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Practice Test II

True/False Indicate whether the statement is true or false. ____ ____ 1. A taxpayer who claims the standard deduction can also deduct expenses that are classified as deductions for AGI. 2. A taxpayer in the 25% tax bracket may receive a different tax benefit for a $100 expenditure that is classified as a deduction from AGI than he or she will receive for a $100 expenditure that is classified as a deduction for AGI. 3. Rob, a shareholder-employee of Falcon, Inc., receives a $300,000 salary. The IRS classifies $100,000 of this amount as unreasonable compensation. The effect of this reclassification is to decrease Robs gross income by $100,000. 4. Using his bank credit card, Seneca, a cash method taxpayer, charged a business expense on December 5, 2008. He paid the credit card bill, which included the charge, on January 23, 2009. Seneca can deduct the expense in 2008. 5. The period in which an accrual basis taxpayer can deduct an expense is determined by applying the economic performance test. 6. Payments that violate public policy are not necessary expenses and therefore are not deductible. 7. The cost of legal advice associated with the preparation of an individuals Federal income tax return is not deductible because it is a personal expense. 8. If a business debt previously deducted as partially worthless becomes totally worthless this year, only the amount not previously deducted can be deducted this year. 9. In determining whether a debt is a business or nonbusiness bad debt, the debtors use of the borrowed funds is not important.

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____ 10. A loss is allowed for a security that declines in value. ____ 11. An individual taxpayer must treat a gain on the sale of 1244 small business stock as ordinary gain. ____ 12. If a storm damages a taxpayers residence and car, the loss on the residence and the loss on the car must each be reduced by $100. ____ 13. A taxpayer must carry any NOL incurred back two years. ____ 14. The basis of cost recovery property must be reduced by the cost recovery allowed and by not less than the cost recovery allowable. ____ 15. Personal use property that is subject to wear and tear is eligible for cost recovery. ____ 16. Land improvements are generally not eligible for cost recovery.

____ 17. Under the MACRS half-year convention, an asset sold on December 10 will be treated as though it were sold on July 1 for a calendar year taxpayer. ____ 18. Under MACRS, if the mid-quarter convention is applicable, all property is treated as being placed in service during the fourth quarter. ____ 19. The 179 deduction can exceed $250,000 in 2008 if the taxpayer had a 179 amount which exceeded the taxable income limitation in the prior year. ____ 20. The amortization period for $4,000 of start-up expenses is 180 months. Multiple Choice Identify the choice that best completes the statement or answers the question. ____ 21. Which of the following are deductions for AGI? a. Qualified moving expenses. b. Reimbursed employee business expenses. c. Alimony. d. Only a. and c. e. a., b., and c. ____ 22. Saul is single, under age 65, and has gross income of $50,000. His deductible expenses are as follows: Alimony Charitable contributions Contribution to a traditional IRA Expenses paid on rental property Interest on home mortgage and property taxes on personal residence State income tax What is Sauls AGI? a. $15,800. b. $27,000. c. $32,000. d. $33,000. e. None of the above. ____ 23. Which of the following is not a trade or business expense? a. Interest on business indebtedness. b. Property taxes on business property. c. Parking ticket paid on business auto. d. Depreciation on business property. e. All of the above are trade or business expenses. ____ 24. Angela, a real estate broker, had the following income and expenses in her business: Commissions income Expenses: Commissions paid to non-brokers for referrals (illegal under state law and subject to criminal penalties) $100,000 20,000 $12,000 2,000 5,000 6,000 7,000 2,200

Commissions paid to other real estate brokers for referrals (not illegal under state law) Travel and transportation Supplies Office and phone Parking tickets How much net income must Angela report from this business? a. $48,500. b. $49,000. c. $60,000. d. $68,500. e. $69,000.

10,000 12,000 4,000 5,000 500

____ 25. Terry and Jim are both involved in operating illegal businesses. Terry operates a gambling business and Jim operates a drug running business. Both businesses have gross revenues of $500,000. The businesses incur the following expenses. Employee salaries Bribes to police Rent and utilities Cost of goods sold Terry $200,000 25,000 50,000 -0Jim $200,000 25,000 50,000 125,000

Which of the following statements is correct? a. Neither Terry nor Jim can deduct any of the above items in calculating the business profit. b. Terry should report profit from his business of $250,000. c. Jim should report profit from his business of $500,000. d. Jim should report profit from his business of $250,000. e. None of the above. ____ 26. Vera is the CEO of Brunettes, a publicly held corporation. For the year, she receives a salary of $950,000, a bonus of $600,000, and contributions to her retirement plan of $35,000. The bonus was awarded at the December board meeting based on Veras threat to accept a better paying job with a competitor. What amount may Brunettes deduct? a. $950,000. b. $985,000. c. $1,550,000. d. $1,585,000. e. None of the above. ____ 27. Which of the following statements is correct in connection with the investigation of a business? a. If the taxpayer is not already engaged in the trade or business, the expenses incurred are deductible if the project is abandoned. b. If the business is acquired, the expenses may be deducted immediately by a taxpayer engaged in a similar trade or business. c. That business must be related to the taxpayers present business for any expense ever to be deductible. d. Regardless of whether the taxpayer is already engaged in the trade or business, the expenses must be capitalized and amortized. e. None of the above.

____ 28. Which of the following is correct? a. If an activity is classified as a trade or business, the net loss can be deducted. b. If an activity is classified as a hobby, none of the expenses can be deducted. c. If an activity is classified as a hobby, part of the expenses may be deductible. d. Only a. and c. are correct. e. a., b., and c. are correct. ____ 29. Cory incurred and paid the following expenses: Tax return preparation fee Moving expenses Investment expenses Expenses associated with rental property Interest expense associated with loan to finance tax-exempt bonds Calculate the amount that Cory can deduct (before any percentage limitations). a. $5,000. b. $4,600. c. $3,000. d. $1,500. e. None of the above. ____ 30. Which of the following statements is correct? a. If a personal residence is rented for fewer than 15 days, the rent income is not included in gross income and no expenses can be deducted. b. If a personal residence is rented for more than 14 days, the rent income must be included in gross income and all the related expenses can be deducted. c. If a personal residence is rented for more than 14 days and the personal use days exceed 14 days and 10% of the rental days, the rent income must be included in gross income, but the expense deductions are limited to the amount of gross income. d. Only a. and b. e. Only a. and c. ____ 31. Jed is an electrician. Jed and his wife are cash basis taxpayers and file a joint return. Jed wired a new house for Alison and billed her $15,000. Alison paid Jed $10,000 and refused to pay the remainder of the bill, claiming the fee to be exorbitant. Jed took Alison to Small Claims Court for the unpaid amount and was awarded a $2,000 judgement. Jed was never able to collect the judgement nor the remainder of the bill from Alison. What amount of loss may Jed deduct in the current year? a. $0. b. $2,000. c. $3,000. d. $5,000. e. None of the above. ____ 32. Jones Corporation incurred a $10,000 bad debt in the current year. Jones Corporation also had a $6,000 longterm capital gain during the current year. How should Jones report the bad debt deduction on the tax return? a. $0 bad debt deduction. b. $3,000 bad debt deduction. c. $4,000 bad debt deduction. d. $10,000 bad debt deduction. e. None of the above. $ 600 2,000 500 1,500 400

____ 33. John files a return as a single taxpayer. In 2008, he had the following items: Salary of $70,000. Loss of $65,000 on the sale of 1244 stock acquired two years ago. Interest income of $8,000. Determine Johns AGI for 2008. a. $13,000. b. $25,000. c. $28,000. d. $75,000. e. None of the above. ____ 34. Which of the following events would produce a deductible loss? a. Erosion of personal use land due to rain or wind. b. Termite infestation of a personal residence over a several year period. c. Damages to personal automobile resulting from a taxpayers willful negligence. d. A stolen diamond ring. e. None of the above. ____ 35. During the year, Rick had the following insured personal casualty losses (arising from one casualty). Rick also had $18,000 AGI for the year. Fair Market Value Before $ 700 2,000 900 Insurance After $300 -0-0Recovery $100 500 200

Asset A B C

Adjusted Basis $ 500 3,000 700

Ricks casualty loss deduction is: a. $400. b. $600. c. $1,000. d. $1,400. e. None of the above. ____ 36. During the current year, Ned and Mary had the following items: Salary Personal use casualty gain Personal use casualty loss (after $100 floor) Other itemized deductions $40,000 10,000 17,000 4,000

Assuming that Ned and Mary file a joint return, determine their taxable income for the current year. a. $22,100. b. $26,000. c. $27,200. d. $30,200. e. None of the above. ____ 37. During the current year, Juans home was burglarized. Juan had the following items stolen:

Securities worth $15,000. Juan purchased the securities four years ago for $20,000. New tools which Juan had purchased two weeks earlier for $6,000. Juan uses the tools in making repairs at an apartment house that he owns and manages. An antique worth $12,000. Juan inherited the antique (a family keepsake) when the property was worth $9,000.

Juans homeowners policy had a $50,000 deductible clause for thefts. If Juans salary for the year is $60,000, determine the amount of his itemized deductions as a result of the theft. a. $3,500. b. $6,000. c. $23,500. d. $28,900. e. None of the above. ____ 38. Blue Corporation incurred the following expenses in connection with the development of a new product: Salaries Utilities Materials Advertising Market survey Depreciation on machine $100,000 18,000 25,000 5,000 3,000 9,000

Blue expects to begin selling the product next year. If Blue elects to expense research and experimental expenditures, determine the amount of the deduction for research and experimental expenditures for the current year. a. $0. b. $118,000. c. $143,000. d. $152,000. e. $160,000. ____ 39. Wu, who is single, has the following items for 2008: Salary Itemized deductions ($27,000 attributable to casualty loss) What is Wus NOL for 2008? a. $0. b. $2,000. c. $15,000. d. $25,000. e. None of the above. ____ 40. Steve and Holly have the following items for 2008: Dividend income Interest income Itemized deductions (none of the amount resulted from a casualty loss) Business capital gains $5,000 6,000 (9,000) 1,000 $25,000 (32,000)

Business capital losses

(3,000)

In calculating their net operating loss, and with respect to the above amounts only, what amount must be added back to taxable income (loss)? a. $0. b. $1,300. c. $1,900. d. $3,000. e. None of the above. ____ 41. Grape Corporation purchased a machine in December of the current year. This was the only asset purchased during the current year. The machine was placed in service in February of the following year. No assets were purchased in the following year. Grape Corporations cost recovery would begin: a. In the current year using a mid-quarter convention. b. In the current year using a half-year convention. c. In the following year using a mid-quarter convention. d. In the following year using a half-year convention. e. None of the above. ____ 42. On June 1 of the current year, Tab converted a machine to rental property. At the time of the conversion, the machine was worth $90,000. Five years ago Tab purchased the machine for $120,000. The machine is still encumbered by a $50,000 mortgage. What is the basis of the machine for cost recovery? a. $70,000. b. $90,000. c. $120,000. d. $140,000. e. None of the above. ____ 43. James purchased a new business asset (three-year property) on July 23, 2008, at a cost of $50,000. He did not elect to expense any of the asset under 179, nor did he elect straight-line cost recovery. Determine the cost recovery deduction for 2008. a. $8,333. b. $16,665. c. $33,333. d. $41,665. e. None of the above. ____ 44. Bonnie purchased a new business asset (five-year property) on March 10, 2008, at a cost of $20,000. She also purchased a new business asset (seven-year property) on November 20, 2008, at a cost of $13,000. Bonnie did not elect to expense either of the assets under 179, nor did she elect straight-line cost recovery. Determine the cost recovery deduction for 2008 for these assets. a. $5,858. b. $7,464. c. $9,586. d. $19,429. e. None of the above. ____ 45. Cora purchased a hotel building on May 17, 2008, for $3,000,000. Determine the cost recovery deduction for 2009. a. $48,150. b. $59,520. c. $69,000.

d. $109,080. e. None of the above. ____ 46. On June 1, 2008, Sam purchased a truck for $50,000. The truck weighed less than 13,000 lbs and Sam used the truck in connection with his farming business. Sam does not elect to expense assets under 179. Sam has, however, made an election to not have the uniform capitalization rules apply to the farming business. Sam does elect not to take additional first-year depreciation. Determine the cost recovery deduction for 2008. a. $5,000. b. $7,500. c. $10,000. d. $12,500. e. None of the above. ____ 47. White Company acquires a new machine (seven-year property) on January 10, 2008, at a cost of $840,000. White makes the election to expense the maximum amount under 179. No election is made to use the straight-line method. Determine the total deductions in calculating taxable income related to the machine for 2008 assuming White has taxable income of $500,000. a. $143,162. b. $161,162. c. $570,014. d. $660,009. e. None of the above. ____ 48. Hans purchased a new passenger automobile on August 17, 2008, for $40,000. During the year the car was used 40% for business and 60% for personal use. Determine his cost recovery deduction for the car for 2008. a. $500. b. $1,000. c. $1,224. d. $1,500. e. None of the above. ____ 49. Bhaskar purchased a new factory building on September 2, 2008, for $4,000,000. He elected the alternative depreciation system (ADS). Determine the cost recovery deduction for 2009. a. $30,000. b. $36,000. c. $44,000. d. $100,000. e. None of the above. ____ 50. Orange Corporation begins business on April 2, 2008. The corporation has start-up expenditures of $54,000. If Orange Corporation elects 195, determine the total amount that Orange may deduct in 2008. a. $1,000. b. $2,650. c. $3,650. d. $5,000. e. None of the above.

Practice Test II Answer Section


TRUE/FALSE 1. ANS: T A taxpayer can deduct both items. PTS: 1 REF: p. 6-2 2. ANS: T The value of the tax benefit for the deduction from AGI may be less than that for the deduction for AGI. The value of the deduction for AGI for a taxpayer in the 25% bracket for a $100 expenditure is $25 ($100 25%). If the taxpayer takes the standard deduction rather than itemizing deductions, then the $100 expenditure that is classified as a deduction from AGI has no tax benefit. PTS: 1 REF: Example 1 3. ANS: F While Robs salary income decreases by $100,000, his dividend income increases by $100,000. Thus, his gross income does not change. PTS: 1 REF: Example 6 4. ANS: T At the time Seneca used the bank credit card, he is deemed to have simultaneously borrowed money from the credit card issuer and constructively paid the expense. PTS: 1 REF: p. 6-9 5. ANS: T PTS: 1 REF: p. 6-10 6. ANS: T PTS: 1 REF: p. 6-11 7. ANS: F This deduction is expressly allowed under 212. PTS: 1 REF: p. 6-12 8. ANS: T PTS: 1 REF: p. 7-3 9. ANS: T The use of the funds by the debtor is of no consequence in making the determination. The determination is made at the creditor level. PTS: 1 REF: p. 7-4 10. ANS: F A loss is allowed for securities that become completely worthless during the tax year. PTS: 1 REF: p. 7-6 11. ANS: F Gain on 1244 small business stock is treated as capital gain. PTS: 1 REF: p. 7-7 12. ANS: F The $100 floor is per event.

PTS: 1 REF: p. 7-11 13. ANS: F A taxpayer may elect to forgo the carryback period. PTS: 1 REF: p. 7-21 14. ANS: T PTS: 1 REF: p. 8-3 | p. 8-4 15. ANS: F Personal use property is not eligible for cost recovery. PTS: 1 REF: p. 8-3 16. ANS: F Land improvements are 15-year class property. PTS: 1 REF: p. 8-6 17. ANS: T PTS: 1 REF: p. 8-7 18. ANS: F The property is treated as being placed in service at the mid-point of the quarter in which the property is placed in service. PTS: 1 REF: p. 8-9 19. ANS: F The 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1) the statutory dollar amount ($250,000 in 2008) reduced by the cost of 179 property placed in service in excess of $800,000 in the carryforward year or (2) the business income limitation in the carryforward year. PTS: 1 REF: p. 8-14 20. ANS: F The first $5,000 of start-up expenses may be expensed if total start-up expenses do not exceed $50,000. PTS: 1 REF: p. 8-23

MULTIPLE CHOICE 21. ANS: E PTS: 1 22. ANS: B Sauls AGI is calculated as follows: Gross income Deductions for AGI: Alimony IRA Expenses on rental property AGI $12,000 5,000 6,000 REF: p. 6-4

$50,000

(23,000) $27,000

PTS: 1 REF: p. 6-3 | p. 6-4 23. ANS: C PTS: 1 REF: p. 6-5 24. ANS: E The illegal commissions and the parking tickets are in violation of public policy and are not deductible.

Income Expenses: Commissions to other brokers Travel and transportation Supplies Office and phone Net income PTS: 1 REF: Example 14 | Example 16 25. ANS: B Terry and Jim should report net profit from their businesses as follows: Gross revenues Less: Cost of goods sold Gross income Less: Expenses Employee salaries Rent and utilities Bribes to police Net profit Terry $500,000 (-0-) $500,000 (200,000) (50,000) -0$250,000 $10,000 12,000 4,000 5,000

$100,000

(31,000) $ 69,000

Jim $500,000 (125,000) $375,000 -0-0-0$375,000

For Terry, the bribes to the police of $25,000 cannot be deducted. None of Jims expenses can be deducted. However, the cost of goods sold is viewed as a negative item in calculating gross income (i.e., gross income = gross profit) rather than as a deduction. PTS: 1 REF: p. 6-12 | p. 6-13 26. ANS: E Since Brunettes is a publicly held corporation and Vera is the CEO, the excessive executive compensation limitation (i.e., millionaires provision) applies. Thus, only the following may be deducted. Salary and bonus (limited to $1 million) Retirement plan contribution Note that the bonus does not meet the performance based exception. PTS: 1 REF: p. 6-14 | p. 6-15 27. ANS: B PTS: 1 REF: Concept Summary 6-1 28. ANS: D If the activity is classified as a hobby, expenses can be deducted to the extent of the income. PTS: 1 REF: p. 6-16 29. ANS: B All of the expenses are deductible either as deductions for ($2,000 + $1,500) or as deductions from ($600 + $500) except for the expenses associated with the tax-exempt bonds ($400). PTS: 1 REF: p. 6-28 | Concept Summary 6-3 $1,000,000 35,000 $1,035,000

30. ANS: C Choice a. is incorrect in that itemized deductions such as mortgage interest and property taxes can be deducted. Choice b. is incorrect since only the allocated portion of rental expenses can be deducted. PTS: 1 REF: Concept Summary 6-2 31. ANS: A Jed is a cash basis taxpayer and therefore, has no basis in the $5,000 not collected. PTS: 1 REF: p. 7-3 32. ANS: D The entire $10,000 loss on the bad debt is classified as an ordinary loss. PTS: 1 REF: p. 7-5 33. ANS: B Salary Interest income Ordinary loss ( 1244 ordinary loss) Long-term capital loss (limited to $3,000)* AGI

$70,000 8,000 (50,000) (3,000) $25,000

*$15,000 ($65,000 $50,000) is long-term capital loss. Of this amount, $3,000 can be used to offset ordinary income. $12,000 ($15,000 $3,000) will be carried forward. PTS: 1 REF: p. 7-4 to 7-7 34. ANS: D A loss may be taken for the theft of personal use property (the diamond ring). PTS: 1 35. ANS: A Asset A Asset B Asset C REF: p. 7-8 | p. 7-9 $ 300 1,500 500 $2,300 (100) (1,800) $ 400

Less: Statutory floor Less: AGI limitation (10% $18,000) Casualty loss deduction PTS: 1 REF: p. 7-10 to 7-13 36. ANS: A Salary Personal use casualty gains in excess of personal use casualty losses ($10,000 $10,000) Adjusted gross income Less: Deductions Itemized deductions Casualty loss ($17,000 $10,000) AGI floor (10% $40,000)

$40,000 -0-

$40,000 $7,000 (4,000)

Taxable income

Deductible casualty loss Other itemized deductions Total itemized deductions Standard deduction (larger than itemized deductions) Personal exemption ($3,500 2)

$3,000 4,000 $7,000 (10,900) (7,000) $22,100

PTS: 1 REF: p. 7-10 to 7-14 37. ANS: C Salary Less: Loss on theft of tools AGI Personal use property theft loss Less: $100 floor 10% of AGI (10% $54,000) Deductible loss Loss on securities Total itemized deductions

$60,000 (6,000) $54,000 $ 9,000 (100) (5,400) $ 3,500 20,000 $23,500

PTS: 1 REF: p. 7-10 to 7-13 38. ANS: D A deduction of $152,000 ($100,000 + $18,000 + $25,000 + $9,000) is permitted in the year of incurrence for the research and experimental expenditures. PTS: 1 REF: p. 7-15 | p. 7-16 39. ANS: B Salary Itemized deductions Personal exemption Taxable income Taxable income Personal exemption Excess of nonbusiness deductions ($32,000 $27,000 = $5,000) over nonbusiness income ($0) NOL PTS: 1 REF: p. 7-21 | p. 7-22 40. ANS: C $3,000 [$1,000 + ($11,000 $10,900*)] = $1,900. *Standard deduction would be used. PTS: 1 REF: p. 7-21 | p. 7-22 41. ANS: D PTS: 1 REF: p. 8-3 | p. 8-7 42. ANS: B The basis is $90,000, the lower of the adjusted basis ($120,000) or fair market value ($90,000) at the date of conversion.

$25,000 (32,000) (3,500) ($10,500) ($10,500) 3,500 5,000 ($ 2,000)

PTS: 1 REF: p. 8-4 | Example 3 43. ANS: C Additional first-year depreciation is $25,000 ($50,000 50%). Regular MACRS is $8,333 ($25,000 .3333). So total cost recovery is $33,333 ($25,000 + $8,333). PTS: 1 REF: p. 8-4 to 8-7 | Table 8-1 44. ANS: D The half-year convention applies in this case. Five-year property: Additional first-year depreciation ($20,000 50%) Regular MACRS ($10,000 .20) Seven-year property: Additional first-year depreciation ($13,000 50%) Regular MACRS ($6,500 .1429) Total cost recovery PTS: 1 REF: p. 8-4 to 8-8 | Table 8-1 45. ANS: E The hotel building is nonresidential realty. .02564 $3,000,000 = $76,920. PTS: 1 REF: p. 8-10 | Table 8-6 46. ANS: A .10 $50,000 = $5,000. PTS: 1 REF: p. 8-10 | p. 8-11 | Table 8-5 47. ANS: C 179 deduction [$250,000 ($840,000 $800,000)] Additional first-year depreciation [($840,000 $210,000) . 50] Regular MACRS [($840,000 $210,000 $315,000) .1429] Total deduction PTS: 1 REF: p. 8-13 | p. 8-14 | Table 8-1 48. ANS: C $40,000 .100 = $4,000 (not over $3,060 limit*). $3,060 40% = $1,224. *These depreciation limits are indexed annually. PTS: 1 REF: p. 8-16 | p. 8-17 | Example 27 | Table 8-3 49. ANS: D .025 $4,000,000 = $100,000. PTS: 1 REF: p. 8-20 | p. 8-21 | Table 8-7 50. ANS: C Deductible amount [$5,000 ($54,000 $50,000)] Amortizable amount {[($54,000 $1,000)/180] 9 months} Total deduction $10,000 2,000 6,500 929 $19,429

$210,000 315,000 45,014 $570,014

$1,000 2,650 $3,650

PTS: 1

REF: p. 8-23 | Example 36 | Example 37

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