Download McGraw Hill's Taxation individual tax chapter 6 With 100% correct Answers. and more Exams Business Finance in PDF only on Docsity!
McGraw Hill's Taxation individual tax
chapter 6 With 100% correct Answers.
It has been suggested that tax policy favors deductions for AGI compared to itemized deductions. Describe two ways in which deductions for AGI are treated more favorably than itemized deductions - ✔✔Itemized deductions must exceed the standard deduction before taxpayers receive any tax benefit from the deductions (this is equivalent to an overall floor limit). In contrast, business deductions that are deductible for AGI (above the line) reduce taxable income without being subject to an overall floor limit. Also, itemized deductions are subject to many mechanical limitations including ceilings, floors, and phase-outs whereas business deductions are generally not subject to these limits (there are limits on certain specific deductions, but this will be described in greater detail in chapter 9). How is a business activity distinguished from an investment activity? Why is this
distinction important for the purpose of calculating federal income taxes? - ✔✔Both business and investment activities are motivated primarily by profit intent, but they can be distinguished by the level of profit-seeking activity. A business activity is commonly described as a sustained, continuous, high level of profit-seeking activity, whereas investment activities don't require a high level of involvement. The distinction can be important for the location of deductions, because business deductions are claimed above the line (for AGI on Schedule C) while investment deductions are generally itemized or from AGI deductions (with the exception of rent and royalty expenses which are deductible for AGI on Schedule E). Describe how a business element is reflected in the requirements to deduct moving expenses and how Congress limited this deduction to substantial moves. - ✔✔A business element is reflected in both the distance test and time test associated with the move. To satisfy the distance test, the distance from the taxpayer's old residence to the new place of work (business element) must be at least 50 miles more than the distance from the
income the value of the premiums paid on his behalf. Thus, from the employee's perspective, this arrangement has the same effect as if (1) the employer pays the employee cash compensation in the amount of the premium and (2) the employee pays the premium and deducts the expense for AGI (completely offsetting the compensation income). In contrast to employees, self-employed taxpayers pay their own health insurance costs, because they don't have an employer to pay these costs for them. Absent a rule to the contrary, self-employed taxpayers would deduct their medical expenses as itemized deductions subject to strict limitations, because the cost of the health insurance is a personal expense rather than a business expense. To treat employees and self-employed taxpayers similarly, Congress allows self-employed taxpayers to deduct personal health insurance premiums as for AGI rather than itemized deductions. Thus, self-employed taxpayers are able to (1) receive business income and (2) use the business income to pay their health insurance premiums and deduct the premiums as a for AGI deduction
(completely offsetting the business income they used to pay the premium). Given the preferential treatment of for AGI deductions relative to itemized deductions, a selfemployed taxpayer should never prefer to claim health insurance premiums as an itemized deduction rather than a deduction for AGI Explain why Congress allows self-employed taxpayers to deduct the employer portion of their self-employment tax. - ✔✔To put self-employed individuals on somewhat equal footing with other employers that are allowed to deduct the employer's share of the social security tax. Hence, self-employed taxpayers are allowed to deduct the employer's share of the self- employment tax. {Research} Using the Internal Revenue Code, describe two deductions for AGI that are not discussed in this chapter. - ✔✔2 is the quickest way to identify deductions for AGI, but several can also be identified from the front of form 1040. Examples include the performing artist deduction, deductions of business expenses for state and local officials, reforestation expenses, and remitted jury
($165,000 for married filing jointly). Modified AGI for this purpose is AGI before deducting interest expense on the qualified education loans and before deducting qualified education expenses (scheduled to expire after 2016). Married individuals who file separately are not allowed to deduct this expense under any circumstance. Explain why the medical expense and casualty loss provisions are sometimes referred to as "wherewithal" deductions and how this rationale is reflected in the limits on these deductions. - ✔✔These deductions are designed to reduce the tax burden on taxpayers whose circumstances have involuntarily reduced their ability to pay. Both deductions are restricted to expenses that exceed insurance reimbursements and a floor limit based upon AGI. These limits ensure that taxpayers claiming the deduction have exceedingly large involuntary expenditures as measured by their ability to pay Describe the type of medical expenditures that qualify for the medical expense
deduction. Does the cost of meals consumed while hospitalized qualify for the deduction? Do over-the-counter drugs and medicines qualify for the deduction? - ✔✔Medical expenses include any payments for the care, prevention, diagnosis, or cure of injury, disease, or bodily function that are not reimbursed by health insurance. Included are the costs of prescription medicine, insulin, and payments to doctors, dentists, and the like incurred by the taxpayer, taxpayer's spouse, and dependents. Over- the-counter drugs and medicines do not qualify for the deduction. Besides direct medical expenses, the deduction includes the cost of health insurance (if not already deducted above the line by self-employed taxpayers or if not offset by a premium tax credit under IRC Sec. 36B). Medical expenses also include long-term care services for disabled spouses and dependents to the extent the costs (including meals and lodging) are attributable to medical care. The cost of elective cosmetic surgery and over-the- counter drugs is not deductible. The cost of meals and lodging qualify if incurred at a medical-care facility or
estate taxes, and personal property taxes. State and local sales taxes may also be deducted but only in lieu of state and local income taxes. The deduction for sales tax can be based upon either the amount paid or the amount published in the IRS tables (IRS Publication 600). Vehicle registration fees are not deductible (unless calculated based on the value of the vehicle rather than its weight). Compare and contrast the limits on the deduction of interest on home acquisition indebtedness versus home equity loans. Are these limits consistent with horizontal equity? Explain. - ✔✔Taxpayers can deduct qualified residence interest defined as either (1) interest paid on a loan to purchase or improve a residence (acquisition indebtedness) or (2) interest paid on a loan secured by the residence but not used to purchase or improve the residence (home equity loan). Interest paid can be deducted on $1 million of acquisition indebtedness and $100,000 of home equity debt regardless of the rate of interest on the loan. These limits
are consistent with horizontal equity inasmuch as the limits treat taxpayers consistently across loan amounts. However, the deduction for interest on acquisition indebtedness and home equity loans is definitely not consistent with providing horizontal equity across homeowners and non-homeowners. Explain the argument that the deductions for charitable contributions and home mortgage interest represent indirect subsidies for these activities. - ✔✔In each case, the deduction reduces the after-tax cost of the activity, making it more likely that taxpayers will engage in the activity. For example, contributions to charity reduce the cost of giving thereby indirectly encouraging donations to charitable organizations. Cash donations to charity are subject to a number of very specific substantiation requirements. Describe these requirements and how charitable gifts can be substantiated. Describe the substantiation requirements for property donations. - ✔✔Charitable contributions are only deductible if substantiated with written records such as
Describe the conditions in which a donation of property to a charity will result in a charitable contribution deduction of fair market value and when it will result in a deduction of the tax basis of the property - ✔✔Taxpayers deduct the fair market value of property (noncash) donations when they donate: (1) a capital asset that has appreciated in value (the value is greater than the basis of the property) and the taxpayer has owned the asset for more than a year before donating it (but see exceptions below), or (2) appreciated business assets (value greater than basis) the taxpayer owned for more than a year before donating but only to the extent that the gain on the asset would not be treated as ordinary income if it had been sold. However, the deduction for an appreciated capital asset that is tangible, personal property is limited to the adjusted basis of the property if the charity uses the property for a purpose unrelated to its charitable purpose. Taxpayers donating ordinary income property (or capital loss property) deduct the lesser
of (1) the fair market value of the property and (2) the adjusted basis of the property. Thus when the value of ordinary income property (or capital loss property) is less than the basis, taxpayers deduct the value. Thus, taxpayers deduct the basis of the property when they contribute: ordinary income property that has appreciated in value. capital gain property donated to private nonoperating foundations (other than stock). capital gain property consisting of tangible personal property and the charity uses the property (and the taxpayer should have reasonably expected that) for a purpose unrelated to the reason it is a charity.appreciated business assets held more than a year to the extent that the gain would be recaptured as ordinary income under the depreciation recapture rules. Describe the type of event that qualifies as a casualty for tax purposes - ✔✔A casualty is defined as an unexpected, unforeseen, or unusual event such as a "fire, storm, or shipwreck" or loss from theft. A casualty loss from the complete destruction of a personal asset is limited to the
declaration and any associated tax planning possibilities - ✔✔Under IRC §165(i), individuals who incur a disaster loss are subject to the regular casualty loss floor limits ($100/10 percent of AGI), but they may elect to claim a disaster loss for the tax year before the loss occurred (e.g., by filing an amended return if the original return has been filed). This deduction could accelerate the tax benefit of the loss (and any attendant refund), but also allow the taxpayer to choose the year with the most attractive tax outcome (in terms of AGI limits, other casualty losses (or gains), and marginal tax rate). Describe the types of expenses that constitute miscellaneous itemized deductions and explain why these expenses rarely produce any tax benefits - ✔✔Miscellaneous itemized deductions consist of employee business expenses (not reimbursed under an accountable plan), investment expenses (not related to rental or royalty activities), and tax preparation fees. These deductions must be reduced by two percent of AGI before the deductions can be combined with other itemized deductions. This floor
limit makes it unlikely these itemized deductions will generate any tax benefit. Explain why the cost of commuting from home to work is not deductible as a business expense. - ✔✔The cost of commuting is almost entirely dictated by the location of an individual's residence. This is a personal (rather than business decision), and Congress likely did not want to be seen as subsidizing individuals who wished to live a substantial distance from their business location When is the cost of education deductible as an employee business expense? - ✔✔The cost of education is deductible as an employee business expense if the education maintains or improves the employee's skill in the business, but not if the education is required to qualify a taxpayer for a new business or profession. For example, an IRS agent could not deduct the cost of a legal education even though the education would maintain or improve his skill as a tax auditor. This is because a law degree would also qualify the agent for a new profession (lawyer).
deduction subject to the 2% of AGI floor limit. Explain why an employee should be concerned about whether his employer reimburses business expenses using an "accountable" plan? - ✔✔The employee should be concerned because absent an accountable plan, reimbursements are reported as income to the employee and the expense is reported as a miscellaneous itemized deduction subject to the 2% AGI floor. Thus, the reimbursements would be treated as "wages" for purposes of withholding and employment taxes, and the deduction would be unlikely to generate any reduction in taxable income (e.g., because of the 2% AGI floor). On the other hand, if the plan qualifies as an accountable plan, reimbursements from the plan are not required to be included in income, but the reimbursed expenses are not deductible, either. If, however, the expense exceeds the reimbursement, the excess (unreimbursed) portion of each expense can be deducted as a miscellaneous itemized deduction subject to the 2% of AGI floor limit.
Jake is a retired jockey who takes monthly trips to Las Vegas to gamble on horse races. Jake also trains race horses part time at his Louisville ranch. So far this year, Jake has won almost $47,500 during his trips to Las Vegas while spending $27,250 on travel expenses and incurring $62,400 of gambling losses. Jake also received $60,000 in revenue from his training activities and he incurred $72,000 of associated costs. Explain how Jake's gambling winnings and related costs will be treated for tax purposes. Describe the factors that will influence how Jake's ranch expenses are treated for tax purposes - ✔✔Jake's $47,500 of gambling winnings is included in his gross income. The gambling losses are (total of $62,400) are only deductible as miscellaneous itemized deductions (not subject to the 2% of AGI floor) to the extent of the gambling winnings (thus, only $47, will be deductible). His travel costs are personal expenditures and are nondeductible. Likewise, the $60,000 revenues from Jake's training activities are included in Jake's gross income. The expenses associated with the ranch (assuming the expenses are ordinary and
