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Ch. 6 Tax

1. For the following statements, indicate either “True” or “False” regarding what is the “actually paid” requirement for the deduction of an expense by a cash basis taxpayer.

a. The expenses of cash basis taxpayers are deductible only when they are actually paid with cash but not property.
_________________
b. Promising to pay or issuing a note does not satisfy the actually paid requirement.
_________________
c. At the time taxpayers charge expenses on their credit cards, they are allowed to claim the deduction.
_________________

A. False, The expenses of cash basis taxpayers are deductible only when they are actually paid with cash OR other property.

B. True, Promising to pay or issuing a note does not satisfy the actually paid requirement

C. True, it’s just true.

2. Ray loses his job as a result of a corporate downsizing. Consequently, he falls behind on the mortgage payments on his personal residence. His friend Ted would like to make the delinquent mortgage payments for him.

a. Could the payments be structured so that Ray can deduct the mortgage interest?
_________________
b. Could the payment arrangement deny both Ray and Ted a mortgage interest deduction?
_________________
c. Could the payments be structured so that Ted could deduct the mortgage interest?
_________________

A. Yes, if Ted gifts money to Ray so that he can make the payment then he can deduct.

B. Yes, If ted just pays the mortgage directly Ray cannot deduct

C. No, Ted can never claim a deduction for payments on someone else’s behalf.

3. Trevor, a friend of yours from high school, works as a server at the ST Café. He asks you to help him prepare his Federal income tax return. When you inquire about why his bank deposits substantially exceed his tip income, he confides to you that he is a bookie on the side. Trevor then provides you with the following documented income and expenses for the year:

Tip income $16,000
Gambling income 52,000

Gambling expenses:
Payouts to winners 29,000
Employee compensation 8,000
Bribe to police officer who is aware of Trevor’s bookie activity 7,500

a. The effect of the illegal gambling business on Trevor’s AGI is as follows.
Note: If an amount is zero, enter “0.”

Gross income (from gambling) $ _________________
Deductible expenses:
Salaries $ _________________
Payouts to winners _________________
Bribe to police officer _________________
Subtotal _________________

Increase in AGI $ _________________

b. His taxable income Increased / decreased by $ _________________

a. The effect of the illegal gambling business on Trevor’s AGI is as follows.
Note: If an amount is zero, enter “0.”

Gross income (from gambling) $ 52,000
Deductible expenses:
Salaries $ 8,000
Payouts to winners 29,000
Bribe to police officer 0
Subtotal 37,000

Increase in AGI $ 15,000

b. His taxable income Increased by $ 15,000.

4. Fines and penalties paid for violations of the law (e.g., illegal dumping of hazardous waste) are deductible only if they relate to a trade or business.
a. True b. False
B. False
5. Legal expenses incurred in connection with rental property are deductions from AGI.
a. True b. False
b. False, For AGI because if it’s related to business income, usually above the line.
6. For a taxpayer who is engaged in a trade or business, the cost of investigating a business in the same field is deductible only if the taxpayer acquires the business.
a. True b. False
b. False, The tax result is the same whether or not the taxpayer acquires the business being investigated.
7. In determining whether an activity should be classified as a business or as a hobby, the satisfaction of the presumption (i.e., profit in at least 3 out of 5 years) ensures treatment as a business.
a. True b. False
b. False, does not ensure because the IRS bears the burden of proving the activity is personal rather than trade or business. (TRICKY)
8. If an activity involves horses, a profit in at least two of seven consecutive years meets the presumptive rule of § 183.
a. True b. False
a. True
9. Hobby activity expenses are deductible from AGI to the extent of hobby income. Such expenses not in excess of hobby income are not subject to the 2% of AGI floor.
a. True b. False
b. False, depends on the expense but the first part is true.
10. Martha rents part of her personal residence in the summer for 3 weeks for $3,000. Anne rents all of her personal residence for one week in December for $2,500. Anne is not required to include the $2,500 in her gross income whereas Martha is required to include the $3,000 in her gross income.
a. True b. False
a. True, if it is rented out for fewer than 15 days the income is EXCLUDED from gross income
11. Walt wants to give his daughter $1,800 for Christmas. As an alternative, she suggests that he pay the property taxes on her residence. If Ralph pays the property taxes, he can deduct them.
a. True b. False
b. False, can never deduct interest for payments made on another persons behalf.
12. For purposes of the § 267 loss disallowance provision, a taxpayer’s aunt is a related party.
a. True b. False
b. False, related parties are brothers and sisters , whether spouse, ancestors (parents, grandparents), and lineal descendants (children and grandchilren) of the taxpayer. AUNT IS NOT INCLUDED
13. Sammy, a calendar year cash basis taxpayer who is age 66, has the following transactions:
• Salary from job – $90,000
• Alimony received from ex-wife – 10,000
• Medical expenses – 8,000

Based on this information, Sammy has:
a. Deduction of medical expenses of $0.
b. AGI of $90,000.
c. AGI of $99,500.
d. None of these choices are correct.
e. AGI of $95,000.

d. None of these choices are correct
14. Al is single, age 60, and has gross income of $140,000. His deductible expenses are as follows:
• Alimony – $20,000
• Charitable contributions – 4,000
• Contribution to a traditional IRA – 5,500
• Expenses paid on rental property – 7,500
• Interest on home mortgage and property taxes on personal residence – 7,200
• State income tax – 2,200

What is Al’s AGI?
a. $107,000.
b. $103,000.
c. $94,100.
d. None of these choices are correct.
e. $127,000.

What is Al’s AGI?
a. $107,000, to get AGI only deduct above the line items. (140,000 – 20,000 – 5,550 – 7,500=107,000)
15. Marsha is single, had gross income of $50,000, and incurred the following expenses:

• Charitable contribution $2,000
• Taxes and interest on home 7,000
• Legal fees incurred in a tax dispute 1,000
• Medical expenses 3,000
• Penalty on early withdrawal of savings250

Her AGI is:
a. $40,000.
b. $30,750.
c. None of these choices are correct.
d. $49,750.
e. $39,750.

Her AGI is:
d. $49,750, penalty on early withdrawal of savings $250
16. Which of the following can be claimed as a deduction for AGI?
a. None of these choices are correct.
b. Medical expenses.
c. Property taxes on personal use real estate.
d. Investment interest expenses.
e. Personal casualty losses.
a. None of these choices are correct.
17. Which of the following legal expenses are deductible for AGI?
a. Incurred for tax advice relative to the preparation of an individual’s income tax return.
b. Only “Incurred in connection with a trade or business” and “Incurred in connection with rental or royalty property held for the production of income” qualify.
c. Incurred in connection with a trade or business.
d. “Incurred in connection with a trade or business”, “Incurred in connection with rental or royalty property held for the production of income”, and “Incurred for tax advice relative to the preparation of an individual’s income tax return” qualify.
e. Incurred in connection with rental or royalty property held for the production of income.
b. Only “Incurred in connection with a trade or business” and “Incurred in connection with rental or royalty property held for the production of income” qualify.
18. Andrew, who operates a laundry business, incurred the following expenses during the year.
• Parking ticket of $250 for one of his delivery vans that parked illegally.
• Parking ticket of $75 when he parked illegally while attending a rock concert in Tulsa.
• DUI ticket of $500 while returning from the rock concert.
• Attorney’s fee of $600 associated with the DUI ticket.

What amount can Andrew deduct for these expenses?
a. None of these choices are correct.
b. $1,425.
c. $0.
d. $250.
e. $600.

c. $0. (Note that attorney fees are not deductible)
19. Which of the following may be deductible?
a. Fines paid for violations of the law.
b. Bribes that relate to a U.S. business.
c. Interest on a loan used in a hobby.
d. None of these choices are correct.
e. All of these choices are correct.
c. Interest on a loan used in a hobby.
20. Tom operates an illegal drug-running operation and incurred the following expenses:
• Salaries $ 75,000
• Illegal kickbacks 20,000
• Bribes to border guards 25,000
• Cost of goods sold 160,000
• Rent 8,000
• Interest 10,000
• Insurance on furniture and fixtures6,000
• Utilities and telephone 20,000

Which of the above amounts reduces his taxable income?
a. $324,000.
b. $160,000.
c. $279,000.
d. $0.
e. None of these choices are correct.

b. $160,000. He’s a drug dealer so nothing else can be deducted except COGS.
27. Indicate whether each of the following items is a “Deduction for AGI” or a “Deduction from AGI”.
a. The deduction for part of the self-employment tax paid by a self-employed taxpayer.
_________________
b.
The deductions attributable to property held for the production of rents and royalties.
_________________
c. The deduction for personal casualty losses.
_________________
d.
The deduction for payment of alimony.
_________________
e. The deduction for contributions to qualified charitable organizations.
_________________
f. The deduction for certain retirement savings allowed by § 219 (e.g., traditional IRAs).
_________________
a. The deduction for part of the self-employment tax paid by a self-employed taxpayer.
For

b.
The deductions attributable to property held for the production of rents and royalties.
For

c. The deduction for personal casualty losses.
From

d.
The deduction for payment of alimony.
For

e. The deduction for contributions to qualified charitable organizations.
From

f. The deduction for certain retirement savings allowed by § 219 (e.g., traditional IRAs).
For

21. Iris, a calendar year cash basis taxpayer, owns and operates several TV rental outlets in Florida, and wants to expand to other states. During 2014, she spends $14,000 to investigate TV rental stores in South Carolina and $9,000 to investigate TV rental stores in Georgia. She acquires the South Carolina operations, but not the outlets in Georgia. As to these expenses, Iris should:

a. Capitalize $23,000.

b. Expense $9,000 for 2014 and capitalize $14,000.

c. None of these choices are correct.

d. Capitalize $14,000 and not deduct $9,000.

e. Expense $23,000 for 2014.

e. Expense $23,000 for 2014.
22. Which of the following statements is correct in connection with the investigation of a business?

a. If the business is acquired, the expenses may be deducted immediately by a taxpayer engaged in a similar trade or business regardless of whether the business being investigated is acquired.

b. Regardless of whether the taxpayer is already engaged in the trade or business, the expenses must be capitalized and amortized.

c. None of these choices are correct.

d. That business must be related to the taxpayer’s present business for any expense ever to be deductible.

e. If the taxpayer is not already engaged in the trade or business, the expenses incurred are deductible if the project is abandoned.

a. If the business is acquired, the expenses may be deducted immediately by a taxpayer engaged in a similar trade or business regardless of whether the business being investigated is acquired.
23. For an activity classified as a hobby, the expenses are categorized as follows:
(1) Amounts that affect adjusted basis and would be deductible under other Code sections if the activity had been engaged in for profit (e.g., depreciation, amortization, and depletion).
(2) Amounts deductible under other Code sections without regard to the nature of the activity, such as property taxes and home mortgage interest.
(3) Amounts deductible under other Code sections if the activity had been engaged in for profit, but only if those amounts do not affect adjusted basis (e.g., maintenance, utilities, and supplies).

If these expenses exceed the gross income from the activity and are thus limited, the sequence in which they are deductible is:
a. (2), (1), (3).
b. (1), (2), (3).
c. (1), (3), (2).
d. (2), (3), (1).
e. (3), (2), (1).

d. (2), (3), (1).
24. If a residence is used primarily for personal use (rented for fewer than 15 days per year), which of the following is correct?
a. No expenses are deductible.
b. Expenses must be allocated between rental and personal use.
c. “No income is included in AGI”, “No expenses are deductible”, and “Expenses must be allocated between rental and personal use” are correct.
d. Only “No income is included in AGI” and “No expenses are deductible” are correct.
e. No income is included in AGI.
e. No income is included in AGI.
25. Robyn rents her beach house for 60 days and uses it for personal use for 30 days during the year. The rental income is $6,000 and the expenses are as follows:
• Mortgage interest $9,000
• Real estate taxes 3,000
• Utilities 2,000
• Maintenance 1,000
• Insurance 500
• Depreciation (rental part)4,000

Using the IRS approach, total expenses that Robyn can deduct on her tax return associated with the beach house are:
a. $0.
b. $8,000.
c. $12,000.
d. None of these choices are correct.
e. $6,000.

c. $12,000, can only deduct regular expenses, and then other expenses only up to income but because 12000 is more than 6000 you can’t deduct anything.
26. Melba incurred the following expenses for her dependent daughter during the current year:
• Payment of principal on daughter’s automobile loan $3,600
• Payment of interest on above loan 2,900
• Payment of daughter’s property taxes 1,800
• Payment of principal on daughter’s personal residence loan 2,800
• Payment of interest on daughter’s personal residence loan 7,000

How much may Melba deduct in computing her itemized deductions?
a. $8,800.
b. $18,100.
c. None of these choices are correct.
d. $11,700.
e. $0.

e. $0.

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