Deck 11: Basic Federal Income Tax Structure

Question 1

Present a technique of computing capital gains and losses.

Answer 1

A capital gain is the profit realized from the sale of a capital asset, which is property owned by an individual for investment purposes or for personal use. Gains on property held for personal use must be reported as capital gains, but losses on these assets are not deductible. Gains on investment property must also be reported as capital gains. However, capital losses on investments can be offset in full against capital gains.
The current tax rules on capital gains and losses can best be understood by examining the following steps required for reporting gains and losses:
Step 1. Calculate the cost or tax basis of the capital asset. The basis is the purchase price of the asset plus expenses incurred in improving the asset minus depreciation (if applicable).
Step 2. Determine whether each transaction qualifies as a short- or long-term capital gain or loss by documenting the holding period. Then determine the net long-term or short-term capital gain or loss. The formula is:
Net Gain/Loss = Amount Realized - Adjusted Basis
Step 3. Calculate the net short-term capital gain or loss by subtracting short-term losses from short-term gains.
Step 4. Calculate the net long-term capital gain or loss by subtracting long-term losses from long-term gains.
Step 5. Determine the net long-term or short-term capital gain or loss by combining Steps 3 and 4.

Question 2

Your client, Tim Bailey, doesn't understand your investment strategy of favoring tax credit over tax deduction. How would you explain your recommendation to Tim?

Answer 2

It is easy to explain that a tax credit reduces the tax dollar for dollar, whereas a tax deduction reduces the tax only by the marginal tax rate (e.g., by 28 percent) of the taxpayer.

Question 3

Describe the rules governing passive income and passive losses.

Answer 3

The tax law generally provides that losses from passive activities such as tax shelters, in which an individual does not materially participate, may be used only to offset income from such activities. In general, the passive activity losses may not be used to offset the income from compensation, interest, dividends, royalties, nonbusiness capital gains, or active business income. Disallowed passive activity losses are carried forward and applied against income from passive activities in future years. These losses are deducted in the year in which the passive activity is entirely liquidated.
An exception to the passive loss rules applies to certain real estate activities with material participation. Individuals who own rental property, and whose adjusted gross income is less than $100,000 have the right to offset regular income with up to $25,000 of rental-related losses, provided they actively participated in the rental real estate activity. For individuals who are married but file separately, the amounts are $50,000 and $12,500 respectively. The maximum deduction is phased out between $100,000 and $150,000.

Question 4

At a recent seminar you have explained the concept of the marginal tax bracket. An attendee, Jeff Lions, wants to know why he should bother with that rate when he knows he is in the 25 percent tax bracket. Can you help?

Question 5

Robert Stern is outraged by the high-handed approach of the IRS in raising his taxes by applying the AMT rule. Robert firmly believes that he has faithfully recorded all his income, claimed only allowable deductions, and has observed all the tax rules. Consequently, he is upset by the IRS's decision to increase his taxes. Can you help?

Question 6

Do S corporations face certain tax liabilities?

Question 7

Robin Hugh, a psychiatrist, needs sophisticated tax planning. And yet, he refuses to ask for assistance because, as he puts it as, "the TRA, the RA, and the TAMRA, and the EGTRRA have eliminated the opportunities for tax planning." Do you have any ideas to help Robin?

Question 8

Summarize the deductions that are allowed to be made from adjusted gross income to arrive at the taxable income.

Question 9

What special rules apply to the capital gains realized from the sale of a residence?

Question 10

Explain the basic steps of calculating gross income.

Question 11

What are tax credits? Are there several forms of tax credits?

Question 12

What is meant by wash sales? Why is it important to know about them?

Question 13

Describe the key features of taxation of C corporations.

Question 14

Describe some of the drawbacks of S corporations.

Question 15

What is the purpose of federal income tax? Why is the goal of a fair income tax system so hard to achieve?

Question 16

Explain the concept of alternative minimum tax. How is it calculated?

Question 17

Question 1. Mr and Mrs Jordan of ages 66 and 64 respectively, file a joint return. How much can they deduct if they elect to use standard deduction? Use the 2015 tax rates.

A) $5,950
B) $8,700
C) $11,900
D) $12,600
E) $14,200

Question 18

Patty Wise, who prepares her own tax returns, has taken "several nondeductible" deductions to minimize her adjusted gross income because she hates to pay taxes. Do you have any advice for Patty?

Question 19

Contrast alternative minimum tax with regular tax.

Question 20

Comment on the following statement: "Before the taxable income is computed, adjustments to gross income must be made."

Question 21

Question 11. Which of the following would not be considered miscellaneous business expenses?

A) Membership fees
B) Safe deposit box fees
C) On-the-job uniforms/tools
D) Tax preparation fees/financial planning fees
E) All are considered miscellaneous business expenses

Question 22

Question 5. Which of the following statements are true with respect to the sale of a principal residence?

A) A one life-time exclusion of $125,000 is allowed for taxpayers under age 55
B) All of the gains from the sale need not be used to purchase another residence
C) The original cost basis is adjusted to include all costs related to the improvement of the property i.e. selling, remodeling, landscaping, etc.)
D) Loss of a sale of residence is fully deductible
E) B and C only

Question 23

Question 3. The "wash sale" rule applies if an investor purchases substantially identical securities within what time period?

A) 30 days
B) 31 days
C) 60 days
D) 61 days
E) None of the above represents the correct answer

Question 24

Question 2. How long must an investment be held before it is considered long-term?

A) 6 months
B) 12 months
C) 24 months
D) 18 months
E) It depends on the type of investment

Question 25

Question 17. S corporations are I. always preferable to C corporations
II) not available to less than 10 persons who wish to start them
III) preferable for many closely-held business ventures
IV) taxed like partnerships, thus eliminating corporate level taxation
V) no longer available under the new tax law

A) III only
B) IV and V
C) II, III, IV, and V
D) II and III
E) III and IV

Question 26

Question 7. The law specifies that ________ of Social Security benefits paid to couples with AGI above ________ would be taxed:

A) 85%; $30,000
B) 50%; $30,000
C) 50%; $44,000
D) 85%; $44,000
E) 85%; $40,000

Question 27

Question 13. In order to meet the dependent requirements, a dependent must:

A) receive over half of the support from the taxpayer
B) receive income less than $2,900 if not a full time student
C) be related to, or live with, the taxpayer
D) all of the above are true statements

Question 28

Question 8. Which of the following are not deductible as itemized deductions?

A) Sales taxes
B) Personal property taxes
C) State income taxes
D) Federal income taxes
E) A and D

Question 29

Question 4. With respect to earned, passive, and portfolio incomes, which of the following statements is not true?

A) All gains are taxed as ordinary income
B) All losses are netted against each other
C) Losses are distinct with respect to each other and a loss from one type may not be used to offset income from another type
D) A and C
E) All of the above statements are true

Question 30

Question 20. Which of the following statements relating to alternative minimum tax AMT) is true?

A) If AMT is higher than regular tax liability, the latter tax becomes payable
B) If AMT is lower than regular tax liability, the tax payer can pay either type of tax
C) The IRS decides who should be subject to AMT
D) If AMT is higher than regular tax liability, the AMT becomes payable

Question 31

Question 19. Mr Cann has taxable income of $100,000. His marginal tax rate is 28 percent and his effective, or average, tax rate is 25 percent. He decides to accept a consulting project that will bring him revenues of $1,000. How much will he net after subtracting federal income tax?
A. $250
B. $500
C. $750
D. $720
E. Cannot be determined from the information supplied here

Question 32

Question 10. Which of the following statements is true with respect to moving expenses?

A) They are deductible in full whether the taxpayer uses the itemized or the standard deduction
B) They must exceed 2% of the taxpayer's AGI
C) House hunting trips and living expenses at the new location are fully deductible
D) The cost of moving household goods is deductible within limits
E) None of the above are true statements

Question 33

Question 15. Which of the following are true?

A) Deductions are subtracted from gross income to arrive at AGI
B) Exemptions are subtracted from gross income to arrive at AGI
C) Deductions are subtracted from AGI to arrive at taxable income
D) Exemptions are subtracted from AGI to arrive at taxable income
E) Both C and D

Question 34

Question 18. Which of the following statements is true?

A) It is possible for someone like Donald Trump ignore his continuous financial problems) to be in a lower marginal tax bracket than a person who has an AGI of only $100,000
B) Average tax brackets are useful when considering the after-tax cost of an investment
C) The marginal tax rate equals the average tax rate divided by one minus the marginal tax rate
D) A and B
E) A and C

Question 35

Question 16. C corporations with tax liabilities are required to make estimated tax payments. In order to avoid penalties, the estimated tax payments must be

A) paid monthly
B) equal to 90% of the current year's tax liability, or 90% of the prior year's tax liability, whichever is less
C) paid by April 15 of the year following the current tax year
D) equal to 100% of the current tax liability, or 100% of the prior year's tax liability, whichever is less
E) paid as and when funds become available

Question 36

Question 9. Mr and Mrs Bryan gave a valuable painting worth $65,000 to their favorite charity. The charity sold the painting three weeks later. If the Bryans purchased the painting for $35,000, how much can they deduct from their taxable income for federal tax purposes?

A) $35,000
B) $10,000
C) $30,000
D) $0
E) $65,000

Question 37

Question 6. Suppose in 2015 an investor had a long-term capital loss of $4,000. What is the proper tax treatment of this loss?

A) deduct the full amount of $4,000
B) None of the $4,000 loss is deductible
C) It is not deductible because the loss must exceed 7.5% of AGI
D) Deduct $3,000 in 2015 and carry forward $1,000
E) None of the above

Question 38

Question 14. The Wilmingtons file a joint return and have two sons, Tom and Frederick. Tom attends college full-time and earns $2,500 from a part time job. Frederick attends high school and has no income. How many exemptions can the Wilmingtons claim?

A) 4
B) 3
C) 2
D) 1
E) None of the above is correct

Question 39

Question 12. Miscellaneous business expenses are only useful if:

A) they exceed 2% of the taxpayer's AGI
B) the taxpayer uses itemized deductions
C) the taxpayer uses the standard deduction
D) an individual is self employed
E) A and B