U.S. Federal Tax Concepts: Q&A on Authority, Planning, Compensation, Retirement, and Property

Posted on Mar 28, 2025 in Economy

Chapter 2: Tax Authority & Legislation

  1. Which of the following statements is incorrect? (Answer: C)
    • a. Tax periodicals are secondary authorities.
    • b. A particular court of appeals need not follow the decisions of another court of appeals.
    • c. Revenue procedures have higher authority than temporary regulations. (Incorrect: Temporary regulations generally have higher authority.)
    • d. A disadvantage of electing to use the small claims division of the Tax Court is that the court decision is final and cannot be appealed.
    • e. Committee Reports during the legislative process are a valuable source for taxpayers, the IRS, and the courts for interpreting the intent of Congress.
  2. Which of the following committees typically initiates tax legislation? (Answer: A)
    • a. House Ways and Means Committee
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. [Option missing in original]
    • e. [Option missing in original]
  3. Which of the following has the highest authoritative weight? (Answer: C – *Note: This depends on context; Internal Revenue Code is highest, followed by Treasury Regulations. Among the choices given, a Revenue Ruling is generally higher than procedures but lower than regulations.*)
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. Revenue ruling
    • d. [Option missing in original]
    • e. [Option missing in original]
  4. Which of the following courts is the only court that provides for a jury trial? (Answer: C)
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. U.S. District Court
    • d. [Option missing in original]
    • e. [Option missing in original]
  5. Lavonda discovered that the 5th Circuit (where Lavonda resides) has recently issued a favorable opinion with respect to an issue that she is going to litigate with the IRS. Lavonda should choose which of the following trial courts to hear her case? (Answer: D)
    • a. Tax Court only
    • b. U.S. Court of Federal Claims only
    • c. U.S. District Court only
    • d. Tax Court or the U.S. District Court (will appeal to the 5th circuit – regional circuit)
    • e. Tax Court or the U.S. Court of Federal Claims

Chapter 3: Tax Planning Strategies

  1. Choose T or F: “The *timing strategy* is based on the idea that the location of where the income is taxed affects the tax costs of the income.” (Answer: False)

    Explanation: The timing strategy is based upon when income is taxed or deductions are taken, as opposed to where it is taxed (which relates to jurisdiction or income shifting).

  2. Choose T or F: “When considering cash outflows, higher present values are preferred.” (Answer: False)

    Explanation: When considering cash outflows (like tax payments), lower present values are preferred due to the time value of money.

  3. Choose T or F: “The *timing strategy* becomes more attractive as interest rates (i.e., rates of return) increase.” (Answer: True)

    Explanation: Higher interest rates increase the benefit of deferring income (and tax payments) and accelerating deductions.

  4. If Julius has a 32 percent tax rate and a 10 percent after-tax rate of return, a $40,000 tax deduction in two years will save how much tax in today’s dollars? Use Exhibit 3.1. (Note: Round discount factor(s) to three decimal places.) (Answer: b)

    Calculation:

    • Discount factor = (1 + after-tax rate of return) ^ (-number of years)
    • Discount factor = (1 + 0.10) ^ (-2) = 0.826
    • Tax Savings = Deduction Amount × Tax Rate = $40,000 × 0.32 = $12,800
    • Present Value of Tax Savings = Tax Savings × Discount Factor = $12,800 × 0.826 = $10,572.80

    b. $10,573 (Rounded)

  5. Which of the following decreases the benefits of accelerating deductions? (Answer: B)
    • a. Decreasing tax rates
    • b. Smaller after-tax rate of return
    • c. Larger after-tax rate of return
    • d. Larger magnitude of transactions
    • e. None of the choices are correct.

    Explanation: A smaller rate of return diminishes the time value of money benefit from accelerating deductions.

  6. Assume that Bill’s marginal tax rate is 32 percent. If corporate bonds pay 8 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds? (Answer: E)

    Calculation:

    • After-tax return on corporate bond = Pre-tax return × (1 – Tax Rate)
    • After-tax return = 8% × (1 – 0.32) = 8% × 0.68 = 5.44%

    To be indifferent, the municipal bond must offer 5.44%.

    • a. 32.00 percent
    • b. 10.40 percent
    • c. 8.00 percent
    • d. 7.00 percent
    • e. None of the choices are correct. (Correct answer is 5.44%)
  7. Joe Harry, a cash-basis taxpayer, owes $10,000 in tax-deductible accounting fees for his business. Assume that it is December 28th and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10th. Joe Harry’s tax rate this year is 24 percent. His tax rate next year will be 32 percent. His after-tax rate of return is 5 percent. When should Joe Harry pay the $10,000 fees and why? Use Exhibit 3.1. (Note: Round discount factor(s) to three decimal places.)

    Analysis:

    • Pay in December (This Year): Tax savings = $10,000 × 0.24 = $2,400 (in today’s dollars).
    • Pay in January (Next Year): Tax savings = $10,000 × 0.32 = $3,200 (received in one year).
    • Present Value of January Payment Savings: Discount factor (1 year, 5%) = (1 + 0.05)^(-1) ≈ 0.952. PV = $3,200 × 0.952 = $3,046.40.

    Conclusion: Joe Harry should pay the $10,000 in January because the present value of the tax savings ($3,046.40) is greater than the savings if paid in December ($2,400), saving him an additional $646.40 in today’s dollars.

  8. Which of the following statements is incorrect? (Answer: D)
    • a. Tax planning refers to minimizing the present value of tax liability while not sacrificing other non-tax objectives.
    • b. All else being equal, deferring the recognition of income is preferred due to the time value of money.
    • c. All else being equal, shifting deductions from a low marginal tax rate year to a high marginal tax rate year is preferred.
    • d. Tax avoidance results in civil penalties or prison sentences. (Incorrect: This describes tax evasion.)
    • e. All of the statements above are correct.

    Explanation: Tax evasion results in civil penalties or prison sentences; tax avoidance is legal tax planning.

  9. Determine whether the taxpayer’s action is tax avoidance or tax evasion in the following situations: (Answer: B)
    • Ana de Armas, an accountant, uses the cash method of accounting. To avoid reporting additional income in 2023, she does not send her December bills to clients until January 2, 2024.
    • Denzel Washington, a painter, deposited payments he received by check into his business bank account. When he filed his tax return, he did not report cash receipts as income.
    • a. [Option missing in original]
    • b. Ana de Armas: Tax avoidance; Denzel Washington: Tax evasion
    • c. [Option missing in original]
    • d. [Option missing in original]
  10. Which is not a basic tax planning strategy? (Answer: D)
    • a. Income shifting
    • b. Timing
    • c. Conversion
    • d. Arm’s length transaction (This is a standard for transactions, especially between related parties, not a fundamental strategy itself.)
    • e. None of the choices are correct.
  11. Which of the following tax planning strategies is based on the present value of money? (Answer: A)
    • a. Timing
    • b. Tax avoidance
    • c. Income shifting
    • d. Conversion
  12. If Joel earns a 10 percent after-tax rate of return, $10,000 received in two years is worth how much today? Use Exhibit 3.1. (Note: Round discount factor(s) to three decimal places.) (Answer: c)

    Calculation: PV = Future Value × Discount Factor. Discount factor (2 years, 10%) = (1 + 0.10)^(-2) ≈ 0.826. PV = $10,000 × 0.826 = $8,260.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $8,260
    • d. [Option missing in original]
  13. If Rudy has a 25 percent tax rate and a 6 percent after-tax rate of return, a $30,000 tax deduction in four years will save how much tax in today’s dollars? Use Exhibit 3.1. (Note: Round discount factor(s) to three decimal places.) (Answer: d)

    Calculation: Tax Savings = $30,000 × 0.25 = $7,500. Discount factor (4 years, 6%) = (1 + 0.06)^(-4) ≈ 0.792. PV = $7,500 × 0.792 = $5,940.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. $5,940
  14. Which of the following increases the benefits of income deferral? (Answer: C)
    • a. Increasing tax rates
    • b. Smaller after-tax rate of return
    • c. Larger after-tax rate of return
    • d. Smaller magnitude of transactions
    • e. None of the choices are correct.

    Explanation: A larger rate of return increases the time value of money benefit from deferring income (and the associated tax).

  15. If tax rates are decreasing over time: (Answer: c)
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. taxpayers should defer income. (To recognize it in a lower-tax-rate year.)
    • d. [Option missing in original]
  16. Which of the following is an example of the *timing strategy*? (Answer: D)
    • a. A corporation paying its shareholders a $20,000 dividend. (Income type/character)
    • b. A parent employing her child in the family business. (Income shifting)
    • c. A taxpayer gifting stock to his children. (Income shifting)
    • d. A cash-basis business delaying billing its customers until after year-end.
    • e. None of the choices are correct.
  17. Antonella works for a company that pays a year-end bonus in December of each year. Assume that Antonella expects to receive a $20,000 bonus in December this year, her tax rate is 30 percent, and her after-tax rate of return is 8 percent. If Antonella’s employer paid her bonus on January 1 of next year instead of in December, how much would this action save Antonella in today’s tax dollars? If Antonella’s tax rate increased to 32 percent next year, would receiving the bonus in January still be advantageous?

    Analysis (30% Rate):

    • Tax if paid in December: $20,000 × 0.30 = $6,000 (paid now).
    • Tax if paid in January: $20,000 × 0.30 = $6,000 (paid in one year).
    • PV of January Tax: $6,000 × (1 + 0.08)^(-1) ≈ $6,000 × 0.926 = $5,556.
    • Savings: $6,000 – $5,556 = $444.

    Analysis (32% Rate Next Year):

    • Tax if paid in December: $20,000 × 0.30 = $6,000 (paid now).
    • Tax if paid in January: $20,000 × 0.32 = $6,400 (paid in one year).
    • PV of January Tax: $6,400 × 0.926 = $5,926.40.
    • Savings: $6,000 – $5,926.40 = $73.60.

    Conclusion: Yes, receiving the bonus in January would still be advantageous even with the rate increase, saving $73.60 in present value terms (Note: Original text calculation error adjusted).

  18. Joe Harry, a cash-basis taxpayer, owes $20,000 in tax-deductible accounting fees for his business. Assume that it is December 28th and that Joe Harry can avoid any finance charges if he pays the accounting fees by January 10th. Joe Harry’s tax rate this year is 24 percent. His tax rate next year will be 32 percent. His after-tax rate of return is 8 percent. When should Joe Harry pay the $20,000 fees and why? Use Exhibit 3.1. (Note: Round discount factor(s) to three decimal places.)

    Analysis:

    • Pay in December (This Year): Tax savings = $20,000 × 0.24 = $4,800 (in today’s dollars).
    • Pay in January (Next Year): Tax savings = $20,000 × 0.32 = $6,400 (received in one year).
    • Present Value of January Payment Savings: Discount factor (1 year, 8%) = (1 + 0.08)^(-1) ≈ 0.926. PV = $6,400 × 0.926 = $5,926.40.

    Conclusion: Joe Harry should pay the $20,000 in January because the present value of the tax savings ($5,926.40) is greater than the savings if paid in December ($4,800), saving him an additional $1,126.40 in today’s dollars.

  19. Which of the following is needed to implement the *income-shifting strategy*? (Answer: a)
    • a. Taxpayers with varying tax rates
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. [Option missing in original]
  20. A common *income-shifting strategy* is to: (Answer: b)
    • a. [Option missing in original]
    • b. shift deductions from low tax rate taxpayers to high tax rate taxpayers.
    • c. [Option missing in original]
    • d. [Option missing in original]
  21. Tawana owns and operates a sole proprietorship and has a 37 percent marginal tax rate. She provides her son, Jonathon, $8,000 a year for college expenses. Jonathon works as a pizza delivery person every fall and has a marginal tax rate of 15 percent.
    1. What could Tawana do to reduce her family tax burden? (Answer: a)
      • a. Employ her son in her sole proprietorship.
      • b. Ask Jonathon to find a new job.
      • c. Start a new enterprise.

      Explanation: Employing her son shifts income from her higher rate (37%) to his lower rate (15%), assuming reasonable compensation.

    2. How much pretax income does it currently take Tawana to generate the $8,000 (after taxes) given to Jonathon?

      Calculation: Pretax Income = After-tax Amount / (1 – Tax Rate) = $8,000 / (1 – 0.37) = $8,000 / 0.63 ≈ $12,698.

    3. If Jonathon worked for his mother’s sole proprietorship, what salary would she have to pay him to generate $8,000 after taxes (ignoring any Social Security, Medicare, or self-employment tax issues)?

      Calculation: Pretax Income (Salary) = $8,000 / (1 – 0.15) = $8,000 / 0.85 ≈ $9,412.

    4. How much money would the strategy in part (3) save?

      Pretax Savings (for Tawana): $12,698 (pretax needed before) – $9,412 (deductible salary paid) = $3,286.

      After-tax Savings (Family):

      • Tawana’s tax savings from deduction: $9,412 × 0.37 = $3,482.44
      • Jonathon’s tax cost on income: $9,412 × 0.15 = $1,411.80
      • Net family after-tax savings: $3,482.44 – $1,411.80 = $2,070.64
      • Alternatively: Income shifted × Rate difference = $9,412 × (0.37 – 0.15) = $9,412 × 0.22 = $2,070.64
  22. Investing in municipal bonds to avoid paying tax on interest earned and to earn a higher after-tax yield is an example of: (Answer: Conversion)

    Explanation: This strategy converts income that would normally be taxed at ordinary rates into tax-exempt income.

  23. Rob is currently considering investing in municipal bonds that earn 4 percent interest or taxable bonds issued by Dell Computer that pay 6.5 percent. If Rob’s tax rate is 20 percent, which bond should he choose?

    Analysis:

    • Municipal bond after-tax return = 4.0% (tax-exempt).
    • Dell bond after-tax return = 6.5% × (1 – 0.20) = 6.5% × 0.80 = 5.2%.

    Conclusion: Rob should choose the Dell Computer bond as it offers a higher after-tax return (5.2% vs 4.0%).

  24. Maurice is currently considering investing in a high dividend yield stock with no growth potential that pays a 6 percent dividend yield or bonds issued by the Coca-Cola Company that pay 8 percent. If Maurice’s ordinary tax rate is 25 percent and his dividend tax rate is 15 percent, which investment should he choose?

    Analysis:

    • Stock after-tax return = 6% × (1 – 0.15) = 6% × 0.85 = 5.1%.
    • Coca-Cola bond after-tax return = 8% × (1 – 0.25) = 8% × 0.75 = 6.0%.

    Conclusion: Maurice should invest in the Coca-Cola Company bond as it offers a higher after-tax return (6.0% vs 5.1%).

  25. A taxpayer earning income in “cash” and not reporting it as taxable income is an example of: (Answer: Tax evasion)
  26. Paying “fabricated” expenses in high tax rate years is an example of: (Answer: b. Tax evasion)

Chapter 12: Employee Compensation & Stock Options

  1. Which of the following statements is true? (Answer: D)
    • a. Employees can make adjustments on Form W-4 only at the beginning of the year or start of employment. (False: Can be adjusted anytime.)
    • b. Employees complete a Form W-2 to specify their income tax withholding. (False: Employees complete Form W-4 for withholding; employers issue Form W-2.)
    • c. Offering stock options and restricted stocks are beneficial to the company because more shares are issued at a lower cost than the market price. (False: Beneficial to employees; represents a cost/dilution to the company.)
    • d. Employers computing taxable income receive a deduction for reasonable salary and wages paid to employees.
    • e. Indication as to whether an employee had more than one employer during the year is reported on W-2. (False: Not explicitly reported on W-2.)
  2. Which of the following items is not included on an employee’s Form W-2? (Answer: C)
    • a. Taxable wages, tips, and compensation
    • b. Social Security withholding
    • c. Value of stock options granted during the year (Grant itself is usually not taxable/reported on W-2; income is typically recognized at exercise (NQO) or sale (ISO), or vesting (Restricted Stock).)
    • d. Federal and state income tax withholding
  3. Which of the following regarding the Form W-4 is incorrect? (Answer: D)
    • a. It determines an employee’s income tax withholding.
    • b. Employees can claim dependents eligible for the child tax credit.
    • c. Employees can specify additional amounts to be withheld each month.
    • d. The form can only be adjusted at the beginning of the year or start of employment. (False: Can be adjusted anytime.)
  4. Which of the following refers to the date stock options are awarded to an employee? (Answer: A)
    • a. Grant date
    • b. Exercise date
    • c. Lapse date
    • d. Vesting date
  5. Maren received 11 NQOs (each option gives her the right to purchase 8 shares of stock for $9 per share) at the time she started working when the stock price was $7 per share. When the share price was $19 per share, she exercised all of her options. Eighteen months later, she sold all of the shares for $22 per share. How much gain will Maren recognize on the sale of the shares and how much tax will she pay assuming her marginal tax rate is 37 percent? (Answer: E)

    Calculations:

    • Total shares = 11 options × 8 shares/option = 88 shares.
    • Bargain element at exercise (ordinary income) = 88 shares × ($19 market price – $9 exercise price) = 88 × $10 = $880.
    • Basis in shares = Exercise price + Recognized ordinary income = (88 shares × $9) + $880 = $792 + $880 = $1,672. (Alternatively, basis = market value at exercise = 88 shares × $19 = $1,672).
    • Sale proceeds = 88 shares × $22 = $1,936.
    • Gain on sale (long-term capital gain as held > 1 year) = Sale proceeds – Basis = $1,936 – $1,672 = $264.
    • Tax on sale (assuming 20% capital gains rate, as 37% ordinary rate implies highest capital gains rate) = $264 × 0.20 = $52.80.
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. [Option missing in original]
    • e. $264 gain and $53 tax. (Rounded)
  6. Suzanne received 22 ISOs (each option gives her the right to purchase 22 shares of stock for $10 per share) at the time she started working, when the stock price was $11 per share. Three years later, when the share price was $25 per share, she exercised all of her options. If Suzanne holds the shares for two additional years and sells them when the market price is $35, how much gain will Suzanne recognize on the sale and how much tax will she pay, assuming her marginal tax rate is 37 percent? (Answer: C)

    Calculations (Qualifying ISO disposition):

    • Total shares = 22 options × 22 shares/option = 484 shares.
    • Exercise: No regular tax income. AMT adjustment = 484 shares × ($25 market price – $10 exercise price) = $7,260.
    • Basis in shares = Exercise price paid = 484 shares × $10 = $4,840.
    • Sale proceeds = 484 shares × $35 = $16,940.
    • Gain on sale (long-term capital gain as held > 2 years from grant and > 1 year from exercise) = Sale proceeds – Basis = $16,940 – $4,840 = $12,100.
    • Tax on sale (assuming 20% capital gains rate) = $12,100 × 0.20 = $2,420.
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $12,100 gain and $2,420 tax.
    • d. [Option missing in original]
    • e. [Option missing in original]
  7. Stevie recently received 1,065 shares of restricted stock from her employer, Nicks Corporation, when the share price was $9 per share. Stevie’s restricted shares vested three years later when the market price was $12. Stevie held the shares for a little more than three years and sold them when the market price was $15. Assuming Stevie does NOT make an 83(b) election, what is the amount of Stevie’s ordinary income with respect to the restricted stock? (Answer: C)

    Calculation: Ordinary income recognized at vesting = Number of shares × Market price on vesting date = 1,065 shares × $12/share = $12,780.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $12,780
    • d. [Option missing in original]
    • e. [Option missing in original]
  8. Stevie recently received 1,065 shares of restricted stock from her employer, Nicks Corporation, when the share price was $9 per share. Stevie’s restricted shares vested three years later when the market price was $12. Stevie held the shares for a little more than three years and sold them when the market price was $15. Assuming Stevie made an 83(b) election, what is the amount of Stevie’s ordinary income with respect to the restricted stock? (Answer: c)

    Calculation: With an 83(b) election, ordinary income recognized at grant = Number of shares × Market price on grant date = 1,065 shares × $9/share = $9,585.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $9,585
    • d. [Option missing in original]
    • e. [Option missing in original]
  9. Choose T or F: “Employers always prefer to award incentive stock options rather than nonqualified stock options.” (Answer: False)

    Explanation: Employers generally prefer NQOs because they get a tax deduction when the employee recognizes ordinary income (at exercise). They get no deduction for ISOs (unless it’s a disqualifying disposition). Employees generally prefer ISOs for potential capital gains treatment.

  10. Maren received 10 NQOs (each option gives her the right to purchase 10 shares of stock for $8 per share) at the time she started working when the stock price was $6 per share. When the share price was $15 per share, she exercised all of her options. Eighteen months later, she sold all of the shares for $20 per share. What is the amount of Maren’s bargain element? (Answer: b)

    Calculation: Bargain element = (Market price at exercise – Exercise price) × Number of shares = ($15 – $8) × (10 options × 10 shares/option) = $7 × 100 shares = $700.

    • a. $0
    • b. $700
    • c. $900
    • d. $1,500
    • e. None of the choices are correct.
  11. Maren received 10 NQOs (each option gives her the right to purchase 10 shares of stock for $8 per share) at the time she started working when the stock price was $6 per share. When the share price was $15 per share, she exercised all of her options. Eighteen months later, she sold all of the shares for $20 per share. How much gain will Maren recognize on the sale of the shares and how much tax will she pay assuming her marginal tax rate is 37 percent?

    Calculations:

    • Total shares = 10 options × 10 shares/option = 100 shares.
    • Bargain element (ordinary income at exercise) = 100 shares × ($15 – $8) = $700.
    • Basis in shares = Market value at exercise = 100 shares × $15 = $1,500.
    • Sale proceeds = 100 shares × $20 = $2,000.
    • Gain on sale (long-term capital gain) = $2,000 – $1,500 = $500.
    • Tax on sale (assuming 20% capital gains rate) = $500 × 0.20 = $100.

    Answer: $500 gain and $100 tax

  12. Hazel received 20 NQOs (each option gives her the right to purchase 10 shares of stock for $7 per share) at the time she started working, when the stock price was $14 per share. Now that the share price is $20 per share, she intends to exercise all of her options. How much cash will Hazel need on the exercise date to exercise the stock option?

    Calculation: Cash needed = Number of shares × Exercise price per share = (20 options × 10 shares/option) × $7/share = 200 shares × $7 = $1,400.

    Answer: $1,400

  13. Bad Brad received 20 NQOs (each option gives him the right to purchase 30 shares of stock for $12 per share) from his employer. At the time he started working, the stock price was $11 per share. Now that the share price is $25 per share, he exercises all of the options. Two years later Bad Brad sells the stock for $27 per share. What is Bad Brad’s basis in his stock for purposes of calculating the gain or loss at the time of the sale? (Answer: C)

    Calculations:

    • Total shares = 20 options × 30 shares/option = 600 shares.
    • Bargain element (ordinary income at exercise) = 600 shares × ($25 market price – $12 exercise price) = 600 × $13 = $7,800.
    • Basis = Market value at exercise = 600 shares × $25 = $15,000.
    • Alternatively: Basis = Cash paid + Income recognized = (600 shares × $12) + $7,800 = $7,200 + $7,800 = $15,000.
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $15,000
    • d. [Option missing in original]
    • e. [Option missing in original]
  14. Suzanne received 20 ISOs (each option gives her the right to purchase 20 shares of stock for $12 per share) at the time she started working, when the stock price was $14 per share. Three years later, when the share price was $23 per share, she exercised all of her options. How much cash will Suzanne need on the exercise date of the stock options?

    Calculation: Cash needed = Number of shares × Exercise price per share = (20 options × 20 shares/option) × $12/share = 400 shares × $12 = $4,800.

    Answer: $4,800

  15. Suzanne received 20 ISOs (each option gives her the right to purchase 20 shares of stock for $12 per share) at the time she started working, when the stock price was $13 per share. Three years later, when the share price was $23 per share, she exercised all of her options. If Suzanne holds the shares for two additional years and sells them when the market price is $30, how much gain will Suzanne recognize on the sale and how much tax will she pay, assuming her marginal tax rate is 37 percent?

    Calculations (Qualifying ISO disposition):

    • Total shares = 20 options × 20 shares/option = 400 shares.
    • Basis = Exercise price paid = 400 shares × $12 = $4,800.
    • Sale proceeds = 400 shares × $30 = $12,000.
    • Gain on sale (long-term capital gain) = $12,000 – $4,800 = $7,200.
    • Tax on sale (assuming 20% capital gains rate) = $7,200 × 0.20 = $1,440.

    Answer: $7,200 gain and $1,440 tax.

  16. Suzanne received 20 ISOs (each option gives her the right to purchase 20 shares of stock for $12 per share) at the time she started working, when the stock price was $13 per share. Three years later, when the share price was $23 per share, she exercised all of her options. If Suzanne holds the shares for 10 additional months and sells them when the market price is $30, how much gain will Suzanne recognize on the sale and how much tax will she pay, assuming her marginal tax rate is 35 percent?

    Calculations (Disqualifying ISO disposition – failed holding period):

    • Total shares = 400 shares.
    • Sale occurs less than 1 year after exercise (and less than 2 years after grant).
    • Ordinary income component (lesser of gain realized or bargain element at exercise):
    • Gain realized = $30 sale price – $12 exercise price = $18 per share.
    • Bargain element at exercise = $23 market price – $12 exercise price = $11 per share.
    • Ordinary income = $11 per share × 400 shares = $4,400.
    • Capital gain component = Total gain – Ordinary income = ($18/share × 400 shares) – $4,400 = $7,200 – $4,400 = $2,800. (This is short-term capital gain as held < 1 year).
    • Total gain recognized = $7,200.
    • Tax = (Ordinary Income × Ordinary Rate) + (Short-Term Capital Gain × Ordinary Rate)
    • Tax = ($4,400 × 0.35) + ($2,800 × 0.35) = $1,540 + $980 = $2,520.
    • Alternatively: Total Gain × Ordinary Rate = $7,200 × 0.35 = $2,520.

    Answer: $7,200 gain and $2,520 tax.

  17. Tom recently received 2,000 shares of restricted stock from his employer, Independence Corporation, when the share price was $10 per share. Tom’s restricted shares vested three years later when the market price was $14. Tom held the shares for a little more than three years and sold them when the market price was $20. What is the amount of Tom’s income or loss on the vesting date, assuming Tom does not make an 83(b) election? (Answer: d)

    Calculation: Ordinary income recognized at vesting = Number of shares × Market price on vesting date = 2,000 shares × $14/share = $28,000.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. $28,000
  18. Tom recently received 2,000 shares of restricted stock from his employer, Independence Corporation, when the share price was $10 per share. Tom’s restricted shares vested three years later when the market price was $14. Tom held the shares for a little more than three years and sold them when the market price was $12. What is the amount of Tom’s income or loss on the sale, assuming Tom does not make an 83(b) election? (Answer: d)

    Calculations:

    • Ordinary income at vesting = 2,000 shares × $14 = $28,000.
    • Basis in shares = Market value at vesting = $28,000.
    • Sale proceeds = 2,000 shares × $12 = $24,000.
    • Gain/(Loss) on sale (long-term capital loss) = Sale proceeds – Basis = $24,000 – $28,000 = ($4,000) loss.
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. $4,000 loss
  19. Stevie recently received 1,000 shares of restricted stock from her employer, Nicks Corporation, when the share price was $8 per share. Stevie’s restricted shares vested three years later when the market price was $11. Stevie held the shares for a little more than three years and sold them when the market price was $16. Assuming Stevie made an 83(b) election, what is the amount of Stevie’s ordinary income with respect to the restricted stock?

    Calculation: With an 83(b) election, ordinary income recognized at grant = Number of shares × Market price on grant date = 1,000 shares × $8/share = $8,000.

    Answer: $8,000

  20. Rick recently received 500 shares of restricted stock from his employer, Crazy Corporation, when the share price was $5 per share. Rick’s restricted shares vested three years later, when the market price was $12. Rick held the shares for a little more than a year after vesting and sold them when the market price was $15. Assuming that Rick made an election under 83(b) when the stock was granted and that his marginal tax rate is 24 percent, what is the amount of Rick’s income inclusion and tax liability upon the sale of the stock?

    Calculations (with 83(b) election):

    • Ordinary income at grant = 500 shares × $5 = $2,500 (tax paid in grant year).
    • Basis in shares = Market value at grant = $2,500.
    • Sale proceeds = 500 shares × $15 = $7,500.
    • Gain on sale (long-term capital gain as held > 1 year from grant) = Sale proceeds – Basis = $7,500 – $2,500 = $5,000.
    • Tax on sale (assuming 15% capital gains rate, as 24% ordinary rate is in the 15% LTCG bracket) = $5,000 × 0.15 = $750.

    Answer: $5,000 gain and $750 tax. (Note: Original text used 15% rate, which is consistent with a 24% ordinary bracket for LTCG).

Chapters 13 & 14: Retirement Savings & Rental Property

  1. Which of the following statements regarding IRAs is false? (Answer: D)
    • a. Taxpayers who participate in an employer-sponsored retirement plan may be allowed to make deductible contributions to a traditional IRA (subject to AGI limits).
    • b. The ability to make deductible contributions to a traditional IRA and contributions (always nondeductible) to a Roth IRA may be subject to phase-out based on AGI.
    • c. A taxpayer may contribute to a traditional IRA for 2023 by the tax filing deadline in 2024 and deduct the contribution in 2023.
    • d. Taxpayers who have made nondeductible contributions to a traditional IRA are taxed on the full proceeds when they receive distributions from the IRA. (False: Distributions are partly taxable income and partly a nontaxable return of nondeductible contributions, based on a pro-rata calculation.)
  2. Bryan, who is 45 years old, had some surprise medical expenses during the year. To pay for these expenses (which exceeded the AGI threshold and were claimed as itemized deductions on his tax return), he received a $22,800 distribution from his traditional IRA in 2023 (he has only made deductible contributions to the IRA). Assuming his marginal ordinary income tax rate is 15 percent, what amount of taxes and/or early distribution penalties will Bryan be required to pay on this distribution? (Answer: B)

    Analysis:

    • The distribution is fully taxable as ordinary income because only deductible contributions were made: $22,800.
    • Income tax = $22,800 × 0.15 = $3,420.
    • The 10% early distribution penalty (under age 59½) is waived for distributions used to pay medical expenses exceeding the applicable AGI floor.
    • a. [Option missing in original]
    • b. $3,420 income tax; $0 early distribution penalty
    • c. [Option missing in original]
    • d. [Option missing in original]
  3. During the year, Jessica retired at the age of 65. The current balance in her traditional IRA was $203,000. Over the years, Jessica had made $20,300 of nondeductible contributions and $60,900 of deductible contributions to the account (the rest is earnings). If Jessica receives a $53,000 distribution from the IRA, what amount of the distribution is taxable? (Answer: d – based on calculation)

    Calculation (Pro-rata rule):

    • Nontaxable portion percentage = Nondeductible Contributions / Total IRA Balance = $20,300 / $203,000 = 0.10 or 10%.
    • Nontaxable amount of distribution = Distribution Amount × Nontaxable Percentage = $53,000 × 0.10 = $5,300.
    • Taxable amount of distribution = Distribution Amount – Nontaxable Amount = $53,000 – $5,300 = $47,700. (Or $53,000 × 90%)

    d. $47,700 (Calculation matches explanation)

  4. Choose T or F: “Qualifying distributions from traditional IRAs are nontaxable while qualifying distributions from Roth IRAs are fully taxable as ordinary income.” (Answer: False)

    Explanation: It’s the opposite. Distributions from traditional IRAs are generally taxable (except for the portion related to nondeductible contributions). Qualifying distributions from Roth IRAs are nontaxable.

  5. Choose T or F: “Contributions to Roth IRAs are not deductible.” (Answer: True)
  6. Lisa, age 45, needed some cash so she received a $50,000 distribution from her Roth IRA in 2022. At the time of the distribution, the balance in the Roth IRA was $200,000. Lisa established the Roth IRA eight years ago. Through a rollover and annual contributions, she has contributed $80,000 to her account. What amount of the distribution is taxable and subject to early distribution penalty? (Answer: A)

    Analysis (Roth IRA distribution ordering rules):

    1. Contributions are returned first (tax-free and penalty-free).
    2. Conversions are returned next (tax-free but potentially subject to penalty if within 5 years).
    3. Earnings are returned last (taxable and subject to penalty if non-qualifying).

    Lisa’s distribution of $50,000 is less than her contributions of $80,000. Therefore, the entire distribution is considered a return of contributions.

    a. $0 taxable, $0 penalty.

  7. Tyson (48 years old) owns a traditional IRA with a current balance of $50,000. The balance consists of $30,000 of deductible contributions and $20,000 of account earnings. Convinced that his marginal tax rate will increase in the future, Tyson receives a distribution of the entire $50,000 balance of his traditional IRA in 2023 and he immediately contributes the $50,000 to a Roth IRA (a Roth conversion). Assuming his marginal tax rate is 25 percent, what amount of penalty, if any, must Tyson pay on the distribution from the traditional IRA? (Answer: a)

    Analysis:

    • The distribution from the traditional IRA ($50,000) is fully taxable as ordinary income because it consists of deductible contributions and earnings. Tax = $50,000 × 0.25 = $12,500.
    • Because the entire amount was rolled over/converted to a Roth IRA within 60 days, the 10% early distribution penalty (Tyson is under 59½) does not apply to the amount converted.

    a. $0 penalty (The distribution is taxable, but the question asks only about the penalty).

  8. Kristen rented out her home for 10 days during the year for $5,000. She used the home for personal purposes for the other 355 days. She allocated the following home expenses to the rental use of the home: Insurance $50, Mortgage interest $100, Property taxes $30, Repairs and maintenance $150, Utilities $40, Depreciation $600. Kristen’s AGI is $120,000 before considering the effect of the rental activity. What is Kristen’s AGI after considering the tax effect of the rental use of her home?

    Analysis (Minimal Rental Use Rule – §280A(g)): If a taxpayer rents out their residence for fewer than 15 days during the year:

    • The rental income is excluded from gross income.
    • No deductions attributable to the rental use are allowed (except for otherwise deductible items like qualified mortgage interest and property taxes on Schedule A).

    Conclusion: Kristen ignores the $5,000 income and the associated expenses. Her AGI remains $120,000.

  9. Careen owns a condominium near Newport Beach in California. This year, she incurs the following expenses in connection with her condo: Insurance $1,500, Mortgage interest $8,500, Property taxes $4,000, Repairs and maintenance $950, Utilities $1,900, Depreciation $5,500. During the year, Careen rented the condo for 90 days, receiving $20,000 of gross income. She personally used the condo for 50 days. Careen itemizes deductions and her itemized deduction for non-home business taxes is less than $10,000 by more than the real property taxes allocated to business use of the home. What is Careen’s net rental income for the year? (Assume there are 365 days in the year.)

    Analysis (Vacation Home Rules – §280A – More than 14 days personal use AND more than 10% of rental days): Expenses must be allocated. Tiered deduction limitation applies.

    Allocation Ratios:

    • IRS Method (for Tier 1 – Interest/Taxes): Rental Days / Total Days in Year = 90 / 365
    • Tax Court Method (for Tier 2 & 3 – Other Expenses/Depreciation): Rental Days / Total Days Used = 90 / (90 + 50) = 90 / 140

    Calculations (Using Tax Court method for Tiers 2 & 3 as shown in original):

    • Gross rental income: $20,000
    • Tier 1 Expenses (Interest & Taxes):
      • Mortgage Interest: $8,500 × (90/365) = $2,096
      • Property Taxes: $4,000 × (90/365) = $986
      • Total Tier 1: $3,082
    • Income after Tier 1: $20,000 – $3,082 = $16,918
    • Tier 2 Expenses (Operating Expenses):
      • Insurance: $1,500 × (90/140) = $964
      • Repairs & Maintenance: $950 × (90/140) = $611
      • Utilities: $1,900 × (90/140) = $1,221
      • Total Tier 2: $2,796
    • Income after Tier 2: $16,918 – $2,796 = $14,122
    • Tier 3 Expenses (Depreciation):
      • Depreciation: $5,500 × (90/140) = $3,536
      • Total Tier 3 (limited to income after Tier 2): $3,536
    • Net rental income: $14,122 – $3,536 = $10,586

    Answer: $10,586 (Matches original calculation)

  10. Braxton owns a second home that he rents to others. During the year, he used the second home 50 days for personal use and 100 days for rental use. After allocating the home-related expenses between personal use and rental use, which of the following statements regarding the sequence of deductibility of the expenses allocated to the rental use is correct (assume taxpayer has no expenses to obtain tenants)? (Answer: E)

    Explanation (Tiered Deduction Order under §280A):

    1. Tier 1: Expenses otherwise deductible (mortgage interest, property taxes).
    2. Tier 2: Expenses related to the rental activity other than depreciation (utilities, maintenance, insurance).
    3. Tier 3: Depreciation.

    Deductions in Tiers 2 and 3 are limited to the gross rental income remaining after deducting expenses from the prior tier(s).

    • a. Depreciation expense, other expenses, property taxes and interest expense
    • b. Other expenses, depreciation expense, property taxes and interest expense
    • c. Property taxes and interest expense, depreciation expense, other expenses
    • d. Other expenses, property taxes and interest expense, depreciation expense
    • e. None of the choices are correct. (Correct order is Tier 1, Tier 2, Tier 3 as listed above).
  11. Choose T or F: “Jorge owns a home that he rents for 360 days and uses for personal purposes for five days. Jorge is not required to allocate expenses associated with the home between rental and personal use.” (Answer: False)

    Explanation: Because there was personal use (even just 5 days), expenses must be allocated between personal and rental use. However, since personal use is minimal (not exceeding the greater of 14 days or 10% of rental days), the §280A limitations (tiered deductions) do not apply, and a rental loss may be deductible subject to other rules like passive activity loss rules. But allocation is still required.

  12. Choose T or F: “A self-employed taxpayer reports home office expenses as *for* AGI deductions while home office expenses for employees are nondeductible.” (Answer: True)

    Explanation: Self-employed individuals deduct home office expenses on Schedule C (Form 1040), which flows to AGI. Employee home office expenses were miscellaneous itemized deductions subject to the 2% floor, but these were suspended by the Tax Cuts and Jobs Act for 2018-2025.

  13. Choose T or F: “In general, total deductible home office expenses are limited to the gross income derived from the business minus business expenses unrelated to the home. (This is net Schedule C income before home office expenses.).” (Answer: True)

    Explanation: This describes the overall limitation for the home office deduction for self-employed individuals.

  14. Mercury is self-employed and she uses a room in her home as her principal place of business. She meets clients there and doesn’t use the room for any other purpose. The size of her home office is 400 square feet. The size of her entire home is 2,400 square feet. During the year, Mercury received $6,900 of gross income from her business activities and she reported $3,100 of business expenses unrelated to her home office. For her entire home in the current year, she reported $3,740 of mortgage interest, $1,240 of property taxes, $720 of insurance, $620 of utilities and other operating expenses, and $3,800 of depreciation expense. What amount of home office expenses is Mercury allowed to deduct during the year? Indicate that amount and the type of expenses she must carry over to the next year, if any.

    Analysis (Home Office Deduction – Actual Expense Method):

    • Business Use Percentage = Office Area / Total Home Area = 400 sq ft / 2,400 sq ft = 1/6 ≈ 16.67%.
    • Gross Income Limitation = Gross Income from Business – Non-Home Office Business Expenses = $6,900 – $3,100 = $3,800.
    • Tier 1 Expenses (Interest & Taxes):
      • Mortgage Interest: $3,740 × 16.67% = $623
      • Property Taxes: $1,240 × 16.67% = $207
      • Total Tier 1: $830
    • Limit Remaining after Tier 1: $3,800 – $830 = $2,970.
    • Tier 2 Expenses (Operating Expenses):
      • Insurance: $720 × 16.67% = $120
      • Utilities/Other: $620 × 16.67% = $103
      • Total Tier 2: $223
    • Limit Remaining after Tier 2: $2,970 – $223 = $2,747.
    • Tier 3 Expenses (Depreciation):
      • Depreciation: $3,800 × 16.67% = $633
      • Total Tier 3 (limited to remaining income): $633
    • Total Deductible Home Office Expense = Tier 1 + Tier 2 + Tier 3 = $830 + $223 + $633 = $1,686.
    • Carryover: Since the total allocable expenses ($1,686) are less than the gross income limitation ($3,800), there is no carryover.

    Answer: $1,686, no carryover. (Matches original calculation)

  15. During 2023, Jacob (single), a 19-year-old full-time student, earned $5,250 during the year and was not eligible to participate in an employer-sponsored retirement plan. The general limit for deductible contributions during 2023 is $6,500. How much of a tax-deductible contribution can Jacob make to an IRA? (Answer: c)

    Explanation: IRA contributions (deductible or Roth) are limited to the lesser of the annual contribution limit ($6,500 for 2023 for under age 50) or the individual’s earned income.

    Lesser of $6,500 or $5,250 is $5,250.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $5,250
    • d. [Option missing in original]
  16. Choose T or F: “Taxpayers who participate in an employer-sponsored retirement plan are not allowed to deduct contributions to individual retirement accounts (IRAs) under any circumstances.” (Answer: False)

    Explanation: Deductibility for participants in employer plans is phased out based on Modified Adjusted Gross Income (MAGI). Below the phase-out range, contributions are fully deductible. Within the range, they are partially deductible. Above the range, they are non-deductible (but contributions may still be possible).

  17. Choose T or F: “Darren is eligible to contribute to a traditional IRA in 2023. He forgot to contribute before year-end. If he contributes before April 15, 2024, he is allowed to treat the contribution as though he made it during 2023.” (Answer: True)

    Explanation: IRA contributions for a given tax year can be made up until the tax filing deadline for that year (typically April 15 of the following year), not including extensions.

  18. Which of the following statements regarding traditional IRAs is true? (Answer: D – based on explanation)
    • a. Once a taxpayer reaches 55 years of age she is allowed to contribute an additional $1,000 a year. (False: The catch-up contribution applies starting at age 50.)
    • b. Taxpayers with high income are not allowed to contribute to traditional IRAs. (False: Anyone with earned income below the limit can contribute; deductibility is limited by income and plan participation.)
    • c. Taxpayers who participate in an employer-sponsored retirement plan are allowed to deduct contributions to a traditional IRA regardless of their AGI. (False: Deductibility is limited by AGI.)
    • d. The limit for deductible contributions to traditional IRAs is the lesser of $6,500 or earned income. (True, but this is the general contribution limit; deductibility can be further limited by AGI and plan participation. This statement is the ‘most true’ among the flawed options, reflecting the base limit.)
  19. Bryan, who is 45 years old, had some surprise medical expenses during the year. To pay for these expenses (which exceeded the AGI threshold and were claimed as itemized deductions on his tax return), he received a $20,000 distribution from his traditional IRA in 2023 (he has only made deductible contributions to the IRA). Assuming his marginal ordinary income tax rate is 15%, what amount of taxes and/or early distribution penalties will Bryan be required to pay on this distribution? (Answer: b)

    Analysis:

    • Income tax = $20,000 × 0.15 = $3,000.
    • Early distribution penalty (10%) is waived due to the medical expense exception.
    • a. [Option missing in original]
    • b. $3,000 income tax; $0 early distribution penalty
    • c. [Option missing in original]
    • d. [Option missing in original]
  20. In 2023, Jessica retired at the age of 65. The current balance in her traditional IRA was $200,000. Over the years, Jessica had made $20,000 of nondeductible contributions and $60,000 of deductible contributions to the account. If Jessica receives a $50,000 distribution from the IRA, what amount of the distribution is taxable? (Answer: d)

    Calculation (Pro-rata rule):

    • Nontaxable percentage = Nondeductible Contributions / Total IRA Balance = $20,000 / $200,000 = 10%.
    • Taxable percentage = 100% – 10% = 90%.
    • Taxable amount = Distribution Amount × Taxable Percentage = $50,000 × 0.90 = $45,000.
    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. $45,000
  21. Choose T or F: “Qualified distributions from traditional IRAs are nontaxable while qualified distributions from Roth IRAs are fully taxable as ordinary income.” (Answer: False)

    Explanation: Opposite is true. Traditional IRA distributions are generally taxable; qualified Roth IRA distributions are nontaxable.

  22. Which of the following statements regarding Roth IRA distributions is true? (Answer: C)
    • a. A distribution is not a qualifying distribution unless the distribution is at least two years after the taxpayer has opened the Roth IRA. (False: The account must generally be open for 5 years for earnings to be qualified.)
    • b. A taxpayer receiving a distribution from a Roth IRA before reaching the age of 55 is generally not subject to an early distribution penalty. (False: Non-qualifying distributions of earnings before 59½ are generally subject to penalty, unless an exception applies.)
    • c. A Roth IRA does not have minimum distribution requirements (for the original owner).
    • d. The full amount of all nonqualifying distributions is subject to tax at the taxpayer’s marginal tax rate. (False: Nonqualifying distributions are taxed/penalized only to the extent they represent earnings; contributions come out first, tax/penalty-free.)
  23. Daniela retired at the age of 65. The current balance in her Roth IRA is $200,000. Daniela established the Roth IRA 10 years ago. Through a rollover and annual contributions Daniela has contributed $80,000 to her account. If Daniela receives a $50,000 distribution from the Roth IRA, what amount of the distribution is taxable? (Answer: a)

    Analysis: This is a qualifying distribution because Daniela is over age 59½ and the account has been open for more than 5 years (10 years).

    a. $0 (Qualifying distributions from Roth IRAs are tax-free).

  24. Lisa, age 45, needed some cash so she received a $50,000 distribution from her Roth IRA in 2022. At the time of the distribution, the balance in the Roth IRA was $200,000. Lisa established the Roth IRA 10 years ago. Over the years, she has contributed $20,000 to her account. What amount of the distribution is taxable and subject to early distribution penalty? (Answer: c)

    Analysis (Non-qualifying distribution – under 59½):

    1. Return of Contributions: $20,000 (tax-free, penalty-free).
    2. Distribution Remaining: $50,000 – $20,000 = $30,000.
    3. This remaining $30,000 is deemed to be earnings. Because the distribution is non-qualifying (under 59½, no other exception applies), the earnings are taxable and subject to the 10% penalty.

    Taxable amount = $30,000. Penalty = $30,000 × 10% = $3,000.

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. $30,000 taxable; $3,000 penalty (Assuming the question meant $30,000 taxable and $3,000 penalty, matching the calculation. Option C only states $30,000).
  25. Tyson (48 years old) owns a traditional IRA with a current balance of $50,000. The balance consists of $30,000 of deductible contributions and $20,000 of account earnings. Tyson’s marginal tax rate is 25%. Convinced that his marginal tax rate will increase in the future, Tyson receives a distribution of the entire $50,000 balance of his traditional IRA in 2023. He retains $12,500 to pay tax on the distribution and he contributes $37,500 to a Roth IRA. What amount of income tax and penalty must Tyson pay on this series of transactions? (Answer: b)

    Analysis:

    • The full distribution of $50,000 from the traditional IRA is taxable income. Income Tax = $50,000 × 0.25 = $12,500.
    • Only $37,500 was rolled over/converted to the Roth IRA. The amount not rolled over ($50,000 – $37,500 = $12,500) is subject to the 10% early distribution penalty because Tyson is under 59½. Penalty = $12,500 × 0.10 = $1,250.
    • a. [Option missing in original]
    • b. $12,500 income tax; $1,250 penalty
    • c. [Option missing in original]
    • d. [Option missing in original]
  26. Kenneth lived in his home for the entire year except when he rented his home (near a very nice ski resort) to a married couple for 14 days in December. The couple paid Kenneth $14,000 in rent for the two weeks. Kenneth incurred $1,000 in expenses relating to the home for the 14 days. Which of the following statements accurately describes the manner in which Kenneth should report his rental receipts and expenses for tax purposes? (Answer: d)

    Analysis (Minimal Rental Use Rule – §280A(g)): Rented for 14 days (fewer than 15 days).

    d. Kenneth would exclude the rental receipts, and he would not deduct the rental expenses.

  27. Katy owns a second home. During the year, she used the home for 20 personal-use days and 50 rental days. Katy allocates expenses associated with the home between rental use and personal use. Katy did not incur any expenses to obtain tenants. Which of the following statements is correct regarding the tax treatment of Katy’s income and expenses from the home? (Answer: All are correct – based on original text)

    Analysis (Vacation Home Rules – §280A): Personal use (20 days) exceeds the greater of 14 days or 10% of rental days (10% of 50 = 5 days). Therefore, the §280A limitations apply.

    • a. Katy includes the rental receipts in gross income and deducts the expenses allocated to the rental use of the home for AGI. (True, rental activities are generally reported on Schedule E, flowing to AGI).
    • b. Katy deducts from AGI interest expense and property taxes associated with the home not allocated to the rental use of the home. (True, the personal portion of qualified mortgage interest and property taxes may be deductible as itemized deductions on Schedule A, subject to limitations).
    • c. Assuming Katy’s rental receipts exceed the interest expense and property taxes allocated to the rental use, Katy’s deductible expenses during the year may not exceed the amount of her rental receipts (she may not report a loss from rental property). (True, this is the core limitation under §280A when personal use is significant).

    Since a, b, and c appear correct based on §280A rules, the intended answer is likely that all statements are correct.

  28. Brady owns a second home that he rents to others. During the year, he used the second home for 50 days for personal use and for 100 days for rental use. Brady collected $20,000 of rental receipts during the year. Brady allocated $7,000 of interest expense and property taxes, $10,000 of other expenses, and $4,000 of depreciation expense to the rental use. What is Brady’s net income from the property and what type and amount of expenses will he carry forward to next year, if any? (Answer: a)

    Analysis (Vacation Home Rules – §280A – Tiered Limitation): Personal use (50 days) exceeds the greater of 14 days or 10% of rental days (10% of 100 = 10 days).

    • Gross Rental Income: $20,000
    • Less Tier 1 (Interest/Taxes): $7,000
    • Income Remaining: $13,000
    • Less Tier 2 (Other Expenses): $10,000
    • Income Remaining: $3,000
    • Less Tier 3 (Depreciation): Limited to remaining income. Deduct $3,000.
    • Net Rental Income: $20,000 – $7,000 – $10,000 – $3,000 = $0.
    • Depreciation Carryforward: Total allocable depreciation ($4,000) – Deducted depreciation ($3,000) = $1,000.
    • a. $0 net income. $1,000 depreciation expense carried forward to next year
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. [Option missing in original]
  29. When a taxpayer experiences a net loss from a nonresidence (rental property): (Answer: d)

    Explanation: Losses from rental properties are generally considered passive activity losses (PALs).

    • a. [Option missing in original]
    • b. [Option missing in original]
    • c. [Option missing in original]
    • d. if the taxpayer is not allowed to deduct the loss due to the passive activity limitations, the loss is suspended and carried forward until the taxpayer generates passive income or until the taxpayer sells the property.
  30. Which of the following statements regarding limitations on the deductibility of home office expenses of employees is correct? (Answer: b)
    • a. [Option missing in original]
    • b. Home office expenses of employees are not deductible. (Currently, for 2018-2025, due to TCJA suspension of miscellaneous itemized deductions subject to the 2% floor).
    • c. [Option missing in original]
    • d. [Option missing in original]
  31. Choose T or F: “Taxpayers with a qualifying home office can compute their home office expense using the actual expense method or the simplified method. Taxpayers can choose to use one method for one year and the other method for the next year.” (Answer: True)

    Explanation: Taxpayers can switch between the actual expense method and the simplified method ($5 per square foot, up to 300 sq ft) from year to year.

  32. Choose T or F: “Taxpayers using the simplified method for computing home office expenses do not deduct depreciation expense attributable to the home office use.” (Answer: True)

    Explanation: The simplified method replaces the calculation and deduction of actual expenses, including depreciation.

  33. Which of the following statements regarding limitations on the deductibility of home office expenses of self-employed taxpayers is correct? (Answer: c)
    • a. Deductible home office expenses are itemized deductions. (False: They are *for* AGI, deducted on Schedule C).
    • b. Deductible home office expenses are itemized deductions subject to a 2% floor. (False).
    • c. Deductible home office expenses are for AGI deductions limited to gross income from the business minus non-home-office-related expenses.
    • d. Deductible home office expenses are for AGI deductions and may be deducted without limitation. (False: They are limited as described in c).