Midterm 1 Answer Key BA 128 Professor Alan Cerf

Prepared by: Celia Poon

1. Ans. B - All medical expenses are deductible as from AGI itemized deduction to the extent that it exceeds 7.5% of AGI. Sum = $3110. Allowable deduction is 7.5% of AGI (0.075*3200 = $2400) i.e. 3110-2400 = $710. 2. Ans. D Interest on money borrowed to buy stock is considered as investment interest. Investment interest is deductible to the extent of investment income and the excess is allowed to carry forward. Interest on a personal car loan and credit cards are not deductible. Interest on a personal residence mortgage is deductible up to $1million of acquisition indebtedness and $100,000 of home equity loan. 3. Ans. B - Investment interest is deductible to the extent of investment income. Therefore only $1800 is deductible out of the $2190. Credit card interest is not deductible from AGI. Interest on loans used for a business and interest on a credit card used for business are both for AGI deductions. The total amount deductible for itemized is $8900+$1800 = $10700. 4. Ans. A Real estate taxes on rental property is considered as passive activity expenses (for AGI deductions), federal income taxes and social security taxes for household help are not deductible. Therefore, the total amount of itemized deductions is $4500+$1500+$500 = $6500. 5. Ans. C Hobby expenses are deductible to the extent of hobby income. In this problem, interest on home equity loan is also part of hobby expenses and is considered as tier 1 expenses. The rest of the expenses $8500 is considered as tier 2 expenses and will be deducted up to $4500 as miscellaneous deduction subject to the 2% AGI limitation. Therefore Pauls taxable income is calculated as follows: AGI: Salary Hobby Income Total AGI Itemized deduction Interest on loan to purchase home Taxes on home Interest on home equity loan to hobby assets Expenses on hobby (4500- 2%*100,000) Personal exemption (1997) Taxable Income $95000 $ 5000 $100000 $ $ $ $ 8000 2500 500 2500

$ 2650 $83850

6. Ans. C. The transaction is considered as wash sales. However, only 40 shares are purchased. Therefore, disallowed loss is only 40% of the loss of $1200 ($2000-$800) which is $480. Recognized loss is thus $720. 7. Ans. A Fines and Gifts to Government Inspection Officials are not deductible as business expenses (for AGI deductions). Therefore, only $100,000+$15,000+$10,000 = $125,000 is deductible.

Midterm 1 Answer Key BA 128 Professor Alan Cerf

Prepared by: Celia Poon

8. Ans. C Unreimbursed professional dues and subscriptions to newsletters recommending stocks (investment expenses) are all miscellaneous itemized deductions. Therefore, Susans AGI is calculated as follows: Gross Salary Rent received from tenant Dividends received $40000 $ 6000 $ 8000

For AGI deductions Taxes, interest and repair expenses on rental house $ 2000 Depreciation expense on rental house $ 3000 AGI $49000 9. Ans. B Inherited propertys adjusted basis is the FMV at the decedents date of death. Therefore, the adjusted basis for Bob is $1000,000. Therefore, the capital gain is $200,000 when Bob sells it later. Capital gain of inherited property is always long term regardless of holding period. Problem 5-74, I5-15 10. Ans. B NSTCL and net against NLTCG. From the STCL of $7200 (10,000-2,800), $3000 can be taken as an offset against ordinary income, the rest, $4,200 is carried forward as STCL the following year. 11. Ans. C The sale of the asset generates a Long term capital gain of $10,000 (11,000 1000 adjusted basis), long term capital gain is taxed at a maximum tax rate of 20%. Therefore the tax liability for Everett with regards to this gain is $10,000 * 0.2 = $2000. 12. Ans. A Stock dividend increases the number of shares by 20%, therefore the respective calculations for the two group of stocks are as follows: 2/15 shares 150 shares @ $60 = $9000. After stock dividend, number of shares = 150*1.2 = 180 shares, basis of shares = $9000/180 = $50 per share 5/15 shares 50 shares @$90 = $4500. After stock dividend, number of shares = 50*1.2 = 60 shares, basis of shares = $4500/60 = $75 per share 13. Ans. B Adjusted basis for the donee in the transfer of gifts depends on the donors adjusted basis vs. the FMV of the gift. In this question, the FMV of the necklace ($46,000) is greater than the adjusted basis for the donor ($12,000), so the adjusted basis of the donee is the donors which is $12000. However, the gift taxes paid will also increase the adjusted basis. The formula to calculate the amount to increase the adjusted basis is as follows: (46000-12000)/36000 * 9000 = 8500 The total adjusted basis = 12,000 + 8,500 = $20500. 14. Ans. B The basis of an asset includes money and FMV of property received, any liability assumed, and the costs of acquiring the asset. Therefore, Dianes basis in the asset is the sum of $40,000+$10,000+$1,000+$500+$900 = $52,400. 15. Ans. B Assuming that the fringe benefit is received in cash, Bob will have to pay an extra $28 ($100* 0.28) of taxes. Therefore, the after-tax saving is $28.

Midterm 1 Answer Key BA 128 Professor Alan Cerf

Prepared by: Celia Poon

16. Ans. D Discounts on services for employee fringe benefits is only up to 20%. 17. Ans. C For employees other than key employees, group term coverage in excess of $50,000 must include an amount established by regulations called the uniform one-month group term premiums per $1000 life insurance coverage. The problem specify $1 per $1000 in excess per month. Therefore, the calculation for the amount to include = $50,000 (amount in excess)*$1*12/1000 = $600. 18. Ans. D Tuition, books, supplies and equipment is deductible. The $1500 room and board and the $1700 grading compensation cannot be excluded despite the fact that the work was a requirement by scholarship. Therefore $3200 cannot be excluded. 19. Ans. B Provisional Income Taxable Interest $5000 Taxable Dividends $7000 Taxable pension $13000 AGI (excluding SS benefits) $25000 Plus Tax exempt interest $ 4000 50% of SS benefits $8000 Provisional Income $37000 Taxable SS benefits = the lesser of 50% of SS benefits ($8000) or 50% of (37000-32000) = $2500. 20. Ans. B Interest on county bonds is considered municipal bonds, so it is excluded from income. Interest credited to Ms. Guys account last year is considered income last year, not this year. Therefore, the total amount of gross income = $57000+1865 = $58,865. 21. Ans. B For accrual method taxpayer, prepaid income for services performed next year do not need to include that amount in income (See PI3-11 exceptions). The rest of the mount $6000+$5000 = $11,000 are money collected for services performed this year. Therefore, the amount needs to be included in income. 22. Ans. D Although the paycheck is received by the employee, funds are actually not available because the employer does not have funds in the bank to make the payment. 23. No answer is available. Assumption made is that Sonyas college student status implies that she is a full time student. Since her parents provide more than half of her support, they are able to claim her as a dependent. To be claimed as a dependent, the dependent himself/herself cannot claim a personal exemption and its standard deduction amount is limited to the greater of earned income +$250 or $700. In Sonyas case, her standard deduction is $4250. Her AGI is $4000+$600 = $4600. Therefore, her taxable income is $4600-$4250 = $350. 24. No answer is available. Total personal and dependency exemption = 2700*3 = $8100 Phased out amount (250,000-186800)= 63200 Points of excess amount per $2500 = 63200/2500 = 26 % of reduction = 26*2% = 52% Amount of exemption allowable = 48%*8100 = $3888