IAC00UNTING

& REPORING 2

ADJUSTMENTS TO GROSS INCOME TO ARRIVE AT

AGI (DEDUCTIONS TO ARRIVE AT AGI)
Alimony Paid
Retirement Plans (IRA, Keogh, SEP and Simple)
Interest Penalty for Early Withdrawal
Self-Employed Health Insurance
Tax on Self-Employed-Social Security (50%)
Education Loan Interest
Educational Expenses
Moving Expenses
Medical Savings Accounts
Individual Retirement Accounts (IRAs) (Deductible)
(1) Requirements ~
A taxpayer is not permitted to deduct their contribution to an IRA
when two conditions are both present:
(a) Adjusted gross income exceeds the following amounts:
Individual Joint
2001 33-43,000 53-63,000
2002 33-43,000 53-63,000
(b) Taxpayer or spouse actively participates in a qualified
plan
(1) An individual is not considered to be an active participant
in an employer-sponsored retirement plan merely
because the individual's spouse is an active participant.
(2) The maximum deductible IRA contribution for an
individual who is not an active participant, but whose
spouse is, is phased-out for taxpayers with MAGI
between $150,000 and $160,000.
Individual Retirement Accounts (IRAs) (Deductible) cont'd. 40
(2) Deductibility: The lesser of
(a) 2001 2002-2004
$52,000 $3,000
(b) The individual's compensation.
Alimony is considered earned income.
(c) Married Taxpayers
The maximum contribution for a married couple filing jointly
is as follows, as long as their combined earnings total at
least that much.
2001 2002-2004
$4,000 $6,000
 RULES SUMMARY TRADITIONAL IRA
Earned Income Pension IRA

Spouse 1 Spouse 2 Spouse 1 Spouse 2 MAG.I. Spouse 1 Spouse 2

Yes Yes No No Unlimited Yes Yes


Yes No No N/A Unlimited Yes Yes

Yes No Yes N/A Under $54,000 Yes Yes

Yes No Yes N/A $64,000 - $150,000 No Yes

Yes No Yes N/A Over $160,000 No No

Roth IRA
The nondeductible Roth IRA (Same limits as a deductible IRA).
(a) Non-deductible Contributions
Contributions to a Roth IRA are not deductible when made.
(b) Tax-free Accumulation
Earnings accumulate tax-free.
(c) Tax-free Distributions
Distributions, both of principal and interest, are also tax- free so
long as they are qualified distributions.
(d) Phase-out
Single Joint
AGI Limit 95-110,000 150-160,000
Nondeductible IRA
Individuals not eligible to make deductible contributions of regular and
Roth 'RAs, can sllll make nondeductible contributions.
(a) Non-deductible contribution limitations up to the lesser of:
(1) $2,000
(2) Individual's compensation
(3) Limit not contributed to other (regular and Roth) IRAs
(b) Tax-free Accumulation
(c) Distributions
(1) Taxable - previously untaxed earnings
(2) Non-taxable - the principal contributions
Educational IRA
A separate education IRA (a trust or custodial account, with limits
independent of those for other IRAs) is available. These accounts are set
up to pay the qualified higher education expenses of a designated
beneficiary.
a. Non-deductible contributions: 2001 = $500; 2002 = $2,000
b. Tax-free accumulation
c. Tax-free distributions
Distributions, both of principal and interest, are also tax-free to the
extent they are used for qualified higher education expense of the
designated beneficiary.
(1) Time Limitation (Beneficiary reaches 30 years of age)
d. Contribution Requirements
(1) Child under age 19
(2) Maximum Contribution ($500 per beneficiary)
(3) Phase-out (Modified AGI Test)
 IRA Contribution and Withdrawal Summary
Tradition Catch-up IRA Roth IRA Nondedu Education
al IRA ctible al IRA
IRA
Tax "adjustment Yes Yes Yes Yes Yes

Maximum contribution
2001 $2.000 N/A $2.000 $2.00 $500
2002 $3.000 $500 $3.000 $2.000 $2.000

Accumulate tax tree/deterred Yes Yes Yes Yes Yes

Withdrawals
Principal Taxable Taxable Nontaxable Nontaxable Nontaxa
ble
Earnings Taxable Taxable Nontaxable Taxable Nontaxa
ble
Keogh Plans

A self-employed taxpayer subject to the self-employment tax is

generally allowed to set up a Keogh plan. The maximum contribution
is limited to the lesser of:
(1) 2001 = $35.000-2002=$40,000
(2) 25% of Keogh net earnings from self-employment
Business Income

< Business Expenses>

________________________
Net Business Income

< Y2 Self Employment Tax>

< Keogh Deduction>

_______________________
Keogh Net Earnings
Education Loan Interest
(Limited to $2,500 in 2001)
a. Starting in 2002, all interest payments qualify. Previously,
only interest paid during the first 60 months of payments
(which include interest) on the loan was eligible.
b. It is phased-out for AGI between:
2001 2002
(1) $40,000 - $50,000 (single) $50,000 - $65,000
(2) $60,000 - $75,000 (married taxpayers) $100,000 - $130,000
Educational Expenses (Qualified Higher Education
Maximum $3,000)
For years beginning after 2001, qualified higher education expenses become an
above-the-line deduction (adjustment). Prior to 2002, these expenses are only
deductible as education expenses (itemized deductions subject to 2% of AGI
limitation).
a. Maximum $3,000
The maximum adjustment is $3,000 per year.
b. Maximum Income Limit
(1) Single $65,000
(2) Married/Joint $130,000
c. Restriction on Deduction
A taxpayer is not eligible to claim the deduction if the expenses were
applied to either:
(1) The Hope Credit and/or Lifetime Learning Credit
(2) Non-taxable Educational IRA distributions
Moving Expenses
a. New Workplace-Fifty Miles Farther from Old House than old Workplace
Was
b. Thirty-Nine ,Week Stay
c. Only Direct Moving Costs Are Allowable
(1) Costs of moving the following items are deductible:
a) (Travel and lodging of the taxpayer and his family
b) Household goods and personal effects from the old to the
new location.,
(2) Non-deductible
(a) Meals
(b) Pre-move house hunting.
(c) Expense of breaking a lease.
Deductions from AGI
1. Standard Deduction
Nonitemizers receive a standard deduction, with the amount
dependent on filing status:
2001
Single $4,550
Head of household $6,650
Married filing jointly or surviving spouse $7,600
Married filing separately* $3,800

*Available only if both taxpayer and spouse do not itemize.

a. Additional Deduction for the Elderly and/or Blind
Medical Expenses
1. Payments
Payments on behalf of the following individuals qualify:
(a) Yourself
(b) Spouse
(c) Dependent
2. Timing
Include as potentially deductible expenses:
(a) Paid amounts during the year
(b) Charged
Deductible Medical Expenses Qualified Medical Expenses
1. Deductible
(a) Medicine and drugs (prescription) < Insurance Reimbursement
____________________________
(b) Doctors
Qualified Medical Expense 'Paid"
(c) Medical and accident insurance
(d) Required surgery < 7¥.!% AGI >
(e) Transportation to medical facility ____________________________
Deductible Medical Expenses
(f) Physically handicapped
2. Non-deductible
(a) Cosmetic operations
(b) Life insurance
(c) Capital expenditures (up to the increase in FMV)
Class M/C Question
Ruth and Mark Cline are married and will file a joint 1991 income tax return.
Among their expenditures during 1991 were the following discretionary costs
that they incurred for the sole purpose of improving their physical
appearance and self-esteem:
Face lift for Ruth, performed by a licensed surgeon $5,000
Hair transplant for Mark, performed by a licensed surgeon 3,600
Disregarding the adjusted gross income percentage threshold, what total
amount of the aforementioned doctors' bills may be claimed by the Clines in
their 1991 return as qualifying medical expenses?
a. $.9
b. $3,600
c. $5,000
d. $8,600
State, Local, and Foreign Taxes
1. Deductible Taxes
(a) Real Estate Taxes (State, Local, and Foreign Taxes)
(1) Must be legally obligated to pay
(2) Prorate taxes in year of sale/purchase
(3) Paid under protest are deductible. Subsequent recovery is
included in gross income.
(b) Income Taxes (State, Local, and Foreign Taxes)
(1) Estimated taxes
(2) Withheld taxes
(3) Assessments paid during the year
(c) Property Taxes (State and Local Taxes)
Interest Expense
1. Home Mortgage Interest
(a) Acquisition Indebtedness ($1,000,000)
(b) Home Equity Indebtedness ($100,000)
(1) Maximum Amounts (lesser of)
(a) $100,000
(b) FMV of the property less "acquisition indebtedness"
2. Investment Interest
Investment !interest deduction for individuals is limited to nat
(taxable) Investment Income.
(a) Disallowed Expense - Carry Forward Indefinitely.
3. Personal (Consumer) Interest Is Not Deductible
4. Prepaid Interest (Allocate to Proper Period)
5. Educational Loan Interest (Adjustment/Not Itemized Deduction)
Charitable Contributions
(1) Definitions
(a) Charity-items given to organizations
(b) Gifts-items given to individuals (needy family) (not deductible)
(c) Political contributions-items given to candidates (not deductible)
(2) General
(a) Maximum Allowable Deduction
The maximum allowable deduction for an individual is:
(1) Cash = 50% 01 adjusted gross income
(2) FMV Property = 30% 01 AGI for gilts 01 long-term capital
gain property to public charities
(b) Consideration for Contribution
The taxpayer may only deduct the excess contribution over the
consideration received.
Charitable Contributions cont'd.
(c) Time for Deduction
(1) Cash or check - actually paid
(2) Credit card - when charged
(d) Contribution for Services
A taxpayer may deduct out-ai-pocket expenses incurred
(1) Services
A taxpayer may not deduct the value 01 the time or
services donated.
(e) Carryover of Excess Charitable Contributions: Five Years
Casualty and Theft Losses (10% AGI Test)
Amount of Loss

Smaller Loss 1. Lost Cost ‘

2. Decreased FMV
< Insurance Recovery >
___________________
Taxpayer's Loss

< $100 >

__________________
Eligible Loss

< 10% AGI >

__________________
Deductible Loss
Miscellaneous Itemized Deductions (2% Rule)
1. Educational Expenses ($3,000 allowed as adjustment in 2002)
(a) Qualified
(1) Maintain or improve the skills needed by the individual
in his or her trade or business; or
(2) Meet the express requirements of the individual's
employer for retention of this job.
(b) Disqualified
(1) Meet minimum job requirements
2. Employment Agency Fees (Job Hunting Expenses)
3. Expenses of Invest~s - ~a~et¥ Deposit Box
4. Uniforms
5. Business Gifts
$25 per recipient per year is the deduction for business gifts.
Miscellaneous Itemized Deductions (2% Rule) cont'd,
6. Subscriptions to Professional Journals
7. Tax Preparation Fee
8. Unreimbursed Business Expenses (Employee)
(a) Meals and Entertainment
Only 50% of the cost
(b) Transportation Expenses (100% Deductible)
(c) Entertainment Expenses (50% Deductible)
10. Legal fees to collect back alimony
9. Other Miscellaneous Deductions (No 2% Floor)
(a) Gambling Losses
Child and Dependent Care Credit
A tax credit of 20% to 30%of eligible expenditures:
(i) $2,400 - 1 dependent
(ii) $4,800 - two or more dependents
1. Eligible People:
a. A dependent, under age 13, for whom an
exemption may be claimed.
b. Any disabled dependent.
c. A spouse who is disabled.
2. Eligible Expenses
a. Babysitter
b. Nursery
c. Day Care
d. Not School
Credit for the Elderly and/or Permanently Disabled
1. Eligibility
This credit of 15% of eligible income is available to individuals who are:
a. 65 years of age or older
b. Persons under 65 but who are retired due to permanent disability.
Education Tax Incentives
1. The Hope Scholarship Credit (First Two Years of College)
a. The credit is equal to (maximum credit of $1,500):
(1) 100% of the first $1,000 of qualified expenses plus
(2) 50% of the next $1,000 of expenses paid during the year
b. If a child is claimed as a dependent by a parent, expenses paid
by both are deemed to have been made by the parent.
2. The Lifetime Learning Credit
a. The credit is equal to 20% of qualified expenses up to $5,000
($10,000 beginning in 2003).
3. Both credits are reduced or eliminated based upon income.
Retirement plan contribution credit
Beginning in 2002 (through 2006), a non-refundable tax credit that
can offset both regular and alternative minimum tax is available
for contributions to either a traditional IRA or Roth IRA (other
eligible retirement plans are beyond the
scope of the CPA Examination).
1. Eligible Taxpayers
a. Over age 17
b. Not a full-time'$!~dent
c. Not a dependent
2. Allowable Credit Maximum $1,000
• Foreign Tax Credit
1. Allowable Credit
Limited to the lesser of:
a. Foreign taxes paid
Taxable income from all foreign operations
b. Taxable income + Exemptions = Foreign tax credit limit
2. Carryover = two back/five forward
• Earned income Credit (refundable)
• Withholding Tax (Paycheck Credit)
• Excess FICA
Excess FICA withheld is treated as additional FIT withheld
Class M/C Questions
The following pertains to questions 1•5.
Hall, a divorced person and custodian of her 12-year old child, filed her 1990
federal income tax return as head of a household. She submitted the following
information to the CPA who prepared her 1990 return:
• The divorce agreement, executed in 1983, provides for Hall to receive $3,000
per month, of which 5600 is designated as child support. After the child reaches
18, the monthly payments are to be reduced to $2.400 and are to continue until
remarriage or death. However, for the year 1990, Hall received a total of only
$5,000 from her former husband. Hall paid an attorney $2,000 in 1990 in a suit
to collect the alimony owed.
'In June 1990, Hall's mother gifted her 100 shares of a listed stock. The donor's
basis for this stock, which she bought in 1970, was $4,000. and market value on
the date of the gift was
$3,000. Hall sold this stock in July
1990 for $3,500. The donor paid no gift tax.
• During 1990, Hall spent a total of $1,000 for state lottery tickets. Her lottery
winnings in 1990 fotaled $200.
• Hall eamed a salary of $25.000 in 1990. Hall was not covered by any type of
retirement plan. but contributed $2,000 to an IRA in 1990. 'In 1990, Hall sold an
antique that she bought in 1980 to display in her home. Hall paid $800 for the
antique and sold it for 51 ,400. using the proceeds to pay a court-ordered
judgment.
• Hall paid the following expenses in 1990 pertaining to the home that she owns:
realty taxes, $3.400; mortgage interest, $7,000; casualty insurance. $490;
assessment by city for construction of a sewer system. $910; interest of 51 ,000 on
a personal. unsecured bank loan. the proceeds of which were used for home
improvements. Hall does not rent out any portion of the home.
 Question 1.
The $2,000 legal fee that Hall paid to collect alimony should be
treated as
a. A deduction in arriving at adjusted gross income.
b. An itemized deduction subject to the 2% of adjusted gross
income floor.
c. An itemized deduction not subject to the 2% of adjusted gross
income floor.
d. A nondeductible personal expense.
Question 2.
Hall's lottery transactions should be
reported as follows:
Schedule A-Itemized Deductions
Other miscellaneous deductions

Subject to
Other income 2% AGI Not subject to
on page 1 floor 2% AGI floor

a $0 $0 $0
$200 $200
b 50

$200 $0
c $200

$200 $0
d $0
Question 3.
Hall's $2,000 contribution to an IRA should be treated as
a. An adjustment to income in arriving at adjusted gross income.
b. A deduction from adjusted gross income subject to the 2% of
adjusted gross income floor.
c. A deduction from adjusted gross income not subject to the 2% of
adjusted gross income floor.
d. Nondeductible, with the interest income on the $2,000 to be deferred
until withdrawal.
Question 4.
What amount should be claimed in Hall's 1996 return
as an itemized deduction for interest?

a, $7,000
b. $7,100
c. $7,200
d, $8,000
Question 5.
The $910 sewer system assessment imposed by the city in 1990 is
a. Allowed with the realty taxes as an itemized deduction for taxes,
b. Allowed as an itemized deduction subject to the 2% of adjusted
gross income floor.
c. Deductible ]n arriving at adjusted gross income,
d. Not deductible in 1990.
Question 6.
Hall, a divorced person and custodian of her 12-year old child, filed her
1990 federal income tax return as head of a household. She submitted
the following information to the CPA who prepared her 1990 return:
The casualty insurance premium of $490 is
a. Allowed as an itemized deduction subject to the $100 floor and the 10% of
adjusted gross income floor.
b. Allowed as an itemized deduction subject to the 2% of gross income floor.
c. Deductible in arriving at adjusted gross income.
d. Not deductible in 1990.
Alternative Minimum Tax

Regular Taxable Income'

± Adjustments
+' Preferences
_______________________________
Alternative Minimum Taxable Income
< Exemption >
_______________________________
Alternative Minimum Tax Base
x Tax Computation
_______________________________
Tentative AMT Tax
< Foreign Tax Credit>
_______________________________
Tentative Minimum Tax
< Regular Income Tax>
_______________________________
Alternative Minimum Tax
Exemption Amounts: (Married Filing Joint)
Exemption ($49,000
AMTI
<$150,000>
___________
Excess
x 25%
_____________
<Reduction>
AMT Exemption
Adjustments (mostly "timing differences")
1. Passive activity losses
2. Accelerated depreciation (post-1986 purchase)
3. Net operating loss of this individual taxpayer
4. Installment income of a dealer
5. Contracts-percentage completion vs. completed contract
6. Tax "deductions" (are eliminated)
7. Interest deductions on some home "equity loans"
8. Medical deductions allowed over 10% of AGI
9. Miscellaneous deductions not allowed
10. Exemptions (personal) and standard deduction
Tax Preference Items (always "add-backs")
1. Private activity bond interest income
2. Percentage depletion in excess of regular depreciation
3. Pre-198? accelerated depreciation
AMT Credit - Carry forward
• It may only reduce regular tax, not future alternative
minimum tax.
a. The carry forward is forever.
Depreciation
1. MACRS 198? and Beyond Depreciation Rules
a. Salvage Value Salvage value is ignored under this method.
b. Property Other Than Real Estate (Salvage Value Ignored)
c. Half-Year Convention (Property Other Than Real Estate)
d. A half-year convention applies to personal property.
Mid-Quarter Convention (Property Other Than Real Estate) If more
than 40% of depreciable property is placed in service in the
last quarter of the year, the mid-quarter convention must be used.
e Expense Deduction in Lieu of Depreciation (§179) The limit for 2001-
2002is $24,000.
(1) The maximum amount is reduced dollar for dollar by the
amount of property placed in service during the taxable year that
exceeds $200,000.
(2) The deduction is not permitted when a net loss exists or if it
would create a net loss
Depreciation cont'd.
1. Real Estate (Salvage Value Ignored/Subtract Land Cost)
a. Residential Rental Property
(1) 27.5-year Straight-line
b. Non-residential Real Property
(1) 39-year Straight-line
2. Midmonth Convention (Real Estate)
One half month is taken in the month the property is placed in service.
Statute of Limitations
ASSESSMENTS
1. General Three years from later of:
a. Due date of return
b. Date return is filed
2. 25% Understatement of Gross Income (Good Faith
Mistakes Do Not Affect This Determination)
Six years from later of:
a. Due date of return
b. Date return is filed
3. Fraud and False Returns No statute of limitations.
STATUTE OF LIMITATIONS cont'd.
B. REFUNDS V
Form 1 040X
1. Refund Claim Later of
a. Three years from the time the return was filed
b. Two years from the time the tax was paid (if not
when return was filed)
DECLARATION OF ESTIMATED TAX
A. $1,000 or More Tax Liability
B. Estimated Payments
The taxpayer's withholding is less than the lesser of:
1. 90% of current year's tax,'
2. 100% of last year's tax.
a. No tax liability for last year is required.
b. Use 110% of the prior year's tax liability
when the taxpayers had adjusted gross
incomes in excess of $150,000.