You are on page 1of 29

Name: ________________________ Class: ___________________ Date: __________ ID: A

Sample Exam 2

True/False
Indicate whether the sentence or statement is true or false.

____ 1. A cash basis taxpayer who charges an expense on a bank credit card is allowed to claim a deduction at that
point in time whereas a cash basis taxpayer who charges an expense on a department store credit card is not
allowed to claim a deduction until payment is made.
____ 2. The cost of legal advice associated with the preparation of an individual’s Federal tax return is not deductible
because it is a personal expense.
____ 3. Legal expenses incurred in connection with rental property are deductions from AGI.
____ 4. The ordinary and necessary expenses for operating an illegal gambling operation (excluding such items as
fines, bribes to public officials, illegal kickbacks, and other illegal payments) are deductible.
____ 5. 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.
____ 6. Ralph wants to give his daughter $1,000 for Christmas. As an alternative, she suggests that he pay the
property taxes on her residence. If Ralph pays the property taxes, he cannot deduct them but his daughter
can.
____ 7. A bad debt deduction can result from a purchased debt instrument.
____ 8. In determining whether a debt is a business or nonbusiness bad debt, the debtor’s use of the borrowed funds
is not important.
____ 9. A loss is not allowed for securities that become partially worthless until they are sold.
____ 10. A loss resulting from an accident to an automobile held for personal use is a casualty loss.
____ 11. The amount of the loss for property that is completely destroyed is always the fair market value of the
property prior to the destruction.
____ 12. Depreciation expenses on buildings used in a research activity never qualify as research and experimental
expenditures.
____ 13. An election to expense, rather than capitalize, research and experimental expenditures can be made each
year.
____ 14. Residential rental real estate placed in service after May 12, 1993, has a cost recovery period of 39 years.
____ 15. The basis of property for cost recovery is reduced by the § 179 amount that is disallowed because of the
business income limitation.
____ 16. All listed property is subject to the substantiation requirements of § 274.
____ 17. Section 197 intangibles can be amortized over their actual useful life if that life is less than 15 years.
____ 18. Amy lives and works in St. Louis. In the morning she flies to Boston, has a three-hour business meeting, and
returns to St. Louis that evening. For tax purposes, Amy was not away from home.
____ 19. A taxpayer lives and works in Providence. He travels to Barcelona for a one-week business seminar. After
the seminar, he spends three days touring Spain. All of his air fare is deductible.

1
Name: ________________________ ID: A

____ 20. Dominique quit her job with an accounting firm in Akron to set up her own practice in Nashville. Her
moving expenses can be deductible even though she changed employment status (i.e., went from employee to
self-employed).
____ 21. Mallard Corporation furnishes meals at cost to its employees by means of a cafeteria it maintains. The cost
of operating the cafeteria is not subject to the cutback adjustment.
____ 22. Unlike self-employed taxpayers, the unreimbursed travel expenses of employees are subject to the
2%-of-AGI floor.
____ 23. The § 222 deduction for qualified tuition and related expenses is subject to the 2%-of-AGI floor on employee
expenses.
____ 24. Bert resides in a nursing home primarily for medical reasons rather than personal reasons. Costs for meals
and lodging can be included in determining his deductible medical expenses.
____ 25. Mindy paid an appraiser to determine how much a capital improvement made for medical reasons increased
the value of her personal residence. The appraisal fee qualifies as a deductible medical expense.
____ 26. In 2006, Rhonda received an insurance reimbursement for medical expenses incurred in 2005. She is not
required to include the reimbursement in gross income in 2006 if she claimed the standard deduction in 2005.
____ 27. Felix sells his personal residence to Julio on July 1, 2005. He had paid $9,000 in real property taxes on
March 1, 2005, the due date for property taxes for 2005. Felix may deduct the portion of the taxes he paid
for the period the property was owned by Julio.
____ 28. Grace’s sole source of income is from a restaurant that she owns and operates as a proprietorship. Any state
income tax Grace pays on the business net income must be deducted as a business expense rather than as an
itemized deduction.
____ 29. Angie, whose MAGI is $80,000, paid interest on a qualified education loan in 2005. Angie is single. She
may deduct the interest as a deduction for AGI.
____ 30. Carolyn mailed a check for $1,000 to a qualified charitable organization on December 31, 2005. The $1,000
contribution is not deductible on Carolyn’s 2005 tax return because the charity does not receive the check
until 2006.

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

____ 31. Larry, a calendar year cash basis taxpayer, has the following transactions:

Salary from job $60,000


Alimony paid to ex-wife 9,000
Medical expenses 4,500

Based on this information, Larry has:


a. AGI of $46,500.
b. AGI of $51,000.
c. AGI of $60,000.
d. Medical expense deduction of $0.
e. None of the above.

2
Name: ________________________ ID: A

____ 32. 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.
____ 33. Janice is single, had gross income of $38,000, and incurred the following expenses:

Charitable contribution $2,500


Taxes and interest on home 9,000
Legal fees incurred in a tax dispute 1,000
Medical expenses 4,000
Penalty on early withdrawal of savings 200

Her AGI is:


a. $21,300.
b. $28,800.
c. $32,800.
d. $35,500.
e. $37,800.
____ 34. Which of the following is correct?
a. All deductions are classified as deductions for AGI.
b. All deductions are classified as deductions from AGI.
c. Some deductions are classified as deductions for AGI and some are classified as
deductions from AGI.
d. All of the above are correct.
e. None of the above is correct.
____ 35. During 2005, the first year of operations, Silver, Inc., pays salaries of $175,000. At the end of the year,
employees have earned salaries of $20,000 which are not paid by Silver until early in 2006. What is the
amount of the deduction for salary expense?
a. If Silver uses the cash method, $175,000 in 2005 and $0 in 2006.
b. If Silver uses the cash method, $0 in 2005 and $195,000 in 2006.
c. If Silver uses the accrual method, $175,000 in 2005 and $20,000 in 2006.
d. If Silver uses the accrual method, $195,000 in 2005 and $0 in 2006.
e. None of the above is correct.

3
Name: ________________________ ID: A

____ 36. Angela, a real estate broker, had the following income and expenses in her business:

Commissions income $100,000


Expenses:
Commissions paid to non-brokers for referrals
(illegal under state law and subject to criminal penalties) 20,000
Commissions paid to other real estate brokers for referrals
(not illegal under state law) 10,000
Travel and transportation 12,000
Supplies 4,000
Office and phone 5,000
Parking tickets 500

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.
____ 37. Gerald owns an illegal casino. Which of the following expenses incurred in connection with this activity are
deductible currently?
a. Rent.
b. Illegal kickbacks to officials to stay in business.
c. Fines.
d. Purchase of a building.
e. None of the above.
____ 38. Iris, a calendar year cash basis taxpayer, owns and operates several TV rental outlets in Florida, and wants to
expand to other states. During 2005, 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 $14,000 and not deduct $9,000.
b. Expense $23,000 for 2005.
c. Expense $9,000 for 2005 and capitalize $14,000.
d. Capitalize $23,000.
e. None of the above.
____ 39. 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 taxpayer’s 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.

4
Name: ________________________ ID: A

____ 40. Which of the following is not relevant in determining whether an activity is profit-seeking or a hobby?
a. Whether the activity is enjoyed by the taxpayer.
b. The expertise of the taxpayers or their advisers.
c. The time and effort expended.
d. The relationship of profits earned to losses incurred.
e. All of the above are relevant factors.
____ 41. Which of the following is correct?
a. A taxpayer generally can claim a deduction for payment of an obligation of a dependent.
b. Expenses paid for medical care of a dependent are deductible by the payor.
c. A taxpayer can deduct interest paid on a dependent’s debt.
d. All of the above.
e. None of the above.
____ 42. In January, Lance sold stock with a cost basis of $26,000 to his brother, James, for $24,000, the fair market
value of the stock on the date of sale. Five months later, James sold the same stock through his broker for
$27,000. What is the tax effect of these transactions?
a. Disallowed loss to James of $2,000; gain to Lance of $1,000.
b. Disallowed loss to Lance of $2,000; gain to James of $3,000.
c. Deductible loss to Lance of $2,000; gain to James of $3,000.
d. Disallowed loss to Lance of $2,000; gain to James of $1,000.
e. None of the above.
____ 43. On January 3, 2005, Harry sold stock (cost of $8,000) to his sister Florine for its fair market value of $7,000.
On July 30, 2005, Florine sold the same stock to a friend for $8,200. What is the proper treatment in 2005
for these transactions?
a. Neither Harry nor Florine has a recognized gain or loss.
b. Harry has a recognized loss of $1,000.
c. Florine has a recognized gain of $200.
d. Florine has a recognized gain of $1,200.
e. None of the above.
____ 44. On February 20, 2004, Bill purchased stock in Pink Corporation (the stock is not small business stock) for
$1,000. On May 1, 2005, the stock became worthless. During 2005, Bill also had an $8,000 loss on § 1244
small business stock purchased two years ago, a $9,000 loss on a nonbusiness bad debt, and a $5,000
long-term capital gain. How should Bill treat these items on his 2005 tax return?
a. $4,000 long-term capital loss and $9,000 short-term capital loss.
b. $4,000 long-term capital loss and $3,000 short-term capital loss.
c. $8,000 ordinary loss and $3,000 short-term capital loss.
d. $8,000 ordinary loss and $5,000 short-term capital loss.
e. $8,000 long-term capital loss and $6,000 short-term capital loss.

5
Name: ________________________ ID: A

____ 45. John, who is single, had the following items for the current year:

 Salary of $90,000.
 Gain of $30,000 on the sale of § 1244 stock acquired two years earlier.
 Loss of $75,000 on the sale of § 1244 stock acquired three years earlier.
 Worthless stock of $7,000. The stock was acquired on February 1 of the prior year and
became worthless on January 15 of the current year.

Determine John’s AGI for the current year.


a. $37,000.
b. $38,000.
c. $42,000.
d. $47,000.
e. None of the above.
____ 46. 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 Insurance


Asset Adjusted Basis Before After Recovery
A $ 500 $ 700 $300 $100
B 3,000 2,000 -0- 500
C 700 900 -0- 200

Rick’s casualty loss deduction is:


a. $400.
b. $600.
c. $1,000.
d. $1,400.
e. None of the above.
____ 47. During the current year, Ned and Mary had the following items:

Salary $40,000
Personal use casualty gain 10,000
Personal use casualty loss (after $100 floor) 17,000
Other itemized deductions 4,000

Assuming that Ned and Mary file a joint return, determine their taxable income for the current year.
a. $23,600.
b. $26,800.
c. $27,600.
d. $31,000.
e. None of the above.

6
Name: ________________________ ID: A

____ 48. Alma is in the business of dairy farming. During the year, one of her barns was completely destroyed by fire.
The adjusted basis of the barn was $90,000. The fair market value of the barn before the fire was $75,000.
The barn was insured for 95% of its fair market value, and Alma recovered this amount under the insurance
policy. Alma has adjusted gross income for the year of $40,000 (before considering the casualty).
Determine the amount of loss she can deduct on her tax return for the current year.
a. $3,750.
b. $14,650.
c. $14,750.
d. $18,750.
e. None of the above.
____ 49. For tax purposes, a deduction is allowed for the consumption of the cost of timber through:
a. Cost recovery.
b. Amortization.
c. Depletion.
d. All of the above.
e. None of the above.
____ 50. 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.
____ 51. Tara purchased a machine for $40,000 to be used in her business. The cost recovery allowed and allowable
for the three years the machine was used are as follows:

Cost Recovery Allowed Cost Recovery Allowable


Year 1 $16,000 $ 8,000
Year 2 9,600 12,800
Year 3 5,760 7,680

If Tara sells the machine after three years for $15,000, how much gain should she recognize?
a. $3,480.
b. $6,360.
c. $9,240.
d. $11,480.
e. None of the above.
____ 52. Hazel purchased a new business asset (five-year property) on March 10, 2005, at a cost of $100,000. She did
not elect to expense any of the asset under § 179, nor did she elect straight-line cost recovery. Hazel sold the
asset on January 20, 2008. Determine the cost recovery deduction for 2008.
a. $2,400.
b. $3,226.
c. $5,760.
d. $11,520.
e. None of the above.

7
Name: ________________________ ID: A

____ 53. Carlos purchased an apartment building on November 16, 1988, for $1,000,000. Determine the cost recovery
for 2005.
a. $36,360.
b. $32,100.
c. $45,500.
d. $331,850.
e. None of the above.
____ 54. Diane purchased a factory building on November 15, 1993, for $5,000,000. She sells the factory building on
February 2, 2005. Determine the cost recovery deduction for the year of the sale.
a. $16,025.
b. $19,844.
c. $26,458.
d. $158,750.
e. None of the above.
____ 55. On June 1, 2005, James places in service a new automobile that cost $21,000. The car is used 70% for
business and 30% for personal use. (Assume this percentage is maintained for the life of the car.) Determine
the cost recovery deduction for 2006.
a. $5,362.
b. $4,900.
c. $3,360.
d. $2,352.
e. None of the above.
____ 56. On July 10, 2005, Ariff places in service a new sports utility vehicle that cost $60,000 and weighed 6,300
pounds. The SUV is used 100% for business. Determine Ariff’s maximum deduction for 2005, assuming
Ariff’s § 179 business income is $110,000.
a. $7,660.
b. $26,400.
c. $35,500.
d. $40,400.
e. None of the above.
____ 57. George purchases new office furniture (seven-year class property) at a cost of $50,000 on April 20, 2005.
Determine George’s cost recovery deduction for 2005 for alternative minimum tax purposes, assuming
George does not elect § 179 and the maximum cost recovery deduction is taken for regular income tax
purposes.
a. $2,500.
b. $3,750.
c. $5,355.
d. $6,212.
e. None of the above.

8
Name: ________________________ ID: A

____ 58. During the year, Hugh went from Cleveland to Fairbanks on business. Preceding a five-day business
meeting, he spent five days vacationing at a dude ranch. Excluding the dude ranch costs, his expenses for the
trip are:

Air fare $1,800


Lodging 600
Meals 500
Entertainment 300

Presuming no reimbursement, deductible expenses are:


a. $3,200.
b. $3,050.
c. $2,800.
d. $1,900.
e. None of the above.
____ 59. During the year, Irv travels from Philadelphia to Berlin, Germany, on business. His time was spent as
follows: 2 days travel, 4 days business, and 4 days personal. His expenses for the trip were (meals and
lodging reflect only the business portion):

Air fare $3,000


Lodging 800
Meals 1,000

Presuming no reimbursement, deductible expenses are:


a. $1,800.
b. $3,300.
c. $3,600.
d. $4,300.
e. None of the above.
____ 60. Carolyn is single and has a college degree in finance. She is employed as a loan officer at a bank; her yearly
AGI approximates $50,000. During 2005, she enrolled in a weekend MBA program and incurred the
following nonreimbursed expenses: $3,900 (tuition), $300 (books), $200 (other school supplies), and $200
(transportation to and from campus). Disregarding the 2%-of-AGI limitation, as to the MBA program,
Carolyn has a:
a. Deduction for and deduction from AGI of $0.
b. Deduction for AGI of $3,900 and deduction from AGI of $700.
c. Deduction for AGI of $4,000 and deduction from AGI of $600.
d. Deduction for AGI of $4,100 and deduction from AGI of $500.
e. None of the above.
____ 61. Which of the following expenses, if any, qualify as deductible?
a. Contribution to a Roth IRA.
b. Costs involved in maintaining an office in the home by a self-employed insurance
adjuster. Taxpayer’s wife also uses the office as a meeting place for her bridge club.
c. Cost of moving to first job location. Taxpayer just graduated from college.
d. Job hunting expenses of a fishing guide to become an insurance salesman.
e. None of the above.

9
Name: ________________________ ID: A

____ 62. Larry and Beth are married and together have AGI of $80,000 in 2005. They have two dependents and file a
joint return. They pay $3,000 for a high deductible health insurance policy and they contribute $2,400 to a
qualified Health Savings Account. During the year, they paid the following amounts for medical care:
$7,500 in doctor and dentist bills and hospital expenses, and $1,700 for prescribed medicine and drugs. In
November 2005, they received an insurance reimbursement of $2,100 for hospitalization. They expect to
receive an additional reimbursement of $1,000 in January 2006. Determine the maximum deduction
allowable for medical expenses in 2005.
a. $4,100.
b. $6,100.
c. $7,100.
d. $10,100.
e. None of the above.
____ 63. Charles is employed as a consultant. For calendar year 2005, he had AGI of $125,000 and paid the following
medical expenses:

Medical insurance premiums $3,600


Doctor and dentist bills for John and Carol (Charles’s parents) 7,500
Doctor and dentist bills for Charles 7,750
Prescribed medicines for Charles 200
Nonprescribed insulin for Charles 740

John and Carol would qualify as Charles’s dependents except that they file a joint return. Charles’s medical
insurance policy does not cover them. Charles filed a claim for $4,300 of his own expenses with his
insurance company in November 2005 and received the reimbursement in January 2006. What is Charles’s
maximum allowable medical expense deduction for 2005?
a. $10,415.
b. $12,290.
c. $15,590.
d. $19,790.
e. None of the above.
____ 64. Lonnie developed severe arthritis and was unable to climb the stairs to reach his second-floor bedroom. His
physician advised him to add a first-floor bedroom to his home. The cost of constructing the room was
$28,000. The increase in the value of the residence as a result of the room addition was determined to be
$12,000. In addition, Lonnie paid the contractor $5,000 to construct an entrance ramp to his home and
$7,000 to widen the hallways to accommodate his wheelchair. Lonnie’s AGI for the year was $80,000. How
much of these expenditures can Lonnie deduct as a medical expense?
a. $10,000.
b. $16,000.
c. $22,000.
d. $40,000.
e. None of the above.

10
Name: ________________________ ID: A

____ 65. Your friend Scotty informs you that he received a “tax-free” reimbursement in 2005 of some medical
expenses he paid in 2004. Which of the following statements best explains why Scotty is not required to
report the reimbursement in gross income?
a. Scotty itemized deductions in 2004.
b. Scotty did not itemize deductions in 2004.
c. Scotty itemized deductions in 2005.
d. Scotty did not itemize deductions in 2005.
e. Scotty itemized deductions in 2005 but not in 2004.
____ 66. During the current year, Sam, a self-employed individual, paid the following amounts:

Real estate tax on residence $3,900


State income tax 1,400
Real estate taxes on land in Canada (held as an investment) 900
State sales taxes 1,950
State occupational license fee 250
Personal property tax on value of his automobile 200

What amount can Sam claim as taxes in itemizing deductions from AGI?
a. $6,600.
b. $6,950.
c. $7,200.
d. $8,600.
e. None of the above.
____ 67. During 2005, Tara paid the following taxes:

Taxes on residence (for the period from March 1 through August 31, 2005) $5,888
State motor vehicle tax (based on the value of the personal use automobile) 220

Tara sold her personal residence on May 30, 2005, under an agreement in which the real estate taxes were not
prorated between the buyer and the seller. What amount qualifies as a deduction from AGI for 2005 for
Tara?
a. $6,108.
b. $5,888.
c. $3,100.
d. $2,880.
e. None of the above.
____ 68. Dirk, who uses the cash method of accounting, lives in a state that imposes an income tax (including
withholding from wages). On April 14, 2005, he files his state return for 2004, paying an additional $800 in
state income taxes. During 2005, his withholdings for state income tax purposes amount to $4,550. On April
13, 2006, he files his state return for 2005 claiming a refund of $900. Dirk receives the refund on August 3,
2006. If he itemizes deductions, how much may Dirk claim as a deduction for state income taxes on his
Federal income tax return for calendar year 2005 (filed in April 2006)?
a. $4,450.
b. $4,550.
c. $5,350.
d. $6,250.
e. None of the above.

11
Name: ________________________ ID: A

____ 69. Jennifer, who lives in New Jersey, volunteered to travel to New Mexico in March to work on a
home-building project for Habitat for Humanity (a qualified charitable organization). She was in New
Mexico for three weeks. She normally makes $500 per week as a carpenter’s assistant and plans to deduct
$1,500 as a charitable contribution. In addition, she incurred the following costs in connection with the trip:
$400 for transportation, $900 for lodging, and $210 for meals. What is Jennifer’s deduction associated with
this charitable activity?
a. $400.
b. $1,300.
c. $1,405.
d. $1,510.
e. $3,010.
____ 70. Jennifer, a calendar year taxpayer, made the following donations to qualified charitable organizations in
2005:

Basis Fair Market Value


Cash donation to Ohio State University $40,000 $ 40,000
Unimproved land to the city of Columbus, Ohio 80,000 240,000

The land had been held as an investment and was acquired 3 years ago. Shortly after receipt, the city of
Columbus sold the land for $240,000. Jennifer’s AGI is $400,000. The allowable charitable contribution
deduction is:
a. $84,000 if the reduced deduction election is not made.
b. $112,000 if the reduced deduction election is not made.
c. $160,000 if the reduced deduction election is not made.
d. $200,000 if the reduced deduction election is made.
e. None of the above.

Problem

71. Kitty runs a brothel (illegal under state law) and has the following items of income and expense. What is the
amount that she must include in taxable income from her operation?

Income $200,000
Expenses:
Rent 8,000
Utilities 2,000
Bribes to police 10,000
Medical expense 5,000
Legal fees 20,000
Depreciation 14,000
Illegal kickbacks 15,000

12
Name: ________________________ ID: A

72. The stock of Eagle, Inc. is owned as follows:

Tom 25%
Tom’s uncle 20%
Tom’s daughter 10%
Tom’s sister 15%
Tom’s spouse 15%
Tom’s cousin 5%
Tom’s attorney, unrelated 10%

Tom sells land and a building to Eagle, Inc. for $100,000. His adjusted basis for these assets is $125,000.
Calculate Tom’s realized and recognized loss associated with the sale.
73. Norm purchases a new sports utility vehicle (SUV) on October 12, 2005, for $50,000. The SUV has a gross
vehicle weight of 6,200 lbs. It is used 100% of the time for business and it is the only business asset acquired
by Norm during 2005. Compute the maximum deduction with respect to the SUV for 2005.
74. Ethan is employed as an assistant manager in the menswear division of a national chain of department stores.
He is a recent college graduate with a degree in marketing. During 2005, he enrolls in the evening MBA
program of a local university and incurs the following expenses: tuition, $4,200; books and computer
supplies, $600; transportation expense to and from the university, $250; and meals while on campus, $300.
Ethan is single and his annual AGI is less than $65,000. As to these expenses, what are Ethan’s:

a. Deductions for AGI?

b. Deductions from AGI?


75. Russell and Meg are married and file a joint return. They claim Meg’s father (Dennis) and Meg’s son (Joe)
as dependents. During the current year, they paid the following expenses:

Tuition to send Joe to a special school for children with physical and learning
disabilities $14,000
Medical equipment for Joe 3,500
Room and board at Riverview Manor paid on behalf of Dennis 24,000
Doctor and hospital charges for Dennis’s arthritis 4,400

Dennis moved to Riverview Manor, an assisted living home, because he felt living with Russell and Meg was
too much of a burden for them. Disregarding percentage limitations, how much qualifies as a medical
expense on Russell and Meg’s tax return for:

a. Joe?

b. Dennis?

13
Name: ________________________ ID: A

76. Wilma, who uses the cash method of accounting, lives in a state that imposes an income tax. In April 2005,
she files her state income tax return for 2004 and pays an additional $1,000 in state income taxes. During
2005, her withholdings for state income tax purposes amount to $7,400, and she pays estimated state income
tax of $700. In April 2006, she files her state income tax return for 2005 claiming a refund of $1,800.
Wilma receives the refund in August 2006.

a. Assuming Wilma itemized deductions in 2005, how much may she claim as a deduction for
state income taxes on her Federal return for calendar year 2005 (filed in April 2006)?

b. Assuming Wilma itemized deductions in 2005, how will the refund of $1,800 that she
received in 2006 be treated for Federal income tax purposes?

c. Assume that Wilma itemized deductions in 2005 and that she elects to have the $1,800
refund applied toward her 2006 state income tax liability. How will the $1,800 be treated
for Federal income tax purposes?

d. Assuming Wilma did not itemize deductions in 2005, how will the refund of $1,800
received in 2006 be treated for Federal income tax purposes?

Matching

Match the statements that relate to each other. (Note: Choice L may be used more than once.)
a. Must involve the same trade or business
b. Must be for the convenience of the employer
c. Meals while in route
d. Lodging while in route
e. Out-of-town job assignment is temporary
f. Can include actual cost of gasoline
g. Payment for services rendered based on tasks performed
h. Excludes use of MACRS depreciation
i. Taxpayer is provided with tools and a place to work
j. Transportation must be allocated if taxpayer spends two weeks on business and one week
sightseeing
k. Paralegal obtains a law degree
l. Correct match not provided
____ 77. Characteristic of a taxpayer who has the status of an employee
____ 78. Characteristic of a taxpayer who is self-employed
____ 79. Operating cost method of determining auto expense
____ 80. Automatic mileage method
____ 81. Deductible moving expense
____ 82. Nondeductible moving expense
____ 83. Mixed (both business and pleasure) foreign travel
____ 84. Education expense that is not deductible to maintain or improve existing skills
____ 85. Tax home has not changed
____ 86. Deductible job-hunting expenses
____ 87. Deduction by an employee of unreimbursed office-in-the-home expenses

14
Name: ________________________ ID: A

____ 88. Safety goggles purchased by an employed carpenter

Match the statements that relate to each other. (Note: Choice L may be used more than once.)
a. Cover charge paid to entertain client at a night club
b. Not deductible unless taxpayer takes the new job
c. Company picnic sponsored by employer
d. Use of Federal per diem allowance to substantiate meals while in travel status
e. Does not have to be job related
f. Can include cost of car insurance and automobile club dues
g. Contribution to plan is not deductible
h. Contribution to plan is deductible
i. Expatriate (U.S. person who is employed overseas) returns home to retire
j. Taxpayer moves to a new residence 55 miles closer to his present job
k. Annual Rotary Club membership fee
l. Correct match not provided
____ 89. Operating cost method of determining car expense
____ 90. Distance test (for moving expenses) not satisfied
____ 91. Time test (for moving expenses) waived
____ 92. Roth IRAs
____ 93. Keogh (H.R. 10) plans
____ 94. Cutback adjustment applies
____ 95. Cutback adjustment does not apply
____ 96. Deemed substantiation
____ 97. Job hunting expenses
____ 98. Qualified tuition and related expenses (under § 222)
____ 99. Club dues deductible
____ 100. Club dues not deductible

15
ID: A

Sample Exam 2
Answer Section

TRUE/FALSE

1. ANS: T
At the time a cash basis taxpayer charges the expense on his or her bank credit card, the taxpayer is deemed
simultaneously to have borrowed money from the credit card issuer and constructively paid the expense.
This is not the case where the charge is made on a department store credit card.

PTS: 1 REF: p. 6-9


2. ANS: F
This deduction is expressly allowed under § 212.

PTS: 1 REF: p. 6-13


3. ANS: F
This is a deduction for AGI.

PTS: 1 REF: p. 6-13


4. ANS: T PTS: 1 REF: p. 6-13 | p. 6-14
5. ANS: F
Such expenses are an itemized deduction and are subject to the 2% floor on miscellaneous itemized
deductions except for the property tax and mortgage interest.
Example 22

PTS: 1
6. ANS: F
A taxpayer cannot deduct another taxpayer’s obligation. Thus, Ralph cannot deduct his daughter’s property
taxes. His daughter is not eligible for a deduction since she did not pay them.

PTS: 1 REF: p. 6-25


7. ANS: T PTS: 1 REF: p. 7-3
8. 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. 7-5


9. ANS: T PTS: 1 REF: p. 7-6
10. ANS: T PTS: 1 REF: p. 7-8
11. ANS: F
The amount of the loss for business use property or property held for the production of income is the adjusted
basis of the property. For personal use property, the amount of the loss is the lesser of the adjusted basis of
the property, or the decline in fair market value resulting from the casualty.

PTS: 1 REF: p. 7-11

1
ID: A

12. ANS: F
Depreciation on a building used for research can be a research and experimental expenditure.

PTS: 1 REF: p. 7-16


13. ANS: F
Once an election has been made to expense research and experimental expenditures, a taxpayer must
continue to expense these items in subsequent years.

PTS: 1 REF: p. 7-17


14. ANS: F
Residential rental real estate has a cost recovery period of 27.5 years.

PTS: 1 REF: p. 8-9


15. ANS: T
The basis is reduced by the § 179 amount before the business income ceiling is applied.

PTS: 1 REF: p. 8-12


16. ANS: T PTS: 1 REF: p. 8-17
17. ANS: F
Section 197 intangibles must be amortized over the statutory 15-year amortization period regardless of the
actual life of the intangible asset.

PTS: 1 REF: p. 8-20


18. ANS: T
The absence must be a period substantially longer than an ordinary day’s work and must require rest.

PTS: 1 REF: p. 9-7 | p. 9-8


19. ANS: F
The taxpayer does not meet either the seven-days-or-less or the less-than-25%-personal-time tests.
Example 22

PTS: 1
20. ANS: T
A change in employment status is immaterial as long as all other requirements are met for the moving
expense deduction.

PTS: 1 REF: p. 9-13


21. ANS: T
Example 32

PTS: 1
22. ANS: T
For self-employed taxpayers, travel expenses are deductions for adjusted gross income. The 2%-of-AGI
floor applies only to certain deductions from AGI, such as unreimbursed employee expenses.

PTS: 1 REF: p. 9-27 | p. 9-28

2
ID: A

23. ANS: F
The § 222 amount is a deduction for AGI.

PTS: 1 REF: p. 9-16


24. ANS: T
If the primary reason for being in a nursing home is medical, the cost of meals and lodging can be included in
medical expenses, along with the costs for medical or nursing care.
Example 4

PTS: 1 REF: p. 10-4


25. ANS: F
The appraisal fee does not qualify as a medical expense, but it qualifies as a deduction under § 212 (related to
the determination of tax liability) as a miscellaneous itemized deduction.

PTS: 1 REF: p. 10-5


26. ANS: T
The reimbursement is included in gross income only to the extent the taxpayer derived a tax benefit from
deducting the expense in the previous year. Because Rhonda did not itemize in 2005, she received no tax
benefit.
Example 12

PTS: 1
27. ANS: F
The real property taxes paid by the seller (Felix) but apportioned to the buyer (Julio) reduce the amount Felix
realized from the sale of the residence. Felix may not deduct the portion of the taxes related to the period
Julio owned the property.
Example 19

PTS: 1 REF: p. 10-13


28. ANS: F
State and local income taxes imposed on an individual are deductible only as an itemized deduction even if
the taxpayer’s sole source of income is from a business.

PTS: 1 REF: p. 10-13


29. ANS: F
The deduction is phased out when MAGI reaches $65,000.

PTS: 1 REF: p. 10-14


30. ANS: F
The mailing date is treated as the date of the charitable contribution.

PTS: 1 REF: p. 10-22

3
ID: A

MULTIPLE CHOICE

31. ANS: B
Larry’s AGI is calculated as follows:
Salary $60,000
Alimony paid (9,000)
AGI $51,000

Larry’s medical expense deduction is $675 [$4,500 – 7.5%($51,000)].


Example 2

PTS: 1 REF: p. 6-3 | p. 6-4


32. ANS: E PTS: 1 REF: p. 6-3 | p. 6-4
33. ANS: E
Janice’s AGI is calculated as follows:
Gross income $38,000
Deductions for AGI:
Penalty on early withdrawal of savings (200)
AGI $37,800

PTS: 1 REF: p. 6-3 to 6-5


34. ANS: C PTS: 1 REF: p. 6-3 to 6-5
35. ANS: D PTS: 1 REF: p. 6-9 | p. 6-10
36. ANS: E
The illegal commissions and the parking tickets are in violation of public policy and are not deductible.

Income $100,000
Expenses:
Commissions to other brokers $10,000
Travel and transportation 12,000
Supplies 4,000
Office and phone 5,000 (31,000)
Net income $ 69,000

Examples 14 and 16

PTS: 1
37. ANS: A
All usual expenses of operating an illegal business are deductible; the illegal expenses are not. The building
must be capitalized and depreciated.

PTS: 1 REF: p. 6-13 | p. 6-26


38. ANS: B
Since Iris owns and operates TV rental outlets, all of the investigation expenses can be deducted.
Example 18

PTS: 1 REF: p. 6-15

4
ID: A

39. ANS: B
Concept Summary 6-1
Examples 18, 19

PTS: 1
40. ANS: E
All of these items are relevant factors in determining whether an activity is profit-seeking or a hobby.

PTS: 1 REF: p. 6-16 | p. 6-17


41. ANS: B PTS: 1 REF: p. 6-25
42. ANS: D
Lance’s realized loss of $2,000 ($24,000 – $26,000) is disallowed. James may reduce his realized gain of
$3,000 ($27,000 – $24,000) by Lance’s disallowed loss of $2,000. So James’ recognized gain is $1,000.
Example 35

PTS: 1 REF: p. 6-27


43. ANS: C
Examples 35 and 36

PTS: 1
44. ANS: C
Ordinary loss (small business stock) ($8,000)

Long-term capital gain $5,000


Less long-term capital loss (worthless securities) (1,000)
Net long-term capital gain $4,000
Less short-term capital loss (nonbusiness bad debt) (9,000)
Net short-term capital loss ($5,000)
Short-term capital loss limited to ($3,000)

PTS: 1 REF: p. 7-5 to 7-8


45. ANS: B
Salary $90,000
§ 1244 ordinary loss (50,000)
Long-term capital gain $30,000
Long-term capital loss
Excess § 1244 loss ($75,000 – $50,000) $25,000
Worthless security 7,000 (32,000)
Net long-term capital loss (limited to $3,000) (2,000)
Adjusted gross income $38,000

PTS: 1 REF: p. 7-6 to 7-8

5
ID: A

46. ANS: A
Asset A $ 300
Asset B 1,500
Asset C 500
$2,300
Less: Statutory floor (100)
Less: AGI limitation (10% X $18,000) (1,800)
Casualty loss deduction $ 400

PTS: 1 REF: p. 7-11 to 7-14


47. ANS: A
Salary $40,000
Personal use casualty gains in excess of personal use
casualty losses ($10,000 – $10,000) -0-
Adjusted gross income $40,000
Less: Deductions
Itemized deductions
Casualty loss ($17,000 – $10,000) $7,000
AGI floor (10% X $40,000) (4,000)
Deductible casualty loss $3,000
Other itemized deductions 4,000
Total itemized deductions $7,000
Standard deduction (larger than itemized deductions) (10,000)
Personal exemption (6,400)
Taxable income $23,600

PTS: 1 REF: p. 7-11 to 7-16


48. ANS: D
Amount of loss (adjusted basis for business property that is completely destroyed) $90,000
Less: Insurance proceeds received ($75,000 X 95%) (71,250)
Business loss $18,750

A business casualty loss is classified as an ordinary loss.

PTS: 1 REF: p. 7-8 to 7-12


49. ANS: C
Timber is subject to depletion.

PTS: 1 REF: p. 8-3


50. 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.
Example 3

PTS: 1 REF: p. 8-4

6
ID: A

51. ANS: D
Cost $40,000
Less the greater of cost recovery allowed or allowable (36,480)
($16,000 + $12,800 + $7,680)
Adjusted basis $ 3,520

The recognized gain is $11,480 ($15,000 – $3,520).


Example 2

PTS: 1
52. ANS: C
$100,000 X .1152 X 1/2 = $5,760.

PTS: 1 REF: p. 8-7


53. ANS: A
$1,000,000 X .03636 = $36,360.

Table 8-8

PTS: 1 REF: p. 8-9


54. ANS: A
.02564 X $5,000,000 X 1.5/12 = $16,025.

Table 8-8

PTS: 1 REF: p. 8-9 | p. 8-10


55. ANS: C
$21,000 X .32 = $6,720 (limited to $4,800*)

$4,800 X 70% $3,360

*These depreciation limits are indexed annually.

Example 23 and Table 8-1

PTS: 1
56. ANS: E
Since the SUV weighs over 6,000 pounds, it is not subject to the statutory dollar limits on luxury
automobiles.

§ 179 expensing (limited to $25,000 for such SUVs) $25,000

Regular MACRS [($60,000 – $25,000) X .20] 7,000


Total $32,000

PTS: 1 REF: p. 8-13 to 8-15

7
ID: A

57. ANS: C
.1071 X $50,000 = $5,355.

Table 8-4

PTS: 1 REF: p. 8-18 | p. 8-19


58. ANS: C
$1,800 + $600 + $400 [50%($500 + $300)] = $2,800. No allocation is required for domestic transportation
costs (i.e., the airfare).
Example 20

PTS: 1
59. ANS: E
As Irv was gone for over one week and more than 25% was devoted to personal, an allocation must be made
to determine the portion of the airfare that is deductible (6 days/10 days = 60%). The deduction is: $1,800
(60% X $3,000) + $800 + $500 (50% X $1,000) = $3,100.
Example 22

PTS: 1
60. ANS: B
Section 222 allows up to $4,000 for qualified tuition and related expenses. As Carolyn spent only $3,900,
this is the amount she can claim as a deduction for AGI. The remaining expenses of $700 ($300 + $200 +
$200) can be claimed as deductions from AGI.
Example 28

PTS: 1
61. ANS: C
Contribution to a Roth IRA (choice a.) is not deductible. An office in the home deduction (choice b.) is not
allowed because the location is not used exclusively for business. Moving expenses (choice c.) are allowed
even in a first-job context. Job hunting expenses (choice d.) are not allowed because a change from fishing
guide to insurance salesman is a different trade or business.

PTS: 1 REF: p. 9-13 | p. 9-21 | p. 9-22 to 9-24

8
ID: A

62. ANS: A
Larry and Beth can claim a medical expense deduction for the current year of $4,100, determined as follows:

Physician bills, dentist bills, and hospital expenses $ 7,500


Less: Reimbursement (2,100)
Unreimbursed expenses $ 5,400
Health insurance premiums 3,000
Prescribed medicines and drugs 1,700
Total medical expenses $10,100
Less: 7.5% of $80,000 (AGI) (6,000)
Deductible medical expenses $ 4,100

The contribution of $2,400 to the HSA is a deduction for AGI, and is not included in the medical expense
calculation.
Examples 12 and 15

PTS: 1 REF: p. 10-3 | p. 10-4 | p. 10-8 to 10-11


63. ANS: A
Charles’s medical expense deduction is $10,415, determined as follows:

Medical insurance premiums $ 3,600


Doctor and dentist bills for John and Carol 7,500
Doctor and dentist bills for Charles 7,750
Prescribed medicines for Charles 200
Nonprescribed insulin for Charles 740
Total medical expenses $19,790
Less: 7.5% of $125,000 (AGI) (9,375)
Deductible portion of medical expenses $10,415

Although John and Carol cannot be claimed as Charles’s dependents, they could have been had they not filed
a joint return. Therefore, they qualify for the medical expense deduction. Insulin is an exception to the rule
that nonprescribed drugs do not qualify as medical expenses. The insurance recovery was not received until
2006. Therefore, it has no effect on the medical expense deduction for 2005.
Exhibit 10-1

PTS: 1 REF: p. 10-3 to 10-9

9
ID: A

64. ANS: C
A capital improvement that ordinarily would not have a medical purpose qualifies as a medical expense if it
is directly related to prescribed medical care and is deductible to the extent that the expenditure exceeds the
increase in value of the related property. Examples of such improvements include dust elimination systems,
elevators, and a room built to house an iron lung. Lonnie’s medical expense related to the room addition is
$16,000 ($28,000 – $12,000).
Example 6

The full cost of home-related capital expenditures incurred to enable a physically handicapped individual to
live independently and productively qualifies as a medical expense. Qualifying costs include expenditures
for constructing entrance and exit ramps to the residence, widening hallways and doorways to accommodate
wheelchairs, installing support bars and railings in bathrooms and other rooms, and adjusting electrical
outlets and fixtures. These expenditures are subject to the 7.5% floor only, and the increase in the home’s
value is deemed to be zero. Lonnie’s medical expense related to the ramp and hallways is $12,000 ($5,000 +
$7,000). So Lonnie’s medical expense deduction is as follows:

Qualifying medical expenses ($16,000 + $12,000) $28,000


Less: 7.5% X $80,000 (6,000)
Deductible medical expenses $22,000

PTS: 1 REF: p. 10-5 | p. 10-6


65. ANS: B
If Scotty did not itemize in 2004, he can exclude the reimbursement from gross income in 2005. If Scotty
itemized deductions in 2004, he must report the reimbursement as gross income in 2005 to the extent he
received a tax benefit from deducting medical expenses in 2004. Whether he itemized in 2005 will have no
impact on the treatment of the reimbursement.
Example 12

PTS: 1
66. ANS: B
State sales taxes ($1,950) are more than the state income tax ($1,400); so Sam will choose to deduct the sales
tax rather than the state income tax. The state occupational license fee ($250) is deductible for AGI as a
business expense. The state sales tax ($1,950), the personal property tax on the auto ($200), and the real
estate taxes ($3,900 + $900) are deductible as itemized deductions. The total itemized deductions are $6,950.
Exhibit 10-2

PTS: 1 REF: p. 10-11 to 10-14


67. ANS: C
[(90 days/184 days X $5,888) + $220] = $3,100.
Example 17

PTS: 1 REF: p. 10-12 | p. 10-13

10
ID: A

68. ANS: C
Dirk is a cash basis taxpayer. His deduction is limited to the amounts paid in 2005. The $900 refund is
reported as income in 2006 under the tax benefit rule. Dirk’s state income tax deduction for 2005 is
determined as follows:

Paid April 14, 2005, for 2004 $ 800


Withholdings for 2005 4,550
Total deduction $5,350

PTS: 1 REF: p. 10-13


69. ANS: D
Jennifer cannot deduct the estimated value of $1,500 of her contributed services. However, she can deduct
out-of-pocket costs of $1,510 ($400 for transportation, $900 for lodging, and $210 for meals).

PTS: 1 REF: p. 10-20 | p. 10-21


70. ANS: C
$40,000 (cash) + $120,000 (30% X $400,000 AGI) = $160,000. The long-term capital gain property is
limited to 30% of $400,000 AGI, or $120,000. The carryover to the next five years is $120,000 [$240,000
(FMV of the land) – $120,000 (deduction allowed for 2005)]. If the reduced deduction election is made, the
deduction becomes $120,000 [$40,000 (cash) + $80,000 (basis of land)].
Examples 35 and 36

PTS: 1 REF: p. 10-25 | p. 10-26

PROBLEM

71. ANS:
Income $200,000
Expenses:
Rent $ 8,000
Utilities 2,000
Medical 5,000
Legal fees 20,000
Depreciation 14,000 (49,000)
$151,000

The bribes to police of $10,000 and illegal kickbacks of $15,000 are not deductible.
Example 16

PTS: 1

11
ID: A

72. ANS:
Tom’s realized loss is $25,000.

Amount realized $100,000


Adjusted basis (125,000)
Realized loss ($ 25,000)

However, his recognized loss is $0 because the loss is disallowed as a § 267 related party transaction.

A related party includes a corporation more than 50% (directly or indirectly) owned by the taxpayer. Tom’s
total ownership (i.e., both direct and constructive) of Eagle, Inc. is 65%.

Tom 25%
Tom’s daughter 10%
Tom’s sister 15%
Tom’s spouse 15%
65%

Tom’s uncle, cousin, and the attorney are not related parties for § 267 purposes.

PTS: 1 REF: p. 6-27 | p. 6-28


73. ANS:
The SUV is not classified as a passenger automobile because of its GVW exceeding 6,000 lbs. Therefore, it
is not subject to the cost recovery limits of § 280F.

§ 179 expense (limited to $25,000) $25,000


MACRS ($50,000 – $25,000) X .05 1,250
Total deduction $26,250

Table 8-2

PTS: 1 REF: p. 8-8 | p. 8-9 | p. 8-13 to 8-15 |


74. ANS:
a. $4,000. Although the tuition was $4,200, § 222 imposes a limitation of $4,000 for tax years
2004 and 2005.

b. $1,050. $200 (excess tuition not allowed under § 222) + $600 (books and computer
supplies) + $250 (transportation) = $1,050. No deduction is allowed for meals, since Ethan
is not in travel status. Further adjustment will be required due to the 2%-of-AGI limitation
on certain itemized deductions.

Figure 9-1 for (a) and Examples 27 and 28 for (b)

PTS: 1 REF: p. 9-16

12
ID: A

75. ANS:
a. $17,500 ($14,000 + $3,500) for Joe.

b. $4,400 for Dennis. Going to Riverview Manor appears to be a matter of personal choice
and not necessitated by medical reasons.

Example 4

PTS: 1 REF: p. 10-4


76. ANS:
General discussion. A cash basis taxpayer deducts state income taxes in the year paid or withheld. Any
refund of state income taxes must be reported as income in the year received to the extent the taxpayer
received a tax benefit from deducting the taxes in a prior year. The income must be reported whether the
taxpayer receives a cash refund or has the refund applied against taxes.

a. $7,400 withheld in 2005 + $700 estimated tax payment in 2005 + $1,000 paid in 2005 for
2004 = $9,100.

b. The $1,800 will be included in 2006 gross income to the extent the taxpayer derived a tax
benefit from itemizing in 2005.

c. The $1,800 will be included in 2006 gross income to the extent the taxpayer derived a tax
benefit from itemizing in 2005, even if she elects to have the refund applied toward her
2006 state income tax.

d. If Wilma did not itemize deductions in 2005, she is not required to report any of the $1,800
refund as income in 2006.

PTS: 1 REF: p. 10-13 | p. 10-14

MATCHING

77. ANS: I PTS: 1 REF: p. 9-3


78. ANS: G PTS: 1 REF: p. 9-3
79. ANS: F PTS: 1 REF: p. 9-6
80. ANS: H PTS: 1 REF: p. 9-7
81. ANS: D PTS: 1 REF: p. 9-12
82. ANS: C PTS: 1 REF: p. 9-12
83. ANS: J PTS: 1 REF: p. 9-10
NOT: Allocation is necessary since the taxpayer meets neither of the two exceptions—trip lasts 7 days or
less, or less than 25% of time was for personal purposes.
84. ANS: K PTS: 1 REF: p. 9-14 | p. 9-15
NOT: According to the IRS, a law degree does not maintain or improve existing skills but leads to the
creation of a new skill (see choice K.).
85. ANS: E PTS: 1 NOT: Example 10
86. ANS: A PTS: 1 REF: p. 9-23
87. ANS: B PTS: 1 REF: p. 9-21

13
ID: A

88. ANS: L PTS: 1 REF: p. 9-23

89. ANS: F PTS: 1 REF: p. 9-6 | p. 9-30


90. ANS: J PTS: 1 REF: p. 9-11
NOT: Taxpayer did not change jobs, so no moving expense deduction is allowed.
91. ANS: I PTS: 1 REF: p. 9-13 NOT: Global Tax Issues on p. 9-13
92. ANS: G PTS: 1 REF: p. 9-24
NOT: The advantage to a Roth IRA is that withdrawals are nontaxable exclusions.
93. ANS: H PTS: 1 REF: p. 9-24
NOT: However, withdrawals are subject to tax.
94. ANS: A PTS: 1 REF: p. 9-18
95. ANS: C PTS: 1 REF: p. 9-18
96. ANS: D PTS: 1 REF: p. 9-26
97. ANS: L PTS: 1 REF: p. 9-23
NOT: Taxpayer need not accept any employment offers that result from the job search (see choice B.).
98. ANS: E PTS: 1 REF: p. 9-16
NOT: One of the major advantages of § 222 is that the education need not be job related.
99. ANS: K PTS: 1 REF: p. 9-19
100. ANS: L PTS: 1 REF: p. 9-19

14