide any medical services?Does Aidan go to the school only during the day, or is it a boarding school?Do Patrick and Belinda receive any reimbursement for the tuition paid to the school?What is their AGI?Page Ref.: I:7-4Objective: 1


105) Discuss what circumstances must be met for personal property taxes to be deductible.Answer: Two basic tests must be met in order for a personal property tax to be deductible. The first is that the tax must be an ad valorem tax on personal property. This means a tax is imposed based on the value of the property. The second requirement is that the tax must be imposed on an annual basis, even if the tax is not paid annually.Page Ref.: I:7-10Objective: 2

106) Explain why interest expense on investments is limited to net investment income.Answer: With no limitation, high-income taxpayers could realize significant tax savings by borrowing large amounts of money for investments that appreciate in value but that produce no current income. This would allow the taxpayer to have a large interest expense deduction in the current year to offset current high ordinary income and enjoy tax savings at ordinary tax rates while deferring the tax on the capital gain on the investments until they are sold and then paying taxes at the preferential capital gain rate.Page Ref.: I:7-14Objective: 3

107) When are points paid on a loan deductible as interest expense?Answer: Points paid for the purchase, construction, or substantial improvement of a taxpayer's principal residence are deductible if the loan is secured by the residence and the payment of points is an established business practice in that particular area. Points paid on a loan to purchase property other than a principal residence or to refinance a mortgage on a principal residence must be capitalized and amortized over the life of the loan.Page Ref.: I:7-17 and I:7-18; Example I:7-19Objective: 3

108) Sharif is planning to buy a new car for personal use and will need to take out a loan. His sources of the financing include (1) a loan from the car dealership charging 6% interest, (2) a loan from his brokerage firm secured against his stock portfolio charging 6.2% and (3) a home equity bank loan secured against his home charging 7%. Sharif has AGI of $150,000 and does itemize his deductions. He is in the 28% tax bracket. Discuss how income taxes can influence his decision regarding the source of financing.Answer: Interest on the car dealership loan will be considered personal interest expense and will not be deductible at all so the after-tax cost of borrowing will be 6%. The loan from the brokerage firm will also be considered a personal loan so the interest will not be deductible. Therefore the after-tax cost will be 6.2%. Securing the loan against the stock portfolio does not turn the interest expense into investment interest expense. Assuming Sharif has net equity in his home at least equal to the loan principle needed for the car purchase (and that the loan does not exceed $100,000), interest on the home equity loan will be treated as qualified residential interest and therefore deductible. The after-tax cost of borrowing will be 5.04% [.07 × (1 - .28)]. The home equity loan will provide the lowest cost means of financing the car purchase.Page Ref.: I:7-14 through I:7-19Objective: 3


109) May an individual deduct a charitable contribution for services rendered to a charitable organization?Answer: No deduction is allowed for the value of the services provided. The unreimbursed expenses incurred in performing the services are deductible. For example, actual out-of pocket transportation expenses (or 14 cents a mile), the cost of lodging and 50% of the cost of meals while away from home, and the cost of a uniform without general utility that is required to be worn in performing the donated services are deductible. No deduction is allowed for traveling expense while away from home unless there is no significant element of personal pleasure, recreation, or vacation in such travel.Page Ref.: I:7-24 and I:7-25Objective: 4

110) What is the result if a taxpayer makes a contribution to a college or university and in return receives the right to purchase tickets to athletic events?Answer: The taxpayer may only deduct 80% of the payment to the college or university as a charitable contribution.Page Ref.: I:7-25Objective: 4

111) What is the treatment of charitable contributions in excess of the applicable limits for the current year?Answer: The charitable contribution in excess of the limits is carried forward to the subsequent five tax years. These carryovers are subject to the same limitations that apply in the subsequent years. That is, a contribution carryover subject to the 30% limit remains subject to the 30% limit in the carryover years. Carryovers may only be deducted to the extent that the limit in the subsequent year exceeds the contributions made during that year.Page Ref.: I:7-26Objective: 4

112) Explain how tax planning may allow a deduction of qualified medical expenses.Answer: Medical expenses may be pushed into one year so that the total exceeds 10% of the taxpayer's AGI (7.5% for those 65 and older). New eyeglasses, contact lenses, or other non-time sensitive dental treatments are examples.

If medical treatment has already been received, the medical expenses may be pushed into one year by borrowing cash to pay the expenses or by using a credit card. Page Ref.: I:7-30Objective: 7


113) Explain what types of tax planning are available for taxpayers making charitable contributions.Answer: 1. A taxpayer who plans to sell a substantially appreciated long term capital asset and contribute the cash proceeds to charity should instead donate the property directly to charity. A direct donation will give the taxpayer a deduction equal to FMV of the property and will avoid a gain on the property's disposition. On the other hand, if a taxpayer is planning to contribute a capital asset that has declined in the value, the taxpayer should sell the property, recognize the loss and contribute the cash.

2. Taxpayers who don't have any other large itemized deductions may want to bunch their charitable contributions into one year and then take the standard deduction in a year when they don't make substantial charitable contributions.

3. A contribution of long-term capital gain property to a public charity is subject to a 30% of AGI limit. An election can be made to have the property subject to a 50% of AGI limit. This election reduces the amount of contribution of the property's FMV by the gain that would have been realized had the property been sold. Thus, this election should only be made in special circumstances. (e.g. the 30% limit applies and there is little difference between the property's FMV and its basis).Page Ref.: I:7-31 and I:7-32Objective: 7

114) Jill is considering making a donation to her church. She wants to give $50,000 for the new church building. She has some stock with a FMV of $50,000 and an adjusted basis of $10,000 that she has held for 3 years. She is planning to sell the stock and donate the $50,000 proceeds to the church. What should she consider before taking that action?Answer: If Jill sells the stock, she will realize a long-term capital gain of $40,000 on which she will pay 15% tax ($6,000) if she has no losses against which to offset the gain. Her after-tax proceeds will be $44,000 and she will need an additional $6,000 to donate $50,000 to the church. However, when a taxpayer donates long-term capital gain property, the amount of the contribution is the FMV of the property. Thus, Jill gets a tax deduction of $50,000 (subject to the charitable contribution limits).Page Ref.: I:7-31 to I:7-32; Example I:7-36Objective: 7


chapter i7

Documents

medical expenses

deductible medical expense

deductible expenses

preventative medical

definition of medical

specific medical condition

false explanation

certified medical doctor