Chapter+6+_+Midterm+Review

Report
CONCEPTS IN
FEDERAL TAXATION
CHAPTER 6:
BUSINESS EXPENSE
&
MIDTERM REVIEW
October 5,
2012
ADMINISTRATIVE
 Extra problems
HOMEWORK PROBLEMS
1 . HW Problems
Assignment #6
Chapter 6
P31 , 36, 36, 39, 44, 54
2. Midterm Review
#31
You have just been hired as a tax accountant by a local public
accounting firm. One partner is impressed by your writing skills
and asks you to write a one -page memo to a client describing
the general rules on the deductibility of meals and
entertainment. The client also needs to know under what
circumstances the cost of its skybox (with 10 tickets) at Optus
Park is deductible.
#31
General rules for meals and entertainment expenses to qualify
as deductible business expenses:
1. Business purpose—to make a profit
2. Ordinary, necessary, and reasonable in amount
3. Directly related to or associated with the active conduct of
the taxpayer’s business activity
4. Adequately documented
#31
Directly related test:
1. General expectation of deriving income or a business benefit
from the meals or entertainment
2. A bona fide business activity takes place during the meal or
entertainment
3. The principal reason for providing the meal or entertainment is
to conduct business
4. The expenses are related to the taxpayer and people involved
in the business
Associated with test:
1. Clear business purpose
2. Meal or entertainment must directly precede or follow
substantial business discussions
#31
Skybox:
 No portion of the skybox fee is deductible
 Client can deduct the cost of the ten tickets
 Deduction for each ticket is limited to the price of the most
expensive non-luxury box seat
 Only 50% of meal and entertainment expenses are deductible
(you’re eating the food too!)
#36
Prudy is a recent college graduate who has taken a position
with a real estate brokerage firm. Initially, Prudy will be selling
both residential and commercial property. She is thinking
about buying a new car at a cost of $14,500. However, the
salesperson is trying to sell her a car that costs $18,000. He
has assured her that because she is now self -employed, the
entire cost of the car is tax -deductible. Prudy comes to you, her
tax accountant, for advice about the purchase of the car. She
tells you she expects that 65% of her driving will be for
business purposes. She asks you to write her a letter specifying
whether she can deduct the entire cost of the car, which
expenses she needs to keep track of, and how these expenses
are used in computing the business deduction for her car.
#36
 The information provided to Prudy by the car dealer is not
correct!
 Because Prudy will be using her car for business and personal
purposes, the cost of the car and any expenditures associated
with it must be allocated between the business and personal
use in a reasonable manner
 Only 65% of the cost of operating the automobile is
deductible. The remaining 35% is a personal expense and is
not deductible
 The automobile is treated as two separate assets for tax
purposes
#36
 Prudy may elect to use either the actual cost method or the
standard mileage rate method to determine the allowable
deductions on the automobile
Standard Mileage Rate Method:
 Deduct 55.5 cents per business mile driven
 Deduct direct out of pocket expenses that are unrelated to the
operating costs of the car:
 Business portion of
 Business portion of
 Business portion of
employed)
 Business portion of
parking
tolls
interest (deductible only if tax payer is self
property taxes
 May not be used by a business that operates more than 5
vehicles in the business at the same time
#36
Actual Cost Method:
 Deduct direct out of pocket expenses that are unrelated to the
operating costs of the car (same as Standard Method)
 Also deduct business portion of:
 Depreciation (Depreciation of automobiles is subject to special rules
discussed in Chapter 10)
 Gas and oil
 Repairs
 Insurance
 License
#36
 Both methods require Prudy to substantiate the business
miles driven (keep records )
 Because she is self-employed, she can deduct the business
portion of any ad valorem property taxes and interest she
pays on her car loan
Remember, property taxes are referred to as ad valorem taxes
because they are based on the value of the property being taxed
(most property taxes are not based on the true fair market value of
the property)
#39
Olga has to travel to Philadelphia for 2 days on business. She
enjoys history and is planning to visit the Liberty Bell and other
historic sights in the city. If time permits, she would like to
make a side-trip to nearby Gettysburg. A friend of Olga’s tells
her, “The best part of traveling on business is that once the
business is over, you can sightsee all you want and the cost is
tax-deductible.” Olga, who is self -employed, has scheduled her
trip over the Labor Day weekend so that she can spend 3 days
sightseeing. Write a letter to Olga in which you explain whether
her friend’s advice is correct.
#39
 Olga’s friend has provided her with poor advice!
 Only the business por tion of a combined business and per sonal trip is
deductible
 In determining whether the travel cost of a combined business and
per sonal trip is deductible, the taxpayer must determine whether the
primar y purpose of the trip is business or pleasure—this is determined
based on whether more days were spent on business than for pleasure:
 Because only 2 days are spent on business while 3 days are for pleasure, the
primary purpose of the trip is considered pleasure (40% business < 60%
personal)
 Olga will not able to deduct the cost of her travel to Philadelphia (nor
Gettysburg)
 She may deduct her lodging, meals (limited to 50%) and the cost of
incidental expenses (laundr y, tips, etc.) for the two business days
 The costs of the remaining 3 days are considered nondeductible
per sonal expenditures
#44
Paula is single and works as a high school science teacher. Each summer,
she travels to a national conference on high school science curriculum. She
also spends one week during the summer traveling to areas in the United
States to fur ther her science knowledge. This year, she spent one week
exploring the caves and rock formations around Carlsbad, New Mexico. She
plans on using the knowledge and information from this trip in her ear th
science class. The costs of each trip are as follows:
Air fare
Hotel
Meals
Incidentals
Rental car
Registration
Tour s
Science Conference
$350
200
1 20
40
75
100
-
Carlsbad Trip
$450
375
250
110
190
90
Paula has asked for your advice on the deductibility of these costs as a
business expense. Write her a letter explaining the allowable deduction for
these costs. If any of the costs are not deductible, explain why she cannot
deduct them.
#44
 Because Paula is a high school science teacher and attends the
annual science conference to improve her skills as a science
teacher, the cost of the conference qualifies as a deductible
business expense
 The amount she can deduct as an unreimbursed business
expense is:
Air fare
Hotel
Meals ($120 x 50%)
Incidentals
Car rental
Conference registration
Total deduction
$ 350
200
60
40
75
100
$ 825
#44
 Unreimbursed business expenses are treated as a
miscellaneous itemized deduction, which is reduced by 2% of
AGI
 The expense would not qualify as an education expense
deductible for AGI because the expense was not paid to a
qualified educational institution ($5,250 deduction for
reimbursement from a qualified educational assistance plan)
#44
 None of the costs that Paula incurs on her trip to Carlsbad are
deductible travel expenses
 Travel as a form of education is not deductible
 In this case, the travel is intended to improve Paula’s job
skills (a form of education) and is not deductible
#54
For each of the following situations, state whether the expense
related to the transaction can be deducted as an insurance
expense:
Types of insurance premiums that qualify for deduction include:
 Fire, theft, and other casualty insurance, and liability
insurance
 Employees’ group medical and group term life insurance, and
workers’ comp
 Employee performance and fidelity bonds to protect against
losses caused by employees
 Business interruption and overhead insurance to reimburse
the business for lost profits and overhead from casualty or
other unexpected event
#54
a. Baker Company pays the insurance premium to provide each of
its employees with a $50,000 whole life insurance policy. Baker
and the insurance company consider the employee the owner of
the policy. As owner of the policy, the covered employee
designates the beneficiary of the life insurance proceeds in the
event of the employee’s death. Each employee’s policy costs
$2,000 per year.
 The $2,000 premium paid for each employee is not a deductible
insurance expense
 Only premiums on group-term life insurance qualify for deduction
as life insurance expense
 Because Baker does not benefit directly or indirectly from the
policy, the insurance premiums can be deducted (by Baker) as
additional compensation paid to the employees (the employees
must include the $2,000 in gross income )
 When the employee dies, the beneficiary of the policy excludes
the insurance proceeds from gross income
#54
b. Baker Company has a nondiscriminatory self -insured medical
reimbursement plan for the benefit of its employees. Once a
month, Baker transfers $1 ,000 in cash from its general bank
account to a special medical reimbursement checking account.
The transfer is based on the premium an insurance company would
demand to provide the same benefits to the employees.
 The $1 ,000 per month deposited into the medical
reimbursement checking account is not deductible as an
insurance expense
 The company still controls the money while it is in the checking
account and can withdraw it for general business use at any time
 The amount deposited represents an estimated expense that is
not permitted as a tax deduction (reser ve accounting —need to
know who and what amount)
 The amount actually reimbursed to employees from the medical
reimbursement account can be deducted as a medical insurance
expense and excluded from the employee’s gross income
#54
c. The employees’ of Baker Company receive large sums of cash
in the mail. To protect against loss, Baker pays a $500 annual
insurance premium for an employees fidelity bond.
 The $500 premium paid for the employees fidelity bond is
deductible as an insurance expense
 The purpose of the fidelity bond is to protect Baker from
losses due to an employee’s dishonesty
#54
d. Baker Company is owned by Ross. Baker pays a $1 ,500 annual
premium for a sickness and disability income continuation
insurance policy on Ross. The purpose of the policy is to give Ross
$3,500 per month if he is unable to work for Baker because he is
sick or disabled.
 The $1 ,500 premium paid on the income continuation policy is
not deductible as an insurance expense but as compensation
expense (Baker directly benefits when the policy pays off on
Ross’s death)
 If Ross collects the $3,500 per month benefit because he
becomes ill or disabled, the payments are excluded from his
gross income
The income is excluded because when the company made the payments,
the premium amount was already included in Ross’s income
MIDTERM REVIEW – FALL 2011 Q1
MIDTERM REVIEW – Q1
Loan Fee—$3,200
 Not deductible as an ordinary expense
 Illegal kickback
Home expenses related to business

1/6 is used for business, so deduct 1/6 of these expenses:
Utilities
Interest
Depreciation
Total
$ 6,400 x 1/6 =
$ 2,400 x 1/6 =
$ 2,900 x 1/6 =
$ 1 ,067
400
483
$ 1 ,950
Mortgage Interest
 The interest expense related to personal use of the home is an itemized
deduction:
 $2,400 x (5 ÷ 6) = $2,000
MIDTERM REVIEW – Q1
Sales
Cost of cars sold
Gross profit
Interest expense on cars
Property tax on cars
Gas, oil, repairs
Loan fees
Depreciation on equipment
Business use of home
Net
$110,000
78,000
$ 32,000
$ 4,200
700
1 ,200
-01 ,800
1 ,950
(9,850)
$ 22,150
MIDTERM REVIEW – Q1
 Some may question whether Ray qualifies for a home of fice
deduction…
 Since the home is his principal place of business, the of fice
should qualify for deduction (exclusive use test)
 Ray should report $22,150 of adjusted gross income from his
used car business
MIDTERM REVIEW – Q2
Todd, age 26 and single, is an employee of the Ice Corporation. Todd's annual salary is
$50,000. Ice has a qualified pension into which employees may contribute 5% of their
annual salary (Todd contributes the maximum). The corporation also offers employees a
flexible benefits plan. Todd pays $500 into the plan and is reimbursed for $500 of
medical expenses not covered by his medical insurance. Ice also provides Todd with the
following benefits:
$ 3,200
Medical insurance
900
Group-term life insurance ($80,000 of coverage)
3,120
Free-parking
300
Dues to professional organizations
860
Health club membership
What is Todd's taxable income from his employment? Show calculations.
MIDTERM REVIEW – Q2
 Todd's gross income is $ 48,121 .6:
Salary
Less:
Pension plan payment by Todd ($50,000 * 5%)
Flexible benefits plan payment
Group-term life coverage in excess of $50,000
(30 * $.72)
Free parking - $3,120 - (12 * $240)
Health club membership
Taxable income
$50,000
(2,500)
(500)
21 .6
240
860
$48,121 .6
MIDTERM REVIEW – Q2
Employer contribution
 Todd is not taxed on his employer's $2,500 contribution to his
retirement plan
Medical expenses, medical insurance, professional dues
 He is not taxed on the reimbursement of medical expenses from the
flexible benefits plan. The provision of medical insurance and the
payment of his dues to professional organizations are also excludable
fringe benefits
MIDTERM REVIEW – Q3
Stephanie and Matt are married with 2 dependent children.
During 2011 , they have total gross income of $140,000. Their
allowable deductions for adjusted gross income total $6,000
and they have $6,000 of allowable itemized deductions.
Compute Stephanie and Matt's 2011 taxable income and 2011
income tax liability. Show calculations.
MIDTERM REVIEW – Q2
 Stephanie and Matt have taxable income of $ 106,900. Their
tax liability on $106,900 is $18,785 [$9,735 + 25% *
($106,900 - $70,700)]
Gross income
$140,000
Deductions for AGI
(6,000)
AGI
$134,000
Deductions from AGI (Standard deduction ) (11 ,900)
Personal exemptions (4 * $3,800)
(15,200)
Taxable income
$106,900
MIDTERM REVIEW – Q3
a. Assume that in addition to the above information, Stephanie sold some
land that she had held as an investment at a gain of $5,000. What is the
ef fect of the gain on their taxable income and income tax liability? You
do not need to recalculate, just explain the general ef fect of the sale of
the land.
Capital asset:
 Any asset other than inventor y, receivables, and depreciable or real
proper ty used in a trade or business
 Investment asset (stocks, bonds, rental property held for investments, etc.)
 Assets used for personal use purposes (home, furniture, clothing, personal
automobile, etc.) by individuals

A sale or other disposition of capital assets results in a capital gain or
loss

Capital gains and losses receive special tax treatment
MIDTERM REVIEW – Q3
Characterization of gain on sale
 The gain on the sale of the land is a capital gain. The capital
gain is included in their gross income, increasing taxable
income by $5,000
Tax rate
 The ef fect on their tax liability depends on whether the gain is
short-term or long-term:
 Short-term: If the gain is short-term, the $5,000 will be taxed at their
25% marginal tax rate
 Long-term: If the gain is long-term, it will be taxed at the 15% longterm capital gains rate
 Their tax liability will increase by $1,250 ($5,000 * 25%) if the gain
is short-term or by $750 ($5,000 * 15%) if it is long-term
MIDTERM REVIEW – Q3
b. Assume the same facts as in part (a) and that Matt also sold
some stock he purchased several years ago at a $12,000 loss.
What is the effect of the gain on the land and the loss on the stock
on their taxable income? Explain.
Characterization
 The loss on the sale of the stock is a capital loss
Tax effect
 To determine the tax effect of the loss, it must be netted against
other capital gains. This results in a net capital loss of $7,000
($5,000 gain - $12,000 loss)
 Capital losses are deductible, but are limited to $3,000 per year.
Stephanie and Matt's taxable income will decrease by the $3,000 capital
loss deduction. The remaining $4,000 of net capital loss is carried
forward. The $3,000 capital loss deduction reduces their tax liability by
$750 ($3,000 * 25%)
MIDTERM REVIEW – Q3
MIDTERM REVIEW – Q3
1
2
MIDTERM REVIEW – MC
1 . The rules that limit self -dealing through the related party
provisions is a result of the:
a.
Ability to Pay Concept
b.
Administrative Convenience Concept
c.
Arm’s-Length Transaction Concept
d.
Capital Recovery Concept
e.
Pay -as-You-Go Concept
MIDTERM REVIEW – MC
Arm’s-length transaction:
 Transacti on in which all par ties have bargained in good faith for their
individual benefit
 Transaction that are not at arm’s length are generally not given any tax effect or are
not given the intended tax effect
1) Family
2) Entity
MIDTERM REVIEW – MC
2. Susan purchased a lot for investment purposes. She paid
$10,000 for the lot. Three years later she sold the lot to her
daughter for $8,000. Susan cannot deduct the loss due to
a.
Ability to Pay Concept
b.
Administrative Convenience Concept
c.
Arm’s-Length Transaction Concept
d.
Capital Recovery Concept
e.
Pay -as-You-Go Concept
MIDTERM REVIEW – MC
3. Withholding of taxes from the taxpayers wages and quarterly
estimated tax payments are a result of the
a.
Ability to Pay Concept
b.
Administrative Convenience Concept
c.
Arm’s-Length Transaction Concept
d.
Capital Recovery Concept
e.
Pay -as-You-Go Concept
 Pay-as-you-go: Taxpayers must pay as they generate income
 Tax withholding and estimated tax payments (methods to insure)
MIDTERM REVIEW – MC
4. The allowance of deductions in calculating taxable income and the use
of a progressive tax rate structure are a direct application of the
a.
Ability to Pay Concept
b.
Administrative Convenience Concept
c.
Arm’s-Length Transaction Concept
d.
Capital Recover y Concept
e.
Pay -as-You-Go Concept
Ability to pay:
 Tax should be based on an amount that a taxpayer can af ford to pay
 Where do you see this concept:




Deductions
Exclusions
Credits
Progressive tax rates
MIDTERM REVIEW – MC
5. Penelope purchased an annuity contract that cost $45,000.
The contract will pay Penelope $600 per month for 10 years
after she reaches the age of 62. During the current year,
Penelope turns 62 and receives 4 payments under the contract.
The amount Penelope may exclude from taxable income as a
return of capital on this year's payments is:
a.
$
692
b.
$
900
c.
$1 ,500
d.
$2,250
e.
$2,400
MIDTERM REVIEW – MC
Annuity Rule
Cost of contract
Number of payments
Exclusion per payment
Payments
Total exclusion
$45,000
10 months x 12 years
/120
$375
4
$1,500
MIDTERM REVIEW – MC
5. Penelope purchased an annuity contract that cost $45,000.
The contract will pay Penelope $600 per month for 10 years
after she reaches the age of 62. During the current year,
Penelope turns 62 and receives 4 payments under the contract.
The amount Penelope may exclude from taxable income as a
return of capital on this year's payments is:
a.
$
692
b.
$
900
c.
$1 ,500
d.
$2,250
e.
$2,400
MIDTERM REVIEW – MC
6. Benjamin has the following capital gains and losses for the
current year:
Long-term capital loss
$(13,000)
Long-term capital gain
6,000
Short-term capital loss
(10,000)
Short-term capital gain
12,000
What is Benjamin's net capital gain or loss for the year?
a.
Net long-term capital loss of $ 7,000
b.
Net short-term capital gain of $ 2,000
c.
Net long-term capital loss of $ 5,000
d.
Net short-term capital gain of $ 1 ,000
e.
Net long-term capital loss of $ 3,000
MIDTERM REVIEW – MC
Long-term capital loss
Long-term capital gain
$(13,000)
6,000
Net long-term capital loss
Short-term capital loss
Short-term capital gain
(10,000)
12,000
Net short-term capital gain 2,000
$(7,000)
1
2
Net long-term capital loss
- Net short-term capital gain
= Net long-term capital loss
$(7,000)
2,000
$(5,000)
Only net if signs in
Step 1 are different
MIDTERM REVIEW – MC
6. Benjamin has the following capital gains and losses for the
current year:
Long-term capital loss
$(13,000)
Long-term capital gain
6,000
Short-term capital loss
(10,000)
Short-term capital gain
12,000
What is Benjamin's net capital gain or loss for the year?
a.
Net long-term capital loss of $ 7,000
b.
Net short-term capital gain of $ 2,000
c.
Net long-term capital loss of $ 5,000
d.
Net short-term capital gain of $ 1 ,000
e.
Net long-term capital loss of $ 3,000
MIDTERM REVIEW – MC
7. Nora receives a salary of $55,000 during the current year.
She sells some land that she held as an investment at a loss of
$15,000 and some stock at a gain of $10,000. Nora's adjusted
gross income is:
a.
$50,000
b.
$52,000
c.
$55,000
d.
$62,000
e.
$65,000
MIDTERM REVIEW – MC
1
2
Salary
Land
Stock
$55,000
(15,000)
10,000
Capital gain
Capital loss
Net capital loss
$10,000
(15,000)
(5,000)
Ordinary income
Capital loss
Capital gain
Limit of $3,000 per year
MIDTERM REVIEW – MC
7. Nora receives a salary of $55,000 during the current year.
She sells some land that she held as an investment at a loss of
$15,000 and some stock at a gain of $10,000. Nora's adjusted
gross income is:
a.
$50,000
b.
$52,000
c.
$55,000
d.
$62,000
e.
$65,000
MIDTERM REVIEW – MC
8. Boris, a single individual, has two sales of stock during the
current year. The first sale produces a short -term loss of
$27,000 and the second sale results in a long -term gain of
$57,000. Boris's taxable income without considering the gain is
$125,000. Boris's stock transactions will increase his taxable
income by:
a.
$
b.
$30,000
c.
$34,000
d.
$54,000
ST loss
LT gain
Net LT gain
-0-
$(27,000)
57,000
30,000
No limit on gains
MIDTERM REVIEW – MC
9. Victor receives a $4,000 per year scholarship from Southern
College. The college specifies that $2,500 is for tuition, books,
supplies, and equipment for classes. The other $1 ,500 is for
room and board. As part of the conditions of the scholarship,
Victor must also work ten hours per week as a grader, for which
he is paid $1 ,700 for the year. Of the total amount received,
Victor will include in income:
a.
$1 ,500
b.
$1 ,700
c.
$2,500
d.
$3,200
e.
$5,700
MIDTERM REVIEW – MC
Scholarships: Excluded to provide incentive for education
1. Must not require the performance of future services
2. Must be used for direct costs of education such as tuition, fees, books, and supplies
Scholarship
Tuition, books, supplies
and equipment
Room and board
Grader
$4,000
Exclude from taxable income
2,500
1,500
1,700
Exclude from taxable income
Taxable income
Taxable income
MIDTERM REVIEW – MC
9. Victor receives a $4,000 per year scholarship from Southern
College. The college specifies that $2,500 is for tuition, books,
supplies, and equipment for classes. The other $1 ,500 is for
room and board. As part of the conditions of the scholarship,
Victor must also work ten hours per week as a grader, for which
he is paid $1 ,700 for the year. Of the total amount received,
Victor will include in income:
a.
$1 ,500
b.
$1 ,700
c.
$2,500
d.
$3,200
e.
$5,700
MIDTERM REVIEW – MC
10. Nancy teaches school in a Chinese univer sity. She is a U.S. citizen and
has been teaching in China for 5 year s. In the current year she will earn
$95,000. What are some of Nancy's options for repor ting U.S. gross income?
I. She may include the foreign earned income in her gross income, calculate
her U.S. income tax, and take a tax credit for foreign taxes paid.
II. She may exclude up to $ 95,100 in foreign earned income for the current
year.
III. She may exclude all of her income because it is earned outside of the U.S.
a.
Only I is correct
b.
Only II is correct
c.
Only III is correct
d.
I and II are correct
e.
II and III are correct
MIDTERM REVIEW – MC
Options for foreign earned income:
1
2
Claim a tax credit that is the lesser of
1. Foreign taxes paid
2. U.S. tax that would have been paid on the foreign income
Exclude up to $95,100 of foreign earned income
1. Must be a resident of the foreign country, or
2. Must reside in the foreign country for 330 days
MIDTERM REVIEW – MC
10. Nancy teaches school in a Chinese univer sity. She is a U.S. citizen and
has been teaching in China for 5 year s. In the current year she will earn
$95,000. What are some of Nancy's options for repor ting U.S. gross income?
I. She may include the foreign earned income in her gross income, calculate
her U.S. income tax, and take a tax credit for foreign taxes paid.
II. She may exclude up to $ 95,100 in foreign earned income for the current
year.
III. She may exclude all of her income because it is earned outside of the U.S.
a.
Only I is correct
b.
Only II is correct
c.
Only III is correct
d.
I and II are correct
e.
II and III are correct
MIDTERM REVIEW – MC
11 . Fanny's employer has a qualified pension plan. The employer
makes all payments into the plan; employees do not contribute to
the plan. During the current year, the employer pays $4,000 into
the plan on Fanny's behalf. The plan also earns $3,000 during the
year on the balance in Fanny’s retirement account. Which of the
following statements is true?
I.
Fanny is not taxed on the $4,000 in the current year.
II.
Fanny is not taxed on the $3,000 in the current year.
a.
Only statement I is correct
b.
Only statement II is correct
c.
Both statements are correct
d.
Neither statement is correct
MIDTERM REVIEW – MC
Qualified pension plan: Payments made by employers to qualified pension plans
1. Are not included in income in the year of payment
2. Are included in income in the year of withdrawal
Employer contribution
Pension account appreciation
$4,000
3,000
Exclude from taxable income
Exclude from taxable income
Defer tax until
withdrawal
MIDTERM REVIEW – MC
11 . Fanny's employer has a qualified pension plan. The employer
makes all payments into the plan; employees do not contribute to
the plan. During the current year, the employer pays $4,000 into
the plan on Fanny's behalf. The plan also earns $3,000 during the
year on the balance in Fanny’s retirement account. Which of the
following statements is true?
I.
Fanny is not taxed on the $4,000 in the current year.
II.
Fanny is not taxed on the $3,000 in the current year.
a.
Only statement I is correct
b.
Only statement II is correct
c.
Both statements are correct
d.
Neither statement is correct
MIDTERM REVIEW – MC
12. Milton is experiencing cash flow problems during the
current year. Rather than foreclose on the $120,000 mortgage
loan on his principal residence, his bank agrees to reduce the
debt to $90,000. Prior to the debt reduction, Milton's total
assets were $400,000 and his total liabilities were $390,000.
How much income must Milton recognize from the reduction of
his bank loan?
a.
-0 -
b.
$10,000
c.
$20,000
d.
$30,000
MIDTERM REVIEW – MC
Discharge of indebtedness
 Loan:
 An amount received as a loan is generally excluded from income under the
realization concept because it must be returned
 Loan forgiveness:
 If a lender forgives all or a portion of the debt, realization occurs and the
forgiven portion is income


Insolvency: Discharge due to insolvency or bankruptcy is excluded from income (Q: is
the lender solvent?)
Qualified principal residence : Discharge of indebtedness on qualified principal
residence is excluded
MIDTERM REVIEW – MC
12. Milton is experiencing cash flow problems during the
current year. Rather than foreclose on the $120,000 mortgage
loan on his principal residence, his bank agrees to reduce the
debt to $90,000. Prior to the debt reduction, Milton's total
assets were $400,000 and his total liabilities were $390,000.
How much income must Milton recognize from the reduction of
his bank loan?
a.
-0 -
b.
$10,000
c.
$20,000
d.
$30,000
MIDTERM REVIEW – MC
13. Charlotte traveled to Annapolis to attend a three -day
business conference. After her meetings concluded, she stays 2
additional days sightseeing. Charlotte's airfare is $400 and
pays $110 per night for lodging, $60 a day for meals, and $20 a
day for incidentals. How much of Charlotte's costs can be
deducted as a business expense?
a.
$
-0 -
b.
$
400
c.
$
880
d.
$
970
e.
$1 ,200
MIDTERM REVIEW – MC
Conference
Airfare
Lodging
Meals
Incidentals
Deductible
One-time expense
$400
400
Day 1
Day 2
Sightseeing
Day 3
110
60
20
110
60
20
110
60
20
160
160
160
Day 4
110
60
20
Day 5
110
60
20
Total
Deductible
$400
550 3 days deductible
50% of 3 days
300
deductible
100
3 days deductible
880
MIDTERM REVIEW – MC
13. Charlotte traveled to Annapolis to attend a three -day
business conference. After her meetings concluded, she stays 2
additional days sightseeing. Charlotte's airfare is $400 and
pays $110 per night for lodging, $60 a day for meals, and $20 a
day for incidentals. How much of Charlotte's costs can be
deducted as a business expense?
a.
$
-0 -
b.
$
400
c.
$
880
d.
$
970
e.
$1 ,200
MIDTERM REVIEW – MC
1 4 . M a r i o p a i n t s l a n d s c a p e p o r t r a i t s , a n d h e t r e a t s t h e a c t i v i t y a s a h o b by. D u r i n g t h e
c u r r e n t ye a r, M a r i o i n c ur r e d t h e f o l l owi n g ex p e n s e s w h i l e e a r n i n g $ 2 , 5 0 0 f r o m s a l e s
o f p a i n t i n g s:
Paints and supplies
U t i l it i e s ex p e n s e s f o r h i s s t u d i o
$2,200
1,000
Advertising
300
Insurance on his studio and equipment
700
M a r i o u s e s t h e s t a n d a r d d e d uc t i o n a n d n ev e r i te m i z e s h i s d e d uc t i o n s . H o w s h o u l d
M a r i o r e p o r t a l l o f t h e i te m s r e l a te d to h i s h o b by o n h i s t a x r et u r n ?
a.
H o b by l o s s e s a r e n o t a l l owe d s o h e c o ul d n ’ t d e d uc t a ny t h i n g w h et h e r o r n o t
h e i te m i z e s a ny w ay
b.
Re p o r t a $ 4 0 0 l o s s a s a d e d u c t io n f o r AG I
c.
I n c l ud e $ 2 , 5 0 0 i n g r o s s i n c o m e a n d d e d u c t $ 2 , 5 0 0 f o r AG I
d.
I n c l ud e $ 2 , 5 0 0 i n g r o s s i n c o m e a n d d e d u c t n o t h i n g f o r AG I
e.
I n c l ud e $ 2 , 5 0 0 i n g r o s s i n c o m e a n d d e d u c t $ 1 , 7 0 0 f o r s t u d i o ex p e n s e s
MIDTERM REVIEW – MC
15. Elise is a self -employed business consultant who operates her
business out of an of fice in her home. The home of fice passes the
qualifying tests for deducting of fice in the home expenses. For the
current tax year, Elise earns $90,000 from her business activities. She
incurs $82,000 in supplies, travel expenses, wage expense, etc. Elise's
mor tgage interest and real estate taxes allocable to the home of fice
space were determined to be $9,000. Also, other expenses including
insurance, repairs and maintenance, utilities, and depreciation allocable
to the home of fice space total $11 ,000. How much of the other expenses
(insurance, repairs, etc.) can Elise deduct?
a.
$ - 0 -
b.
$ 2,000
c.
$ 8,000
d.
$ 9,000
e.
$11 ,000
MIDTERM REVIEW – MC
1
2
Home office deduction cannot exceed income
from home office minus deductions from all
other business expenses
Capped deductions can be carried forward to
next year
Income
Supplies, etc.
Mortgage interest & tax
Other expenses
$90,000
(82,000)
(9,000)
(11,000)
$90,000
limit
MIDTERM REVIEW – MC
15. Elise is a self -employed business consultant who operates her
business out of an of fice in her home. The home of fice passes the
qualifying tests for deducting of fice in the home expenses. For the
current tax year, Elise earns $90,000 from her business activities. She
incurs $82,000 in supplies, travel expenses, wage expense, etc. Elise's
mor tgage interest and real estate taxes allocable to the home of fice
space were determined to be $9,000. Also, other expenses including
insurance, repairs and maintenance, utilities, and depreciation allocable
to the home of fice space total $11 ,000. How much of the other expenses
(insurance, repairs, etc.) can Elise deduct?
a.
$ - 0 -
b.
$ 2,000
c.
$ 8,000
d.
$ 9,000
e.
$11 ,000

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